3 JUNE 2011
Rich multimedia content to triple Internet data traffic in five years China optical broadband connections to triple in three years Optical network/component suppliers exposed to Asia Pacific will benefit Initiate coverage on O-Net and CCS with BUY ratings
Alen Lin
+852 2825 1801 alen.lin@asia.bnpparibas.com
Joyce Zhou
+852 2825 1120 joyce.zhou@asia.bnpparibas.com
ALEN LIN
3 JUNE 2011
Contents
1) Executive Summary .................................................................................................................................................................... 3 Tripling of optical broadband access in China..................................................................................................................... 3 Demand-driven network upgrades ...................................................................................................................................... 3 Optical networks at the core of higher data capacity........................................................................................................... 3 Initiate coverage of O-Net Comm, China ComService with BUY ........................................................................................ 3 2) Insatiable demand for data ......................................................................................................................................................... 5 Asia/Pacific data traffic to more than triple in five years ................................................................................................... 5 Data infrastructure capex set to rise.................................................................................................................................... 6 The rise of Chinese system and component suppliers ........................................................................................................ 7 China upgrades to optical broadband ............................................................................................................................... 10 3) The big deal about transmitting light ...................................................................................................................................... 12 Long-haul networks ........................................................................................................................................................... 12 Metro networks.................................................................................................................................................................. 14 Access networks ............................................................................................................................................................... 15 Key components in optical communications equipment .................................................................................................... 15 4) Demand-driven investments .................................................................................................................................................... 18 5) Company updates .................................................................................................................................................................... 19 O-Net................................................................................................................................................................................. 20 China ComService ............................................................................................................................................................ 36 ZTE Corp........................................................................................................................................................................... 55
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3 JUNE 2011
Executive Summary
Tripling of optical broadband access in China
We estimate China will continue its optical broadband upgrades through 2013, to provide broadband access of >20Mbps to nearly all of the 238m households located in cities that have more than 1.5m households. By the end of 2010, the number of households with >20Mbps connections was 80.5m, which implies a near-tripling in optical broadband access within three years. We estimate this represents approximately RMB187b in capex over the three-year timeframe. Of this total capex, we estimate RMB84b would be spent directly on broadband equipment, and the remaining on ancillary equipment and engineering/civil work.
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O-Net Communications (877 HK, BUY, CP: HKD3.55; TP: HKD4.90) As one of the worlds major passive optical component (OC) provider, we believe the company is well positioned to benefit from the massive global broadband build-out and upgrade, with its wide range of products and diversified customer base. Its advanced design and manufacturing technologies as well as the vertically-integrated business model should help O-Net maintain higher-than-industry growth rate and enjoy high margins in the coming years. Our target price of HKD4.90 is based on DCF valuation, with WACC of 12.5% and terminal growth of 2%. It translates to 20.1x 2011E P/E. ONet has a market cap of USD380m and three-month average daily trading volume of USD3.2m. China ComService (552 HK, BUY, CP: HKD4.81; TP: HKD6.06) With its leading position in the telecom infrastructure service (TIS) business and strong relationships with the three China telecom operators, we believe CCS will generate healthy revenue growth from China operators continuing capex on broadband upgrade and 3G network build-out. CCS is also increasing its exposure to operators opex by providing business process outsourcing (BPO) services, and applications, content and other services (ACO). In addition, we see further upside from the companys nonoperator business, which will benefit from the fast-growing government and enterprise IT spending in China. We also see huge upside from its overseas business, which we forecast will accelerate and contribute over 10% of revenue in 2013 (5% in 2010). Our target price of HKD6.06 is based on DCF valuation, assuming WACC of 10% and terminal growth of 2%. CCS has a market cap of USD3,569m and three-month average daily trading volume of USD7.0m. ZTE (763 HK, HOLD, CP: HKD27.05; TP: HKD31.00) We expect ZTE to be one of the beneficiaries of Chinas broadband upgrade cycle, as we estimate its combined revenue for the optical transport and wire line segments will grow 36% in 2011. However, we believe weaker mobile network revenue growth and weak handset margins will limit ZTEs overall profit growth in the near term, and we estimate net profit will grow 6.3% in 2011. Given the weak profit growth prospect, we maintain our HOLD recommendation and target price of HKD31.00 based on 25x 2011E P/E multiple. ZTE has a market cap of USD11.404b and three-month average daily trading volume of USD22.0m.
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North America Asia Pacific Latin America Middle East and Africa
2010
2011
2012
2013
2014
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market share for both optical transport and access network (Exhibits 9-10). ZTE also placed in the top four for both categories. Similarly, among the upstream suppliers, Chinese optical component suppliers including Accelink Technologies (002281 CH, Not rated) and O-Net Communications are becoming more important in the optical communications space. While the component space is still dominated by traditional suppliers including Finisar (FNSR US, Not rated), JDSU (JDSU US, Not rated), Avago (AVGO US, Not rated) and others; Accelink Technologies and O-Net Communications registered 2010 revenue growth of 25% and 95%, respectively. We believe Chinese component suppliers will also become more relevant going forward, as they increase their exposure to Chinese system integrators. Exhibit 2: Asia Pacific (ex-Japan) broadband and monthly Internet traffic
(Thousand connections) 300,000 250,000 200,000 150,000 100,000 50,000 0 2009
Source: BNP Paribas
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MEA has been in the 20% range in recent years. Globally, in 2010, capex on data infrastructure represented 39% of total telecom capex (Exhibit 5-6). Given the strong growth forecast in data traffic, as we discussed earlier, we believe spending on data infrastructure will remain robust, particularly for emerging markets that have under-spent in this category (Exhibit 4). Thee Gartner forecast indicates that while global spending on data infrastructure would see a five-year CAGR of 6.1% during 2010-15, Asia Pacific and Latin America would see stronger CAGRs of 8.3% (from USD7.9b to USD11.7b) and 8.8% (from USD1.7b to USD2.6b), respectively. Given the relatively high base of Asia Pacific, this is the region that offers the greatest opportunity for equipment providers; the region contributed to 24.5% of global spending on data infrastructure in 2010, second only to North America, which contributed 32.8% (Exhibit 7). Japan, Eastern Europe, Latin America and MEA all contributed to 5.1-6.4% each. Exhibit 4: Regional spending on data infrastructure/total capex
(%) 60 50 40 30 20 10 0 2007 2008 2009 2010 2011 2012 2013 Asia/Pacific Latin America Western Europe Eastern Europe Middle East & Africa Japan North America
Traditional switching Service 166 provider routers and switches 2,584 Optical transport 3,640
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represented 31.8% of the regions total telecom capex (Exhibit 8); this is likely to continue rising as it is still below the levels of the mature markets. Exhibit 7: Regional contribution to global data infrastructure capex (2010)
Western Europe 19.9% Asia/Pacific 24.5% Eastern Europe 6.0% Japan 6.4% North America 32.8% Latin America 5.4%
System integrators Huawei and ZTE rise to top At the global level, Chinese equipment providers, Huawei and ZTE, are increasingly becoming major players in the optical communications space. In 2010, Huawei topped the optical transport segment with 20.1% global market share, and ZTE came in third with 7.3% market share (Exhibit 9). Similarly for the access network category, Huawei topped the list with 14.7% global market share, and ZTE was fourth with a 10% share. Our discussions with Huaweis product team responsible for optical networks also indicate its dominance in this space. Huawei indicated that it held 27% global market share in signal aggregation equipment, 26% share in bandwidth management category, 18% share in metro WDM, and 25% in backbone WDM. Overall, it estimates that it holds a 23.2% market share in optical data transport. Within the Asia Pacific region, in 2010, Huawei and ZTE captured the top two positions in optical transport with market shares of 47.5% and 22%, respectively (Exhibit 11). Similarly for access network where Huawei and ZTE also occupied the top two positions with 29.5% and 27.7%, respectively (Exhibit 12). The market share data clearly illustrates the high leverage Huawei and ZTE have to the Asia Pacific region. We believe Huawei and ZTE would be key beneficiaries in the coming years driven by strong data traffic growth in Asia Pacific.
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Others 31.0%
Others 27.3%
AlcatelLucent 16.1%
AlcatelLucent 14.6%
Tellabs 4.4%
ZTE 22.0%
Samsung 9.9%
Sources: Gartner; BNP Paribas
Optical component suppliers early phase for Chinese suppliers Going up the value chain, we note that traditional optical component suppliers are mostly dominated by US and Japanese suppliers including Finisar, Sumitomo (5802 JP, Not rated), JDSU, Avago and others (Exhibit 13). Chinese optical component suppliers are gaining traction; they include Accelink Technologies and O-Net. While they still lack the full breadth of products that their foreign competitors have, the Chinese suppliers are expanding their respective customer bases and product offerings. Accelink indicated that it derived about 40% of revenue from its optical amplifier products, and 35% from domestic equipment providers, primarily Huawei, ZTE and Fiberhome. For O-Net, 96% of 2010 revenue was derived from its power management, transmission management, and wavelength management products; we provide more details on O-Net in our initiation report, O-Net: Speeding up the internet. Other Chinese suppliers include Jiangsu Zhongtian Technology (600522 CH, Not rated) and Yangtze Optical Fibre and Cable Co (private) that specializes in optical fibers and cables.
