China / Hong Kong Company Guide China Tower Version 1 | Bloomberg: 788 HK Equity | Reuters: 0788.HK Refer to important disclosures at the end of this report DBS Group Research . Equity 12 Jul 2019 BUY(Initiating Coverage) Final call to participate in 5G rally • Faster 5G rollout driving stronger demand for tower services Last Traded Price ( 11 Jul 2019):HK$2.14(HSI : 28,432) Price Target 12-mth:HK$3.10 (44.9% upside) • Increase of macro cells in BTS mix in FY20-21 will lead to stronger business growth Analyst • Expect continuous re-rating driven by stronger growth outlook Tsz-Wang TAM, CFA+852 36684195, [email protected] and higher profitability Chris KO CFA,+852 36684172, [email protected] • Initiating coverage with BUY rating and a TP of HK$3.1 for re- Price Relative rating potential and 5G beneficiary Largest tower company benefiting from 5G rollout in China. China Tower is the largest tower company in China with a market share of 96%. We are initiating coverage with a BUY rating as China Tower will benefit from stronger demand for tower services driven by acceleration of 5G rollout and increase of macro cells in base transceiver station (BTS) mix in FY20-21. Where we differ. Increase of macro cells in BTS mix. In FY19, telecom operators are focusing on 4G network optimisation which Forecasts and Valuation utilises more small cells and distributive antenna systems (DAS) in FY Dec (RMBm) 2018A 2019F 2020F 2021F Turnover 71,819 78,081 87,633 97,459 the mix of BTS. China Tower has a smaller market share in these EBITDA 41,926 46,218 52,467 59,113 two products. For 5G network buildouts in FY20-21, we expect the Pre-tax Profit 3,475 7,828 13,106 17,561 mix of BTS to shift to macro cells, in which China Tower has more Net Profit 2,650 5,871 9,830 13,171 than 90% market share. This will accelerate the company’s growth. Net Pft (Pre Ex) (core profit) 2,650 5,871 9,830 13,171 Net Profit Gth (Pre-ex) (%) 36.4 121.6 67.4 34.0 Potential catalyst. Increase in capex budgets of telecom operators. EPS (RMB) 0.02 0.03 0.06 0.08 EPS (HK$) 0.02 0.04 0.06 0.09 There are more signs of acceleration of 5G rollout. The 5G licenses EPS Gth (%) 18.8 90.8 67.4 34.0 were released on 6 Jun 2019, which was earlier than market Diluted EPS (HK$) 0.02 0.04 0.06 0.09 expectations. China Mobile’s (941 HK, CM) 5G commercial services DPS (HK$) 0.00 0.02 0.04 0.06 will be launched in 50 cities in 2019 and all prefecture-level cities, BV Per Share (HK$) 1.38 1.23 1.27 1.32 PE (X) 105.4 55.3 33.0 24.6 which include 300+ cities and represent a nation-wide scale (vs P/Cash Flow (X) 6.1 5.4 8.5 4.6 previous market expectations of selected regions only) in 2020. P/Free CF (X) 21.8 9.3 99.5 9.1 These may lead to increase in capex budgets of telecom operators. EV/EBITDA (X) 8.9 8.4 7.5 6.2 Net Div Yield (%) 0.1 1.0 1.8 2.6 Valuation: P/Book Value (X) 1.5 1.7 1.7 1.6 Net Debt/Equity (X) 0.5 0.3 0.4 0.2 Our TP of HK$3.1 is based on 12x FY19F EV/EBITDA, which is 20% ROAE(%) 1.7 3.2 5.2 6.7 below the average valuation of 15x of its global peers. Earnings Rev (%): New New New Key Risks to Our View: Consensus EPS (RMB) 0.03 0.05 0.07 Slower 5G development due to tech war. Sino-US tech conflict may Other Broker Recs: B:21 S:2 H:5 slow down the global 5G technology development and lead to Source of all data on this page: Company, DBS Bank (Hong Kong) slower 5G deployment in China. Limited (“DBS HK”), Thomson Reuters CT/CU merger. The merger of China Telecom (CT) and China Unicom (CU) will reduce the demand for tower services in China. At A Glance Issued Capital (m shrs) 176,008 Mkt Cap (HK$m/US$m) 374,898 / 47,930 Major Shareholders (%) (H shrs) Hillhouse Capital Advisors, Ltd. 7.0 Wellington Management Company, LLP 6.6 GIC Private Limited 6.0 Free Float (%) (H shrs) 80.4 3m Avg. Daily Val. (US$m) 169.66 ICB Industry: Telecommunications / Mobile Telecommunications ed-JS/ sa- CS /DL Company Guide China Tower Table of Contents Investment Summary 3 Valuation & Peers Comparison 4 Key Risks 5 SWOT Analysis 6 Critical Factors 7 Financials 9 Environment, Social & Governance (ESG) 10 Company Background 11 Management 15 Page 2 Company Guide China Tower Investment Summary of self-built towers reached 74%. We forecast a higher tenancy ratio of 1.7x