China / Hong Kong Industry Focus

Hong Kong Telecom Sector Refer to important disclosures at the end of this report

DBS Group Research . Equity

26 January 2016

OTT players to shift broadband market share

HSI: 19,340



Expect HKBN to further gain market share in 2016 through aggressive pricing strategies and the co-operation with Letv

ANALYST Tsz Wang TAM CFA +852 2971 1772 [email protected]



More co-operations between fixed-line players and OTT multi-media content providers ahead

Chris KO [email protected]



Tariff hike in the mobile market continues with more focus on lower-tier plans going forward

Recommendation & valuation



HKBN is our top pick with expected dividend growth of 20%+p.a. in the next few years

Expect HKBN to gain market share amid intense competition. In 2016, we expect competition in the residential broadband market to remain intense; and HKBN (1310 HK, BUY) to continue to gain market share with aggressive pricing strategies. We expect to see more co-operations between fixed-line players and over-the-top (OTT) multi-media content providers, providing alternatives for existing pay-TV and broadband users. HKBN, a pure broadband operator, is likely to benefit from gaining market share from existing integrated players such as HKT (6823 HK, BUY) and i-Cable (1097 HK, NR) in the next few years. Tariff hike continues with more focus on lower-tier plans and top-up plans. In 2016, mobile operators are relatively passive in raising the tariff for high-tier plans due to insufficient pricing power. Tariff hike in high-tier plans will count on the market reception for iPhone 7 in 3Q16. We expect mobile operators to focus on raising the tariffs for lower-tier plans and launching various top-up plans and value-added services to enhance overall ARPU. On a negative note, declining mobile roaming revenue also continues to weigh on the mobile service revenue growth. HKBN is our top pick for its high growth potential. We expect HKBN’s sub growth to accelerate in FY8/16F, fuelled by bundling with Letv media service. HKBN is on track to achieve its target of 300k sub net-adds in FY8/15-FY8/19F, which will support 20%+ p.a. dividend growth in the coming few years. The stock currently offers a 4.4% dividend yield. We like HKBN the most in the sector due to its strongest dividend growth potential. Smartone (SMT, 315 HK, BUY), as a pure mobile operator, is well positioned to benefit from the industry-wide mobile data tariff hike in the medium term. Maintain BUY on SMT.

ed-TH / sa- DL

Co mp an y

Pric e HK $

T arg et Pric e HK $

H o n g K o n g T elec o m o p erat o rs HKBN 9.74 11.6 (1310 HK) HKT Trust (6823 HK)

R ec

Mkt Cap U S$ m

F Y 16F PE x

Buy

1,257

27.9

10.0

10.0

Hold

9,714

22.5

Hutchison Telecom (215 HK)

2.4

2.8

Hold

1,484

12.9

Smartone Telecom (315 HK)

11.72

13.0

Buy

1,597

14.0

Source: Thomson Reuters, DBS Vickers Based on closing prices as at 25 Jan 2016

Industry Focus Hong Kong Telecom Sector

Table of Contents Broadband market



Mobile market



Interest rate risk



Earnings revision and preview



Valuation and recommendation



Stock Profiles



HKBN (1310 HK)



HKT Trust (6823 HK)

14 

Hutchison Telecom (215 HK)

20 

Smartone Telecom (315 HK)

28 

Page 2

Industry Focus Hong Kong Telecom Sector

Broadband market In 2016, we expect the residential broadband sub in Hong Kong to grow by c.1%, mainly driven by the increase in the number of households. ARPU will be under pressure due to HKBN’s aggressive pricing strategies in gaining market share. NOW TV has lost its exclusive broadcasting rights for the new season of the English Premier League (EPL) to Letv. The cooperation between Letv and HKBN (or other broadband operators in the future) offers alternatives for HKT’s broadband and NOW TV service package users. The window for switching is expected to be in Aug 2016. HKBN gaining market share through co-operation with Letv. HKBN announced the pricing details for Le Sports' Package (including English Premier League) on 8 Dec 2015. Customers can choose a designated broadband plan with a price starting from HK$188/month with an additional charge of HK$99/month to access Letv's content service including the Le Sports' Package (2016 and 2017 seasons of English Premier League matches). NOW TV currently offers EPL plan (without broadband service) at HK$264 per month to new customers. It has lost its exclusive broadcasting rights for EPL in Hong Kong, and we believe that some customers will look for other options such as Letv. We estimate that the HKBN and Letv service bundling is 30-50% cheaper than NOW TV and HKT service package. These will encourage those pay-TV as well as broadband users to switch to Letv and HKBN.

More co-operations with OTT players…. We expect more cooperations between fixed-line players and OTT multi-media content providers. HKBN is in talks with other local and foreign OTT multi-media content providers in addition to the cooperation with Letv. In Jan 2016, Netflix launched its multimedia content service in Hong Kong as part of a larger global expansion. We believe it will find local fixed-line operators as partners to distribute its service. Hutchison Telecom (HT, 215 HK, HOLD) also signed MOU with Letv on more collaboration between the two companies in Nov 2015. We expect HT’s 3Home Broadband to be another platform to distribute Letv’s services (including the EPL broadcasting) and products (such as Le TV Box). HT has been providing Letv with data centre hosting and collocation, as well as local and international networking services. We expect co-operations to grow beyond simple distribution between fixed-line operators and OTT players such as on-line shopping, content production and payment service etc. Hong Kong residential broadband market share (1H15)

i-Cable 7% HT 9% HKBN 29%

HKT 55%

Source: HKT, HKBN, HT, i-Cable, DBS Vickers

Page 3

Industry Focus Hong Kong Telecom Sector

Mobile market In 2016, the mobile market lacks catalysts before the launch of iPhone7 in 3Q16. The mobile market in Hong Kong is saturated with a penetration rate of more than 200%. We expect the post-paid sub to grow by a low single-digit rate this year, driven by population growth. In 2016, we do not expect much sub market share reshuffle as HT has re-launched speedcapped plans after losing c.900k subs (since 2014). Post-paid ARPU remains on the uptrend but the improvement will be slower due to limited price hike in 2015. Tariff hike focusing on lower-tier plan. Mobile operators lack pricing power due to strong market competition. The window for industry-wide price hike will count on the availability of “star handsets”. Market reception for iPhone 7 will be a key this year during 3Q16. Notably, mobile operators are quite passive in raising the tariff for high-tier plans. They will focus more on raising the tariff for lower-tier plans. To improve ARPU, they took more initiatives to monetise data usage. Case in point is HKT’s newly launched data roll-over service. Another example is that China Mobile Hong Kong (CMHK) has started charging data roaming in China, which was free in the past. More stable market share. We do not expect much sub market share reshuffle in 2016. HT has lost c.900k subs (to SMT and CMHK) since the decision to give up offering 3G speed-capped plan in 2014. However, HT has re-launched its 3G speedcapped plan recently as the company noticed spare resources in 3G spectrums after upgrading some subs to 4G. We accordingly may see slower sub growth for SMT. As for HKT,

we believe it will continue to record slight decline in sub number due to short-term network instability brought about by HKT/CSL network integration, and re-branding exercise. Roaming revenue continue to weigh on mobile service revenue. On a negative note, roaming revenue's decline will continue to drag down mobile service revenue. HKT’s and HT’s FY14 and SMT’s FY6/15 roaming revenues accounted for 18%, 25% and 15% of the mobile service revenue respectively. We expect the roaming contribution to drop to 10-15% of mobile service revenue over the next 2-3 years. Hong Kong mobile market share (2014)

Others 12% HKT 33% CMHK 18%

SMT 14%

HT 23%

Source: HKT, HT, SMT, DBS Vickers

3G speed-capped plans of Hong Kong mobile operators M o n t h ly d at a u sag e: Un limit ed ( 3 G ) 1 2 - mo n t h c o n t rac t HK$ Monthly fee (HK$ /month) A dministration fee (HK$ /month) Speed / bandwidth

Smart o n e 88 18

T h ree 88 18

SUN M o b ile 88 18

Ch in a M o b ile 88 18

Ch in a Un ic o m 88 18

384kbps

first 5Gb: 384kbps after 5Gb: 128kbps

first 2Gb: 384kbps after 2Gb: 128kbps

384kbps

first 3Gb: 384kbps after 3Gb: 128kbps

V oice minutes (per month)

2,000

3,000

Special offer

None

-HK$10 per month for designated credit card & Self serv ice: -HK$10 per month the elderly

Source: Companies

Page 4

2,000 None

2,000 None

1,500 None

Industry Focus Hong Kong Telecom Sector

Interest rate risk Hong Kong Telecom operators are highly leveraged. This may be a concern for some investors as the coming interest rate upcycle will negatively impact earnings or dividends. We accordingly performed a sensitivity analysis on their dividends towards interest rate changes. HKT and HT have a relatively higher portion of floating-rate borrowings of 79% and 100%

respectively. We estimate that for any 1% interest rate increase, HKT’s and HT’s dividend will decrease by 7% and 4% in FY15F respectively. SMT and HKBN have higher proportion of fixedrate borrowings of 81% and 85% respectively, with a maturity of more than 3 years. The impact is limited In FY16F, we expect HT to increase its total borrowings to finance the spectrum payment of HK$1.8bn. SMT had already financed the spectrum payment earlier. In the longer term, HKBN and HKT are mostly impacted due to the higher gearing.

Interest rate sensitivity analysis T o t al b o rro w in g s ( H K $ m)

HKBN HKT HT SMT

N et g earin g F Y 16F 150% 90% 30% 10%

% o f T o t al b o rro w in g s

1 % in t . rat e imp ac t ( f lo at in g o n ly ) #

F Y 14* 3,100 36,426 3,952 2,969

F ix ed rat e 85% 21% 0% 81%

F lo at in g rat e 15% 79% 100% 19%

D o llar amo u n t ( H K $ m) 5 286 40 6

% d ec rease o f d iv id en d in F Y 1 5 F 1.1% 7.2% 4.3% 0.6%

1 % in t . rat e imp ac t ( assu me all f lo at in g ) D o llar amo u n t ( H K $ m) 31 364 40 30

% d ec rease o f d iv id en d in F Y 15F 7% 9% 4% 3% #

*FY8/15 for HKBN, FY6/15 for SMT Source: SMT, HKT, HKBN, HT, DBS Vickers

Page 5

Industry Focus Hong Kong Telecom Sector

consolidation of CSL’s full-year results vs 7.5 months’ results in FY14 and cost synergy.

Earnings revision and preview SMT will reveal its interim results for FY6/16F in early February. We also expect HKT and HT to announce their annual results in late February. For HKBN, its FY8/16 interim period end is at Feb 2016 and the results announcement will be some time later.

HT. We have revised up our earnings estimates by 0.4% for FY15F and 2.4% for FY16F, by assuming a higher sub number to factor in the re-launch of speed-capped plan recently. We expect the pretax earnings from handset sales, which accounted for c.23% of the total pretax profit in FY14, to drop by more than 20% in FY15F. We also reckon that the negative impact from sub loss and shrinking roaming revenue will offset the improvement in ARPU and profitability, resulting in flat mobile service earnings for FY16F. We expect net profit to grow by 9% to HK$908m in FY15F due to cost savings but decrease by 4% to HK$875m in FY16F due to weaker handset sales.

SMT. In FY6/16F, we expect the earnings to drop by 6% to HK$875m due to drop in handset sales. We estimate the earnings from handset sales to drop more than 50% and this is partly offset by the strong growth from that of mobile service. As at the end of FY6/15, SMT had a Renminbi deposit of HK$1bn. We believe that the deposit has been switched out and our estimates have assumed HK$45m pretax loss from the depreciation of Renminbi. We believe the market has largely digested the disappointment in handset sales. In 1HFY6/16F, we expect the pretax earnings to drop by c.15-20% y-o-y (compared with 1HFY6/15’s HK$564m) mainly due to the fall in handset sales. The next key thing to keep an eye on will be the launch of iPhone 7 which will dictate the mobile operators' ability to raise tariff, in our view.

