China / Hong Kong Industry Focus Hong Kong Telecom Sector Refer to important disclosures at the end of this report DBS Group Research . Equity 5 June 2018 Ringing a different tone HSI : 30,998 Expect higher residential broadband ARPU upside as low-ARPU subs contracted during the price war A N ALYST two years ago are due to renew their service Chris KO CFA, +852 2971 1707 [email protected] plans at higher prices in 2018 Tsz Wang TAM CFA, +852 2971 1772 Residential broadband operators are focusing on [email protected] raising revenue per customer by offering more services Mobile roaming market becoming a new arena Recommendation & valuation for price competition HKBN is our top pick in the sector as it benefits Company Price T arget Rec Mk t Cap F Y19F the most from a tariff hike in the residential Price Yield broadband market HK$ HK$ US$m % HKBN 11.08 13.90 BUY 1,426 6.7 Renew ing low-ARPU residential broadband subs at higher (1310 HK) HKT Trust prices. We expect the low-ARPU residential broadband subs 9.91 12.80 BUY 9,599 6.7 contracted in 2016 (when there was a price war) to renew (6823 HK) their service plans at a higher price in 2018, supporting an Hutchison Telecom 2.81 3.10 HOLD 1,732 2.0 industry tariff hike. Moreover, the duopoly players HKT (6823 (215 HK) HK, BUY) and HKBN (1310 HK, BUY) are also focusing on Smartone Telecom 8.65 7.80 HOLD 1,245 4.4 increasing their revenue per customer by bundling and selling (315 HK) more value-added services. Source: Thomson Reuters, DBS Vickers, Bloomberg Finance L.P. Price cuts in mobile roaming market. Competition in the *Closing Price as of 4 June 2018 mobile market remains challenging with the roaming market becoming a new arena. HKBN has launched Global Phone service plan which offers global and local data services at a low price of HK$216 per month. SmarTone (SMT, 315 HK, HOLD) and Hutchison Telecom (HT, 215 HK, HOLD) reacted by offering promotional free data roaming packages on top of the local mobile service plans. Mobile service revenue and margin will face extra pressure as the roaming business commands a higher margin. HKBN is our top pick. We continue to prefer operators with more fixed-line business exposure, i.e. HKBN and HKT over pure mobile operators, i.e. SMT and HT. We expect upside in the residential broadband market as low-ARPU subs contracted in 2016 will be renewed this year. HKBN will be the biggest beneficiary and is our top pick in the sector. Despite being cautious on mobile ARPU outlook, we upgrade SMT from FULLY VALUED to HOLD as its current price has reflected negative ARPU outlook in the next 1-2 years following a 17% share price decline since our last downgrade. ed-TH / sa-CS / AH Industry Focus Hong Kong Telecom Sector Fixed-line market is 10-30% or HK$20-70 higher than the pricing in 2016. We believe this represents more upside for industry ARPU More ARPU upside as low-ARPU subs contracted during 2016 improvement in 2018 than that in 2017. price war are due for renewal in 2018 Some investors were concerned that HKT was reluctant to raise In 2016, HKBN started a price war in the residential broadband residential broadband tariffs in the past year, thereby hindering market to add 100,000 (or 13%) residential broadband subs. an industry-wide tariff hike. However, HKT’s current pricing is Residential broadband subs contracted at a low ARPU in 2016 still higher than its own pricing in 2016, and also HKBN's, are due for renewal in 2018. Based on our shop visits in the thereby leaving room for price increase. past and present, we estimate that the current monthly pricing HKT and HKBN's broadband service pricing in public HKT and HKBN's broadband service pricing in public housing estates (May 2018) housing estates (June 2016) HKT - Netvigator HKBN HKT - Netvigator HKBN A v erage 223 216 A v erage 206 168 monthly price* monthly price* (HK$/month) (HK$/month) Service package - HK$168 per month for - HK$198 per month for Service package - 1,000M broadband - 1,000M broadband 2x1,000M broadband 1,000M broadband services services services services - Free myTV SUPER content - Letv content services - Free NOW TV content services - myTV SUPER content services with selected - HK$10 per month for services channels Home telephone services - Home telephone service - HK$38.7 per month for Home telephone services Note - Charging an installation fee - First 10 months services Note - Charging an installation fee - Register before 30 Jun, of HK$480 fee HK$148 of HK$680m HK$148.5 per month - Charging an installation fee - HK$340 coupon of HK$680 - A gift valued at c.HK$500- 600 Contract Period 30 months 24 months Contract Period 