28,491 PRICE: HK$ EARNINGS

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1 2 Recommendation: BUY TP: HK$139 (+18.1%) VTech Holdings Ltd (303.HK) 11 October 2017 SECTOR: Communications Equipment HSI: 28,491 PRICE: HK$ EARNINGS (reported in USDm) KEY DATA For the fiscal year ended E 2019E 2020E Issued Capital (m Shrs) Revenue 1,857 2,079 2,223 2,328 2,417 M arket Cap (b) HK$29.59 Operating Profit Avg. 6M Turnover (m) HK$37.9 Net Profit Week High/Low HK$128 / $86.05 EPS (USD) Net Gearing -43.0% % Change (8.5%) (1.2%) 19% 14% 2% Book Value per Share HK$18.1 DPS (USD) Free Float 65.1% Dividend yield 2.8% 4.6% 5.5% 6.3% 6.5% M ajor Shareholder(s) Dr. Allan Wong 34.92% Capital Group 15.00% INTERIM RESULTS (USDm) For the fiscal year ended 1H15 1H16 % change Revenue % Operating Profit (28.6%) Net Profit (28.7%) EPS (USD) (28.8%) Note: Time-sensitive data and value were retrieved as at 10 Oct 2017 Source: Bloomberg, Company data, Platinum Research; FX Rate: USD:HKD 7.8 SECTION 1 FY17 RESULTS BRIEFING Better than the Market Expectation Year ended 31 March 2017 revenue grew 12% YoY to US$2,079.3m. o Revenues were mainly driven by higher sales in VTech s core regions of North America (15.7% YoY), Europe (9% YoY) and Asia Pacific (15.2% YoY). Gross profit margin increased to 33.2% from 31.4% (gross profit up 18.2% YoY). Three strategic acquisitions completed in electronic learning products (ELP), telecommunication (TEL) and contracted manufacturing services (CMS). Net profit decreased 1.3% YoY to US$179m, caused by the one-off restructuring costs for the integration of the LeapFrog Enterprises acquisition. One-off legal costs associated to the investigation conducted by the U.K Competition and Markets Authority (CMA) and professional services for improving cyber security also weighed down on FY17 profit. Full year dividend of US$0.70 per share, a 66% YoY increase and a return to VTech s historic dividend payout ratio level of 98.2%. VTech is in a net cash position with US$267m with negligible debt. Platinum Broking IMPORTANT DISCLOSURES ARE PROVIDED ON THE LAST PAGE OF THIS REPORT

2 SECTION 2 COMPANY BACKGROUND Global manufacturer of electronic learning products and cordless phones Founded in 1976, as a leader in manufacturing electronic learning products and cordless phones globally. The company operates in over 75 countries. VTech is the leader in electronic learning products (ELP) based on retail sales in North America, France, the UK, and Germany as reported in the NPD s Retail Tracking Service. Acquisition of LeapFrog in April 2016 LeapFrog was founded in 1995 and has established a well-known brand. It is a developer of educational entertainment products for children aged below 3 years of age; it is the number one supplier of electronic learning toys for that age group according to the NPD Group. 70% of sales in are in the U.S. The acquisition strengthens VTech s electronic learning product business. ELP revenue grew by 44.7% YoY in North America, mainly driven by the acquisition. Acquisition of Snom in November 2016 Snom Technology is a manufacturer and pioneer of Voice over Internet Protocol (VoIP). VoIP is voice communications delivery over internet protocol network technology; it was founded in Snom has product distribution to North America, Europe, Australia and India. Vtech acquired Snom Technology was from a PE firm (Heidelberg Capital) that failed to bring the new direction they envisioned for Snom. VTech acquired Snom to gain synergies in hardware and software development as well as expanded sales channels and improvements in operational efficiency. SECTION 3 BUSINESS OUTLOOK VTech operates three business lines: electronic learning products (ELP), 42% of revenues, telecommunication (TEL) products with 27% of revenues and contract manufacturing service (CMS), 31% of FY17 sales. We include key comments and views from the interview we conducted with VTech s Chairman and Group CEO, Dr. Allan Wong, below. Platinum Broking 2