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Exhibit 13: Global optical component market share (4 quarters ending 2Q10)
Finisar 14.9% Sumitomo 10.6%
Others 42.9%
JDSU 9.0%
Opnext 6.6%
Oclaro 7.4%
Avago 8.6%
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Long-haul networks
This part of the data network provides data transport between major metropolitan areas and serves as the backbone of the data network. The main characteristics of long-haul networks are to provide high capacity over long distances. The equipment employed includes Dense Wavelength Division Multiplex (DWDM) transmission and detection equipment that transport data over fiber cables. On DWDM networks, signals are effectively carried on multiple wavelengths (channels) and transmitted over single strands of fiber lines (Exhibit 17); as more wavelengths are packed into limited optical spectrum, the accuracy of transmission and reception equipment becomes increasingly critical. In addition, as distance and data capacity are increased on these fiber cables, equipment to amplify and condition the signals also become necessary to retain signal integrity. Exhibit 17: DWDM network concept
Source: Cisco
While the optical fiber cables are very costly to install, and are mostly fixed, the capacity supported over the cables continues to increase with equipment upgrades that enable more data to be transported. Capacity increase can be achieved through increasing data speed per wavelength, and increasing the number of wavelengths per strand of fiber. The former approach utilized more advanced signal modulation techniques, such as DQPSK (differential quatrature phase shift keying); the latter approach is to reduce the spacing between distinct wavelengths (carriers), thus packing more carriers onto the optical fiber. Current commercial systems mostly utilize 2.5Gb/s (2.5G) and 10Gb/s (10G) per wavelength, and can support up to 80 wavelengths per strand of fiber. 40G upgrades are currently in progress on high-traffic networks (Exhibit 18). According to Huawei, it has captured 44% of the 40G market share globally, with Ciena (CIEN US, Not rated) in second position with 15% market share. 100G systems have also been demonstrated in
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trials; however, the current high cost is prohibitive for mass commercial rollout of such technology. Our checks with industry experts suggest that mainstream commercial deployment of 100G systems may be close to five years away. Exhibit 18: DWDM interface modules spending
(USD m) 1,200 1,000 800 600 400 200 0 2008
Sources: Ovum; BNP Paribas
10G
40G
100G
2009
2010
2011
2012
2013
A sample national fiber backbone China Telecom An illustration of China Telecoms national fiber network backbone is shown in Exhibit 19. The network map indicates major network hubs in the cities of Beijing, Nanjing, Shanghai, Wuhan, Guangzhou, Xian, and Chengdu. From these network hubs, an extensive web of network extends to all major cities throughout China, and to overseas networks in Japan, the US, Korea, Europe, and Southeast Asia. Our checks with China Telecom (728 HK, BUY, CP HKD4.67) indicate that most of its backbone network is on 2.5G and 10G technologies; 40G technology is currently in the testing phase and likely to be rolled out in the near future. Also, unique to China Telecom is its CN2 network it is effectively a parallel network to the public fiber backbone that is intended to offer better quality of service for enterprise customers compared to the public data network.
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Metro networks
Metro networks, frequently referred to as metro rings, are extensions from the backbone network to provide metropolitan data coverage. They connect from the national backbone and provide local data bus for access networks (Exhibit 20). These systems utilize many of the same subsystem components as in long-haul networks including DWDM equipment; however, they are configured for metropolitan coverage rather than long-haul data transport. As such, they are likely to include components such as OADM (optical add/drop module) to route signals out of and on to the metro ring. Also, as the distance of data transport tends to be shorter than on long-haul networks, trade-offs can be made in network designs. For example, CWDM (coarse wavelength division multiplexing) may be used in place of DWDM for short distance transmission; CWDM can use lower precision lasers that are cheaper than those used in DWDM systems.
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Access networks
Access networks
Access networks make the connection between a users device and the core network via metro networks. One common approach is to provide optical broadband access using FTTx (fiber to the premise) approach where optical signals are routed to/from the user premise. These networks are mostly enabled with EPON (Ethernet passive optical network) and GPON (Gigabit passive optical network), which connects the metro ring and the user premise. This approach is also referred to as a centralized network where the active routing of signals occurs at the operators facilities. The use of passive optical network has the advantage of lower maintenance cost, as there is limited use of active components that are frequent source of failures. A different approach that is utilized by Hong Kongs City Telecom (1137 HK, Not rated) is a distributed network where data routers are placed inside large residential buildings, and traditional copper based Ethernet cables connect the users to the routers. As copper cables can only support high-speed data over short distance, such architecture is only feasible in high density areas such as Hong Kong. According to City Telecom, the setup cost for such network architecture is only 25% of GPON setup as no user premise equipment is necessary. Additional details on City Telecom were published in our Greater China Connections dated 23 May 2011.
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A number of optical components manufactured by O-Net are used for the DWDM subsystem (refer to the O-Net report, Speeding up the internet); they include DPSK demodulators (differential phase-shift keying), tunable filters, signal isolators, signal amplifiers, and wavelength locker. In some DWDM subsystems, OADM (optical drop/add modules) can also be used to extract signals from a cable, and insert signals into a cable where needed. For high bit rate transmission such as 40G networks, TDC (tunable dispersion compensator) products are also necessary to maintain signal integrity; this is potentially a strong growth driver for O-Net as the ASP for TDC is estimated to be over USD1,000 per unit. The company indicated that it plans to launch its TDC product around mid-2011. Exhibit 21: Optical spectrum allocations
Source: Cisco
Access network subsystem components At the access network level, passive components that combine and split signals, and customer premise equipment that convert optical signals to electrical signals, make up much of the network. The main function at this level is to maximize termination points for the network like maximizing the number of on/off ramps for highways. Specific components used in access network subsystems include PON (passive optical networks), splitter modules, isolators, optical triplexers, etc.
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System integrators
ZTE Corp Huawei Ericsson Alcatel-Lucent Motorola Solutions Tellabs Inc Juniper Networks Ciena Corp Cisco Systems 763 HK Private ERICB SS ALU FP MSI US TLAB US JNPR US CIEN US CSCO US
Key Players
Oplink Communications Finisar Corp JDS Uniphase Corp Alliance Fiber Optic Opnext Inc Avago NeoPhotonics MRV Communications Emcore Corp
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Demand-driven investments
Despite the short-term volatility in optical communications equipment cycles, we believe the secular trend of investments in more bandwidth and more broadband connections will continue. We believe bandwidth-hungry multimedia services such as Netflix, PPTV, BitTorrent, and others will rapidly gain popularity and continue to drive up demand for more data capacity. While high-quality multimedia streaming services are becoming more common in developed markets such as the US, we believe they are still in the early stages for the emerging markets. These high-quality multimedia services are the main driver for potential tripling of data traffic in Asia Pacific over a five-year span. In order to satisfy such high growth in data capacity demand, we believe optical communications will play a central role in data infrastructure. While the traditional communications equipment providers still play an important role in the optical communications space, increasingly, Chinese suppliers such as Huawei and ZTE have risen to become relevant. As these Chinese system integrators are also highly leveraged to the emerging markets, including the Asia Pacific markets, we believe they are well positioned for above-average industry growth in the current upgrade cycle. Going upstream to the optical component suppliers, this space is dominated by US and Japanese suppliers. However, Chinese suppliers such as Accelink Technologies and O-Net are starting to gain momentum on sub-categories of optical components. We believe as their respective exposures to the Asia Pacific markets increase, they are also well positioned for continuing growth. As China undergoes the multi-year upgrade cycle of its broadband network, we expect a significant part of the overall capex to be allocated to engineering and civil work. We believe companies such as China ComService that have strong relationships with telecom operators and solid experience in communication networks will also benefit from the upgrade cycle. Exhibit 23: Valuation comparison
Share Company BBG code price Market cap P/E 2011E (x) 14.9 35.5 15.3 na 10.9 14.3 20.5 13.4 na 62.5 27.6 na 20.4 2012E (x) 12.2 28.0 12.7 49.7 12.4 13.4 17.2 9.6 na 22.5 12.5 34.6 18.2 EV/EBITDA 2011E (x) 10.0 25.8 9.0 21.3 4.3 9.4 12.0 4.6 (10.2) 8.4 5.5 na 11.6 2012E (x) 8.0 20.5 8.1 10.4 3.2 7.8 9.3 3.3 15.9 6.5 3.2 na 9.5 P/BV 2011E (x) 2.1 4.9 2.8 1.8 1.5 3.1 4.2 na 1.0 1.1 na na 3.5 2012E (x) 1.8 4.3 2.3 1.6 1.3 2.7 3.8 na 1.1 1.2 na na 3.1 Yield 2011E (%) 0.0 0.7 na na na na na na 0.1 2012E (%) 0.0 0.8 na na na na na na na 0.1 ROE 2011E (%) 15.0 14.0 21.3 (8.4) 10.4 19.0 8.5 na (13.0) 3.2 na na 11.5 2012E (%) 15.6 15.5 21.2 11.2 8.5 18.8 13.2 na (13.8) 5.2 na na 14.5
(LC) (USD m) Optical components & fiber O-Net Communications Accelink Technologies Jiangsu Zhongtian Oclaro Oplink Communications Finisar JDS Uniphase Alliance Fiber Optic Opnext NeoPhotonics MRV Communications Emcore Corp 877 HK 002281 CH 600522 CH OCLR US OPLK US FNSR US JDSU US AFOP US OPXT US NPTN US MRVC US EMKR US 3.63 36.35 23.54 8.90 18.33 22.29 19.18 9.14 2.72 9.50 1.38 2.42 389 898 1,166 449 379 1,998 4,353 81 245 234 217 214
Optical components & fiber - mcap weighted average Equipment & service ZTE Corp China ComService Fiberhome Telefonaktiebolaget Alcatel-Lucent Motorola Solutions Tellabs Juniper Networks Ciena Corp Cisco Systems 763 HK 552 HK 600498 CH ERICB SS ALU FP MSI US TLAB US JNPR US CIEN US CSCO US 27.50 4.89 26.75 94.20 3.96 46.88 4.52 32.97 25.48 16.38 10,507 3,629 1,824 49,711 13,213 15,917 1,642 17,575 2,421 90,549
21.7 11.3 22.8 15.2 17.6 20.2 na 21.7 463.3 10.2 19.6
19.2 10.1 18.0 13.6 11.5 18.5 68.5 17.5 23.5 9.5 13.0
11.1 5.2 16.5 6.9 5.7 7.3 32.4 12.4 19.5 5.2 7.2
10.3 4.6 12.9 6.1 5.0 6.5 9.8 9.7 10.2 4.7 6.0
2.7 1.5 3.0 2.0 2.3 2.4 0.9 2.4 31.6 1.9 2.4
2.4 1.4 2.6 1.8 2.0 2.1 0.9 2.2 14.9 1.7 2.0
13.5 14.2 13.1 12.7 11.3 12.4 (0.8) 11.4 30.9 17.9 15.0
13.5 14.9 14.7 13.2 15.3 10.1 1.5 11.9 363.7 17.2 18.9
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Company updates
O-Net............................................................................................................................................................................................. 20 China ComService....................................................................................................................................................................... 36 ZTE Corp ...................................................................................................................................................................................... 55
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877 HK
BUY
INITIATION
INDUSTRY OUTLOOK
Joyce Zhou
+852 2825 1120 joyce.zhou@asia.bnpparibas.com
Alen Lin
+852 2825 1801 alen.lin@asia.bnpparibas.com
(%)
Aug-10
Nov-10
1 Month (22.5) (19.3)
Share price performance Absolute (%) Relative to country (%) Next results Mkt cap (USD m)
A sharp increase of data traffic has driven the worldwide broadband capacity and speed upgrades. Gartner data suggest worldwide FTTx/ Ethernet subscribers will grow at 12.3% five-year CAGR and account for 21% of total broadband subscribers in 2015 (16% in 2010). China has also started its broadband upgrade with fixed-line operators increasing their capex on broadband networks for 2011. Increasing data demand will drive the whole industry supply chain. We believe O-Net, with advanced design and manufacturing technologies and well developed product portfolio (from sub-component and component to module and subsystems in five product lines) is going to enjoy the huge boom in the OC industry. The upcoming TDC products for 40G applications will be one of the key growth drivers for the next three years, due to limited supply in the market.
