Credit Analysis of China’s Technology Hardware and Semiconductor Manufacturers November 26, 2020 ANALYSTS Key Takeaways Xiaoliang Liu, CFA Beijing ― The technology hardware and semiconductor sector has relatively high industry risk, +86-10-6516 6040 amid fast-paced advances in technology, cyclical downstream demand and intense [email protected] competition between players in the industry. Lianghan Wu ― Our sample of technology hardware companies is mainly composed of upstream Beijing manufacturers, core equipment suppliers and downstream consumer hardware +86-10-6516 6043 suppliers. In our view, these three types of companies generally derive their competitive [email protected] advantages from controlling cost, R&D strength and market influence respectively. ― We view that companies in the sector tend to use equity financing, and their financial leverage is generally low, putting the indicative financial risk profiles of most of the firms in our sample at a moderate or relatively low level. Overview This report aims to provide an overview of the process and methodology behind our analysis of technology hardware and semiconductors companies, through analyzing the business and financial metrics of technology hardware and semiconductors companies. The report also provides insight into the key drivers behind our analysis of technology hardware and semiconductors companies’ credit quality. By applying our corporate ratings methodology framework to public information, we have carried out a desktop analysis of 30 technology hardware and semiconductors companies, reaching an initial overview of the relative ranking of each company’s credit quality, or their “indicative issuer credit quality.” To better understand the relative position of each firm within the industry in terms of key metrics, we have also collected further data on a wider pool of 148 companies, including the 30 entities in our sample. By looking at the key business and financial data of these companies, we can observe the distribution of the key metrics within the industry. The distribution of indicative issuer credit quality among our sample of 30 entities is displayed in the chart below. S&P Global (China) Ratings www.spgchinaratings.cn November 26, 2020 Credit Analysis of China’s Technology Hardware and Semiconductor Manufacturers November 26, 2020 Chart 1 Indicative Issuer Credit Quality of 30 Sampled Entities No. of Companies [AA] category & above [A] category [BBB] category [BB] category Source: S&P Global (China) Ratings. Copyright © 2020 by S&P Ratings (China) Co., Ltd. All rights reserved. Through this report, we use S&P Global (China) Ratings’ Corporate Methodology Framework to analyze the indicative issuer credit quality of relevant companies. When we analyze the credit quality of non-financial companies, we usually begin with analysis of the entity’s business risk profile and financial risk profile, and then look at the modifiers before arriving at its Stand-alone Credit Profile (SACP). We then analyze the external support that companies may obtain, including group or government support, to arrive at the Issuer Credit Rating (ICR). Unless stated otherwise, data in this report is calculated based on the weighted average of data from 2017 to 2019. Chart 2 About This Article S&P Ratings (China) Co., Ltd. (S&P China) has conducted a desktop analysis of a selection of entities, which we have chosen based on their asset sizes, representativeness of most regions and availability of public information. The analysis contained herein has been performed using S&P China Methodologies. S&P China Methodologies and analytical approaches are intended specifically for use in China only, and are distinct from those used by S&P Global S&P Global (China) Ratings www.spgchinaratings.cn 2 Credit Analysis of China’s Technology Hardware and Semiconductor Manufacturers November 26, 2020 Ratings. An S&P China opinion must not be equated with or represented as an opinion by S&P Global Ratings, or relied upon as an S&P Global Ratings opinion. This desktop analysis has been conducted using publicly available information only, and is based on S&P China’s methodologies for corporates. The analysis involves a desktop application of our methodologies to public information to arrive at a potential view of credit quality across sectors. It is important to note that the opinions expressed in this report are based on public information and are not based on any interactive rating exercise with any particular entity. The opinions expressed herein are not and should not be represented as a credit rating, and should not be taken as an indication of a final credit rating on any particular entity, but are initial insights of potential credit quality based on the analysis conducted. This desktop analysis does not involve any surveillance. The opinions expressed herein are not and should not be viewed as recommendations to purchase, hold, or sell any securities or to make any investment decisions, and do not address the suitability of any security. We have conducted this desktop analysis on individual corporates and present the results contained herein at an aggregate group level. The different sections of this research show the statistics and performance of different groups of entities and the market more broadly against the metrics we generally consider most relevant under our methodologies. Given the desktop nature of this analysis, and that we have not conducted an interactive review with any particular entity, we may have made certain assumptions in lieu of confirmed information and where relevant we may also have attempted to consider any possibility of parent, group, government or other forms of potential support, to inform our view of potential credit quality. S&P China is not responsible for any losses caused by reliance on the content of this desktop analysis. Business Risk Profile In general, we assess a company’s business risk profile by combining our analysis of its industry risk and competitive position. We typically arrive at the latter by considering the company’s competitive advantages, scale, scope and diversity, operating efficiency, and profitability. Industry Risk We view the technology hardware and semiconductor sector as a moderate high-risk industry (4), putting it at a mid-to-high level on our six-tier ranking. This reflects how growth prospects in the sector are impacted by three main factors: rapid advances in technology in the industry; strong cyclicality of downstream demand; and intense competition between technology hardware companies. In our view, demand for technology hardware and semiconductor manufacturers is highly cyclical and largely dependent on national economic growth, capital expenditure and IT hardware spending of key clients, fluctuations in demand caused by product innovation and technology upgrades, consumer confidence and motivation to purchase on credit Technology hardware and semiconductor manufacturers look to predict the demand cycle and gauge the direction of new technology, making corresponding investments in advance. This may widen the gap between production capacity and demand, further increasing product price volatility. Competitive Position In our assessment of technology hardware and semiconductor companies' competitive position, we place particular emphasis on their competitive advantage. Companies with leading R&D capability and intellectual property as well as strong market acumen can improve their pricing ability and capacity to respond to cyclical fluctuations in the industry. S&P Global (China) Ratings www.spgchinaratings.cn 3 Credit Analysis of China’s Technology Hardware and Semiconductor Manufacturers November 26, 2020 At the same time, due to the diverse range of business models in this industry, we focus on different key areas when assessing the competitive position of companies in different subsectors. For companies directly facing end users, we focus more on the company's reputation or strength of its brand, product differentiation, and the ability of companies to respond to changes in market demand. Such companies are represented by Xiaomi. Processing and manufacturing technology hardware companies generally have capital intensive and tech- intensive business models. For such firms, including FII and BOE, operating efficiency is a key driver for gaining competitive advantage, alongside companies’ cost flexibility and cost control ability. In addition, some core equipment suppliers or technology solutions providers in the upper and middle reaches of the industry gain competitive advantage through strong investment in technology, which elevates their market share. R&D investment and the ability to produce leading technology are key to such firms maintaining their competitive position, as seen among companies like Huawei and Hikvision. The technology hardware and semiconductor manufacturers in our sample vary in terms of revenue scale, which is mainly due to the diverse range of subsectors in this industry and the large number of companies. These companies are present in upstream, middle, and downstream segments of each industrial value chain, with significant differences between their cost structure and business models as well as varied competition patterns. As shown in the chart below, the weighted average 2017-2019 revenue of the 30 technology hardware and semiconductor manufacturers in our sample varies widely from RMB 2.3 billion to RMB 759.1 billion. Among these firms, companies with very large