HKBN. Management has been targeting 10%/15%/20% fiveyear growth CAGRs for revenue/EBITDA/AFF respectively through sub growth in FY8/15-FY8/19F. In FY8/16F, we expect the EBITDA to grow at a slower rate of 14% to HK$1,112m due to the aggressive pricing strategies to take market share. The customer acquisition cost for new subs accounts for 35% of the total contract value but it is reduced to 6% for contract renewal. Therefore, we forecast the EBITDA to grow at a faster rate of 16% in FY8/17F. We estimate the adjusted free cash to grow by 9% to HK$428m in FY8/16F and by 28% to HK$546m in FY8/17F. The slower growth in FY8/16F is mainly due to a more conservative assumption on capex.

HKT. We have revised up our estimates for adjusted funds flow per share stapled unit by 1.2% each for FY15F and FY16F, to reflect a higher growth rate in the International carrier business. We expect the AFF to grow by 17% to HK$3,919m in FY15F and 7% to HK$4,210m in FY16F attributable to the SmarTone and Hutchison Telecom pretax profit breakdowns HK$m SmarT one Mobile Service pretax profit Handset pretax profit Hut chison T elecom Service pretax profit Handset pretax profit

Source: SMT, HT, DBS Vickers

Page 6

J un-12

Dec- 12

J un-13

Dec- 13

J un-14

Dec- 14

J un- 15

454 22

529 18

368 92

271 41

187 38

312 252

432 135

587 140

589 253

593 146

296 132

414 30

481 243

545 175

Industry Focus Hong Kong Telecom Sector

Valuation and recommendation HKBN is our top pick. We expect HKBN’s sub growth to accelerate in FY8/16F, fuelled by bundling with Letv media service. HKBN is on track to achieve its target of 300k sub netadds in FY8/15-FY8/19F, which will support 20%+ p.a. dividend growth in the coming few years. The stock currently offers a 4.4% dividend yield. We like HKBN the most in the sector due to its strongest dividend growth potential. Maintain BUY on HKBN with a higher TP of HK$11.6, rolling forward to Aug 2016. Our TP is based on dividend discount model (DDM) with 7.9% cost of equity and 1% terminal growth rate.

SMT, as a pure mobile operator, is well positioned to benefit from the industry-wide mobile data tariff hike in the medium term. Maintain BUY on SMT with a lower TP of HK$13.0, pegged at 15x FY6/16F PE (vs previously 18x FY6/16F PE) to reflect a less exciting sector outlook. HT. Maintain HOLD on HT with a higher TP of HK$2.8, pegged at 15x FY16F PE, which is in line with historical average. HKT. Maintain HOLD on HKT as the current share price has reflected its fair value, with a higher TP of HK$10.0 by rolling forward to Dec 2016. Our TP is based on DDM with 7.6% cost of equity and 1% terminal growth rate.

Peers valuation

Company Name

Currenc y Pric e Code L oc al$

Mk t Cap F isc al US$m Yr

PE 16F x

PE Y ield Y ield 17F 16F 17F x % %

P/Bk 16F x

P/Bk EV /EBIT DA 17F 16F 17F x x x

F CF Y ield 16F 17F % %

Hong K ong t elec om operat ors HKT Trust* 6823 HK Hutchison Telecom* 215 HK Smartone Telecom* 315 HK HKBN* 1310 HK A v erage

HKD HKD HKD HKD

10 2.4 11.72 9.74

9,714 1,484 1,597 1,257

Dec Dec J un Aug

22.5 21.8 12.9 12.3 14.0 12.8 27.9 20.9 19.3 17.0

5.6 5.8 5.3 4.4 5.3

5.8 6.1 5.8 5.6 5.8

2.1 1.0 3.0 5.9 3.0

2.1 1.0 2.8 5.7 2.9

8.5 5.9 4.5 11.0 7.5

8.3 11.6 11.8 5.5 10.4 11.2 4.1 17.6 17.8 9.4 5.9 7.1 6.8 11.4 12.0

China t elec om operat ors China Mobile* 941 HK China Unicom* 762 HK China Telecom 'H'* 728 HK A v erage

HKD HKD HKD

83.75 219,993 8.31 25,531 3.42 35,509

Dec Dec Dec

11.4 11.0 12.9 11.4 11.2 10.0 11.8 10.8

3.8 2.9 2.6 3.1

3.9 2.9 2.6 3.1

1.4 0.7 0.7 1.0

1.3 0.7 0.7 0.9

3.5 2.7 3.5 3.3

3.3 2.5 3.4 3.1

3.3 7.2 (1.0) 3.2

4.0 9.7 4.5 6.1

T aiw an t elec om operat ors Chunghwa Telecom 2412 TT Taiwan Mobile 3045 TT F ar Eastone Telecom. 4904 TT A v erage

TWD TWD TWD

102 99.9 69.7

23,597 10,191 6,773

Dec Dec Dec

18.4 18.0 17.4 16.4 18.4 17.1 18.1 17.2

5.1 5.4 5.5 5.4

5.2 5.7 5.8 5.6

2.2 4.8 3.2 3.4

2.1 4.7 3.2 3.3

8.8 9.9 8.7 9.1

8.6 9.4 8.2 8.7

5.7 6.8 7.2 6.6

6.2 7.3 8.4 7.3

Singapore t elec om operat ors Starhub* STH SP M1 M1 SP A v erage

SGD SGD

3.37 2.24

4,076 1,468

Dec Dec

15.7 16.1 11.6 11.8 13.6 13.5

6.0 7.4 6.3

5.9 27.4 25.9 7.3 4.8 4.6 6.4 11.4 10.8

8.1 7.9 7.9

8.2 7.9 7.8

6.0 9.1 6.7

6.0 8.0 5.8

M alay sia t elec om operat ors Axiata Group* AXIATA MK Digi.Com* DIGI MK Maxis* MAXIS MK Telekom Malay sia* T MK A v erage

MYR MYR MYR MYR

6.14 5.12 6.55 6.56

12,633 9,454 11,479 5,753

Dec Dec Dec Dec

21.1 19.2 20.3 19.7 22.6 20.6 23.1 20.0 21.8 19.9

4.0 4.9 4.3 3.9 4.3

4.4 2.4 2.4 8.9 5.1 58.0 58.0 12.4 4.9 10.2 10.3 12.7 4.5 3.1 3.1 7.1 4.7 18.5 18.4 10.3

8.5 11.9 12.4 6.7 9.9

3.3 4.7 4.9 2.6 3.9

4.4 5.0 5.4 3.6 4.6

# FY16: FY17; FY17: FY18 Source: Thomson Reuters, *DBS Vickers

Page 7

China / Hong Kong Company Guide

HKBN Ltd. Version 4 |Bloomberg: 1310 HK Equity

| Reuters: 1310.HK Refer to important disclosures at the end of this report

DBS Group Research . Equity

26 January 2016

BUY

Tactical pricing strategy to drive dividend growth

Last Traded Price: HK$9.74 (HSI : 19,340) Price Target: HK$11.60 (19% upside) (Prev. HK$11.0) Potential Catalyst: Market share gain and ARPU increase Where we differ: We focus more on the long-term prospects despite short term growth volatility due to tactical pricing strategy Analyst Tsz Wang TAM CFA, +852 2971 1772 [email protected] Chris KO [email protected] Price Relative HK$

Relative Index

10.8

213

10.3

193

9.8

173

9.3

153

8.8

133

8.3 7.8

113

7.3

93

6.8 Mar-15

73 Jun-15

HKBN Ltd. (LHS)

Forecasts and Valuation FY Aug (HK$ m) Turnover Core EBITDA EBITDA Pre-tax Profit Net Profit Net Profit Gth (Pre-ex) (%) EPS (HK$) EPS Gth (%) Diluted EPS (HK$) AFCF DPS (HK$) BV Per Share (HK$) PE (X) P/Cash Flow (X) P/Free CF (X) EV/EBITDA (X) Net Div Yield (%) P/Book Value (X) Net Debt/Equity (X) ROAE (%)

Sep-15

Dec-15

Relative HSI INDEX (RHS)

2014A 2,132 845 845 105 54

2015A 2,341 979 923 190 104

2016F 2,536 1,112 1,112 450 352

2017F 2,797 1,296 1,296 591 469

N/A

94.7

237.3

33.4

0.05 N/A 0.05 311 0.00 1.63 182.9 11.2 18.5 14.6 0.0 6.0 1.6 3.3

0.10 94.7 0.10 391 0.20 1.51 93.9 14.9 29.4 13.5 2.1 6.5 1.8 6.6

0.35 237.3 0.35 428 0.43 1.66 27.9 10.0 17.0 11.0 4.4 5.9 1.5 22.1

0.47 33.4 0.47 546 0.54 1.70 20.9 8.6 14.1 9.4 5.6 5.7 1.4 27.8

B: 7

Nil 0.39 S: 0

Nil 0.49 H: 2

Earnings Rev (%): Consensus EPS (HK$) Other Broker Recs:

Source of all data: Company, DBSV, Thomson Reuters, HKEX

ASIAN INSIGHTS ed-TH / sa- DL

Buying opportunity emerges due to excessive concerns on price war Market’s excessive concerns on price war in the Hong Kong residential broadband market offer a buying opportunity on HKBN. The company has been successful in gaining market share through its aggressive and effective pricing strategy. We estimate that the recent price discount for new subscribers would have limited impact on its core EBITDA, but could help achieve long-term growth. Market share gain through tactical pricing strategy HKBN increased its market share from c.16% in FY8/08 to c.29% in FY8/15, and is now the second largest residential broadband operator in Hong Kong. It strategically offers deep discounts to lure subs away from competitors from time to time. Upon contract renewal, it raises the tariff back to normal level which is still lower than that of its major competitor HKT (6823 HK). Churn rate has been maintained at a low level. The incumbent operator HKT focuses on stable profitability and cash flow, and therefore has less flexibility to undercut HKBN’s pricing. A growth stock with decent dividend yield We expect the company to grow its revenue by 10% p.a. from FY8/16FY8/19F, driven by market share gain and ARPU improvement. In view of the recent marketing campaign, we estimate that its core EBITDA will grow slower at 14% for FY8/16F, but accelerate to 16% for FY8/17F upon contract renewal. The company intends to pay out 90100% adjusted free cash flow (AFCF), which is estimated to grow at 20% p.a. from FY8/16-FY8/19F. The stock offers a 4.3% dividend yield for FY8/16F and 5.4% for FY8/17F. Valuation: We have a BUY rating on HKBN for its dividend growth potential. We have rolled forward our TP to Dec 2016. Our TP of HK$11.6 is based on dividend discount model (DDM), with 7.9% cost of equity and 1% terminal growth rate. Key Risks to Our View: A real price war. Competitors irrationally cut prices to be lower than that offered by HKBN for a prolonged period of time. Increase in finance cost in interest rate up-cycle. Increase in interest rates will decrease the adjusted free cash flow and the dividend yield. At A Glance 1,006 Issued Capital (m shrs) 9,795 / 1,257 Mkt. Cap (HK$m/US$m) Major Shareholders Canada Pension Plan Investment Board (%) 18.0 GIC Private Limited (%) 9.0 The Capital Group Companies, Inc. (%) 6.0 Mondrian Investment Partners Limited (%) 5.6 JP Morgan Asset Management (%) 5.1 100.0 Free Float (%) 3m Avg. Daily Val. (US$m) 2.2 ICB Industry : Telecommunications / Fixed Line Telecommunications

VICKERS SECURITIES

Company Guide HKBN Ltd.

broadband sub (k)

CRITICAL DATA POINTS TO WATCH Earnings Drivers: Expanding market share through tactical pricing strategy. HKBN has been gaining market share from its competitors through its aggressive pricing strategy. It strategically offers deep discounts to gain new subscribers, and has been capable of raising back the tariff upon contract renewal. It has a track record of managing ARPU growth over a longer period of time despite short-term volatility. We are confident that HKBN can achieve its target of 300k net-adds in five years through a similar strategy.

894

900

834

800 700

754 660

500 400 300 200 100 0 2013A

Migration to fibre. Consumers are looking for faster broadband connection due to rising demand for internet multimedia content, and therefore continuously migrate to fibre network (FTTx), from other slower technologies such as Hybrid Fibre Coaxial (HFC) and Digital Subscriber Line (xDSL) for broadband services. HKBN’s Metro Ethernet network supports symmetric upstream/downstream transmission speeds from 100Mbps to 1,000Mbps, while HFC and xDSL offer only up to a maximum of 100Mbps downstream speed with limitations such as lower upstream speeds. We expect HKBN to gain market share from operators providing HFC and xDSL network services. Replication of success in residential market to enterprise market. HKBN is replicating its success in the residential broadband market to the enterprise market. HKBN focuses on the small enterprise segment, of which broadband penetration is expected to increase due to the robust development of cloud services, enterprise internet applications and e-commerce. We expect the revenue from HKBN's enterprise broadband business to grow at an 11% CAGR from FY8/16-FY8/17F.