3m avg daily turnover (USD m) Free float (%) Major shareholder 12m high/low (HKD) 3m historic vol. (%) ADR ticker ADR closing price (USD)
Sources: Bloomberg consensus; BNP Paribas estimates
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Base Year-end 31 Dec Gross margin (%) EPS (HKD) Change (%) 2011E 50.6 0.24 2012E 50.6 0.30
16.00% 11.00% 6.00% 1.00% -22.00% -17.00% -12.00% -7.00% -2.00% -4.00% -9.00% -14.00% MSCI China O-Net = 3 + 0.0366 * MXCN Index R Square = 0.2878 Regression based on 57 observations of 5 years weekly data. Please refer to Appendix 1 for the explanation of R-square Sources: Bloomberg; BNP Paribas 3.00% 8.00% 13.00% 18.00%
Apr-11
O-Net - 6M Realised - Vol MSCI China - 6M Realised - Vol
1.00
Long/short chart
(x) 0.26 0.24 0.22 0.20 0.18 0.16 0.14 0.12 0.10 Apr-10 Oct-10
O-Net - ZTE Corp
Our starting point for this page is a recognition of the macro factors that can have a significant impact on stockprice performance, sometimes independently of bottom-up factors. With our Risk Expert page, we identify the key macro risks that can impact stock performance. This analysis enhances the fundamental work laid out in the rest of this report, giving investors yet another resource to use in their decision-making process.
Apr-11
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JDSU 16.5%
Finisar 12.4%
JDSU 23.2%
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Source: O-Net
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North America Asia Pacific Latin America Middle East and Africa
2011
2012
2013
2014
In 2010, O-Net has 50.4% of total revenue coming from its top-five customers. AlcatelLucent alone contributes nearly 20% of total revenue and Huawei also contributes over 10% of total revenue. We expect the revenue source to be further diversified with new customers including ZTE and Fiberhome to contribute around 10% of total revenue in 2011E.
Power management
Transmission
Wavelength Management
Others
DPSK demodulator DQPSK demodulator Wavelength locker Isolator Optical Circulator Optical Switch
Channel Monitor Tap-PD Monitor Tunable Dispersion -Compensator (TDC) Tap-PD Array module Integrated Module & Subsystem
PON WDM Transceiver module Transmitter PLC Splitter Receiver Etalon Compensator & Waveplate
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2008
2009
2010
Source: O-Net
O-Net is also adding new products in each category, with 331 new products launched in total during 2010. We expect more new products to come during 2011 including the TDC products for 40G applications, which the company announced would achieve mass production in 2H11. We believe the new product launches will not only provide additional growth drivers for the company, but also help keep O-Nets margin level high, and enhance its competitive advantage over peers.
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As per IPO (HKD m) New production facilities : Construction and build-out of new facilities located in Pingshan New District, Shenzhen City (Leasehold land owned of approx. 38,000 sqm) Production line and research & development expansion Repayment of Shenzhen Kaifa for rent and operating expenses paid on behalf of O-net Working capital Others including M&A Total
Source: O-Net
200
46 34 33
44.5 34 101.8
64
75
154.5
189.4
364.5
During 2010, the companys overall capacity increased by 50%, and the company expects it to increase another 30% in 2011. The companys total headcount will also increase by nearly 40% to capture the fast demand growth. The new facilities in Shenzhen are still under construction the company expects to complete the first phase in 2011 and achieve operation before end of this year. In addition to organic growth, O-Net is also looking for M&A opportunities. It has increased its funds for M&A and others from HKD137m to HKD319.5m in 2011, and it is actively looking for good targets that either can help enhance its product portfolio with complementary technology or that has strong synergy with O-Nets current products.
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Financials
Impressive top-line growth
O-Net has been enjoying higher-than-market growth since 2008. Even in the financial crisis period during 2009, O-Net achieved 18.9% revenue growth, compared to the market which saw 13% revenue declines. Though we do not expect O-Net to achieve the same growth level as 2010 in the next three years, we believe it will continue to achieve higher-than-average growth in the future due to its competitive product portfolio and good operation management. Exhibit 12: Revenue growth vs OC market growth
(%) 120 100 80 60 40 20 0 (20) 2008 2009 2010 2011 2012 2013 Optical component market growth O-Net revenue growth
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(%) 5 10 15 20 25
We believe O-Net needs to invest more in R&D in the coming years to keep its leading position in the industry and prepare for future growth. We forecast O-Net will gradually increase its R&D spending from 4.8% of total revenue in 2010 to 7% of total revenue in 2013E. In addition, O-Net is also budgeting HKD319.5m on future M&A and targeting part of the acquisition at new technology. Even if we assume 30% of this M&A budget is to be spent on new technologies and amortise it into the next three years, the R&D plus acquisition of new technology spending will be in the range of 7-9% of total revenue in next three years, in line with its peers.
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4.90
Investment risk
The system integrators are cutting their orders in 1H11 to digest their own inventory. The process may take longer than expected, which may have a negative impact on our revenue forecast for 2011. Lower-than-industry R&D expenses may not be enough to keep the companys technology lead, and may have an impact on the companys future growth. Exhibit 17: Shareholding structure
Kaifa Technology (HK) Ltd (Hong Kong) 27.32% Mandarin IT Fund I (Cayman Islands) 49.18% O-Net Employee Plan Ltd (BVI) 18.48%
Na Qinglin
Xue Yahong
23.70%
6.95%
1.69%
O-Net Holdings (BVI) (investment holding) 30.01% The Company (Cayman Islands) (investment holding) 100%
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Mr Xue Yahong
Mr Chen Zhujiang
Mr Huang Bin
Senior management Mr Eddie Kung VP of Finance. Mr Kung is an associate member of the Association of International Accountants and the Hong Kong Institute of Certified Public Accountants. Prior to joining O-Net, He had held various positions including CFO, company secretary, and authorised representative in the company listed in HKEx. He has over 13 years of experience in finance, accounting, auditing, taxation and company secretarial services. VP of R&D Modules and Subsystems. Dr Yu joined the Company in 2004 and has been involved in the optical communications industry since 1982 when he graduated from Nanjing Institute of Technology) (now Southeast University), specializing in electrical engineering. He also held the position of Chief Research Officer in the Department of Electronic Systems Engineering of Essex University between 1992 and 1997. Dr Yu received his Doctorate degree in electronic systems engineering in 1993 from Essex University in the United Kingdom. He completed his MS in electrical engineering in 1984 at Nanjing Institute of Technology. VP of R&D - Components. Ms Xie She became Head of Research and Development on 3 January 2001 focused on research and development related to optical components. She joined Shenzhen Kaifas fiber optic department in 1999. Ms Xie holds a Master's degree from Zhejiang Unicersity in 1988 and a Bachelor's degree from Zhejiang University in 1983. From 1983 through 1997, Ms Xie was a faculty member at Zhejiang University, teaching optical engineering courses. VP of Sales and Marketing. He has been leading the Companys international sales since 2002 and global sales and marketing since 2004. He joined Shenzhen Kaifa in 1998 where he was responsible for project engineering. Prior to that Mr.Tan worked as technical staff at Thomson Electric (Malaysia) Sdn. Bhd. and Seagate Technologies (Malaysia) Sdn Bhd. Mr Tan graduated with a Bachelors degree in physics from the National University of Malaysia in 1994.
