INDUSTRY NOTE China | Technology 6 November 2017 Technology EQUITY RESEARCH China Summit Takeaway: AI, Semi, Smartphone Value Chain Key Takeaway We hosted several experts and 24 A/H corporates at our China Summit and Digital Disruption tour last week. Key takeaways: 1) AI shifting from central cloud to the edge (end devices), driving GPU/FPGA demand in near term, 2) AI leaders in China rolling out own ASICs in the next 2~3 years, 3) China's new role in semi, forging ahead in design and catching up in foundry. In smartphone value chain, maintain AAC as top pick for lens opportunity and Xiaomi strength. CHINA Artificial Intelligence - From cloud to edge computing: The rise of AI on the edge (terminal devices, like surveillance cameras, smartphones) from central cloud, can solve one key weakness of AI: the brains are located thousands of miles away from the applications. The benefits of AI on the edge include: 1) better analysis based on non-compressed raw data, which contains more information, 2) lower requirement on bandwidth, as transmitted data has been pre-processed, 3) faster response. This will keep driving the demands for GPUs and FPGAs in near term. Meanwhile, China's leading AI companies including Hikvision (002415 CH) and Unisound (private, leader in voice recognition) also noted they may develop own ASICs in the next 2~3 years, for better efficiency and low power. While machines getting smarter, we notice increasing concerns on data privacy. Governments are not only implementing Big Data laws and policies, also starts investing AI leaders, like Face ++ (computer vision) in China. Semiconductor - From catching up to forging ahead: Government investments and strategic M&A are pushing the development of local IC industry. In high-end chips including microprocessors, memory, DSP and FPGA, China remains heavily dependent on imports of semiconductor and technology. In 2016, China's IC self-sufficiency rate reached 21.6%, vs. national goal of 40% by 2020 and 70% by 2025. The slowing of Moore's Law may give China a chance to catch up over time. China's advantage is it has a large domestic market, for example, ~30% of memory consumption is already coming from China, mainly for smartphones, PCs and servers. On design side, local industry revenue rose 24% y- y to USD24.7bn in 2016, weighted 28% of global market. Huawei's Hisilicon is near the leading edge. Chinese design houses also have great opportunities in Bluetooth and WiFi. On foundry side, SMIC (981 HK) has improved yield rate on 28nm, and is focusing on 14nm R&D, in order to begin ramping in 2019. This will continue putting pressure on earnings, but we remain confident in 2018~20 revenue CAGR of 17% thanks to diverse technology portfolio and customer mix. According to National IC Investment Fund, local foundry supply is ~50% of demand from local design houses. China is building 26 new 12- inch fabs, accounting for 42% of worldwide new fabs. This will add 1.1mn wafer/month capacity in total, including 400k for foundry and 650k for memory. Smartphone Value Chain: Key takeaways from our recent channel checks and corporate meetings are: 1) Xiaomi's 2017 smartphone shipment will reach ~90mn units in 2017, beat consensus estimate of 70~75mn units. This will benefit AAC (2018 HK) as a major RF mechanics and optical lens vendor to Xiaomi; 2) Memory and OLED are still the most difficult to get components for Android brands; 3) 3D sensing adoption in Android should start from early-2018, led by Oppo, Xiaomi, Huawei and Moto; 4) Dual camera penetration will reach 15-20% by 2017 and likely 40-50%+ by 2018; 5) Camera pixel migration will Rex Wu * Equity Analyst continue, mainly in mid- and low-end smartphones (from 8MP to 12MP/16MP); 6) Huawei +852 3743 8074 [email protected] and Oppo/Vivo are unlikely to use foreign camera module makers as primary supplier, due * Jefferies Hong Kong Limited to mature technology and customer priority. Local leaders like Sunny Optical (2382 HK) are ^Prior trading day's closing price unless still preferred; 7) Hybrid lens adoption should remain conservative due to low yield and otherwise noted. expensive to plastic lens; 8) Handset lens market sees regular price decline. Largan pays more attention to China Top-10 brands now, even Meizu (~20mn units per year) and Meitu. Please see analyst certifications, important