ASIAN INSIGHTS Page 9

2014A

2015A

2016F

2017F

183

183

184

2015A

2016F

2017F

ARPU (HK$) 188

Rising ARPU. We forecast HKBN’s ARPU to grow by c.2% p.a. from FY8/16-FY8/19F through (i) upselling higher-tier plan, and (ii) narrowing the price differences with HKT in selected estates. As a percentage of subscriber number, HKBN’s subscribers for 500Mbps and 1,000Mbps increased from 8% in FY8/12 to 16% in FY8/14. We expect HKBN to continue upselling higher-tier plans to its customers. HKT generally charges a c.20% premium over HKBN’s pricing. HKBN may selectively narrow the differences in some areas without losing its customers.

692

600

165

176

150 113 75 38 0 2013A

2014A

Core EBITDA (HK$m) 18% 16% 14% 12% 10% 8% 6% 4% 2% 0%

1,400 1,200 1,000 800 600 400 200 0 FY13

FY14

FY15

FY16F

Core EBITDA

FY17F

Growth %

AFCF (HK$m) 40% 35% 30% 25% 20% 15% 10% 5% 0%

600 500 400 300 200 100 0 FY13

FY14 AFCF

FY15

FY16F

FY17F

Growth %

Source: Company, DBS Vickers

VICKERS SECURITIES

Company Guide HKBN Ltd.

Leverage & Asset Turnover (x)

Balance Sheet: Strong free cash flow. The company generates strong free cash flow with expected growth rate of 20% p.a. The company intends to pay out 90-100% of the adjusted free cash flow (AFCF) as dividend. AFCF is derived from core EBITDA adjusted for capex, net interest, non-recurring items, non-cash items, tax paid and changes in working capital.

0.5 2.00

0.5 0.5 0.4

1.50

0.4 0.4

1.00

0.4 0.4 0.50

0.3 0.3

Healthy balance sheet. HKBN had a total borrowing of HK$3bn in FY8/15 and it intends to maintain the current debt level. Debtto-EBITDA ratio stood at a healthy level of 3.1x in FY8/15. Share Price Drivers: Stronger sub growth. Management is targeting 300k net-adds (or 60k p.a. on average) in FY8/15-FY8/19F. Faster sub net-adds will be positive for share price.

0.3

0.00 2013A

2014A

2015A

2016F

Gross Debt to Equity (LHS)

2017F

Asset Turnover (RHS)

Capital Expenditure (HK$m) HK$ 500.0 450.0 400.0 350.0 300.0 250.0 200.0 150.0

Increase in ARPU. HKBN has a track record of managing ARPU growth over a longer period of time despite aggressive pricing strategy and short term volatility. While market is concerned about ARPU pressure due to price discounts, we expect an uptrend in ARPU driven by upselling of bandwidth and the narrowing of the price differences with HKT in selected estates in the medium term. Stronger dividend growth. Strong business growth and operating leverage could lead to stronger EBITDA growth. Reduction in capex as a percentage of revenue will further enhance the AFCF and therefore dividend distribution

100.0 50.0 0.0 2013A

2014A

2015A

2016F

2017F

Capital Expenditure (-)

ROE (%) 25.0% 20.0% 15.0% 10.0% 5.0% 0.0% 2013A

Key Risks: A real price war Competitors irrationally cut prices to be lower than that offered by HKBN for a prolonged period of time. Increase in interest rates Increase in interest rates will decrease the adjusted free cash flow and the dividend yield.

2014A

2015A

2016F

2017F

Forward EV/EBITDA (x) x 45 40

+1SD: 34.6x

35

Avg: 28.9x

30 -1SD: 23.3x

25 20

Jan-16

Dec-15

Dec-15

Oct-15

Nov-15

Oct-15

Sep-15

Aug-15

Jul-15

Aug-15

Jun-15

Jun-15

Apr-15

May-15

Apr-15

Company Background: HKBN is a broadband service provider in Hong Kong. It is the second largest player in the residential segment with a market share of c.29%.

Mar-15

15

PB Band (x) (x) 7.5 7.0

+2sd: 6.85x

6.5

+1sd: 6.44x Avg: 6.04x

6.0

‐1sd: 5.63x

5.5

‐2sd: 5.23x 5.0 4.5 Mar-15

Jun-15

Sep-15

Dec-15

Source: Company, DBS Vickers

ASIAN INSIGHTS

VICKERS SECURITIES Page 10

Company Guide HKBN Ltd.

Key Assumptions FY Aug broadband sub (k) ARPU (HK$)

2013A

2014A

2015A

2016F

2017F

660 158

692 175

754 183

834 183

894 184

Income Statement (HK$ m) FY Aug Revenue Cost of Goods Sold Gross Profit Other Opng (Exp)/Inc Operating Profit Other Non Opg (Exp)/Inc Associates & JV Inc Net Interest (Exp)/Inc Dividend Income Exceptional Gain/(Loss) Pre-tax Profit Tax Minority Interest Preference Dividend Net Profit Net Profit before Except. EBITDA Growth Revenue Gth (%) EBITDA Gth (%) Opg Profit Gth (%) Net Profit Gth (%) Margins & Ratio Gross Margins (%) Opg Profit Margin (%) Net Profit Margin (%) ROAE (%) ROA (%) ROCE (%) Div Payout Ratio (%) Net Interest Cover (x)

2013A 1,949 (305) 1,644 (1,454) 191 0 0 (301) 0 0 (110) (29) 0 0 (139) (139) 741

2014A 2,132 (287) 1,844 (1,552) 293 0 0 (188) 0 0 105 (51) 0 0 54 54 845

2015A 2,341 (306) 2,035 (1,588) 447 0 0 (257) 0 0 190 (86) 0 0 104 104 923

2016F 2,536 (304) 2,232 (1,633) 599 0 0 (148) 0 0 450 (99) 0 0 352 352 1,112

2017F 2,797 (308) 2,489 (1,750) 739 0 0 (148) 0 0 591 (122) 0 0 469 469 1,296

(2.3) 12.4 (45.0) N/A

9.3 14.1 53.6 N/A

9.8 9.2 52.7 94.7

8.3 20.5 33.9 237.3

10.3 16.5 23.5 33.4

84.3 9.8 (7.1) (6.8) (2.4) 3.5 N/A 0.6

86.5 13.7 2.5 3.3 0.9 2.8 0.0 1.6

86.9 19.1 4.5 6.6 1.9 4.8 192.9 1.7

88.0 23.6 13.9 22.1 6.3 9.1 121.6 4.0

89.0 26.4 16.8 27.8 8.2 11.3 116.3 5.0

Source: Company, DBS Vickers

ASIAN INSIGHTS Page 11

VICKERS SECURITIES

Company Guide HKBN Ltd.

Balance Sheet (HK$ m) FY Aug

2013A

2014A

2015A

2016F

2017F

Net Fixed Assets Invts in Associates & JVs Other LT Assets Cash & ST Invts Inventory Debtors Other Current Assets Total Assets

1,943 0 3,270 355 14 75 199 5,855

1,957 0 3,044 436 22 80 181 5,719

1,970 0 2,954 329 14 82 202 5,551

1,972 0 2,844 555 15 86 212 5,685

1,973 0 2,734 673 16 90 223 5,709

ST Debt Creditors Other Current Liab LT Debt Other LT Liabilities Shareholder’s Equity Minority Interests Total Cap. & Liab.

0 14 443 3,231 578 1,590 0 5,855

0 12 541 2,994 530 1,643 0 5,719

0 7 482 3,019 529 1,514 0 5,551

0 7 489 3,019 506 1,665 0 5,685

0 7 495 3,019 482 1,706 0 5,709

(170) (2,876) 12.9 (33.1) (33.3) 0.3 1.4 0.9 1.8 1.8 10.0 NA

(270) (2,558) 13.3 (18.0) (24.3) 0.4 1.3 0.9 1.6 1.6 11.5 NA

(190) (2,690) 12.6 (19.5) (38.8) 0.4 1.3 0.8 1.8 1.8 10.7 NA

(182) (2,463) 12.1 (11.7) (25.7) 0.5 1.8 1.3 1.5 1.5 13.4 NA

(174) (2,346) 11.5 (10.4) (22.7) 0.5 2.0 1.5 1.4 1.4 14.8 NA

Non-Cash Wkg. Capital Net Cash/(Debt) Debtors Turn (avg days) Creditors Turn (avg days) Inventory Turn (avg days) Asset Turnover (x) Current Ratio (x) Quick Ratio (x) Net Debt/Equity (X) Net Debt/Equity ex MI (X) Capex to Debt (%) Z-Score (X)

Source: Company, DBS Vickers

Cash Flow Statement (HK$ m) FY Aug Pre-Tax Profit Dep. & Amort. Tax Paid Assoc. & JV Inc/(loss) (Pft)/ Loss on disposal of FAs Chg in Wkg.Cap. Other Operating CF Net Operating CF Capital Exp.(net) Other Invts.(net) Invts in Assoc. & JV Div from Assoc & JV Other Investing CF Net Investing CF Div Paid Chg in Gross Debt Capital Issues Other Financing CF Net Financing CF Currency Adjustments Chg in Cash Opg CFPS (HK$) Free CFPS (HK$)

2013A (110) 550 (4) 0 0 22 307 765 (324) 0 0 0 (64) (389) (776) 715 0 (147) (208) 2 171 0.74 0.44

2014A 105 552 (43) 0 0 74 186 875 (346) 0 0 0 22 (324) 0 (256) 0 (169) (425) 0 126 0.80 0.53

2015A 190 476 (86) 0 0 (115) 193 657 (324) 0 0 0 0 (324) (230) (105) 0 (108) (443) 2 (107) 0.77 0.33

2016F 450 514 (114) 0 0 (8) 139 982 (406) 0 0 0 3 (403) (201) 0 0 (151) (352) 0 226 0.98 0.57

2017F 591 556 (137) 0 0 (9) 139 1,141 (448) 0 0 0 3 (445) (428) 0 0 (151) (579) 0 118 1.14 0.69

Source: Company, DBS Vickers

ASIAN INSIGHTS

VICKERS SECURITIES Page 12

Company Guide HKBN Ltd.

Target Price & Ratings History S.No. Dat e

HK$ 11.0 3

10.5

4

2

10.0

1

9.5

1: 2: 3: 4:

26-Oct-15 3-Nov -15 27-Nov -15 19-J an-16

Closing Pric e HK$8.98 HK$9.18 HK$10.20 HK$9.52

T arget Pric e HK$11.00 HK$11.00 HK$11.00 HK$11.00

Rat ing Buy Buy Buy Buy

9.0 8.5 8.0

Jan-16

Dec-15

Nov-15

Oct-15

Sep-15

Aug-15

Jul-15

Jun-15

May-15

Apr-15

7.0

Mar-15

7.5

Source: DBS Vickers

ASIAN INSIGHTS Page 13

VICKERS SECURITIES

China / Hong Kong Company Guide

HKT Trust Version 2 |Bloomberg: 6823 HK Equity

| Reuters: 6823.HK Refer to important disclosures at the end of this report

DBS Group Research . Equity

26 January 2016

HOLD

Incumbent operator with stable yield

Last Traded Price: HK$10.00 (HSI : 19,340) Price Target: HK$10.00 (0%) (Prev HK$9.10)

Stable dividend yield. We have a HOLD rating on HKT, with a dividend discount model (DDM)-based TP of HK$10.0. We believe that the current valuation reflects its fair value. HKT offers a stable dividend yield of 5%+. It is an incumbent player in the fixed-line segment with residential market share threatened by HKBN. It became the largest mobile operator after merging with CSL in FY14. HKT intends to pay out 100% of adjusted fund flows which is expected to grow at single-digit rate p.a. from FY16F onward.