3 Exhibit 1: VTech product lines structure Source: Company data Exhibit 2: VTech FY17 revenue of product lines by region North America Europe Asia- Pacific Others ELP 45% 41% 35% 29% TEL 36% 15% 26% 70% CMS 19% 44% 39% 1% 100% 100% 100% 100% Source: Company data Electronic Learning Products (ELP) Cyber attack in 2015 impacted sales of electronic platform products in FY16 ELP revenue grows and Platform product sales recovered in FY17 ELP saw higher sales across all regions. Management expect further growth in FY18 driven by new product releases. New generations of smart watches and children communication devices will also be seen. LeapFrog introduced an interactive learning system that will expand its software library and licenses. Revenues were negatively impacted by falling content downloads. The 2015 cyber-attack remains in fresh memory of parents. VTech worked with a leading cyber security firm to strengthen data protection on learning platforms and connected services. Standalone products contributed 77% and electronic platform products accounted for 23% of the ELP revenue in FY17. The sales of electronic platform products have grown from 16% to 23% of total ELP revenues in FY16, largely due to the addition of LeapFrog. Today s cutting-edge technology ultimately becomes widely available and affordable over time. VTech s core strategy is to leverage their experience in design and manufacturing to bring products with new features into the market at a competitive cost and quality. Platinum Broking 3

4 Telecommunication (TEL) FY18 is expected to achieve growth based on higher sales from commercial products and other telecommunication products. Residential phone sales faced contraction of demand globally. Revenue declined by 12.9% YoY in FY17, its pace is expected to moderate as VTech gains more shelf space in the US. Commercial phone sales saw a 22.4% YoY growth. Cordless Advanced Technology internet and quality (CAT-iq 2.0), essentially smart VoIP, handsets are distributed to major telecommunication companies in France, Germany and Switzerland. This area has performed well for the Company. Sales in this segment are also expected to grow as wider adoption grows the market. VoIP Industry Forecast: As consumers gradually switch to VoIP telephony, the cost per remaining consumer increases on public switched telephone networks (PTSN). This will rapidly accelerate the penetration of VoIP technology as PTSN costs become untenable. The FCC s Technology Advisory Council (Federal Communications Commission) has set the date for PTSN network replacement for the U.S. in o In a Frost & Sullivan report, the trend in adoption of VoIP technology is expected to be supported by major governments implying potential large demand in the near future. Exhibit 3: Frost & Sullivan estimates of total revenue CAGR in the session initiation protocol protocal (SIP), a broad term that encapsulates VoIP. CAGR E North America 11.1% Europe, Middle East & 14.7% Africa Asia (inc. China) 16.5% China 21.5% Rest of the world 15.6% Source: Frost & Sullivan Contract Manufacturing Service (CMS) Contract manufacturing services is a supply-chain service for offering design for manufacture (DFM) in a number of product categories such as home appliances, medical and health products, solid-state lighting, professional audio equipment, hearables and communication products. Strong reputation to secure existing manufacturing orders and attracting new customers. A new factory which commenced operation in July 2015 will increase capacity by 25% for CMS. Kenny Precision Products (Shenzhen) started revenue contribution in 4Q FY17. This revenue line achieved 15 years of consecutive growth and outperformed the top 50 global Electronic Manufacturing Service (EMS) market. Platinum Broking 4

5 Other Sales of Integrated Access Devices (IADs), such as baby monitors and wireless monitoring systems have seen growth in North America and Asia Pacific segments, and slightly declined in Europe segment due to delayed launch of new product. Future Impact of Recent Acquisitions LeapFrog Enhances an important age group category of 1-3 years. Further expansion is expected including smart watches and tablets. Majority of revenues are generated in the US. We expect VTech s manufacturing experience to bring LeapFrog s margins in-line with VTech s. VTech will reduce workers of duplicated duties after consolidation. Margins of LeapFrog products should improve significantly. Snom Technology Snom Technology has had two decades to mature and refine their engineering in VoIP products. Management has stated to us that they believe that the high-quality technology will compliment VTech s SIP TEL (VoIP) segment. Due to the shift from Public Switched Telephone Networks (PSTN) to VoIP technology, the demand for VoIP is expected to grow. Yealink Network Technology, a Shenzhen IPO that specialises in SIP (VoIP/multi-media) telecoms and was oversubscribed 7,000 times, according to Reuters. The business is now valued at 39x trailing P/E. Recent Updates Toys R Us is filing for chapter 11 bankruptcy in the US as US$400m of debt nears maturity in VTech management have announced that their receivables have been insured for credit protection, thus we apply no provision for bad debt. We have reflected the impact in the ELP revenues in FY19. Platinum Broking 5