Dr Yu Aihua
Ms Xie Hong
Mr Steven Tan
Source: O-Net
33 15
BNP PARIBAS
JOYCE ZHOU
O-NET
3 JUNE 2011
FINANCIAL
STATEMENTS
O-Net
Profit and Loss (HKD m) Year Ending Dec
Revenue Cost of sales ex depreciation Gross profit ex depreciation Other operating income Operating costs Operating EBITDA Depreciation Goodwill amortisation Operating EBIT Net financing costs Associates Recurring non operating income Non recurring items Profit before tax Tax Profit after tax Minority interests Preferred dividends Other items Reported net profit Non recurring items & goodwill (net) Recurring net profit Per share (HKD) Recurring EPS * Reported EPS DPS Growth Revenue (%) Operating EBITDA (%) Operating EBIT (%) Recurring EPS (%) Reported EPS (%)
2009A
338 (175) 163 0 (66) 98 (10) 0 87 1 0 0 0 88 (9) 79 0 0 0 79 0 79 0.14 0.14 0.00 18.9 134.9 186.5 244.2 244.2
2010A
661 (308) 352 0 (132) 220 (15) 0 206 (2) 0 0 0 204 (22) 182 0 0 0 182 0 182 0.25 0.25 0.00 95.2 125.7 135.0 84.7 84.7 51.1 33.3 31.1 27.5 10.9 0.0 107.2 101.2 121.7 157.9 41.6 38.7 25.3 21.1
2011E
799 (374) 425 0 (169) 257 (21) 0 236 3 0 0 0 239 (36) 203 0 0 0 203 0 203 0.24 0.24 0.00 21.0 16.5 14.8 (3.3) (3.3) 50.6 32.1 29.5 25.4 15.0 0.0 124.3 136.7 155.7 23.2 22.4 15.0 13.0
2012E
973 (452) 520 0 (204) 316 (28) 0 288 3 0 0 0 291 (44) 248 0 0 0 248 0 248 0.30 0.30 0.00 21.7 23.2 22.2 21.9 21.9 50.6 32.5 29.6 25.5 15.0 0.0 125.3 136.3 156.9 23.2 22.5 15.6 13.5
2013E
1,178 (554) 624 0 (241) 383 (30) 0 353 3 0 0 0 356 (53) 303 0 0 0 303 0 303 0.36 0.36 0.00 21.1 21.1 22.5 22.3 22.3 50.5 32.5 30.0 25.7 15.0 0.0 124.4 136.7 155.9 26.3 25.5 16.2 14.0
We forecast over 21% revenue growth for the next three years
Operating performance Gross margin inc depreciation (%) 45.3 Operating EBITDA margin (%) 28.8 Operating EBIT margin (%) 25.9 Net margin (%) 23.4 Effective tax rate (%) 10.6 Dividend payout on recurring profit (%) 0.0 Interest cover (x) Inventory days 107.1 Debtor days 139.3 Creditor days 227.9 Operating ROIC (%) 71.5 Operating ROIC WACC (%) ROIC (%) 55.5 ROIC WACC (%) ROE (%) 53.7 ROA (%) 28.5 * Pre exceptional, pre-goodwill and fully diluted
Sources: O-Net; BNP Paribas estimates
34 16
BNP PARIBAS
JOYCE ZHOU
O-NET
3 JUNE 2011
O-Net
Cash Flow (HKD m) Year Ending Dec
Recurring net profit Depreciation Associates & minorities Other non-cash items Recurring cash flow Change in working capital Capex - maintenance Capex new investment Free cash flow to equity Net acquisitions & disposals Dividends paid Non recurring cash flows Net cash flow Equity finance Debt finance Movement in cash Per share (HKD) Recurring cash flow per share FCF to equity per share
2009A
79 10 0 4 93 (68) (6) 0 19 0 0 0 19 0 (25) (7) 0.16 0.03
2010A
182 15 0 12 208 (139) (55) 0 13 0 0 (383) (369) 847 (4) 474 0.29 0.02
2011E
203 21 0 13 237 (50) (75) (210) (99) 0 0 0 (99) 0 0 (99) 0.28 (0.12)
2012E
248 28 0 15 290 (64) (50) 0 177 0 0 0 177 0 0 177 0.35 0.21
2013E
303 30 0 17 349 (75) (50) 0 224 0 0 0 224 0 0 224 0.42 0.27
2009A
2010A
2011E
2012E
979 (250) 729 369 1,098 0 1 0 33 1,132 (586) 0 0 (586) 0 0 1,718 0 1,132
2013E
1,100 (304) 796 389 1,186 0 1 0 34 1,220 (810) 0 0 (810) 0 0 2,031 0 1,220
Working capital assets 226 795 878 Working capital liabilities (134) (168) (206) Net working capital 92 627 672 Tangible fixed assets 40 82 347 Operating invested capital 132 709 1,019 Goodwill 0 0 0 Other intangible assets 0 1 1 Investments 0 0 0 Other assets 29 32 32 Invested capital 162 742 1,052 Cash & equivalents (27) (508) (409) Short term debt 0 0 0 Long term debt * 0 0 0 Net debt (27) (508) (409) Deferred tax 0 0 0 Other liabilities 0 0 0 Total equity 188 1,249 1,461 Minority interests 0 0 0 Invested capital 162 742 1,052 * includes convertibles and preferred stock which is being treated as debt Per share (HKD) Book value per share Tangible book value per share Financial strength Net debt/equity (%) Net debt/total assets (%) Current ratio (x) CF interest cover (x) 0.32 0.32 (14.1) (8.2) 1.9 1.50 1.50 (40.6) (35.8) 7.7 7.9 1.75 1.75 (28.0) (24.6) 6.3 -
Valuation
2009A
2010A
2011E
2012E
11.9 16.5 11.9 0.0 10.2 16.7 1.7 1.7 7.8 11.3 2.1
2013E
9.8 13.5 9.8 0.0 8.5 13.2 1.5 1.5 5.9 8.8 1.8
Recurring P/E (x) * 26.0 14.1 14.6 Recurring P/E @ target price (x) * 35.9 19.4 20.1 Reported P/E (x) 26.0 14.1 14.6 Dividend yield (%) 0.0 0.0 0.0 P/CF (x) 22.2 12.3 12.5 P/FCF (x) (30.0) 108.9 192.0 Price/book (x) 10.9 2.4 2.0 Price/tangible book (x) 11.0 2.4 2.0 EV/EBITDA (x) ** 21.0 10.2 9.7 EV/EBITDA @ target price (x) ** 29.0 14.5 14.1 EV/invested capital (x) 12.6 3.3 2.4 * Pre exceptional, pre-goodwill and fully diluted ** EBITDA includes associate income and recurring non-operating income
Sources: O-Net; BNP Paribas estimates
35 17
BNP PARIBAS
China ComService
CHINA / DIVERSIFIED TELECOMMUNICATION HOW WE DIFFER FROM THE STREET
BNP Consensus Target Price (HKD) EPS 2011 (RMB) EPS 2012 (RMB) 6.06 0.36 0.40 Positive Market Recs. 10 5.46 0.36 0.41 Neutral 9 % Diff 11.0 0.0 (2.4) Negative 1
552 HK
BUY
INITIATION
INDUSTRY OUTLOOK
Aug-10
Nov-10
1 Month 2.2 6.3
Feb-11
3 Month (5.6) (8.1)
Share price performance Absolute (%) Relative to country (%) Next results Mkt cap (USD m)
3m avg daily turnover (USD m) Free float (%) Major shareholder 12m high/low (HKD) 3m historic vol. (%) ADR ticker ADR closing price (USD)
Sources: Bloomberg consensus; BNP Paribas estimates
JOYCE ZHOU
CHINA COMSERVICE
3 JUNE 2011
Base Year-end 31 Dec Gross margin (%) EPS (RMB) Change (%) 2011E 16.6 0.36 2012E 16.8 0.40
12.00% 2.00% -22.00% -17.00% -12.00% -7.00% -2.00% -8.00% -18.00% -28.00% -38.00% MSCI China China ComService = 0 + 0.0765 * MXCN Index R Square = 0.3729 Regression based on 234 observations of 5 years weekly data. Please refer to Appendix 1 for the explanation of R-square Sources: Bloomberg; BNP Paribas 3.00% 8.00% 13.00% 18.00%
600 500 400 300 200 100 0 Dec-06 Dec-07 Dec-08 Dec-09 Dec-10
1.00
Long/short chart
(x) 0.65 0.60 0.55 0.50 0.45 0.40 0.35 0.30 0.25 Jun-08 Dec-08 Jun-09 Dec-09 Jun-10 Dec-10
37 3
BNP PARIBAS
JOYCE ZHOU
CHINA COMSERVICE
3 JUNE 2011
CCS holds the leading position in the TIS business: it is the biggest network design service provider, the biggest network construction provider, and the biggest project supervision service provider in the telecom industry in China. Currently, the TIS business is the biggest revenue contributor of the three business segments, contributing 47.6% of total revenue in 2010. Exhibit 2: Revenue breakdown
(RMB m) 50,000 45,000 40,000 35,000 30,000 25,000 20,000 15,000 10,000 5,000 0 2005 2006 2007 2008 2009 2010 TIS BPO ACO
38 4
BNP PARIBAS
JOYCE ZHOU
CHINA COMSERVICE
3 JUNE 2011
and management services, CCS holds a number of qualification certificates such as the Class-A Communication Construction Project Supervision and Management Qualification and Class-A Project Supervision and Management Enterprise Qualification.
39 5
BNP PARIBAS
JOYCE ZHOU
CHINA COMSERVICE
3 JUNE 2011
Operator revenue
40 6
BNP PARIBAS
JOYCE ZHOU
CHINA COMSERVICE
3 JUNE 2011
completion of Chinas 3G network construction. The number of 3G base stations is only 403,000, compared to 2G base stations of 883,000 (Exhibit 5). Operators still need to improve coverage in second- and third-tier cities, and there is more to do on indoor coverage. Exhibit 5: China 3G base stations vs 2G base station 2010
('000) 600 500 400 300 200 100 0 China Mobile
Sources: China Mobile; China Unicom
China Unicom
The three China telecom operators have together allocated a combined capex of RMB67.5b on 3G networks during 2011, including RMB25b from China Mobiles parent company for TD-SCDMA network, RMB23b from China Telecoms parent company for CDMA2000 network, and RMB19.5b from China Unicom for WCDMA network (Exhibit 6). We believe 3G operators will continue to spend on 3G with the 3G subscriber growth and 3G coverage expansions. Exhibit 6: China 3G Capex: 2010 vs 2011E
(RMB b) 80 70 60 50 40 30 20 10 0 2010
Sources: China Mobile, China Unicom,China Telecom, BNP Paribas estimates
2011E
41 7
BNP PARIBAS
JOYCE ZHOU
CHINA COMSERVICE
3 JUNE 2011
Sources: China Mobile; China Telecom; China Unicom; BNP Paribas estimates
In the next three years we believe China operators capex will remain high due to the continuous investment needs from both fixed and mobile networks. Meanwhile, we see higher growth from operators opex. Currently, under operator revenue, the majority of BPO and ACO revenues are coming from telecom operators opex. Exhibit 8: BPO revenue breakdown 2010 Exhibit 9: ACO revenue breakdown 2010
Maintenance 23.1%
Others 27.4%
Distribution 64.6%
Within operator revenue we expect the growth rates of BPO and ACO revenue to exceed that of TIS revenue in the next three years on the back of increasing revenue from operators opex (Exhibit 10). This is in line with CCSs strategy of transforming itself from being a labour-intensive company to being a tech- and service-intensive company. This would also help maintain or even improve margins, as the ACO business tends to generate higher margins than the TIS and BPO businesses.