Potential Catalyst: Price hike and market share gain Where we differ: We believe HKT focuses on profitability and stable AFF rather than market share, making it unlikely to cut prices Analyst Tsz Wang TAM CFA, +852 2971 1772 [email protected] Chris KO [email protected]

Growth driven by CSL consolidation plus cost synergy HKT benefits from the disciplined price competition environment in the mobile market through ARPU increase. We also expect more cost synergies from the merger with CSL to materialise in the future. On the other hand, HKT faces aggressive pricing strategy from HKBN in the residential broadband market. Despite market’s concern on price war, broadband network revenue increased by 5% in 1H15, driven by customer upgrades. We expect the overall fixed-line business to be stable with a low-single-digit growth.

Price Relative HK$

Relative Index 248

11.2

228

10.2

208

9.2

188

8.2

168

7.2

148

6.2

128

5.2

108

4.2 Jan-12

Jan-13

HKT Trust (LHS)

Forecasts and Valuation FY Dec (HK$ m) Turnover EBITDA Pre-tax Profit Net Profit Net Pft (Pre Ex) Net Profit Gth (Pre-ex) (%) EPS (HK$) AFF AFF / SSU EPS Gth (%) Diluted EPS (HK$) DPS (HK$) BV Per Share (HK$) PE (X) P/Cash Flow (X) P/Free CF (X) EV/EBITDA (X) Net Div Yield (%) P/Book Value (X) Net Debt/Equity (X) ROAE (%)

Jan-14

88 Jan-16

Jan-15

Relative HSI INDEX (RHS)

2014A 28,823 10,310 3,300 2,991 2,991

2015F 32,857 12,181 3,885 3,295 3,295

21.6

10.2

2.2

3.4

0.42 3,354 0.44 10.0 0.42 0.47 5.35 23.7 7.4 10.0 10.1 4.7 1.9 0.9 8.7

0.44 3,967 0.52 3.1 0.44 0.52 4.95 23.0 6.6 9.1 8.9 5.2 2.0 0.9 8.7

0.44 4,262 0.56 2.2 0.44 0.56 4.85 22.5 6.3 8.6 8.5 5.6 2.1 0.9 9.1

0.46 4,373 0.58 3.4 0.46 0.58 4.74 21.8 6.2 8.5 8.3 5.8 2.1 0.9 9.6

2 0.51 B: 9

1 0.56 S: 0

2 0.59 H: 5

Earnings Rev (%): Consensus EPS (HK$) Other Broker Recs:

2016F 33,730 12,722 3,961 3,366 3,366

Source of all data: Company, DBSV, Thomson Reuters, HKEX

ASIAN INSIGHTS sa- DL

2017F 34,555 13,019 4,093 3,480 3,480

Limited upside on share price We forecast AFF, which is fully distributed as dividends, to grow at 17% in FY15F and 7% FY16F, driven by the consolidation of CSL’s fullyear results in FY15F and the cost synergy from the merger. We reckon a steady AFF growth at a single-digit rate after FY16F. With limited growth potential, we believe its current valuation offers limited upside on share price. Valuation: We have a HOLD rating on HKT as we believe that the current share price has largely reflected its fair value. We have rolled forward our TP to Dec 2016. Our TP of HK$10.0 is based on DDM with 7.6% cost of equity and 1% terminal growth rate. Key Risks to Our View: Availability of “star” handsets (upside risk). Mobile operators would have stronger pricing power to raise the tariffs for handset-bundled mobile data plans during the launch of “star” handsets. Interest rate up-cycle (downside risk). Increase in interest rates will reduce the adjusted funds flow and therefore the dividend distribution. At A Glance Issued Capital (m shrs) Mkt. Cap (HK$m/US$m) Major Shareholders PCCW Limited (%) The Capital Group Companies, Inc. (%) Free Float (%) 3m Avg. Daily Val. (US$m) ICB Industry : Telecommunications / Fixed Line l i i

7,572 75,717 / 9,714 63.1 6.9 36.9 7.1

VICKERS SECURITIES

Company Guide HKT Trust

Mobile sub growth (%)

CRITICAL DATA POINTS TO WATCH

177

181

Earnings Drivers: CSL consolidation plus cost savings. HKT has been integrating CSL’s networks as well as optimising the retail channels. We expect cost savings as well as other synergies in operation after the HKT/CSL integration. It targets to close down 380 cell sites (or 1/3 of total) in FY15F. This should have saved network maintenance costs, which is positive to earnings and operating cash flow.

145

Mobile tariff hike. The competitive environment in the Hong Kong mobile market has improved since the merger of HKT and CSL. Operators have been able to raise the tariffs for mobile data plans in the past 1-2 years. The market has been recently focusing more on raising the tariffs for lower-tier plans and launching various top-up plans to monetise more data usage. HKT has now become the largest mobile operator. It is well positioned to take the lead to raise the tariff when the timing is appropriate.

177

108 72 36 0

1 2013A

2014A

1

1

1

2015F

2016F

2017F

168

171

175

2015F

2016F

2017F

37.2

37.8

37.8

2015F

2016F

2017F

Mobile ARPU (HK$)

155 133

146 133

110 88 66 44 22 0 2013A

2014A

EBITDA margin (%)

Mobile sub growth. Hong Kong's mobile market is matured with low-single-digit growth in the past two years. It is dominated by HKT, Hutchison Telecom, SmarTone and China Mobile Hong Kong with market shares c.33%, c.20%, c.14% and c.20% respectively in 2014. We expect HKT to continue optimising its customer mix to align its new rebranding (csl., 1O1O and SUN mobile). We believe that HKT will continue to grow its mobile sub base going forward.

38.2

34.6

35.5

2013A

2014A

30.5 22.9 15.3 7.6 0.0

Source: Company, DBS Vickers

ASIAN INSIGHTS Page 15

VICKERS SECURITIES

Company Guide HKT Trust

Leverage & Asset Turnover (x)

Balance Sheet: Healthy financials with a debt-to-EBITDA ratio of 3.6x. HKT had bank borrowings of HK$36bn and the debt to EBITDA ratio remained healthy at 3.6x in FY14. Average debt maturity is around five years with effective interest rate of c.2.9%. The company intends to pay out 100% adjusted funds flow (which is basically free cash flow), and maintains debt level unchanged.

0.4 0.4

1.00

0.4 0.4

0.80

0.4 0.60

0.4 0.3

0.40

0.3 0.3

0.20

0.3 0.3

0.00 2013A

Share Price Drivers: CSL consolidation plus cost savings. HKT has been integrating CSL’s networks as well as optimising the retail channels. We expect cost savings as well as other synergies in operation after the HKT/CSL integration. It targets to close down 380 cell sites (or 1/3 of total) in FY15F.

2014A

2015F

Gross Debt to Equity (LHS)

2016F

2017F

Asset Turnover (RHS)

Capital Expenditure (HK$m) HK$ 3,500.0 3,000.0 2,500.0 2,000.0 1,500.0

Tariff hike in the mobile market. We believe the price competition in the industry is disciplined as mobile operators focus more on profitability rather than market share. We believe further tariff hikes will focus on the lower-tier plans to narrow the gap between lower-tier and high-tier plans to prevent trade downs.

1,000.0 500.0 0.0 2013A

2014A

2015F

2016F

2017F

Capital Expenditure (-)

ROE (%) 9.0% 8.0%

Mobile sub growth. HKT rebranded SUM Mobile to focus on mass market and csl. and 1O1O to focus on mid- to high-end postpaid customers. The brands have clear market focuses and price differentials. We believe this market repositioning may lead to some marginal postpaid sub loss in the near term but the impact should be limited. Signs of bottoming out are positive to the share price.

7.0% 6.0% 5.0% 4.0% 3.0% 2.0% 1.0% 0.0% 2013A

2014A

2015F

2016F

2017F

Forward PE Band (x)

Key Risks: Market competition. HKT faces severe competition from HKBN in the residential broadband market. Hong Kong's mobile market is crowded with four major players and the penetration is more or less saturated. Irrational pricing may lead to a price war.

24.9

+2sd: 23.9x 22.9

+1sd: 21.9x 20.9

Avg: 19.8x 18.9

‐1sd: 17.8x 16.9

Interest rate up-cycle. Increase in interest rates will reduce the adjusted fund flows and therefore the dividend distribution.

‐2sd: 15.8x 14.9 12.9 Jan-12

Jan-13

Jan-14

Jan-15

Jan-16

PB Band

Company Background HKT is an integrated telecom services provider in Hong Kong, with the largest market share in the fixed-line and mobile market. The broadband services are provided via the brand “Netvigator” and the mobile services are provided via the brands “SUN Mobile”, “csl.” and “1O1O”. HKT is 63.07% owned by PCCW.

(x) 2.4

+2sd: 2.2x

2.2 2.0

+1sd: 1.88x

1.8 1.6

Avg: 1.56x

1.4

‐1sd: 1.24x

1.2 1.0

‐2sd: 0.91x

0.8 0.6 Jan-12

Jan-13

Jan-14

Jan-15

Jan-16

Source: Company, DBS Vickers

ASIAN INSIGHTS

VICKERS SECURITIES Page 16

Company Guide HKT Trust

Key Assumptions FY Dec Fixed-line sub growth (%) Broadband sub growth (%) Mobile sub growth (%) Mobile ARPU EBITDA margin (%)

2013A

2014A

2015F

2016F

2017F

0.2

0.1

0.2

0.2

0.2

0.0

0.0

0.0

(0.6)

(0.6)

0.5 133.0 34.6

177.2 146.0 35.5

1.5 168.0 37.2

0.9 171.0 37.8

1.0 175.0 37.8

Segmental Breakdown (HK$ m) FY Dec Revenues (HK$ m) TSS Mobile Other businesses Elliminations Total

2013A

2014A

2015F

2016F

2017F

19,251 3,371 688 (478) 22,832

19,913 8,950 564 (604) 28,823

20,940 12,088 500 (671) 32,857

21,468 12,450 500 (688) 33,730

21,936 12,824 500 (705) 34,555

2013A 22,832 (10,117) 12,715 (9,501) 3,214 84 50 (833) 0 0 2,515 (16) (39) 0 2,460 2,460 8,048

2014A 28,823 (12,053) 16,770 (12,416) 4,354 99 (29) (1,124) 0 0 3,300 (242) (67) 0 2,991 2,991 10,310

2015F 32,857 (13,537) 19,320 (14,063) 5,257 0 (29) (1,343) 0 0 3,885 (550) (40) 0 3,295 3,295 12,181

2016F 33,730 (13,897) 19,833 (14,437) 5,397 0 (29) (1,407) 0 0 3,961 (555) (40) 0 3,366 3,366 12,722

2017F 34,555 (14,237) 20,318 (14,790) 5,529 0 (29) (1,407) 0 0 4,093 (573) (40) 0 3,480 3,480 13,019

8.3 5.8 7.8 52.8

26.2 28.1 35.5 21.6

14.0 18.2 20.7 10.2

2.7 4.4 2.7 2.2

2.4 2.3 2.4 3.4

55.7 14.1 10.8 8.0 3.7 5.4 117.9 3.9

58.2 15.1 10.4 8.7 3.8 5.9 112.1 3.9

58.8 16.0 10.0 8.7 3.7 5.7 120.4 3.9

58.8 16.0 10.0 9.1 3.8 5.9 126.6 3.8

58.8 16.0 10.1 9.6 3.9 6.1 125.7 3.9

Source: Company, DBS Vickers

Income Statement (HK$ m) FY Dec Revenue Cost of Goods Sold Gross Profit Other Opng (Exp)/Inc Operating Profit Other Non Opg (Exp)/Inc Associates & JV Inc Net Interest (Exp)/Inc Dividend Income Exceptional Gain/(Loss) Pre-tax Profit Tax Minority Interest Preference Dividend Net Profit Net Profit before Except. EBITDA Growth Revenue Gth (%) EBITDA Gth (%) Opg Profit Gth (%) Net Profit Gth (%) Margins & Ratio Gross Margins (%) Opg Profit Margin (%) Net Profit Margin (%) ROAE (%) ROA (%) ROCE (%) Div Payout Ratio (%) Net Interest Cover (x)

Source: Company, DBS Vickers

ASIAN INSIGHTS Page 17

VICKERS SECURITIES

Company Guide HKT Trust

Interim Income Statement (HK$ m) FY Dec

1H2013

2H2013

1H2014

2H2014

1H2015

11,071 (4,901) 6,170 (4,720) 1,450 49 6 (458) 0 1,047 161 (19) 1,189 1,189

11,761 (5,216) 6,545 (4,781) 1,764 35 44 (375) 0 1,468 (177) (20) 1,271 1,271

12,520 (5,333) 7,187 (5,114) 2,073 41 2 (452) 0 1,664 (245) (19) 1,400 1,400

16,303 (6,720) 9,583 (7,302) 2,281 58 (31) (672) 0 1,636 3 (48) 1,591 1,591

15,974 (6,544) 9,430 (6,851) 2,579 33 (15) (631) 0 1,966 (171) (17) 1,778 1,778

14.0 (0.5) 52.8

3.5 15.7 52.8

13.1 43.0 17.7

38.6 29.3 25.2

27.6 24.4 27.0

55.7 13.1 10.7

55.7 15.0 10.8

57.4 16.6 11.2

58.8 14.0 9.8

59.0 16.1 11.1

FY Dec

2013A

2014A

2015F

2016F

2017F

Net Fixed Assets Invts in Associates & JVs Other LT Assets Cash & ST Invts Inventory Debtors Other Current Assets Total Assets

14,399 852 41,097 2,134 1,018 3,000 3,319 65,819

15,767 721 61,054 3,613 621 3,875 4,149 89,800

15,918 692 60,028 3,833 652 4,069 4,349 89,541

16,074 663 58,759 3,980 685 4,272 4,560 88,992

16,234 634 57,472 4,036 719 4,486 4,780 88,360

ST Debt Creditors Other Current Liab LT Debt Other LT Liabilities Shareholder’s Equity Minority Interests Total Cap. & Liab.

