Asia Pacific Equity Research 15 September 2013 Initiation Overweight PCCW Limited 0008.HK, 8 HK Growth businesses coming into the limelight; Initiate Price: HK$3.31 with OW Price Target: HK$4.10 We initiate coverage of PCCW with an OW rating and a Dec-14 PT of HK$4.1 Hong Kong which implies 24% share price potential upside plus a 5.9% 2014E yield. We Telecoms think a re-rating is deserved based on its: 1) strengthening pay-TV leadership Michelle Wei, CFA AC driven by the exclusive broadcasting rights of the Barclays Premier League (BPL) (852) 2800-8562 and 2) the rising growth profile of its Solutions business, both organically and [email protected] inorganically. PCCW provides an attractive combination of 9% EPS CAGR J.P. Morgan Securities (Asia Pacific) Limited (2012-2015E) with yield sustainable above 5.5%. Lucy Liu Media business to solidify market leadership: We see BPL as a strategic (852) 2800-8566 asset which will enable NOW TV to consolidate its market value capture, i.e. a [email protected] 5% subs market share gain and a 31% increase in ARPU throughout the J.P. Morgan Securities (Asia Pacific) Limited upcoming three seasons. We are confident NOW TV can achieve much better James R. Sullivan, CFA monetization and profitability than i-Cable given: 1) its stronger pricing power (65) 6882-2374 (HK$288 for a BPL-bundled sports pack vs. i-Cable of <HK$80 for standalone [email protected] BPL); 2) a larger addressable internal customer base and 3) a higher EBITDA J.P. Morgan Securities (Asia Pacific) Limited base to absorb the fixed BPL costs. Our scenario analysis shows BPL can add Price Performance HK$0.3 to PCCW’s fair value. 4.4 IT solutions raising the profile (>20% yoy growth): PCCW Solutions is well 4.0 positioned to ride the rising demand for data center and cloud computing by HK$ leveraging its leadership in the local IT service industry, plentiful supply of 3.6 floor area to be converted to data centers and a fast increase in secure backlog 3.2 of cloud computing services. Acquisitions of value-accretive businesses that can Sep-12 Dec-12 Mar-13 Jun-13 Sep-13 0008.HK share price (HK$) expand its core competencies and geographical reach are another growth driver. HSI (rebased) A free option of the growth businesses: PCCW is trading at a 24% discount to YTD 1m 3m 12m Abs -7.3% -8.6% -7.3% -7.3% the combined market value of its stakes in HKT and PCPD, in line with its Rel -8.4% -10.3% -17.0% -21.6% historical avg. This implies the improved growth prospects of its media and Solutions businesses are yet to be priced in. A re-rating is deserved, in our view. Initiate with OW on value recognition for growth businesses and attractive valuations at 12.6x 2014E P/E and 5.7x 2014E EV/EBITDA. PCCW’s commitment to a 70-80% pass-through of the cash distributions from HKT Trust (OW, covered by Lucy Liu) should be able to sustain a yield of > 5.5%. Our SOTP-based Dec-14 PT is HK$4.1. Downside risks include worse-than- expected BPL take-up, a sell-down of its stake in HKT and interest rate risk. PCCW Limited (Reuters: 0008.HK, Bloomberg: 8 HK) HK$ in mn, year-end Dec FY11A FY12A FY13E FY14E FY15E Company Data Revenue (HK$ mn) 24,638 25,318 28,132 30,180 32,390 52-week Range (HK$) 4.21-2.98 Revenue growth (%) 7.3% 2.8% 11.1% 7.3% 7.3% Market Cap (HK$ mn) 24,071 EBITDA (HK$ mn) 7,585 7,788 8,272 8,856 9,456 Market Cap ($ mn) 3,104 EBITDA Growth 3.2% 2.7% 6.2% 7.1% 6.8% Shares O/S (mn) 7,272 Net Profit (HK$ mn) 1,607 1,663 1,704 1,910 2,164 Free Float(%) 53.7% Net Profit growth (%) (16.6%) 3.5% 2.5% 12.1% 13.3% 3M - Avg daily volume (mn) 5.91 EPS (HK$) 0.22 0.23 0.23 0.26 0.30 3M - Avg daily value (HK$ 20.85 DPS (HK$) 0.16 0.19 0.19 0.20 0.20 mn) P/E (x) 15.0 14.5 14.1 12.6 11.1 3M - Avg daily value ($ mn) 2.7 EV/EBITDA (x) 5.6 5.9 5.8 5.7 5.5 HSI 2,2915.28 Dividend Yield 4.8% 5.8% 5.7% 5.9% 6.2% Exchange Rate 7.75 Source: Company data, Bloomberg, J.P. Morgan estimates. Price (HK$) 3.31 Date Of Price 13 Sep 13 See page 25 for analyst certification and important disclosures, including non-US analyst disclosures. J.P. Morgan does and seeks to do business with companies covered in its research reports. As a result, investors should be aware that the firm may have a conflict of interest that could affect the objectivity of this report. Investors should consider this report as only a single factor in making their investment decision. www.jpmorganmarkets.com Michelle Wei, CFA Asia Pacific Equity Research (852) 2800-8562 15 September 2013 [email protected] Company Description NAV sensitivity metrics PCCW is a Hong Kong-based company which (Impact on PCCW's end-2014E NAV holds interests in telecommunications (63% of HKT Trust), media (Now TV), IT solutions 10% change in HKT Trust's fair value 8.6% (PCCW Solutions), property development and 50bps increase in interest rate forecasts -2.5% to 2014E div. investment (74.5% of PCPD), and other businesses. Richard Li and China Unicom are the two largest shareholders with 28% and 18% interests in the company, respectively. Source: J.P. Morgan estimates. Price target and valuation analysis 2014E Revenue by business segment We use SOTP as the valuation methodology. We have arrived at our NAV estimate of HK$5.2 by combining the equity value of each business and Solutio Others adding the redemption value of its convertible bond issued to PCPD. Our ns , , 0.2% Dec-14 PT of HK$4.1 is based on a holding company discount of 20%. 