42 8
BNP PARIBAS
JOYCE ZHOU
CHINA COMSERVICE
3 JUNE 2011
43 9
BNP PARIBAS
JOYCE ZHOU
CHINA COMSERVICE
3 JUNE 2011
Multi-dimensional expansion
We believe CCSs incremental growth will come from multi-dimensional expansion. Since its listing in 2006, the company has expanded its business through several asset injections from its parent company, China Telecom Group, and acquisitions. Also, CCS has entered into the non-operator business and is aggressively exploring the overseas market.
In May 2009, CCS announced the acquisition of equity interests in Guoxin Lucent (51%), Shanghai Tongmao Import & Export (95.95%) and Shenzhen Telecom Engineering (40%) for a total consideration of RMB115m. In April 2010, CCS acquired the remaining 49% stake in Guoxin Lucent. In 2009, CCS and Accenture also set up a joint venture (JV), China Communication Service Application Solution Technology Co, which focuses on telecom support software and service business. The series of corporate activity helped CCS complete the business lines from hardware import and export, to equipment installations, and also software supporting. Going forward, we believe the company will continue to look for good acquisition opportunities in operatorrelated areas. We see more such potential in the BPO and ACO segments as the
44 10
BNP PARIBAS
JOYCE ZHOU
CHINA COMSERVICE
3 JUNE 2011
market in these two areas is more fragmented than in the TIS segment. The company is also involved in the tower-sharing projects led by SASAC and MIIT. Though the revenue contribution is very small as the tower-sharing project is still in trial period, we believe CCS is well positioned to provide this service if it is rolled out nationwide.
We are positive on CCSs growth potential in the government and corporate IT market. Based on Gartner forecasts, government and enterprise IT spending in China will show 11.6% CAGR in the next five years, with highest growth coming from the software and IT services category, at 14.7% CAGR and 17.8% CAGR, respectively (Exhibit 14). Industry-wise, Gartner projects similar growth among different industries, all within the 10-13% range (Exhibit 15). Exhibit 14: Government and enterprise IT spending in China
(USD b) 180 160 140 120 100 80 60 40 20 0 2009
Source: Gartner (April 2011)
(%) 14 12 10 8 6 4 2 0
2010
2011E
2012E
2013E
2014E
2015E
45 11
BNP PARIBAS
JOYCE ZHOU
CHINA COMSERVICE
3 JUNE 2011
Government
2010
2011E
2012E
2013E
2014E
2015E
Overseas markets Back in 2007, CCS established China Communications Services (Hong Kong) International (CCSI) as its overseas business arm. The company is responsible for coordinating and supporting the overseas projects. Gartner estimates that developing markets such as Latin America, Middle East and Africa will enjoy higher-than-average network infrastructure expense growth in the next five years. The Asia Pacific region will also start to accelerate in 2011 (Exhibit 16). In addition to telecom-related projects, CCS is also involved in some overseas non-operator projects. Gartner data also shows that developing markets such as Latin America, the Middle East and Africa will enjoy aboveaverage government and enterprise IT spending growth than developed markets in the next five years (Exhibit 17). In our view, CCS has been focusing on the right markets (mainly Africa, the Middle East, Latin America, Hong Kong, Macau and Southeast Asia) where both telecom infrastructure investment and government and enterprise IT spending have higher growth potential and China equipment suppliers such as Huawei (privately held) and ZTE (763 HK) have higher market shares. Exhibit 16: Carrier network infrastructure expenses growth by region
(%) 10 8 6 4 2 0 (2) (4) (6) (8) (10) 2010
Source: Gartner
2011E
2012E
2013E
2014E
2015E
46 12
BNP PARIBAS
JOYCE ZHOU
CHINA COMSERVICE
3 JUNE 2011
2011E
2012E
2013E
2014E
2015E
Currently, most of CCSs overseas projects are subcontracted projects from ZTE and Huawei. Only a few projects, such as the Congo and Tanzania projects, are turnkey and led by CCS. However, the company guides that it will try to win more turnkey projects as they generate higher margins (generally over 30% vs around 15% for the subcontracted projects). By end-2010, CCS had set up 27 overseas platforms to develop the overseas business (Exhibit 18) with more than 3,000 staff. In 2010, overseas revenue reached RMB2.2b and represented 5% of the companys total revenue. With the more completed overseas presence and the past years operating experience, we believe the companys overseas business will accelerate in the coming years, and represent over 10% of total revenue in 2013E. Exhibit 18: CCSI overseas subsidiaries
47 13
BNP PARIBAS
JOYCE ZHOU
CHINA COMSERVICE
3 JUNE 2011
Leisure venues - weak current engineering projects, mechanical and electrical engineering projects Campus intranet construction National fiber optic backbone & transmission network construction (Phase 1) Submarine cable projects
Up to RMB1.5b Up to RMB1.5b
Source: China ComService
The company has got the SASACs approval for the rights issue, but still needs to get approvals from shareholders and the CSRC. We believe CCS needs more working capital to bid for big overseas projects on its own (compared to subcontracting projects for ZTE and Huawei), as most of such projects require initial capital and continued spending before revenue starts coming in. On the acquisition side, CCS is targeting several business segments including submarine cable construction and maintenance.
48 14
BNP PARIBAS
JOYCE ZHOU
CHINA COMSERVICE
3 JUNE 2011
There are also several JV opportunities under discussion in the ACO segment. On the R&D side, the company plans to focus on 4G technology, cloud computing and wireless broadband technology. The proceeds will be mainly used for the BPO and ACO businesses and also for the non-operator/overseas markets, where the company sees greater growth potential. We believe the proposed capital raising will further strengthen CCSs financial position and prepare it for future growth. The company expects the rights issue to be completed in 3Q11. Our model currently does not account for the proposed rights issue as it is still pending approvals. Assuming the deal is closed at the end of 3Q11 with the maximum of 2 rights shares per 10 existing shares, we estimate EPS dilution of 4.8% for 2011 and 16.7% for 2012-13. However, this does not factor in revenue from possible acquisition and other corporate activity.
49 15
BNP PARIBAS
JOYCE ZHOU
CHINA COMSERVICE
3 JUNE 2011
6.06
Jan-08
Feb-09
Mar-10
Apr-11
Jan-08
Feb-09
Mar-10
Apr-11
50 16
BNP PARIBAS
JOYCE ZHOU
CHINA COMSERVICE
3 JUNE 2011
Public Shareholders
34.53%
100% Guangdong Communications Services Co Ltd Zhejiang Communications Services Co Ltd 100% Shanghai Communications Services Co Ltd Fujian Communications Services Co Ltd 100% Hubei Communications Services Co Ltd Jiangsu Communications Services Co Ltd 100% Anhui Communications Services Co Ltd Jiangxi Communications Services Co Ltd 100% Hunan Communications Services Co Ltd Guangxi Communications Services Co Ltd 100% Chongqing Communications Services Co Ltd Sichuan Communications Services Co Ltd 100% Guizhou Communications Services Co Ltd Yunnan Communications Services Co Ltd 100% Shaanxi Communications Services Co Ltd Gansu Communications Services Co Ltd 100% Qinghai Communications Services Co Ltd Xinjiang Communications Services Co Ltd China International Telecommunications Communications Corp Guoxin Lucent Technologies Network Technologies Co Ltd 100% 100% China Communications Services (Hong Kong) International Ltd 100% 100% 100% 100% 100% 100% 100% 100%
100%
100%
51 17
BNP PARIBAS
JOYCE ZHOU
CHINA COMSERVICE
3 JUNE 2011
Zheng Qibao
Yuan Jianxing
Hou Rui
Liu Aili
Zhang Junan
52 18
BNP PARIBAS
JOYCE ZHOU
CHINA COMSERVICE
3 JUNE 2011
FINANCIAL
STATEMENTS
China ComService
Profit and Loss (RMB m) Year Ending Dec
Revenue Cost of sales ex depreciation Gross profit ex depreciation Other operating income Operating costs Operating EBITDA Depreciation Goodwill amortisation Operating EBIT Net financing costs Associates Recurring non operating income Non recurring items Profit before tax Tax Profit after tax Minority interests Preferred dividends Other items Reported net profit Non recurring items & goodwill (net) Recurring net profit
Per share (RMB) Recurring EPS * Reported EPS DPS Growth Revenue (%) Operating EBITDA (%) Operating EBIT (%) Recurring EPS (%) Reported EPS (%) Operating performance Gross margin inc depreciation (%) Operating EBITDA margin (%) Operating EBIT margin (%) Net margin (%) Effective tax rate (%) Dividend payout on recurring profit (%) Interest cover (x) Inventory days Debtor days Creditor days Operating ROIC (%) Operating ROIC WACC (%) ROIC (%) ROIC WACC (%) ROE (%) ROA (%) * Pre exceptional, pre-goodwill and fully diluted
2009A