0 1,803 5,354 24,022 3,835 30,623 182 65,819

3,877 1,979 8,559 32,549 4,797 37,932 107 89,800

3,877 2,078 8,559 32,549 4,852 37,479 147 89,541

3,877 2,182 8,559 32,549 4,907 36,731 187 88,992

3,877 2,291 8,559 32,549 4,965 35,893 227 88,360

180 (21,888) 51.4 127.0 67.0 0.3 1.3 0.7 0.7 0.7 8.2 2.3

(1,893) (32,813) 43.5 111.9 48.5 0.4 0.9 0.5 0.9 0.9 6.9 1.7

(1,567) (32,593) 44.1 112.5 35.3 0.4 0.9 0.5 0.9 0.9 8.6 1.9

(1,224) (32,446) 45.1 118.8 37.3 0.4 0.9 0.6 0.9 0.9 8.8 1.9

(865) (32,390) 46.3 121.5 38.1 0.4 1.0 0.6 0.9 0.9 9.0 1.9

Revenue Cost of Goods Sold Gross Profit Other Oper. (Exp)/Inc Operating Profit Other Non Opg (Exp)/Inc Associates & JV Inc Net Interest (Exp)/Inc Exceptional Gain/(Loss) Pre-tax Profit Tax Minority Interest Net Profit Net profit bef Except. Growth Revenue Gth (%) Opg Profit Gth (%) Net Profit Gth (%) Margins Gross Margins (%) Opg Profit Margins (%) Net Profit Margins (%) Source: Company, DBS Vickers Balance Sheet (HK$ m)

Non-Cash Wkg. Capital Net Cash/(Debt) Debtors Turn (avg days) Creditors Turn (avg days) Inventory Turn (avg days) Asset Turnover (x) Current Ratio (x) Quick Ratio (x) Net Debt/Equity (X) Net Debt/Equity ex MI (X) Capex to Debt (%) Z-Score (X)

Source: Company, DBS Vickers

ASIAN INSIGHTS

VICKERS SECURITIES Page 18

Company Guide HKT Trust

Cash Flow Statement (HK$ m) FY Dec

2013A

2014A

2015F

2016F

2017F

Pre-Tax Profit Dep. & Amort. Tax Paid Assoc. & JV Inc/(loss) (Pft)/ Loss on disposal of FAs Chg in Wkg.Cap. Other Operating CF Net Operating CF Capital Exp.(net) Other Invts.(net) Invts in Assoc. & JV Div from Assoc & JV Other Investing CF Net Investing CF Div Paid Chg in Gross Debt Capital Issues Other Financing CF Net Financing CF Currency Adjustments Chg in Cash Opg CFPS (HK$) Free CFPS (HK$)

2,515 4,700 (331) (50) 0 (518) 827 7,143 (1,980) (2,091) 0 0 (152) (4,223) (2,731) 298 0 (751) (3,184) (3) (267) 1.19 0.80

3,300 5,886 (395) 29 0 (545) 1,294 9,569 (2,510) (3,219) 0 0 (18,857) (24,586) (3,141) 11,909 7,807 (34) 16,541 (45) 1,479 1.43 1.00

3,885 6,953 (495) 29 0 (326) 1,393 11,439 (3,121) (2,957) 0 0 0 (6,079) (3,748) 0 0 (1,393) (5,141) 0 220 1.55 1.10

3,961 7,354 (499) 29 0 (342) 1,457 11,959 (3,204) (3,036) 0 0 0 (6,240) (4,115) 0 0 (1,457) (5,572) 0 147 1.62 1.16

4,093 7,520 (516) 29 0 (360) 1,457 12,223 (3,283) (3,110) 0 0 0 (6,393) (4,318) 0 0 (1,457) (5,775) 0 56 1.66 1.18

Source: Company, DBS Vickers

Target Price & Ratings History S.No. Dat e

HK$ 11.0 1 2

10.5

1: 2: 3: 4: 5:

5

34

10.0

30-J an-15 11-Feb-15 27-J ul-15 6-Aug-15 27-Nov -15

Closing Pric e HK$9.91 HK$10.14 HK$9.52 HK$9.11 HK$9.72

T arget Pric e HK$9.20 HK$9.70 HK$9.50 HK$9.50 HK$9.10

Rat ing Hold Hold Hold Hold Hold

9.5 9.0

Jan-16

Dec-15

Nov-15

Oct-15

Sep-15

Aug-15

Jul-15

Jun-15

May-15

Apr-15

Mar-15

Feb-15

8.0

Jan-15

8.5

Source: DBS Vickers

ASIAN INSIGHTS Page 19

VICKERS SECURITIES

China / Hong Kong Company Guide

Hutchison Telecom Version 2 | Bloomberg: 215 HK Equity

| Reuters: 0215.HK Refer to important disclosures at the end of this report

DBS Group Research . Equity

26 January 2016

HOLD

Expect sub number to stabilise in FY16F

Last Traded Price: HK$2.40 (HSI : 19,340) Price Target: HK$2.80 (17% upside) (Prev HK$2.70) Potential Catalyst: Price hike and availability of “star” handsets Where we differ: Our earnings estimates for FY15-16F are lower than concensus Analyst Tsz Wang TAM CFA, +852 2971 1772 [email protected] Chris KO [email protected]

Re-launching the 3G speed-capped plan HT has officially re-launched the 3G speed-capped plan at the same price as its competitors. They notice spare resources in 3G spectrums after upgrading some subs to 4G. In fact, HT has been selectively offering the plan to retention customers earlier in FY15. Therefore, we do not expect any significant impact to the market competition but this could help the company’s subscriber number to stabilise in FY16F.

Price Relative HK$

Relative Index

5.1

222 202

4.6

182 4.1

162

3.6

Current valuation reflects fair value We have a HOLD rating on Hutchison Telecom (HT) as we believe the current valuation has reflected its fair value. Mobile service revenue has been declining in the past 1-2 years, while fixed-line revenue registered a steady growth. HT has lost c.900k subs after the decision to give up the lower-end market in FY14. Overall profitability improvement was mainly due to cost savings. The company benefits from the disciplined price competition environment in the mobile market but a meaningful tariff hike will count of the availability of “star” handsets.

142 122

3.1

102 2.6

82

2.1 Jan-12

Jan-13

Jan-14

Hutchison Telecom (LHS)

Forecasts and Valuation FY Dec (HK$ m) Turnover EBITDA Pre-tax Profit Net Profit Net Pft (Pre Ex) Net Profit Gth (Pre-ex) (%) EPS (HK$) EPS Gth (%) Diluted EPS (HK$) DPS (HK$) BV Per Share (HK$) PE (X) P/Cash Flow (X) P/Free CF (X) EV/EBITDA (X) Net Div Yield (%) P/Book Value (X) Net Debt/Equity (X) ROAE (%)

Jan-15

62 Jan-16

Relative HSI INDEX (RHS)

2014A 16,296 2,644 1,168 833 833

2015F 18,176 2,731 1,270 912 912

2016F 16,224 2,785 1,252 896 896

2017F 16,585 2,905 1,301 937 937

(9.1)

9.4

(1.7)

4.6

0.17 (9.1) 0.17 0.13 2.34 13.9 4.7 8.8 5.9 5.4 1.0 0.3 7.5

0.19 9.4 0.19 0.14 2.40 12.7 4.6 9.7 5.5 5.9 1.0 0.3 8.0

0.19 (1.7) 0.19 0.14 2.44 12.9 4.6 9.6 5.9 5.8 1.0 0.3 7.7

0.19 4.6 0.19 0.15 2.49 12.3 4.5 9.0 5.5 6.1 1.0 0.3 7.9

0.4 0.19 B: 1

2 0.20 S: 0

3 0.21 H: 8

Earnings Rev (%): Consensus EPS (HK$) Other Broker Recs:

Source of all data: Company, DBSV, Thomson Reuters, HKEX

Expect stable service revenue with declining handset sales profit By assuming a higher sub base, we have revised up our earnings estimates by 0.4%, 2.4% and 3.3% for FY15-17F respectively. We expect the earnings in FY15F to grow by 9% to HK$912m, due to a 19% earnings improvement from service which is partly offset by a 24% drop in earnings from handset sales. In FY16F, we expect handset sales profit to drop by a further 20% and the contribution from service to grow by 2%. We forecast the net profit for FY16F to fall by 2% to HK$896m. Valuation: We have a HOLD rating on HT. Our target price of HK$2.8 is pegged at 15x FY16F PE, which is in line with the historical average. Key Risks to Our View: Availability of “star” handsets (upside risk). Launch of “star” handsets could result in higher handset sales volume and margins. Mobile operators would also have stronger pricing power to raise the tariffs for handset-bundled mobile data plans. Irrational market competition (downside risk). Hong Kong's mobile market is crowded with four major players and the penetration is more or less saturated. Irrational pricing may lead to a price war. At A Glance Issued Capital (m shrs) Mkt. Cap (HK$m/US$m) Major Shareholders CK Hutchison Holdings Ltd. (%) Li Ka-Shing (%) The Capital Group Companies, Inc. (%) Free Float (%)

4,819 11,565 / 1,484 66.1 8.4 5.1 20.4

3m Avg. Daily Val. (US$m) 1.1 ICB Industry : Telecommunications / Mobile Telecommunications

ASIAN INSIGHTS sa- DL

VICKERS SECURITIES

Company Guide Hutchison Telecom

Sub number (k) 3,771 3,500

CRITICAL DATA POINTS TO WATCH

3,197

3,000

2,889

2,918

2,947

2015F

2016F

2017F

2,500

Earnings Drivers: Tariff hike. The competitive environment has improved since the merger of HKT and CSL. Operators have been able to raise the tariffs for mobile data plans in the past 1-2 years. The market recently focuses more on raising the tariffs for lower-tier plans and launching various top-op plans to monetise more data usage. HT has also taken multiple initiatives to increase the mobile ARPU. It has raised the tariffs of its 4G SIM-only plans by HK$20-30 to narrow the pricing discounts to its major competitors. It also launched “Top Up Data Pack” with additional HK$40 per month for 1Gb or HK$70 per month for 2.5Gb to enhance mobile ARPU. Mobile ARPU uplift will be a key earnings growth driver. Mobile sub growth. Hong Kong's mobile market is more or less matured with low-single-digit sub growth in the past two years. There are four major players: HKT, Hutchison Telecom, SmarTone and China Mobile Hong Kong with market shares of c.33%, c.20%, c.14% and c.20% in 2014 respectively. HT stopped offering low-tier speed-capped plan in FY14. It has lost c.900 mobile subs since then (from 3,771k by the end of FY13 to 2,869k by the end of Jun 2015). Mobile post-paid subs decreased by c.390k from 1,933m by end of FY13 to 1,542m by end of Jun 2015. HT has officially re-launched the 3G speed-capped plan in Nov 2015. We expect the mobile sub number to stabilise in FY16F.