6 SECTION 4 VALUATION Exhibit 4: VTech Valuation Comparison Name Ticker FY16 Mkt Total cap Assets (HK$m) (HK$m) EV (HK$m) Closing price (HK$) 52-week High/Low (HK$) 6M Vol. (m shrs) 6M TO (HK$m) FY15 Avg. P/E (x) FY16 Avg. P/E (x) Cur. FY17E FY18E P/E (x) P/E (x) P/E (x) FY15 Avg. Yield FY16 Avg. Yield FY17E Yield FY18E Yield FY15 ROE FY16 ROE FY17E ROE FY18E ROE 1 Vtech 303 HK 8,272 29,411 27, / Techtronic 669 HK 39,959 78,503 80, / Asm Pacific 522 HK 15,639 46,417 45, / Yealink CH 1,076 25,778 25, / Simple avg Mkt cap wtd avg Source: Bloomberg Consensus, Company data We believe the opportunistic acquisitions VTech have made will pay-off, management act within their core areas of expertise. We adjust ELP revenue by -1.5% in FY19 due to the Toys R Us Chapter 11 proceedings, Toys R Us Asia/Europe/Australia are not affected by the proceedings. We look favourably on the SIP VoIP market as adoption accelerates when services become more attractive. In other segments, we see steady growth in the CMS segment and expect new products to continue driving ELP revenue. New CMS orders should come on stream in FY18. The Company has sustained its high payout ratio over the last 10 years. It is a constituent of the Hang Seng High Dividend Yield Index. VTech is also a constituent of the newly formed (May 2017) Hang Seng High Dividend Low Volatility Index. The Chairman has confirmed to us that he will continue to support their high-payout policy and continue to give value back to the shareholders. Exhibit 5: VTech 10-year Dividend Payout Ratio Source: Company data TP: HK$ % BUY FY20E target price of HK$139 is derived from our DCF valuation based on a (Risk free: 1.65%; ERP: 6.9%; beta: 0.47) WACC of 8.54%. We discount VTech s free cash flow and apply a terminal value growth rate of 2%. Platinum Broking 6

7 Oct-15 Nov-15 Dec-15 Jan-16 Feb-16 Mar-16 Apr-16 May-16 Jun-16 Jul-16 Aug-16 Sep-16 Oct-16 Nov-16 Dec-16 Jan-17 Feb-17 Mar-17 Apr-17 May-17 Jun-17 Jul-17 Aug-17 Sep-17 Oct-17 Volume (m shares) Share price (HK$) VTech Holdings Ltd 11 October 2017 Exhibit 6: VTech 2-Year Share Price Performance Vtech Holdings Ltd (303.HK) Last price (Oct 10,17) = HK$117.7 SMA(50) = SMA(100) = SMA(200) = Volume (Oct 10,17) = 0.2m 6M avg. = 37.9m 0 Source: Bloomberg, Company data Platinum Broking 7