39,499 (32,518) 6,982 521 (4,768) 2,734 (610) 0 2,124 (88) 2 0 0 2,038 (427) 1,610 12 0 0 1,622 0 1,622 0.28 0.28 0.11 19.7 9.5 10.6 20.4 20.4 16.1 6.9 5.4 4.1 21.0 39.4 24.0 16.0 91.5 93.1 41.4 27.9 28.1 14.7 12.9 5.8
2010A
45,417 (37,396) 8,022 630 (5,698) 2,953 (623) 0 2,331 (58) 3 0 0 2,276 (460) 1,816 1 0 0 1,818 0 1,818 0.31 0.31 0.13 15.0 8.0 9.7 12.1 12.1 16.3 6.5 5.1 4.0 20.2 40.0 40.4 17.0 93.8 90.8 38.1 24.7 26.3 12.9 13.3 5.8
2011E
52,033 (42,878) 9,155 650 (6,574) 3,231 (543) 0 2,687 (58) 3 0 0 2,633 (553) 2,080 1 0 0 2,081 0 2,081 0.36 0.36 0.14 14.6 9.4 15.3 14.5 14.5 16.6 6.2 5.2 4.0 21.0 40.0 46.6 16.7 97.0 89.1 35.0 21.6 25.1 11.7 14.2 6.0
2012E
59,212 (48,666) 10,546 650 (7,590) 3,606 (598) 0 3,008 (58) 3 0 0 2,953 (620) 2,333 1 0 0 2,334 0 2,334 0.40 0.40 0.16 13.8 11.6 11.9 12.2 12.2 16.8 6.1 5.1 3.9 21.0 40.0 52.2 16.8 97.3 89.3 34.9 21.5 25.9 12.5 14.9 6.1
2013E
67,038 (54,915) 12,123 650 (8,718) 4,055 (659) 0 3,396 (58) 3 0 0 3,341 (702) 2,639 1 0 0 2,641 0 2,641 0.46 0.46 0.18 13.2 12.4 12.9 13.1 13.1 17.1 6.0 5.1 3.9 21.0 40.0 58.9 16.8 97.5 89.5 35.2 21.8 26.9 13.5 15.7 6.2
2009A
19,289 15,943 4,267
2010A
21,637 18,508 5,272
2011E
24,607 21,099 6,326
2012E
27,667 23,954 7,592
2013E
31,208 26,720 9,110
53 19
BNP PARIBAS
JOYCE ZHOU
CHINA COMSERVICE
3 JUNE 2011
China ComService
Cash Flow (RMB m) Year Ending Dec
Recurring net profit Depreciation Associates & minorities Other non-cash items Recurring cash flow Change in working capital Capex - maintenance Capex new investment Free cash flow to equity Net acquisitions & disposals Dividends paid Non recurring cash flows Net cash flow Equity finance Debt finance Movement in cash Per share (RMB) Recurring cash flow per share FCF to equity per share
2009A
1,622 610 0 (7) 2,225 (516) (725) 0 984 0 (309) (89) 585 0 (602) (17) 0.39 0.17
2010A
1,818 623 0 (55) 2,385 (1,669) (820) 0 (104) 0 (1,298) (235) (1,637) 0 437 (1,200) 0.41 (0.02)
2011E
2,081 543 0 0 2,625 (749) (850) 0 1,025 0 (727) 0 298 0 0 298 0.45 0.18
2012E
2,334 598 0 0 2,933 (818) (950) 0 1,165 0 (833) 0 333 0 0 333 0.51 0.20
2013E
2,641 659 0 0 3,300 (904) (1,050) 0 1,347 0 (934) 0 413 0 0 413 0.57 0.23
We have not factored in the up to RMB4b rights issue as it is still pending approvals from shareholders and the regulator
2009A
2010A
2011E
2012E
24,620 (22,938) 1,682 5,138 6,820 103 152 633 1,372 9,079 (9,098) 1,781 0 (7,318) 0 32 16,233 133 9,079
2013E
27,828 (25,876) 1,952 5,679 7,631 103 152 633 1,372 9,891 (9,510) 1,781 0 (7,729) 0 32 17,455 133 9,891
Working capital assets 15,428 18,958 21,673 Working capital liabilities (15,681) (17,702) (20,217) Net working capital (253) 1,256 1,456 Tangible fixed assets 3,986 4,180 4,636 Operating invested capital 3,733 5,436 6,092 Goodwill 103 103 103 Other intangible assets 148 152 152 Investments 318 633 633 Other assets 1,308 1,372 1,372 Invested capital 5,611 7,696 8,352 Cash & equivalents (8,870) (8,470) (8,767) Short term debt 1,268 1,781 1,781 Long term debt * 0 0 0 Net debt (7,602) (6,690) (6,986) Deferred tax 0 0 0 Other liabilities 36 32 32 Total equity 13,069 14,221 15,174 Minority interests 109 133 133 Invested capital 5,611 7,696 8,352 * includes convertibles and preferred stock which is being treated as debt
Per share (RMB) Book value per share Tangible book value per share Financial strength Net debt/equity (%) Net debt/total assets (%) Current ratio (x) CF interest cover (x)
Valuation
2009A
2010A
2011E
2012E
9.9 12.5 9.9 4.0 7.9 19.8 1.4 1.4 4.5 5.6 1.8
2013E
8.8 11.0 8.8 4.6 7.0 17.2 1.3 1.3 3.9 4.9 1.6
Recurring P/E (x) * 14.3 12.7 11.1 Recurring P/E @ target price (x) * 18.0 16.0 14.0 Reported P/E (x) 14.3 12.7 11.1 Dividend yield (%) 2.8 3.1 3.6 P/CF (x) 10.4 9.7 8.8 P/FCF (x) 23.5 (222.7) 22.5 Price/book (x) 1.8 1.6 1.5 Price/tangible book (x) 1.8 1.7 1.5 EV/EBITDA (x) ** 5.9 5.4 5.1 EV/EBITDA @ target price (x) ** 7.4 6.8 6.4 EV/invested capital (x) 2.8 2.2 1.9 * Pre exceptional, pre-goodwill and fully diluted ** EBITDA includes associate income and recurring non-operating income
Sources: CCS; BNP Paribas estimates
54 20
BNP PARIBAS
ZTE Corp
763 HK
HOLD
UNCHANGED
INDUSTRY OUTLOOK
NEW INFORMATION
Alen Lin
+852 2825 1801 alen.lin@asia.bnpparibas.com
Joyce Zhou
+852 2825 1120 joyce.zhou@asia.bnpparibas.com
(HKD) 30 25 20 15 10 May-10
Aug-10
Nov-10
1 Month (0.9) (0.8)
Feb-11
3 Month (4.1) (13.6)
Share price performance Absolute (%) Relative to country (%) Next results Mkt cap (USD m)
3m avg daily turnover (USD m) Free float (%) Major shareholder 12m high/low (HKD) 3m historic vol. (%) ADR ticker ADR closing price (USD)
Sources : Bloomberg consensus; BNP Paribas estimates
55
3 June 2011
ALEN LIN
ZTE CORP
3 JUNE 2011
Base Year-end 31 Dec Net sales (RMB m) EPS (RMB) Change (%) 2011E 2012E
140 120
ZTE Corp
10.00% 0.00% -2.00% -10.00% -20.00% -30.00% -40.00% MSCI China ZTE Corp = 3 + 0.2199 * MXCN Index R Square = 0.3505 Regression based on 261 observations of 5 years weekly data. Please refer to Appendix 1 for the explanation of R-square Sources: Bloomberg; BNP Paribas
3.00%
8.00%
13.00%
18.00%
1.00
Long/short chart
(x) 9.352559749 8.352559749 7.352559749 6.352559749 5.352559749 4.352559749 3.352559749 Apr-10 +2s +1s Mean -1s -2s Oct-10
ZTE Corp - O-NET
Apr-11
56 2
BNP PARIBAS
ALEN LIN
ZTE CORP
3 JUNE 2011
FINANCIAL
STATEMENTS
ZTE Corp
Profit and Loss (RMB m) Year Ending Dec
Revenue Cost of sales ex depreciation Gross profit ex depreciation Other operating income Operating costs Operating EBITDA Depreciation Goodwill amortisation Operating EBIT Net financing costs Associates Recurring non operating income Non recurring items Profit before tax Tax Profit after tax Minority interests Preferred dividends Other items Reported net profit Non recurring items & goodwill (net) Recurring net profit Per share (RMB) Recurring EPS * Reported EPS DPS Growth Revenue (%) Operating EBITDA (%) Operating EBIT (%) Recurring EPS (%) Reported EPS (%)
2009A
60,273 (40,896) 19,376 0 (15,675) 3,702 (772) 0 2,930 (641) 0 1,036 0 3,325 (629) 2,696 (238) 0 0 2,458 0 2,458 0.82 0.82 0.20 36.1 9.4 4.8 41.3 41.3
2010A
70,264 (47,731) 22,532 0 (18,506) 4,026 (868) 0 3,159 (628) 0 1,829 0 4,360 (884) 3,476 (226) 0 0 3,250 0 3,250 1.06 1.06 0.21 16.6 8.8 7.8 29.9 29.9 30.8 5.7 4.5 4.6 20.3 20.0 7.9 81.9 157.3 200.1 16.0 6.5 16.2 6.7 16.3 5.1
2011E
87,361 (59,401) 27,960 0 (22,626) 5,333 (1,158) 0 4,175 (700) 0 1,210 0 4,685 (898) 3,786 (330) 0 0 3,456 0 3,456 1.05 1.05 0.21 24.3 32.5 32.2 (0.9) (0.9) 30.7 6.1 4.8 4.0 19.2 20.0 7.7 83.5 154.9 195.1 17.5 7.9 14.0 4.4 13.5 4.7
2012E
102,323 (70,065) 32,258 0 (26,399) 5,859 (1,164) 0 4,694 (700) 0 1,585 0 5,580 (1,150) 4,429 (330) 0 0 4,099 0 4,099 1.19 1.19 0.24 17.1 9.9 12.4 13.1 13.1 30.4 5.7 4.6 4.0 20.6 20.0 9.0 85.5 159.2 199.7 17.3 7.7 14.1 4.6 13.5 4.6
2013E
113,585 (77,525) 36,059 0 (29,305) 6,754 (1,170) 0 5,585 (700) 0 1,616 0 6,501 (1,329) 5,172 (330) 0 0 4,842 0 4,842 1.41 1.41 0.28 11.0 15.3 19.0 18.1 18.1 30.7 5.9 4.9 4.3 20.4 20.0 10.3 87.9 163.2 205.3 18.9 9.3 14.8 5.2 13.7 4.7
Operating performance Gross margin inc depreciation (%) 30.9 Operating EBITDA margin (%) 6.1 Operating EBIT margin (%) 4.9 Net margin (%) 4.1 Effective tax rate (%) 18.9 Dividend payout on recurring profit (%) 24.4 Interest cover (x) 6.2 Inventory days 81.7 Debtor days 142.1 Creditor days 191.1 Operating ROIC (%) 18.8 Operating ROIC WACC (%) 9.3 ROIC (%) 18.3 ROIC WACC (%) 8.7 ROE (%) 15.8 ROA (%) 5.3 * Pre exceptional, pre-goodwill and fully diluted
2009A
39,982 13,072 7,219
2010A
41,990 17,927 10,346
2011E
53,861 22,000 11,500
2012E
61,923 26,000 14,400
2013E
71,485 30,000 12,100
57 3
BNP PARIBAS
ALEN LIN
ZTE CORP
3 JUNE 2011
ZTE Corp
Cash Flow (RMB m) Year Ending Dec
Recurring net profit Depreciation Associates & minorities Other non-cash items Recurring cash flow Change in working capital Capex - maintenance Capex new investment Free cash flow to equity Net acquisitions & disposals Dividends paid Non recurring cash flows Net cash flow Equity finance Debt finance Movement in cash Per share (RMB) Recurring cash flow per share FCF to equity per share
2009A
2,458 772 0 0 3,230 (3,117) 0 (1,591) (1,478) 0 (447) 2,308 383 22 2,310 2,715 1.08 (0.49)
2010A
3,250 868 0 0 4,118 (4,135) 0 (1,869) (1,886) 0 (630) (906) (3,421) 3,913 375 867 1.35 (0.62)
2011E
3,456 1,158 0 0 4,614 (4,066) 0 (1,200) (652) 0 (698) 1,636 286 0 0 286 1.41 (0.20)
2012E
4,099 1,164 0 0 5,264 (3,491) 0 (1,200) 573 0 (725) 1,487 1,335 0 0 1,335 1.53 0.17
2013E
4,842 1,170 0 0 6,011 (2,816) 0 (1,200) 1,996 0 (820) 964 2,140 0 0 2,140 1.75 0.58
Capex-to-sales ratio has remained less than 5% for recent years and we expect it to decline gradually as it benefits from greater economy of scale
2009A
2010A
2011E
2012E
75,834 (61,073) 14,761 7,798 22,559 0 1,583 1,301 11,715 37,156 (16,526) 7,901 5,475 (3,150) 0 5,501 32,812 1,993 37,156
2013E