disclosure information, and information regarding the status of non-US analysts on pages 7 to 10 of this report. Technology 6 November 2017 Chart 1: China IC industry maintained a 8-year CAGR of Chart 2: Local fabless outperformed packaging and foundry 17% with 45% CAGR in 1999~2016 (Rmb bn) Packaging Foundry Design 500 34.3% 40% 434 100% 450 29.9% 35% 30% 90% 400 361 25.3% 27.2% 28.8% 32.2% 34.7% 36.7% 25% 80% 37.9% 350 19.7% 20.1% 302 20% 70% 300 251 20.2% 60% 31.1% 27.7% 15% 27.3% 24.0% 250 216 50% 23.6% 25.0% 193 16.2% 10% 26.0% 200 11.6% 40% 144 5% 150 125 30% 111 0% 20% 43.6% 45.1% 43.9% 43.8% 41.7% 100 -5% 38.3% 36.1% -0.4%-11.0% 10% 50 -10% 0% 0 -15% 2010 2011 2012 2013 2014 2015 2016 2008 2009 2010 2011 2012 2013 2014 2015 2016 Source: China Semiconductor Industry Association Source: China Semiconductor Industry Association Chart 3: China’s self-sufficiency by product type Chart 4: China's new 12-inch fabs from 2017 Capacity System Equipment IC % self-sufficiency Location Company Fab name Status Business (k wafer/mo) Server MPU 0% Beijing SMIC B2A 35 Existing Foundry Computer PC MPU 0% Beijing SMIC B1 (Fab 4) Existing Foundry 45 Industrial MCU 2% Beijing SMIC B1 (Fab 5) Existing Foundry Programmable logic device FPGA/EPLD 0% Wuhan Xinxin F1 20 Existing Memory General Wuxi Hynix HC1 100 Existing Memory Digital singal processing DSP 0% Wuxi Hynix HC2 70 Existing Memory Appliaction processor 18% Dalian Intel Fab 68 60 Existing Memory Communication processor 22% Xi'an Samsung F1x1 100 Existing Memory Mobile device Shanghai Huali F1 35 Existing Foundry Communication Embedded MPU 0% Shanghai SMIC S2 (Fab 8) 14 Existing Foundry Embedded DSP 0% Hefei Jinghe HF 40 Building Memory Core network equipment NPU 15% Beijing SMIC B23 35 Building Foundry DRAM 0% Quanzhou Jinhua F2 60 Building Memory Xiamen United Chip Fab 12x 50 Building Foundry Memory NAND Flash 0% Shenzhen SMIC SZ 40 Building Foundry NOR Flash 5% Shenzhen Unigroup SZ 40 Building ? Image processor 5% Wuhan Yangtze F2 200 Building Memory Display Hualan Decoma F2 20 Building CIS Display driver 0% Nanjing TSMC NJ 20 Building Foundry Shanghai SMIC SN1 70 Building Foundry Shanghai Huali F2 40 Building Foundry Chengdu Globalchip - 20 Building Foundry Total 1,114 Source: China Semiconductor Industry Association Source: National IC Investment Fund Chart 5: SMIC lags global peers by two generations 2012 2013 2014 2015 2016 2017 2018 2019 2020 28nm PolySION 3Q11 28nm HKMG 1Q12 20nm Planar 2Q14 TSMC 16nm FinFET 4Q15 10nm FinFET 1Q17 7nm FinFET 1Q19 28nm PolySION 4Q12 28nm HKMG 2Q13 22nm FD-SOI 2Q15 Samsung 20nm Planar 2Q14 14nm FinFET 1Q15 10nm FinFET 1Q17 7nm FinFET 1Q19 28nm PolySION 2Q13 22nm FD-SOI 1Q14 20nm Planar 4Q14 GF 14nm FinFET 1Q15 10nm FinFET 1Q17 7nm FinFET 3Q19 22nm Planar 4Q11 14nm FinFET 2Q14 Intel 10nm FinFET 1Q17 7nm FinFET 1Q19 28nm PolySION 2Q15 SMIC 20nm Planar 2Q18 14nm FinFET 1Q19 Source: China Semiconductor Industry Association page 2 of 10 Rex Wu, Equity Analyst, +852 3743 8074, [email protected] Please see important disclosure information on pages 7 - 10 of this report. Technology 6 November 2017 Chart 6: Global smartphone 3Q17 shipment (mn units) 1Q16 2Q16 3Q16 4Q16 1Q17 2Q17 3Q17 % y-y 4Q17E A A A A A A A JEF Samsung 79.2 77.1 76.0 78.0 80.0 80.4 82.5 9% Apple 51.2 40.2 45.5 78.3 50.8 41.0 46.7 3% Huawei 28.4 32.0 33.6 45.0 34.6 38.5 39.1 16% 47.9 Oppo 13.2 23.0 25.8 30.9 26.1 30.5 33.5 30% 39.9 Vivo 12.5 16.5 21.7 23.6 22.8 24.8 28.6 32% 28.8 Xiaomi 14.5 14.5 15.5 17.0 13.4 23.0 28.0 81% 25.6 LG 13.5 13.9 13.5 14.1 14.8 13.3 13.9 3% ZTE 13.0 15.3 15.4 16.4 13.3 12.2 9.8 -36% Lenovo+Moto 11.2 11.3 14.0 14.2 11.4 10.3 13.0 -7% Grand Total 337.2 355.0 380.0 437.6 371.1 365.0 400.5 5% Source: Counterpoint, Jefferies estimates Sunny Optical (2382 HK) . Handset lens: Samsung remains as the biggest customer, which is 30~40% of Sunny’s handset lens sales. This implies 20~30% market share in Samsung. Sunny should see better product mix of 13MP and 16MP in 10MP+, for both Samsung and Chinese customers. 16MP price is 50~60% higher than 13MP. Camera module: Major drivers for MOB/MOC are rising adoption of 16MP and 20MP front cameras, as well as bezel-less design. Sunny expects double digit growth in high-end camera modules. Hikvision (002415 CH) . AI on the edge (surveillance camera), powered by DSP, FPGA and GPU.