24months 24 months HKT and HKBN's broadband service pricing in private HKT and HKBN's broadband service pricing in private housing estates (May 2018) housing estates (June 2016) HKT - Netvigator HKBN HKT - Netvigator HKBN A v erage 248 256 A v erage 246 188 monthly price* monthly price* (HK$/month) (HK$/month) Service package - HK$190 per month for - HK$238 per month for Service package - 1,000M broadband - 100M broadband services 2x1,000M broadband 1,000M broadband services services - Letv content services services - Free myTV SUPER content - myTV SUPER content - Free NOW TV content services services services with selected - HK$10 per month for - Home telephone service channels Home telephone services - HK$38.7 per month for Home telephone services Note - Charging an installation fee - First 10 months services Note - Charging an installation fee - Service not available due HK$680 fee HK$188 of HK$680 to shortage of ports in the - Charging an installation fee - HK$340 coupon building of HK$680 - A gift valued at c.HK$500- 600 Contract Period 36 months 27 months Contract Period 24months 24 months * average monthly tariff including installation fee, refund cash value and months with free services Source: Companies, DBS Vickers Page 2 Industry Focus Hong Kong Telecom Sector Increasing revenue per customer through cross-selling The residential broadband market continues to be dominated HKBN mobile bundle plan ARPU by HKT and HKBN with a combined market share of 80%+. HKT and HKBN are focusing on selling more services to FY17 1HFY8/18 Change Mobile ARPU (with HK$268 HK$311 +HK$43 customers to increase the revenue per customer rather than broadband services) solely increasing tariffs. Mobile ARPU (without HK$119 HK$142 +HK$23 broadband services) Implied broadband HK$149 HK$169 +HK$20 Residential broadband market share (Dec 2017) services ARPU Source: Company, DBS VIckers i-Cable HT 6% 7% HKT has lowered residential broadband tariffs to match HKBN’s pricing. It is also focusing on upselling bandwidth and cross- selling more value-added services to enhance its ARPU. For example, it offers 2X1000M residential broadband services and HKT google wifi, etc. It also set up an IoT experience shop to HKBN 54% promote IoT applications and services for additional revenue in 33% the future. i-Cable’s number of broadband customers continued to decline from 156,000 in 2016 to 149,000 in 2017, though the company had started to upgrade its network to provide high- speed GPON. Going forward, we expect the company to focus more on its media business. Source: Companies, DBS Vickers HGC had been easier in entering the estates developed by HKBN started raising tariffs for residential broadband services Cheung Kong in the past. Going forward, we expect this at the beginning of FY8/17. The company has managed to competitive advantage to decrease as it is no longer a member maintain a stable residential broadband sub base despite its of Cheung Kong Group. It also changed its Chinese name from tariff increase. It is focusing on bundle plans to increase “和記環球電訊” to “環球全域電訊”. We believe retail customer stickiness and revenue per customer. Its ARPU of consumers may not be familiar with the new brand name, bundle plan with residential broadband and mobile services which would reduce its effectiveness in marketing and sales increased by HK$43 to HK$311 in 1HFY8/18 as compared to activities. FY17. Stripping out mobile service ARPU, the implied residential broadband services ARPU would have also increased by HK$20. Page 3 Industry Focus Hong Kong Telecom Sector Mobile market Ov erview Mobile market share (Dec 2017) Mobile sub bases of mobile network operators were stable with a lower churn rate despite intense competition. We noticed that market share is shifting to mobile virtual network operator (MVNOs) from 14% in 2016 to 17% in 2017. MVNO Others / MVNOs mobile subs increased by 30% to 2,635,000 in 2017, partly HKT 17% 28% due to HKBN’s entry into the market. Total mobile sub base grew by only c.8% to 15,724,000 in the same period. We estimate that HKBN added c.200,000 mobile subs in 2017 to CMHK account for c.2-3% of the market share. 20% After rounds of price cuts in 2H17, we estimate that the total HT SMT 21% mobile service revenues of HKT, SMT and HT had dropped by 14% c.1% in 2017. The decline was mild as less than a quarter (half-year period out of a typical 2-year contract period) of the mobile subs renewed their mobile service plans during the period. Mobile service revenue will continue to be dragged Source: Companies, OFCA, DBS VIckers down in FY18 and FY19 as more existing subs renew at lower prices.