2,000 1,500 1,000 500 0 2013A

2014A

Mobile ARPU (DBSV) 129 113

111

2013A

2014A

115

120

126

103 77 51 26 0 2015F

2016F

2017F

Source: Company, DBS Vickers

Availability of “star” handsets. Handset sales depend on the popularity of the new smartphones. Availability of “star” handsets could result in higher handset sales volume and margin. Mobile operators would also have stronger pricing power to raise the tariffs for handset-bundled mobile data plans.

ASIAN INSIGHTS Page 21

VICKERS SECURITIES

Company Guide Hutchison Telecom

Leverage & Asset Turnover (x)

Balance Sheet: Healthy financial position with a net gearing ratio of 38%. The company generates stable operating cash flow. HT has a net gearing ratio of 32% and the debt-to-EBITDA ratio of c.1.5x in FY14. We expect HT to pay c.HK$1.8bn for 2.1GHz spectrum utilisation fees in FY16F. Thereafter, we expect a net gearing ratio of c.38%, which is healthy. Share Price Drivers: Tariff hike. Operators have been able to raise mobile tariffs in the past 1-2 years. The market has been recently focusing more on raising the tariffs for lower-tier plans and launching various top-up plans to monetise more data usage. ARPU uplift will be a key share price catalyst.

0.9 0.50 0.9 0.40 0.8 0.30

0.8

0.20

0.7

0.10

0.7

0.00

0.6 2013A

2014A

2015F

Gross Debt to Equity (LHS)

2016F

2017F

Asset Turnover (RHS)

Capital Expenditure (HK$m) HK$ 1,350.0 1,300.0 1,250.0

Mobile sub growth. Hong Kong's mobile market penetration is more or less matured with low-single-digit sub growth in the past two years. Further sub growth will be mostly coming from market share gain. We believe that HT has to first slow down any sub loss, and then focus on growing its high-tier sub base.

1,200.0 1,150.0 1,100.0 2013A

2014A

2015F

2016F

2017F

Capital Expenditure (-)

ROE (%)

Availability of “star” handsets. Availability of “star” handsets could result in higher handset sales volume and margin. Mobile operators would also have stronger pricing power to raise the tariffs for handset-bundled mobile data plans.

8.0% 7.0% 6.0% 5.0% 4.0% 3.0%

Key Risks: Irrational market competition. Hong Kong's mobile market is crowded with four major players and the penetration is more or less saturated. Irrational pricing may lead to a price war.

2.0%

Lack of “star” handsets. Handset sales depend on the popularity of the new smartphones. Lack of “star” handsets could result in lower handset sales volume and margins. And operators would have weaker pricing power to raise tariff for handset-bundled mobile data plans.

27.1

1.0% 0.0% 2013A

2014A

2015F

2016F

2017F

Forward PE Band (x) 25.1 23.1

+2sd: 22.3x

21.1

+1sd: 19.9x

19.1

Avg: 17.4x

17.1 15.1

‐1sd: 14.9x

13.1

COMPANY BACKGROUND Hutchison Telecom is an integrated telecom service provider in Hong Kong, operating under the brand “3 Hong Kong”. It has a c.23% mobile sub market share. Its major shareholder is CK Hutchison Holdings Limited.

‐2sd: 12.5x

11.1 Jan-12

Jan-13

Jan-14

Jan-15

Jan-16

PB Band (x) 2.2 2.0 1.8

+2sd: 1.84x

1.6

+1sd: 1.64x

1.4

Avg: 1.44x

1.2

‐1sd: 1.25x

1.0

‐2sd: 1.05x

0.8 Jan-12

Jan-13

Jan-14

Jan-15

Jan-16

Source: Company, DBS Vickers

ASIAN INSIGHTS

VICKERS SECURITIES Page 22

Company Guide Hutchison Telecom

Key Assumptions FY Dec Sub number (k) Mobile ARPU (DBSV)

2013A

2014A

2015F

2016F

2017F

3,771.0 113.0

3,197.0 111.0

2,889.0 115.0

2,918.0 120.0

2,947.0 126.0

2013A

2014A

2015F

2016F

2017F

5,138 3,418 4,221 12,777

4,646 3,664 7,986 16,296

4,188 3,607 10,382 18,176

4,196 3,723 8,305 16,224

4,434 3,846 8,305 16,585

Segmental Breakdown (HK$ m) FY Dec Revenues (HK$ m) Moible Fixed-line Hardware sales Total

Source: Company, DBS Vickers

Income Statement (HK$ m) FY Dec

Revenue Cost of Goods Sold Gross Profit

2013A

2014A

2015F

2016F

2017F

12,777 (3,943)

16,296 (7,713)

18,176 (10,174)

16,224 (8,139)

16,585 (8,139)

8,834

8,583

8,002

8,084

8,446

(7,495)

(7,225)

(6,604)

(6,673)

(6,953)

Operating Profit

1,339

1,358

1,399

1,411

1,493

Other Non Opg (Exp)/Inc Associates & JV Inc Net Interest (Exp)/Inc Dividend Income Exceptional Gain/(Loss)

0 (12) (160) 0 0

0 (35) (155) 0 0

0 (10) (118) 0 0

0 (10) (150) 0 0

0 (10) (181) 0 0

Pre-tax Profit

1,167

1,168

1,270

1,252

1,301

Tax Minority Interest Preference Dividend

(77) (174) 0

(205) (130) 0

(229) (130) 0

(225) (130) 0

(234) (130) 0

Other Opng (Exp)/Inc

Net Profit

Net Profit before Except. EBITDA

916

833

912

896

937

916 2,662

833 2,644

912 2,731

896 2,785

937 2,905

(17.8) (11.4) (22.4) (24.6)

27.5 (0.7) 1.4 (9.1)

11.5 3.3 3.0 9.4

(10.7) 2.0 0.9 (1.7)

2.2 4.3 5.8 4.6

69.1 10.5 7.2 8.3 4.4 7.6 75.0 8.4

52.7 8.3 5.1 7.5 4.0 6.6 74.9 8.8

44.0 7.7 5.0 8.0 4.3 6.7 75.0 11.8

49.8 8.7 5.5 7.7 4.0 6.3 75.0 9.4

50.9 9.0 5.6 7.9 3.9 6.1 75.0 8.2

Growth

Revenue Gth (%) EBITDA Gth (%) Opg Profit Gth (%) Net Profit Gth (%) Margins & Ratio

Gross Margins (%) Opg Profit Margin (%) Net Profit Margin (%) ROAE (%) ROA (%) ROCE (%) Div Payout Ratio (%) Net Interest Cover (x) Source: Company, DBS Vickers

ASIAN INSIGHTS Page 23

VICKERS SECURITIES

Company Guide Hutchison Telecom

Interim Income Statement (HK$ m) FY Dec

Revenue Cost of Goods Sold Gross Profit Other Oper. (Exp)/Inc Operating Profit Other Non Opg (Exp)/Inc Associates & JV Inc Net Interest (Exp)/Inc Exceptional Gain/(Loss) Pre-tax Profit Tax Minority Interest Net Profit Net profit bef Except.

Growth Revenue Gth (%) Opg Profit Gth (%) Net Profit Gth (%) Margins Gross Margins (%) Opg Profit Margins (%) Net Profit Margins (%) Source: Company, DBS Vickers

1H2013

2H2013

1H2014

2H2014

1H2015

6,149 (1,668) 4,481 (3,661) 820 0 (4) (77) 0 739 (39) (128) 572 572

6,628 (2,275) 4,353 (3,834) 519 0 (8) (83) 0 428 (38) (46) 344 344

6,227 (2,060) 4,167 (3,640) 527 0 (12) (71) 0 444 (82) (39) 323 323

10,069 (5,653) 4,416 (3,585) 831 0 (23) (84) 0 724 (123) (91) 510 510

11,020 (6,975) 4,045 (3,256) 789 0 (18) (51) 0 721 (120) (92) 508 509

(8.6) 2.4 0.7

(24.7) (43.9) (46.8)

1.3 (35.7) (43.5)

51.9 60.1 48.3

77.0 49.7 57.3

72.9 13.3 9.3

65.7 7.8 5.2

66.9 8.5 5.2

43.9 8.3 5.1

36.7 7.2 4.6

ASIAN INSIGHTS

VICKERS SECURITIES Page 24

Company Guide Hutchison Telecom

Balance Sheet (HK$ m) FY Dec

2013A

2014A

2015F

2016F

2017F

Net Fixed Assets Invts in Associates & JVs Other LT Assets Cash & ST Invts Inventory Debtors Other Current Assets Total Assets

10,509 715 7,520 209 171 1,881 0 21,005

10,663 515 7,127 359 142 1,892 0 20,698

10,889 505 6,859 910 149 1,987 0 21,298

11,073 495 8,391 1,456 157 2,086 0 23,658

11,219 485 8,123 2,083 164 2,190 0 24,264

ST Debt Creditors Other Current Liab LT Debt Other LT Liabilities Shareholder’s Equity Minority Interests Total Cap. & Liab.

0 3,981 14 4,571 1,103 11,041 295 21,005

0 3,956 18 3,952 1,063 11,293 416 20,698

0 3,956 18 3,952 1,280 11,546 546 21,298

0 3,956 18 5,752 1,493 11,763 676 23,658

0 3,956 18 5,752 1,715 12,017 806 24,264

Non-Cash Wkg. Capital Net Cash/(Debt) Debtors Turn (avg days) Creditors Turn (avg days) Inventory Turn (avg days) Asset Turnover (x) Current Ratio (x) Quick Ratio (x) Net Debt/Equity (X) Net Debt/Equity ex MI (X) Capex to Debt (%) Z-Score (X)

(1,943) (4,362) 56.0 618.7 26.0 0.6 0.6 0.5 0.4 0.4 27.0 1.4

(1,940) (3,593) 42.3 226.6 8.9 0.8 0.6 0.6 0.3 0.3 29.6 1.7

(1,838) (3,042) 38.9 163.5 6.0 0.9 0.8 0.7 0.3 0.3 32.9 1.8

(1,732) (4,296) 45.8 213.7 8.3 0.7 0.9 0.9 0.3 0.4 22.6 1.5

(1,619) (3,669) 47.1 215.0 8.7 0.7 1.1 1.1 0.3 0.3 22.6 1.5

Source: Company, DBS Vickers

ASIAN INSIGHTS Page 25

VICKERS SECURITIES

Company Guide Hutchison Telecom

Cash Flow Statement (HK$ m) FY Dec

2013A

2014A

2015F

2016F

2017F

Pre-Tax Profit Dep. & Amort. Tax Paid Assoc. & JV Inc/(loss) (Pft)/ Loss on disposal of FAs Chg in Wkg.Cap. Other Operating CF Net Operating CF Capital Exp.(net) Other Invts.(net) Invts in Assoc. & JV Div from Assoc & JV Other Investing CF Net Investing CF Div Paid Chg in Gross Debt Capital Issues Other Financing CF Net Financing CF Currency Adjustments Chg in Cash Opg CFPS (HK$) Free CFPS (HK$)

1,167 1,335 (11) 12 0 (832) 64 1,735 (1,234) 0 0 0 (337) (1,571) (929) 800 0 (8) (137) 0 27 0.53 0.10

1,168 1,321 (12) 35 0 (112) 83 2,483 (1,168) 0 0 0 85 (1,083) (591) (650) 0 (9) (1,250) 0 150 0.54 0.27

1,270 1,342 (12) 10 0 (102) (20) 2,489 (1,300) 0 0 0 20 (1,280) (658) 0 0 0 (658) 0 551 0.54 0.25

1,252 1,384 (12) 10 0 (107) (20) 2,506 (1,300) (1,800) 0 0 20 (3,080) (680) 1,800 0 0 1,120 0 547 0.54 0.25

1,301 1,422 (12) 10 0 (112) (20) 2,590 (1,300) 0 0 0 20 (1,280) (683) 0 0 0 (683) 0 627 0.56 0.27