12% Media, HKT, Risks to our price target 12% Downside risks include reduction of its stake in HKT Trust and interest rate 76% increase (lower dividend), slower-than-expected BPL take-up and yield de- rating in a rising interest rate environment. 2014E NAV by business segment Convertib Others le bond, , 4% 8% PCPD, HKT Net profit: J.P. Morgan vs consensus JPM Consensus 2% Trust, FY2013E 1,704 1,669 86% FY2014E 1,910 1,881 Source: Bloomberg and J.P. Morgan estimates HK Telco valuation comp table Op. FCF Ne t debt EBITDA CAGR EPS CAGR Company Stock Rating Price (HK$) PT % to EV /EBITDA P/E (x) Dividend yield P/B ROE yield /EBITDA code Index Level (HK$) Target 2013E 2014E 2013E 2014E 2013E 2014E 2014E 2014E 2014E 2014E (2012-2015E) (2012-2015E) HTHKH 215 HK OW 3.46 4.4 27% 5.9 5.3 13.0 12.3 5.7% 6.1% 1.4 11.5% 7.6% 1.0 7.0% 7.5% PCCW 8 HK OW 3.31 4.1 24% 5.8 5.7 14.1 12.6 5.7% 5.9% 2.6 20.9% 8.3% 3.0 6.7% 9.2% HKT Trust 6823 HK OW 7.06 8.1 15% 9.2 9.0 21.9 25.3 6.2% 6.4% 1.5 6.1% 6.1% 3.4 3.1% 6.4% Sm arTone 315 HK N 10.12 10.8 7% 5.5 5.3 12.4 12.4 6.5% 4.8% 3.3 27.7% 14.5% 0.2 1.0% -4.7% Hang Seng Index H S I n/a 22915 n/a n/a 7.4 6.6 10.9 10.1 3.5% 3.8% 1.2 17.9% n/a n/a n/a n/a Source: Bloomberg and J.P. Morgan estimates. Note: share prices and valuations are as of Sept 13, 2013. 2 Michelle Wei, CFA Asia Pacific Equity Research (852) 2800-8562 15 September 2013 [email protected] Table of Contents Investment Summary ...............................................................4 Valuations .................................................................................6 Investment positive 1: BPL a value-accretive strategic asset ...................................................................................................7 Pay TV leadership to strengthen ..............................................................................7 Strong BPL monetization capability ........................................................................8 Profitability not a big concern..................................................................................9 BPL worth HK$0.3/share ......................................................................................10 Investment positives 2: IT Solutions riding the momentum .................................................................................................11 Organic growth drivers..........................................................................................12 Expansion through acquisitions .............................................................................13 Investment positives 3: HKT a solid cash cow ....................13 Investment concern 1: QE tapering – reduced appetite for yield plays ...............................................................................14 Investment concern 2: Dividend vulnerable to interest rate risk...........................................................................................14 Financial analysis...................................................................16 SWOT.......................................................................................19 Appendix .................................................................................20 Historical financials ..............................................................................................20 Shareholding structure...........................................................................................21 Corporate Structure...............................................................................................21 Management profile ..............................................................................................21 Key milestones......................................................................................................22 3 Michelle Wei, CFA Asia Pacific Equity Research (852) 2800-8562 15 September 2013 [email protected] Investment Summary PCCW: Not just about telecom PCCW has a diversified businesses portfolio comprising: 1) the listed HKT Trust which is a strong-cash-generating integrated telecom operator in HK; 2) Pacific Century Premium Developments (PCPD) – a listed property firm with a current focus on resorts and office development in Asia; 3) NOW TV – the largest pay-TV service provider in HK; 4) IT Solutions – an enterprise IT service company mainly operating in HK and mainland China; 5) a still loss-making wireless broadband business in the UK; and 6) corporate support function (basically opex).