Initiation 10 Feb 2015 TCL Communication Technology Holdings Limited BUY 2618.HK / 2618 HK China Mobile technology – Mobile devices HK$7.20* Smartphones blasting out of China Target price: HK$10.30 Upside: 43% We initiate coverage on TCL Comm with a BUY rating and a target price of HK$10.30. The company HSI: 24,521.00 primarily manufactures and sells feature phones, smartphones and tablets in emerging regions such *Closing price as at 9 Feb 2015 as Latin America (LATAM) and Europe, Middle East and Africa (EMEA). We believe TCL Comm will experience strong and sustainable growth due to the following reasons: Share Data 52week Hi/Lo (HK$) 10.96/6.60 ► Strong shipment growth driven by LATAM and EMEA markets – Overseas shipment in Avg. daily t/o (US$m) 3.582 2014 reached 65.9m units, up 30.8% from 2013. Given low penetration rates of mobile devices Market Cap. (US$m) 1,137 in LATAM and EMEA, we believe shipments in the aforesaid regions are expected to attain over Total issued shares (m) 1,224 20% CAGR for the next 3 years. Auditor E&Y Public float (%) 33.95% ► Migration to smartphones in key markets boost ASP – Currently, around 65% of shipments Major shareholder: are smartphone shipments. ASP of smartphones can reach US$80 compared to ~US$15 for TCL Corporation 60.07% feature phones. We expect migration to smartphones will be the key growth driver in the next 2 Value Partners 5.98% years and up-trading will fuel subsequent growth. Source: HKEx & Bloomberg ► Superior margins compared to Chinese peers – TCL Comm consistently achieves a GPM of ~19% for the past 7 quarters. Compared to Chinese peers like Lenovo and Coolpad’s ~13% GPM for the past year, TCL Comm has done a terrific job maintaining its GPM cutting costs, Company Profile strategically control customers’ spec expectations and exploring markets willing to pay higher TCL Comm manufactures and sells prices, i.e. the Americas. Our channel checks reveal that its ASP for smartphones is among the mobile devices and internet products. lowest in China and India; and highest in North America. The company sells to over 120 countries worldwide including China, the Americas and EMEA. ► TP=HK$10.30, based on 10x 2015E P/E – We expect the company to generate a revenue of 14000 HK$30.2b/39.4b/51.3b in 2014/15/16 respectively. Net profit for the next 3 years is expected to 12000 be HK$933m/HK$1.24b/HK$1.58b. Our TP is based on 10x 2015E P/E, which is near TCL Share Price Chart 10000 Comm’s historical mean and current peer levels. 8000 Installed ► Downside risks – 1) Price war with other smartphone brands. 2) Slower than expected network 6000 Capacity rollouts by carriers. 3) Geopolitical events. 4) Capital controls and FX swings. 4000 (MW) 2000 0 2005 2007 2009 2011 2013 Source: Bloomberg Earnings Forecasts & Valuation Summary Year ended 31 Dec 2012A 2013A 2014E 2015E 2016E Sales (HK$’m) 12,031 19,362 30,281 39,406 51,331 EBITDA (HK$’m) (72) 484 2,090 2,881 3,713 Net profit (HK$’m) (208) 313 933 1,236 1,575 EPS - Fully diluted (HK$ ) (0.185) 0.266 0.738 1.030 1.313 YoY change (%) N/A N/A 177.7 32.6 27.4 PER (x) 26.9 49.4 9.3 6.8 5.3 DPS (HK$) * N/A N/A 0.155 0.206 0.263 Yield (%) N/A N/A 2.1 3.0 3.8 Phelix Lee ROE (%) -9.0 12.9 24.5 25.5 25.5 (852) 2283 7618 Net debt/equity (%) 218.3 113.2 130.8 107.6 64.7 [email protected] Source: Company data, Sunwah Kingsway Research estimates www.kingswayresearch.com Kingsway Financial Services Group Limited Please see the important disclaimer and disclosures (if any) at the end of this report Valuation We initiate coverage on TCL Comm with a “BUY” rating at a target price of HK$10.30. Our TP implies a 10x 2015E P/E. We use P/E as our valuation basis. The company has effectively only ONE operating segment, which is the manufacture and sale of mobile devices. We derive our P/E of 10x 2015E P/E from the following factors: 1) Strong volume growth prospects due to above-peer exposure to LATAM and EMEA regions; 2) ASP are rising due to smartphones beginning to replace feature phones in emerging markets; 3) upside potential in the Palm acquisition leading to North American shipment growth; 4) increasing availability of 3G and 4G connectivity in LATAM and EMEA, which may lead consumers to demand more higher-price 3G/4G handsets. Valuation comparison The closest peers of TCL Comm are Coolpad and HTC, which have their own brand(s), manufacture mobile devices and related accessories. Other major peers include Samsung Electronics, LG Electronics, Apple who produce mobile devices and other consumer electronics. Peer Valuation Table Source：Bloomberg, closing price @, 9 Feb 2015 Sunwah Kingsway Research TCL Communication | 10 Feb 2015 