Source: Company, DBS Vickers

ASIAN INSIGHTS

VICKERS SECURITIES Page 26

Company Guide Hutchison Telecom

Target Price & Ratings History S.No. Dat e

6

1: 2: 3: 4: 5: 6: 7: 8:

30-J an-15 17-F eb-15 27-J ul-15 5-Aug-15 27-Oct-15 27-Nov -15

Closing Pric e HK$3.53 HK$3.46 HK$3.43 HK$3.35 HK$3.04 HK$2.79

T arget Pric e HK$3.20 HK$3.50 HK$3.40 HK$3.70 HK$3.70 HK$2.70

Rat ing Hold Hold Hold Hold Hold Hold

Jan-16

5

Dec-15

Oct-15

Sep-15

4

Aug-15

Jul-15

Jun-15

May-15

Apr-15

3

Nov-15

2

Mar-15

1

Feb-15

Jan-15

HK$ 4.0 3.8 3.6 3.4 3.2 3.0 2.8 2.6 2.4 2.2 2.0

Source: DBS Vickers

ASIAN INSIGHTS Page 27

VICKERS SECURITIES

China / Hong Kong Company Guide

SmarTone Version 2 |Bloomberg: 315 HK EQUITY

| Reuters: 315.HK Refer to important disclosures at the end of this report

DBS Group Research . Equity

26 January 2016

BUY

Robust service revenue outlook

Last Traded Price: HK$11.72 (HSI : 19,340) Price Target: HK$13.00 (11% upside) (Prev HK$15.00) Potential Catalyst: Price hike, avaliability of “star” handsets Where we differ: Our earnings estimates for FY6/15-FY6/16F are lower than concensus Analyst Tsz Wang TAM CFA, +852 2971 1772 [email protected]

Focusing on lower-tier and top-up plans SMT continues to benefit from the disciplined price competition environment. It has further raised the price for the 3G speed-capped plan by HK$10 or c.10% in 2015. We believe further tariff hikes will focus on the lower-tier plans to narrow the gap between lower-tier and high-tier plans to prevent trade downs. SMT also raised the price of the unlimited data top-up plan from HK$128 to HK$148 in 4Q15.

Chris KO [email protected] Price Relative HK$

Relative Index

18.7 204 16.7

184

14.7

164 144

12.7

124 104

10.7

84 8.7 6.7 Jan-12

64 Jan-13

SmarTone (LHS)

Forecasts and Valuation FY Jun (HK$ m) Turnover EBITDA Pre-tax Profit Net Profit Net Pft (Pre Ex) Net Profit Gth (Pre-ex) (%) EPS (HK$) EPS Gth (%) Diluted EPS (HK$) DPS (HK$) BV Per Share (HK$) PE (X) P/Cash Flow (X) P/Free CF (X) EV/EBITDA (X) Net Div Yield (%) P/Book Value (X) Net Debt/Equity (X) ROAE (%)

Jan-14

44 Jan-16

Jan-15

Relative HSI INDEX (RHS)

2014A 13,244 2,456 663 537 537

2015A 18,659 2,857 1,131 935 935

2016F 13,822 2,878 1,058 875 875

(36.3)

74.2

(6.4)

9.5

0.52 (36.4) 0.52 0.31 3.08 22.7 5.7 9.2 4.9 2.7 3.8 CASH 17.4

0.89 72.6 0.89 0.60 3.64 13.1 4.2 5.6 3.9 5.1 3.2 CASH 26.6

0.83 (6.4) 0.83 0.62 3.86 14.0 4.3 5.7 4.5 5.3 3.0 0.1 22.1

0.91 9.5 0.91 0.68 4.12 12.8 4.3 5.6 4.1 5.8 2.8 CASH 22.7

B: 8

Nil 0.85 S: 0

Nil 0.92 H: 4

Earnings Rev (%): Consensus EPS (HK$) Other Broker Recs:

Source of all data: Company, DBSV, Thomson Reuters, HKEX

ASIAN INSIGHTS sa- DL

A key beneficiary of tariff hike We have a BUY rating on SmarTone (SMT). SMT, being a smaller player, focuses on high-end subs. It is also adding lower-end subs without jeopardising its market position in the high-end market. As a pure mobile operator, SMT is the key beneficiary from the industry-wide tariff hike in the mobile market. Despite short-term downside risk from handset sales, outlook for core earnings from mobile services remains positive.

2017F 14,008 3,013 1,158 958 958

Weak handset sales partly offset by growing mobile service Demand for iPhone 6S is lower than iPhone 6 in HK. We expect pretax earnings from handset sales to drop by more than 50% but it is partly offset by a c.28% increase in mobile service, resulting in a c.6% drop in the net profit to HK$875m for FY6/16F. We forecast the net profit to grow by 10% to HK$958m in FY6/17F, driven by continuous ARPU increase. The company has raised its dividend payout ratio to 75% in 2H6/15 and the stock price currently offers c.6% dividend yield for FY6/16F. Valuation: We have a BUY rating on SMT as it is a beneficiary of mobile data tariff hike. It currently offers a decent dividend yield of c.6% for FY6/16. We lowered our target price to HK$13.0, pegged at 15x FY8/16F PE (vs previously 18x FY6/16F PE), to reflect a less exciting sector outlook. Key Risks to Our View: Irrational market competition. Hong Kong's mobile market is crowded with four major players and the penetration is more or less saturated. Irrational pricing may lead to a price war. Lack of “star” handsets. Handset sales depend on the popularity of the new smartphones. Lack of “star” handsets could result in lower handset sales volume and margins. And operators would have weaker pricing power to raise the tariffs for handset-bundled mobile data plans. At A Glance 1,062 Issued Capital (m shrs) 12,446 / 1,597 Mkt. Cap (HK$m/US$m) Major Shareholders Sun Hung Kai Properties Limited (%) 67.0 33.0 Free Float (%) 3m Avg. Daily Val. (US$m) 3.6 ICB Industry : Telecommunications / Mobile Telecommunications

VICKERS SECURITIES

Company Guide SmarTone

CRITICAL DATA POINTS TO WATCH Earnings Drivers: Tariff hike. The competitive environment has improved since the merger of HKT and CSL. Operators have been able to raise the tariffs for mobile data plans in the past 1-2 years. The market has been recently focusing more on raising the tariffs for lower-tier plans and launching various top-up plans to monetise more data usage. SMT has further increased the price for the 3G speed-capped plan from HK$78 to HK$88 per month in FY15. It has also increased the price of its unlimited data top-up plan from HK$128 to HK$148. ARPU uplift will be a key earnings growth driver. Mobile sub growth. Hong Kong's mobile market is more or less matured with low-single-digit sub growth in the past two years. There are four major players: HKT, Hutchison Telecom, SmarTone and China Mobile Hong Kong with market shares of c.33%, c.20%, c.14% and c.20% in 2014 respectively. SMT has a total sub base of 1,960m in FY6/15 with c.70% post-paid subs and c.30% prepaid subs. Speed-capped plan subs accounted for 1/3 of post paid sub base, and mid-tohigh end subs accounted for the remaining 2/3. We believe that SMT will continue to grow its mobile sub base, in particular the lower-tier segment where it has less penetration.

Sub base (k) 1,820

1,880

1,960

2,010

2,040

2015A

2016F

2017F

1,800 1,500 1,200 900 600 300 0 2013A

2014A

ARPU (HK$) 273 244

241

2014A

2015A

250

253

2016F

2017F

223 167 111 56 0 2013A

Source: Company, DBS Vickers

Availability of “star” handsets. Handset sales depend on the popularity of the new smartphones. Availability of “star” handsets could result in higher handset sales volume and margins. Mobile operators would also have stronger pricing power to raise the tariffs for handset-bundled mobile data plans.

ASIAN INSIGHTS Page 29

VICKERS SECURITIES

Company Guide SmarTone

Leverage & Asset Turnover (x)

Balance Sheet: Strong balance sheet to support mobile spectrum fee. SMT has a strong balance sheet with a net cash position of HK$1.2bn by end of FY6/15. We expect SMT to pay c.HK$2.3bn for the 2.1GHz spectrum utilisation fees in FY6/16F. Thereafter, we expect a net gearing ratio of 16%, which is healthy.

1.9

0.90 0.80

1.8

0.70

1.7

0.60 1.6

0.50

1.5

0.40 0.30

1.4

0.20 1.3

0.10

Share Price Drivers: Tariff hike. Operators have been able to raise mobile tariff in the past 1-2 years. The market has been recently focusing more on raising the tariffs for lower-tier plans and launching various topup plans to monetise more data usage. ARPU uplift will be a key share price catalyst.

0.00

1.2 2013A

2014A

2015A

2016F

Gross Debt to Equity (LHS)

2017F

Asset Turnover (RHS)

Capital Expenditure (HK$m) HK$ 1,400.0 1,200.0 1,000.0 800.0

Mobile sub growth. Hong Kong mobile market penetration is more or less matured with low-single-digit sub growth in the past two years. Further sub growth will be mostly coming from market share gain. We believe that SMT will continue to grow its mobile sub base, in particular the lower-tier segment where it has less penetration. Availability of “star” handsets. Availability of “star” handsets could result in higher handset sales volume and margins. Mobile operators would also have stronger pricing power to raise the tariffs for handset-bundled mobile data plans.

600.0 400.0 200.0 0.0 2013A

2014A

2015A

2016F

2017F

Capital Expenditure (-)

ROE 25.0% 20.0% 15.0% 10.0% 5.0%

Key Risks: Irrational market competition. Hong Kong's mobile market is crowded with four major players and the penetration is more or less saturated. Irrational pricing may lead to a price war.

0.0% 2013A

2014A

2015A

2016F

2017F

Forward PE Band (x) 27.6

Lack of “star” handsets. Handset sales depend on the popularity of the new smartphones. Lack of “star” handsets could result in lower handset sales volume and margins. And operators would have weaker pricing power to raise tariffs for handset-bundled mobile data plans.

Company Background Smartone is a mobile operator in Hong Kong focusing on the high-end customer segment. It has a c.14% mobile sub market share. It also provides fixed-line broadband services through partnership with HKBN. Its major shareholder is Sun Hung Kai Properties.

+2sd: 25.1x 22.6

+1sd: 20.9x 17.6

Avg: 16.8x ‐1sd: 12.7x

12.6

7.6 Jan-12

‐2sd: 8.6x Jan-13

Jan-14

Jan-15

Jan-16

PB Band 6.5

(x)

6.0

+2sd: 5.76x

5.5 5.0

+1sd: 4.9x

4.5

Avg: 4.04x

4.0 3.5

‐1sd: 3.17x

3.0 2.5 2.0 Jan-12

‐2sd: 2.31x Jan-13

Jan-14

Jan-15

Jan-16

Source: Company, DBS Vickers

ASIAN INSIGHTS

VICKERS SECURITIES Page 30

Company Guide SmarTone

Key Assumptions FY Jun Sub base (k) ARPU

2013A

2014A

2015A

2016F

2017F

1,820.0 273.0

1,880.0 244.0

1,960.0 241.0

2,010.0 250.0

2,040.0 253.0

2013A

2014A

2015A

2016F

2017F

5,657

5,423

5,564

5,965

6,151

6,410

7,822

13,095

7,857

7,857

12,067

13,244

18,659

13,822

14,008

2013A 12,067 (6,214) 5,852 (4,829) 1,023 0 0 (8) 0 0 1,015 (167) (5) 0 843 843 2,876

2014A 13,244 (7,743) 5,502 (4,801) 700 0 0 (38) 0 0 663 (131) 5 0 537 537 2,456

2015A 18,659 (12,708) 5,951 (4,782) 1,169 0 0 (39) 0 0 1,131 (195) 0 0 935 935 2,857

2016F 13,822 (7,755) 6,067 (4,955) 1,112 0 0 (55) 0 0 1,058 (183) 0 0 875 875 2,878

2017F 14,008 (7,755) 6,253 (5,023) 1,230 0 0 (72) 0 0 1,158 (200) 0 0 958 958 3,013

21.2 0.6 (16.8) (17.6)

9.8 (14.6) (31.6) (36.3)

40.9 16.3 67.0 74.2

(25.9) 0.7 (4.8) (6.4)

1.3 4.7 10.6 9.5

48.5 8.5 7.0 27.7 9.9 14.8 81.2 132.8

41.5 5.3 4.1 17.4 5.5 8.1 60.1 18.6

31.9 6.3 5.0 26.6 9.1 13.3 67.8 30.3

43.9 8.0 6.3 22.1 8.0 11.9 75.0 20.4

44.6 8.8 6.8 22.7 8.7 12.9 75.0 17.1

Segmental Breakdown (HK$ m) FY Jun Revenues (HK$ m) Mobile service Handset and accessory sales Total

Source: Company, DBS Vickers

Income Statement (HK$ m) FY Jun Revenue Cost of Goods Sold Gross Profit Other Opng (Exp)/Inc Operating Profit Other Non Opg (Exp)/Inc Associates & JV Inc Net Interest (Exp)/Inc Dividend Income Exceptional Gain/(Loss) Pre-tax Profit Tax Minority Interest Preference Dividend Net Profit Net Profit before Except. EBITDA Growth Revenue Gth (%) EBITDA Gth (%) Opg Profit Gth (%) Net Profit Gth (%) Margins & Ratio Gross Margins (%) Opg Profit Margin (%) Net Profit Margin (%) ROAE (%) ROA (%) ROCE (%) Div Payout Ratio (%) Net Interest Cover (x)

Source: Company, DBS Vickers

ASIAN INSIGHTS Page 31

VICKERS SECURITIES

Company Guide SmarTone

Interim Income Statement (HK$ m) FY Jun

Revenue Cost of Goods Sold Gross Profit Other Oper. (Exp)/Inc Operating Profit Other Non Opg (Exp)/Inc Associates & JV Inc Net Interest (Exp)/Inc Exceptional Gain/(Loss) Pre-tax Profit Tax Minority Interest Net Profit Net profit bef Except.