in FY21. China Tower is the largest tower company in China with a market share of c.96%. We are initiating coverage on China Despite offering discounts of 30-45% for sharing, the Tower with a BUY rating for its re-rating potential and being a incremental costs such as depreciation and maintenance costs key beneficiary of 5G commercial launch in 2020. We forecast of serving the second and third tenant in the same tower is earnings to grow at a CAGR of 71% in FY19-21 thanks to minimal. China tower’s overall profitability will significantly increasing demand for tower sites, and improving profitability increase along with the tenancy ratio due to the high driven by higher tenancy ratio. operating leverage. We forecast the net profit margin of the company to improve from 3.7% in FY18 to 13.5% in FY21. Increasing number of tenants China Tower had a total number of 3,009k tenants with Tenancy ratios of China Tower (FY15-21) 2,837k tower tenants, 31.4k Distributive antenna system (DAS) tenants and 141k Trans-sector site application and 2.0 information (TSSAI) tenants. Telecom operators plan to launch 5G services commercially in 2020. This will lead to an increase in demand for tower services. Driven by 5G network buildout 1.5 and 4G network optimisation, we forecast the total number of tenants to increase by c.10% p.a. to 3,311k and 3,638k in 1.0 FY19 and FY20 respectively. 0.5 Total number of tenants for China Tower (FY16-21) 0.0 '000 FY15 FY16 FY17 FY18 FY19 FY20 4,500 FY21 4,000 Total tenancy ratio Tower business DAS business 3,500 3,000 Source: Companies, DBS HK 2,500 2,000 Expect continuous re-rating 1,500 1,000 Compared to global peers, China Tower is trading at a 40% discount to their average valuation of 15x FY19 EV/EBITDA. 500 China is at the forefront of 5G rollout which will drive 0 unprecedented demand for tower services in the next few FY16 FY17 FY18 FY19 FY20 FY21 years. We expect the valuation of China Tower to continue to Tower business DAS business TSSAI business re-rate thanks to acceleration of 5G network rollout in China and its monopolistic position in a fast-growing market. Source: Companies, DBS HK Initiate coverage with a BUY and TP of HK$3.1 Rising tenancy ratio enhances profitability We initiate coverage on China Tower with a BUY rating as it will benefit from stronger demand for tower services driven by China Tower’s overall tenancy ratio, which is the total number acceleration of 5G rollout and increase of macro cells in base of tenants divided by total number of sites, was 1.55x as of transceiver station (BTS) mix in FY20-21. We forecast earnings end-FY18. This still has room to grow as a part of the new 5G to grow at CAGR of 71% in FY19-21 thanks to increasing BTSs utilise existing towers, and newly self-built towers have demand for tower sites and improving profitability driven by higher sharing ratios. As of 31 Dec 2018, the co-location level higher tenancy ratio and operating leverage. Page 3 Company Guide China Tower Valuation & Peers Comparison re-rate thanks to acceleration of 5G network rollout in China and its monopolistic position in a fast-growing market. For local peers, there were over 200 companies providing telecommunications tower infrastructure services in the We initiate coverage on China Tower with a BUY rating as it industry as of end-2017 according to Frost & Sullivan (F&S). will benefit from stronger demand for tower services driven by China Tower has a dominant market share of 96% in China acceleration of 5G rollout and increase of macro cells in base and there are only less than 10 companies that own more transceiver station (BTS) mix in FY20-21 We forecast earnings than 1,000 sites. China Tower is the only listed Chinese tower to grow at CAGR of 71% in FY19-21 thanks to increasing company. demand for tower sites and improving profitability driven by higher tenancy ratio and operating leverage. Our TP of Compared to global peers, China Tower is trading at 40% HK$3.1 is based on 12x FY19 EV/EBITDA, which is 20% below discount to their average valuation of 15x FY19 EV/EBITDA. the average valuation of 15x of its global peers China is at the forefront of 5G rollout which will drive unprecedented demand for tower services in the next few years.