2 Company description The only smartphone maker in China with 2-end strategy TCL Comm manufactures and sells mobile devices and internet products. The company sells to over 120 countries worldwide including China, the Americas and EMEA. The company sells mobile devices by leveraging its parent company’s ‘TCL’ brand in China and ‘Alcatel’ brand overseas (including Hong Kong). In 4Q14 alone, TCL Corporation has acquired an additional 42.85m shares or 5.97% of TCL Comm at an average price of HK$7.55 per share. Shareholder structure Source: HKEx, Company data Company milestones Year Milestone TCL Comm was established as the holding company of Huizhou TCL Mobile 2004 Listed on HKEx Established Alcatel Mobile via a 55% JV with Alcatel Lucent Acquired the remaining 45% stake from Alcatel Lucent, Alcatel Mobile became wholly-owned subsidiary 2005 of TCL Comm Announced new strategy called “The Creative Life” Re-launched Alcatel brand in China 2007 Extended Alcatel brand license to 2024 Cooperated with RIM Company (now Blackberry Ltd.) to introduce Blackberry 8700 to China 2008 T-Mobile became a customer of TCL Comm Launched first 3G Android smartphone 2010 Named ‘fastest growing major mobile vendor in the world’ by Strategy Analytics and exceeded 4m monthly shipment in November Opened Chengdu R&D centre 2011 Manufactured for Vodafone the Vodafone 555 Blue, first handset with Facebook pre-installed Launched first tablet, i.e. the TCL Pad16/Alcatel One Touch T60 2012 Launched liquid repellent smartphones –TCLS800 and TCLS600 Launched the slimmest smartphone at the time, i.e. TCLS850/Alcatel One Touch Idol Ultra at 6.45mm Commenced production of new manufacturing facility in Huizhou 2013 Partnered with Hong Kong Applied Science and Technology Research Institute to develop 4G applications and research 5G wireless technology TCL Corporation, TCL Comm and TCL Multimedia (1070 HK) formed JV for smart home initiative 2014 Partnered with Cisco to set up Enterprise Cloud Services Platform 2015 TCL Comm acquired ‘Palm’ brand from Hewlett-Packard, Inc. Source：Company data TCL Communication | 10 Feb 2015 3 Industry Overview 3G/4G network overview Emerging regions including Sub-Saharan Africa (SSA), Latin America (LATAM) and Middle East and North Africa (MENA) represent huge growth opportunities for TCL Comm due to their low smartphone penetration, rising income levels and increasingly available 3G/4G network services offered by national and regional carriers. The following tables summarize carrier availability of 3G/4G services of LATAM, Africa and Middle East respectively. LATAM 3G/4G carrier availability summary Source: Carriers, Census data, Sunwah Kingsway Research As of early Jan 2015, out of the 44 countries/regions in LATAM, only 4 nations have to provide 3G/4G connection, representing just about 1% of total population of the continent. There are 21 countries offering 4G services at the moment and 12 more planning to do so within the next 2-3 years. We believe carriers have incentives to promote low-end smartphones in order to increase their own revenues via data tariff and other value-added services. In turn, TCL Comm will benefit immensely from its good relations with carriers in the region, and sell many more low-end smartphones. LATAM sales account for 51.5% of TCL Comm’s revenue for 9M14. At the moment, TCL Comm has working relationships with América Móvil, which in turns owns major carriers like Claro, TelCel and TelMex; as well as Telefónica, Tigo and Digicel. The four major telecom companies are estimated to have over 80% market share in LATAM, which translates into a formidable distribution channel for TCL Comm. Africa 3G/4G carrier availability summary Source: Carriers, Census data, Sunwah Kingsway Research Middle East 3G/4G carrier availability summary Source: Carriers, Census data, Sunwah Kingsway Research TCL Communication | 10 Feb 2015 4 For Middle East and Africa (including SSA and MENA), out of the 70 countries, only 27 has a carrier providing 4G services, but widening the scope to 3G services, the figure jumps to 51. With 18 countries planning 4G services, we believe carriers will replicate their LATAM peers and bundle low-end smartphones with 3G/4G data plans. A caveat is that Middle Eastern and African countries on average are less stable than other parts of the world, which may significantly delay network development and user adoption. The company generates roughly 10-15% 9M14 sales from Middle East and Africa. TCL Comm has partnerships with major carriers like MTN, Orange, Airtel, Vodafone and Telefónica in Middle East and Africa; which constituted an estimated 60% market share in the region.