Growth Revenue Gth (%) Opg Profit Gth (%) Net Profit Gth (%) Margins Gross Margins (%) Opg Profit Margins (%) Net Profit Margins (%) Source: Company, DBS Vickers

2H2013

1H2014

2H2014

1H2015

2H2015

6,178 (3,287) 2,891 (2,386) 506 0 0 (47) 0 459 (77) 1 384 384

6,531 (3,702) 2,829 (2,399) 431 0 0 (66) 0 364 (56) 3 311 311

6,713 (4,041) 2,672 (2,296) 377 0 0 (78) 0 298 (75) 2 226 226

8,673 (5,675) 2,997 (2,375) 623 0 0 (59) 0 564 (96) (1) 466 466

9,986 (7,032) 2,954 (2,333) 621 0 0 (54) 0 567 (99) 1 469 469

26.3 (29.9) (29.9)

10.9 (30.2) (32.2)

8.7 (25.5) (41.2)

32.8 44.5 49.8

48.7 64.9 107.7

46.8 8.2 6.2

43.3 6.6 4.8

39.8 5.6 3.4

34.6 7.2 5.4

29.6 6.2 4.7

ASIAN INSIGHTS

VICKERS SECURITIES Page 32

Company Guide SmarTone

Balance Sheet (HK$ m) FY Jun

2013A

2014A

2015A

2016F

2017F

Net Fixed Assets Invts in Associates & JVs Other LT Assets Cash & ST Invts Inventory Debtors Other Current Assets Total Assets

3,201 0 3,077 2,514 103 399 335 9,628

3,411 0 2,464 3,169 80 436 232 9,792

3,354 0 2,424 4,155 82 332 466 10,814

3,259 0 4,510 2,423 82 254 466 10,995

3,116 0 4,290 3,011 82 194 466 11,159

ST Debt Creditors Other Current Liab LT Debt Other LT Liabilities Shareholder’s Equity Minority Interests Total Cap. & Liab.

65 537 2,094 2,530 1,354 2,986 62 9,628

101 778 2,070 2,739 854 3,193 57 9,792

124 755 2,413 2,844 770 3,851 57 10,814

124 732 2,459 2,844 696 4,082 57 10,995

124 711 2,447 2,844 621 4,355 56 11,159

(1,794) (81) 11.2 48.2 15.0 1.4 1.2 1.1 0.0 0.0 48.4 3.2

(2,100) 329 11.5 40.1 5.6 1.4 1.3 1.2 CASH CASH 29.0 3.2

(2,287) 1,186 7.5 25.4 2.7 1.8 1.5 1.4 CASH CASH 25.5 3.8

(2,389) (546) 7.7 45.3 5.0 1.3 1.0 0.8 0.1 0.1 22.9 3.1

(2,415) 42 5.8 44.1 5.0 1.3 1.1 1.0 CASH CASH 22.9 3.3

Non-Cash Wkg. Capital Net Cash/(Debt) Debtors Turn (avg days) Creditors Turn (avg days) Inventory Turn (avg days) Asset Turnover (x) Current Ratio (x) Quick Ratio (x) Net Debt/Equity (X) Net Debt/Equity ex MI (X) Capex to Debt (%) Z-Score (X)

Source: Company, DBS Vickers

ASIAN INSIGHTS Page 33

VICKERS SECURITIES

Company Guide SmarTone

Cash Flow Statement (HK$ m) FY Jun

2013A

2014A

2015A

2016F

2017F

Pre-Tax Profit Dep. & Amort. Tax Paid Assoc. & JV Inc/(loss) (Pft)/ Loss on disposal of FAs Chg in Wkg.Cap. Other Operating CF Net Operating CF Capital Exp.(net) Other Invts.(net) Invts in Assoc. & JV Div from Assoc & JV Other Investing CF Net Investing CF Div Paid Chg in Gross Debt Capital Issues Other Financing CF Net Financing CF Currency Adjustments Chg in Cash Opg CFPS (HK$) Free CFPS (HK$)

1,015 1,717 (9) 0 0 (334) 252 2,641 (1,255) (1,873) 78 0 (1,744) (4,795) (998) 2,526 (50) 52 1,531 0 (623) 2.87 1.34

663 1,627 (181) 0 0 (153) 198 2,154 (824) (665) 0 0 629 (860) (285) 236 2 (57) (104) 0 1,191 2.22 1.28

1,131 1,480 (258) 0 0 359 236 2,947 (757) (1,117) 0 0 (444) (2,319) (392) 116 110 4 (163) 1 467 2.47 2.09

1,058 1,575 (183) 0 0 142 257 2,849 (680) (3,255) 0 0 (1) (3,936) (645) 0 0 0 (645) 0 (1,732) 2.58 2.07

1,158 1,593 (200) 0 0 64 257 2,872 (680) (918) 0 0 (1) (1,599) (685) 0 0 0 (685) 0 588 2.68 2.09

Source: Company, DBS Vickers

ASIAN INSIGHTS

VICKERS SECURITIES Page 34

Company Guide SmarTone

Target Price & Ratings History S.No. Dat e

HK$ 17.0 16.0

1

15.0

3

2

4

5

1: 2: 3: 4: 5: 6:

6

14.0 13.0

30-J an-15 18-F eb-15 27-J ul-15 2-Sep-15 19-Oct-15 27-Nov -15

Closing Pric e HK$13.40 HK$13.00 HK$15.34 HK$14.28 HK$13.94 HK$11.74

T arget Pric e HK$16.00 HK$16.00 HK$16.00 HK$17.00 HK$17.00 HK$15.00

Rat ing Buy Buy Buy Buy Buy Buy

12.0

Jan-16

Dec-15

Nov-15

Oct-15

Sep-15

Aug-15

Jul-15

Jun-15

May-15

Apr-15

Mar-15

Feb-15

10.0

Jan-15

11.0

Source: DBS Vickers

ASIAN INSIGHTS Page 35

VICKERS SECURITIES

Industry Focus Hong Kong Telecom Sector

DBSV recommendations are based an Absolute Total Return* Rating system, defined as follows: STRONG BUY (>20% total return over the next 3 months, with identifiable share price catalysts within this time frame) BUY (>15% total return over the next 12 months for small caps, >10% for large caps) HOLD (-10% to +15% total return over the next 12 months for small caps, -10% to +10% for large caps) FULLY VALUED (negative total return i.e. > -10% over the next 12 months) SELL (negative total return of > -20% over the next 3 months, with identifiable catalysts within this time frame)

Share price appreciation + dividends GENERAL DISCLOSURE/DISCLAIMER This report is prepared by DBS Vickers (Hong Kong) Limited (“DBSVHK”) This report is solely intended for the clients of DBS Bank Ltd, DBS Vickers Securities (Singapore) Pte Ltd and DBSVHK, its respective connected and associated corporations and affiliates only and no part of this document may be (i) copied, photocopied or duplicated in any form or by any means or (ii) redistributed without the prior written consent of DBSVHK. The research set out in this report is based on information obtained from sources believed to be reliable, but we (which collectively refers to DBSVHK, its respective connected and associated corporations, affiliates and their respective directors, officers, employees and agents (collectively, the “DBS Group”)) do not make any representation or warranty as to its accuracy, completeness or correctness. Opinions expressed are subject to change without notice. This document is prepared for general circulation. Any recommendation contained in this document does not have regard to the specific investment objectives, financial situation and the particular needs of any specific addressee. This document is for the information of addressees only and is not to be taken in substitution for the exercise of judgement by addressees, who should obtain separate independent legal or financial advice. The DBS Group accepts no liability whatsoever for any direct, indirect and/or consequential loss (including any claims for loss of profit) arising from any use of and/or reliance upon this document and/or further communication given in relation to this document. This document is not to be construed as an offer or a solicitation of an offer to buy or sell any securities. The DBS Group, along with its affiliates and/or persons associated with any of them may from time to time have interests in the securities mentioned in this document. The DBS Group may have positions in, and may effect transactions in securities mentioned herein and may also perform or seek to perform broking, investment banking and other banking services for these companies. Any valuations, opinions, estimates, forecasts, ratings or risk assessments herein constitutes a judgment as of the date of this report, and there can be no assurance that future results or events will be consistent with any such valuations, opinions, estimates, forecasts, ratings or risk assessments. The information in this document is subject to change without notice, its accuracy is not guaranteed, it may be incomplete or condensed and it may not contain all material information concerning the company (or companies) referred to in this report. The valuations, opinions, estimates, forecasts, ratings or risk assessments described in this report were based upon a number of estimates and assumptions and are inherently subject to significant uncertainties and contingencies. It can be expected that one or more of the estimates on which the valuations, opinions, estimates, forecasts, ratings or risk assessments were based will not materialize or will vary significantly from actual results. Therefore, the inclusion of the valuations, opinions, estimates, forecasts, ratings or risk assessments described herein IS NOT TO BE RELIED UPON as a representation and/or warranty by the DBS Group (and/or any persons associated with the aforesaid entities), that: (a) (b)

such valuations, opinions, estimates, forecasts, ratings or risk assessments or their underlying assumptions will be achieved, and there is any assurance that future results or events will be consistent with any such valuations, opinions, estimates, forecasts, ratings or risk assessments stated therein.

Any assumptions made in this report that refers to commodities, are for the purposes of making forecasts for the company (or companies) mentioned herein. They are not to be construed as recommendations to trade in the physical commodity or in the futures contract relating to the commodity referred to in this report. DBS Vickers Securities (USA) Inc ("DBSVUSA")"), a U.S.-registered broker-dealer, does not have its own investment banking or research department, has not participated in any public offering of securities as a manager or co-manager or in any other investment banking transaction in the past twelve months and does not engage in market-making. ANALYST CERTIFICATION The research analyst(s) primarily responsible for the content of this research report, in part or in whole, certifies that the views about the companies and their securities expressed in this report accurately reflect his/her personal views. The analyst(s) also certifies that no part of his/her compensation was, is, or will be, directly, or indirectly, related to specific recommendations or views expressed in this report. As of 26 January 2016, the analyst(s) and his/her spouse and/or relatives who are financially dependent on the analyst(s), do not hold interests in the securities recommended in this report (“interest” includes direct or indirect ownership of securities). COMPANY-SPECIFIC / REGULATORY DISCLOSURES DBSVHK and its subsidiaries do not have a proprietary position in the securities recommended in this report as of 21 Jan 2016. 1. 2.

Page 36

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Industry Focus Hong Kong Telecom Sector RESTRICTIONS ON DISTRIBUTION General

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