84,087 (67,475) 16,613 7,828 24,441 0 1,583 1,321 13,004 40,348 (18,666) 7,901 5,475 (5,289) 0 5,501 37,809 2,327 40,348
Working capital assets 42,652 51,996 64,682 Working capital liabilities (35,371) (41,670) (51,925) Net working capital 7,280 10,327 12,757 Tangible fixed assets 6,058 7,720 7,762 Operating invested capital 13,338 18,047 20,519 Goodwill 0 0 0 Other intangible assets 877 1,583 1,583 Investments 694 1,261 1,281 Other assets 5,108 8,044 10,002 Invested capital 20,018 28,934 33,384 Cash & equivalents (14,076) (14,905) (15,191) Short term debt 6,846 7,901 7,901 Long term debt * 6,029 5,475 5,475 Net debt (1,200) (1,529) (1,815) Deferred tax 0 0 0 Other liabilities 3,269 5,501 5,501 Total equity 16,825 23,094 27,994 Minority interests 1,124 1,868 1,704 Invested capital 20,018 28,934 33,384 * includes convertibles and preferred stock which is being treated as debt Per share (RMB) Book value per share Tangible book value per share Financial strength Net debt/equity (%) Net debt/total assets (%) Current ratio (x) CF interest cover (x) 5.61 5.31 (6.7) (1.7) 1.3 1.2 7.56 7.04 (6.1) (1.8) 1.3 1.0 8.54 8.05 (6.1) (1.8) 1.3 1.8
Valuation
2009A
2010A
2011E
2012E
18.9 21.7 18.9 1.1 14.7 135.3 2.4 2.5 10.1 10.6 2.1
2013E
16.0 18.3 16.0 1.2 12.9 38.8 2.0 2.1 9.0 9.5 1.8
Recurring P/E (x) * 27.5 21.2 21.4 Recurring P/E @ target price (x) * 31.5 24.3 24.5 Reported P/E (x) 27.5 21.2 21.4 Dividend yield (%) 0.9 0.9 0.9 P/CF (x) 20.9 16.7 16.0 P/FCF (x) (45.7) (36.5) (113.3) Price/book (x) 4.0 3.0 2.6 Price/tangible book (x) 4.2 3.2 2.8 EV/EBITDA (x) ** 13.9 11.7 10.9 EV/EBITDA @ target price (x) ** 14.6 12.2 11.4 EV/invested capital (x) 3.4 2.4 2.2 * Pre exceptional, pre-goodwill and fully diluted ** EBITDA includes associate income and recurring non-operating income
Sources: ZTE Corp; BNP Paribas estimates
58 4
BNP PARIBAS
ALEN LIN
3 JUNE 2011
SUN CHUNG
Head of Research, Korea BNP Paribas Securities Korea Co Ltd +822 2125 0532 sun.chung@asia.bnpparibas.com.
ALEN LIN
Telecom Services and Equipment BNP Paribas Securities (Asia) Ltd +852 2825 1801 alen.lin@asia.bnpparibas.com
DOUGLAS KIM
Alternative Energy BNP Paribas Securities Korea Co Ltd +822 2125 0540 douglas.kim@asia.bnpparibas.com
YVONNE YANG
Internet BNP Paribas Equities (Asia) Ltd Shanghai Representative Office +8621 6096 9046 yvonne.q.yang@asia.bnpparibas.com
ABHIRAM ELESWARAPU
Software & Services BNP Paribas Securities India Pvt Ltd +91 22 6628 2406 abhiram.eleswarapu@asia.bnpparibas.com
AVINASH SINGH
Tech - IT (Associate) BNP Paribas Securities India Pvt Ltd +91 22 6628 2407 avinash.singh@asia.bnpparibas.com
SAMEER NARINGREKAR
Tech - Telecom BNP Paribas Securities India Pvt Ltd +91 22 6628 2454 sameer.naringrekar@asia.bnpparibas.com
SCOTT FOSTER
Technology BNP Paribas Securities Japan +81 3 6377 2240 scott.foster@japan.bnpparibas.com
KEI RAMEAU
Technology BNP Paribas Securities (Japan) Ltd +81 3 6377 2232 kei.rameau@japan.bnpparibas.com
HENRY AI
IT Service BNP Paribas Securities (Asia) Ltd Shanghai Representative Office +8621 6069 9037 henry.ai@asia.bnpparibas.com
JOYCE ZHOU
Telecom Services and Equipment BNP Paribas Securities (Asia) Ltd +852 2825 1120 joyce.zhou@asia.bnpparibas.com
HIROSHI YAMASHINA
Telecoms and Internet BNP Paribas Securities Japan +81 3 6377 2235 hiroshi.yamashina@japan.bnpparibas.com
VIVIAN WAN
Telecoms BNP Paribas Securities Japan +81 3 6377 2239 vivian.wan@japan.bnpparibas.com
CHARLES HSU
Displays, Touch Panels, LED BNP Paribas Securities (Taiwan) Co Ltd + 886 2 8729 7055 charles.hsu@asia.bnpparibas.com
LAURA CHEN
Handset/Hardware BNP Paribas Securities (Taiwan) Co Ltd +886 2 8729 7052 laura.chen@asia.bnpparibas.com
PATTY LIU
PC/Downstream BNP Paribas Securities (Taiwan) Co Ltd +886 2 2175 7049 patty.liu@asia.bnpparibas.com
KYNA WONG
Research Associate BNP Paribas Securities (Asia) Ltd +852 2825 1823 kyna.wong@asia.bnpparibas.com
YIFAN LAI
Research Associate BNP Paribas Securities (Taiwan) Co Ltd +886 2 8729 7056 yifan.lai@asia.bnpparibas.com
YOUNG SHIN
Research Associate BNP Paribas Securities Korea Co Ltd +822 2125 0546 young.shin@asia.bnpparibas.com
JAMES WANG
Research Associate BNP Paribas Securities (Taiwan) Co Ltd +886 2 8729 7058 james.m.wang@asia.bnpparibas.com
KYUN JANG
Research Associate BNP Paribas Securities Korea Co Ltd +822 2125 0537 kyun.jang@asia.bnpparibas.com
59 20
BNP PARIBAS
ALEN LIN
3 JUNE 2011
HISTORY
OF
CHANGE
IN
INVESTMENT
RATING
AND/OR
TARGET
PRICE
ZTE Corp
Target Price
TP 14.83 12.50
Jun-08
Jun-09
Jun-10
Jun-11
Alen Lin started covering this stock from 16 September 2009 Price and TP are in local currency Valuation and risks: Risks to our P/E-based TP are India 3G rollout and margin risks due to competitive pressure and China network contract allocation and profitability. Sources: Bloomberg, BNP Paribas
60 21
BNP PARIBAS
ALEN LIN
3 JUNE 2011
NOTES
61 22
BNP PARIBAS
ALEN LIN
3 JUNE 2011
DISCLAIMERS
&
DISCLOSURES
ANALYST(S) CERTIFICATION Alen Lin, BNP Paribas Securities (Asia) Ltd, +852 2825 1801, alen.lin@asia.bnpparibas.com. Joyce Zhou, BNP Paribas Securities (Asia) Ltd, +852 2825 1120, joyce.zhou@asia.bnpparibas.com. The analyst(s) or strategist(s) herein each referred to as analyst(s) named in this report certifies that (i) all views expressed in this report accurately reflect the personal view of the analyst(s) with regard to any and all of the subject securities, companies, or issuers mentioned in this report; (ii) no part of the compensation of the analyst(s) was, is, or will be, directly or indirectly, relate to the specific recommendation or views expressed herein; and (iii) is not aware of any other actual or material conflicts of interest concerning any of the subject securities companies, or issuers referenced herein as of the time of this certification. GENERAL DISCLAIMER This report was produced by BNP Paribas Securities (Asia) Ltd, a member company of the BNP Paribas Group. "BNP Paribas is the marketing 1 name for the global banking and markets business of BNP Paribas Group . This report is for the use of intended recipients only and may not be reproduced (in whole or in part) or delivered or transmitted to any other person without our prior written consent. By accepting this report, the recipient agrees to be bound by the terms and limitations set forth herein. BNP Paribas analysts prudently perform analysis and create quantitative models and estimates derived from their own review of publicly available data without any assistance from any represented company. BNP Paribas analyst estimates and models reflect the analysts current judgment only; they are neither all-inclusive nor can they be guaranteed. The analysts analysis and models are subject to change based on various other factors. Valuations are based on internal quantitative models and qualitative interpretation. No representation or warranty, express or implied, is made that such information or analysis is accurate, complete or verified and it should not be relied upon as such. Analysts' compensation is not linked to investment banking or capital markets transactions performed by BNP Paribas or the profitability or revenues of particular trading desks. BNP Paribas analysts may participate in company events such as site visits and are prohibited from accepting payment by the company of associated expenses unless pre-approved by authorized members of Research management. This report does not constitute a personal recommendation or take into account the particular investment objectives, financial situations, or needs of individual clients. Customers are advised to use the information contained herein as just one of many inputs and considerations prior to engaging in any trading activity. This report does not constitute a prospectus or other offering document or an offer or solicitation to buy or sell any securities or other investments. This report is not intended to provide the sole basis of any evaluation of the subject securities and companies mentioned in this report. Information and opinions contained in this report are published for reference of the recipients and are not to be relied upon as authoritative or without the recipients own independent verification, or taken in substitution for the exercise of judgment by the recipient. Additionally, the products mentioned in this report may not be available for sale in certain jurisdictions. BNP Paribas is not aware of any other actual or material conflicts of interest concerning any of the subject securities and companies referenced herein as of the time of publication of the research report. This report is prepared for professional investors and is being distributed in Hong Kong by BNP Paribas Securities (Asia) Limited to persons whose business involves the acquisition, disposal or holding of securities, whether as principal or agent. BNP Paribas Securities (Asia) Limited, a subsidiary of BNP Paribas, is regulated by the Securities and Futures Commission for the conduct of dealing in securities, advising on securities and providing automated trading services. This report is being distributed in the United Kingdom by BNP Paribas London Branch to persons who are not private customers as defined under U.K. securities regulations. BNP Paribas London Branch, a branch of BNP Paribas, is regulated by the Financial Services Authority for the conduct of its designated investment business in the U.K. This report may be distributed in the United States by BNP PARIBAS SECURITIES ASIA or by BNP Paribas Securities Corp. 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Reproduction, distribution or publication of this report in any other places or to persons to whom such distribution or publication is not permitted under the applicable laws or regulations of such places is strictly prohibited. This report is distributed in Singapore by BNP Paribas Securities (Singapore) Limited ("BNPPSSL") and may be distributed in Singapore only to an accredited investor or an expert investor, each as defined under the Financial Advisers Regulations ("FAR") and the Securities and Futures Act (Chapter 289) of Singapore, as amended from time to time. In relation to the distribution to such categories of investors, BNPPSSL and its representatives are exempted under Regulation 35 of the FAR from the requirements in Section 36 of the Financial Advisers Act of Singapore, regarding the disclosure of certain interests in, or certain interests in the acquisition or disposal of, securities referred to in this report. This report is being distributed in Australia by BNP Paribas Sydney Branch, registered in Australia as ABN 23 000 000 117 at 60 Castlereagh Street Sydney NSW 2000. BNP Paribas Sydney Branch is licensed under the Banking Act 1959 and the holder of Australian Financial Services Licence no. 238043 and therefore subject to regulation by the Australian Securities & Investments Commission in relation to delivery of financial services. By accepting this document you agree to be bound by the foregoing limitations, and acknowledge that information and opinions in this document relate to financial products or financial services which are delivered solely to wholesale clients (in terms of the Corporations Act 2001, sections 761G and 761GA; Corporations Regulations 2001, division 2, reg. 7.1.18 & 7.1.19) and/or professional investors (as defined in section 9 of the Corporations Act 2001). To our readers in Taiwan: Information on securities that trade in Taiwan is distributed by BNP Paribas Securities (Taiwan) Co., Ltd. Such information is for your reference only. The reader should independently evaluate the investment risks and is solely responsible for their investment decision. Information on securities that do not trade in Taiwan is for informational purposes only and is not to be construed as a recommendation or a solicitation to trade in such securities. BNP Paribas Securities (Taiwan) Co., Ltd. may not execute transactions for clients in these securities. This publication may not be distributed to the public media or quoted or used by the public media without the express written consent of BNP Paribas. The distribution of this report in other jurisdictions or to residents of other jurisdictions may also be restricted by law, and persons into whose possession this report comes should inform themselves about, and observe, any such restrictions. By accepting this report you agree to be bound by the foregoing instructions. This report is not directed to, or intended for distribution to or use by, any person or entity that is a citizen or resident of or located in any locality, state, country, or other jurisdiction where such distribution, publication, availability or use would be contrary to law or regulation. All research reports are disseminated and available to all clients simultaneously through our internal client websites. For all research available on a particular stock, please contact the relevant BNP Paribas research team or the author(s) of this report.
62 23
BNP PARIBAS
ALEN LIN
3 JUNE 2011
1 No portion of this report was prepared by BNP Paribas Securities Corp. personnel, and references to BNP Paribas in this General Disclaimer section and in the immediately following Important Disclosures section refer to BNP Paribas Securities (Asia) Ltd only.
IMPORTANT DISCLOSURES The disclosure column in the following table lists the important disclosures applicable to each company that has been rated and/or recommended in this report: Company O-Net Communications China ComService ZTE Disclosure (as applicable) NA NA 2, 5
BNP Paribas represents that: 1. Within the past year, it has managed or co-managed a public offering for this company, for which it received fees. 2. It had an investment banking relationship with this company in the last 12 months. 3. It received compensation for investment banking services from this company in the last 12 months. 4. It beneficially owns 1% or more or the market capitalization of this company. 5. It makes a market in securities issued by this company. 6. The analyst(s) or an individual who assisted in the preparation of this report (or a member of his/her household) has a financial interest position in securities issued by this company or derivatives thereof. 7. The analyst (or a member of his/her household) is an officer, director, or advisory board member of this company. Additional Disclosures Within the next three months, BNP Paribas may receive or seek compensation in connection with an investment banking relationship with one or more of the companies referenced herein. Target price history, stock price charts, valuation and risk details, and equity rating histories applicable to each company rated in this report is available in our most recently published reports available on our website: http://equities.bnpparibas.com, or you can contact the analyst named on the front of this note or your BNP Paribas representative. All share prices are as at market close on 2 June 2011 unless otherwise stated. RECOMMENDATION STRUCTURE Stock Ratings Stock ratings are based on absolute upside or downside, which we define as (target price* - current price) / current price. BUY (B). The upside is 10% or more. HOLD (H). The upside or downside is less than 10%. REDUCE (R). The downside is 10% or more. Unless otherwise specified, these recommendations are set with a 12-month horizon. Thus, it is possible that future price volatility may cause a temporary mismatch between upside/downside for a stock based on market price and the formal recommendation.
* In most cases, the target price will equal the analyst's assessment of the current fair value of the stock. However, if the analyst doesn't think the market will reassess the stock over the specified time horizon due to a lack of events or catalysts, then the target price may differ from fair value. In most cases, therefore, our recommendation is an assessment of the mismatch between current market price and our assessment of current fair value.
Industry Recommendations Improving ( ): The analyst expects the fundamental conditions of the sector to be positive over the next 12 months. Neutral ( ): The analyst expects the fundamental conditions of the sector to be maintained over the next 12 months. Deteriorating ( ): The analyst expects the fundamental conditions of the sector to be negative over the next 12 months. Country (Strategy) Recommendations Overweight (O). Over the next 12 months, the analyst expects the market to score positively on two or more of the criteria used to determine market recommendations: index returns relative to the regional benchmark, index sharpe ratio relative to the regional benchmark and index returns relative to the market cost of equity. Neutral (N). Over the next 12 months, the analyst expects the market to score positively on one of the criteria used to determine market recommendations: index returns relative to the regional benchmark, index sharpe ratio relative to the regional benchmark and index returns relative to the market cost of equity. Underweight (U). Over the next 12 months, the analyst does not expect the market to score positively on any of the criteria used to determine market recommendations: index returns relative to the regional benchmark, index sharpe ratio relative to the regional benchmark and index returns relative to the market cost of equity. RATING DISTRIBUTION (as at 1 June 2011) Total BNP Paribas coverage universe Buy Hold Reduce 557 366 139 52 Investment Banking Relationship Buy Hold Reduce (%) 4.10 4.32 1.92
Should you require additional information concerning this report please contact the relevant BNP Paribas research team or the author(s) of this report. 2011 BNP Paribas Group
63 24
BNP PARIBAS
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