8 Exhibit 7: Financial statements and forecasts INCOME STATEMENT (US$m) E 2019E 2020E Cash Flow Statement (US$m) E 2019E 2020E Electronic Learning Products CASH FLOW FROM OPERATIONS % of Revenue 37.3% 42.2% 42.6% 41.6% 40.7% Net Income Telecommunication Products (less) % of Revenue 31.5% 27.2% 25.4% 25.2% 24.8% Depreciation & amortization Contract Manufacturing Services Operating Profit before WC changes % of Revenue 31.2% 30.6% 32.0% 33.1% 34.5% Changes in Working Capital Total Revenue 1, , , , ,416.7 Tax Paid Growth -1.2% 12.0% 6.9% 4.7% 3.8% Interest received Cost of Goods Sold 1, , , , ,619.3 CFO % of Revenue 68.6% 66.8% 67.2% 67.1% 67.0% CASH FLOW FROM INVESTING Gross Profit Capex % of Revenue 31.4% 33.2% 33.1% 33.0% 33.0% CFI Operating Expenses (SG&A) % of Revenue 17.5% 19.8% 17.9% 18.1% 18.2% FREE CASH FLOW Research and Development % of Revenue 3.0% 3.7% 3.4% 3.3% 3.3% CASH FLOW FROM FINANCING Operating Profit (EBIT) Dividends Paid % of Revenue 10.9% 9.6% 11.5% 11.5% 11.4% Debt Net Finance Income Other Financing Pretax Income (EBT) CFF % of Revenue 10.9% 9.6% 10.7% 11.6% 11.4% Income Tax Expense (21.7) (21.1) (25.3) (28.8) (29.4) Ratio Analysis E 2019E 2020E Effective Tax Rate 10.7% 10.5% 10.6% 10.6% 10.6% Growth (YoY %) Net Income Revenue -1.2% 12.0% 6.9% 4.7% 3.8% % of Revenue 9.8% 8.6% 9.6% 10.4% 10.2% Net Income -8.4% -1.3% 19.0% 13.6% 2.2% DPS (US$ per share) Operating Income (EBIT) Dividend Payout Ratio 98.9% 58.2% 97.5% 98.2% 99.0% Depreciation Return Amortization Operating Return on Assets 22.1% 20.3% 23.4% 22.9% 22.1% EBITDA ROA 19.8% 18.2% 19.4% 20.7% 19.8% EBITDA Margin 12.8% 11.3% 13.1% 13.3% 13.1% ROE 34.0% 32.3% 34.2% 35.0% 32.2% ROCE 38.2% 34.9% 38.6% 36.9% 33.7% Balance Sheet (US$m) E 2019E 2020E Liquidity (x) Debt-to-equity 0% 3% 0% 0% 0% Cash & equivalents Net debt-to-equity (net cash %) -52% -43% -50% -53% -60% Accounts receivable Current ratio Inventory Quick ratio Other current assets Cash Ratio Total current assets , ,140.4 Interest coverage NM NM NM NM NM Net PP&E Total investments Revenue Segment Growth Rates E 2019E 2020E Other long-term assets Electronic Learning Products -1.5% 26.7% 8.0% 2.2% 1.4% Total assets , , , ,283.7 Telecommunication Products -5.7% -3.3% -0.3% 4.2% 2.2% Accounts payable Contract Manufacturing Services 10.4% 9.8% 11.9% 8.4% 8.0% Provision for defective goods Provision for defective goods 1.7% 1.7% 1.6% 1.7% 1.6% Short-term debt Other current liabilities Total current liabilities Long-term debt Other long-term liabilities Total liabilities Total common equity Minority interest Total liabilities & equity , , , ,283.7 Source: Company reports, Platinum Research Note: Differences may arise due to rounding errors; financial year ended in March. Platinum Broking 8

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12 DISCLOSURE OF INTERESTS Analyst Compensation: No part of the Analysts remuneration was, is, or will be directly or indirectly related to the analysis, comments or recommendations stated in this report. Market Making: Within 12 months before and after the publication of this report, this firm has not conducted, and will not participate in any market making in the listed securities of the companies covered in this report. Ownership of Shares: On the date of publication of this report, this firm does not own more than 1% of the common class of securities of the companies covered in this report. The analyst(s) who prepared this report does not have any financial interests in the common class of securities of the companies covered in this report. Investment Banking Service: Within 12 months before the publication of this report, this firm has not provided any investment banking services to and received any compensation from the companies covered in this report. Affiliation and Employment Relationship: On the date of publication of this report, no director or employee of this firm is serving as a director, consultant or an employee of the companies covered in this report. DISCLAIMER This report is prepared, produced and published by Platinum Broking Company Limited and its affiliated companies based in Shanghai and Singapore. Platinum Broking Company Limited is a licensed corporation registered with Hong Kong Securities and Futures Commission. This report is for distribution in Hong Kong and in other jurisdictions to the extent permissible by applicable law. This is neither a solicitation nor a recommendation to buy or sell any financial instruments in jurisdictions where such a solicitation or recommendation would be illegal, including but not limited to the United States of America, the United Kingdom and the European Union. This report does not take into account the specific investment objectives, financial situation or needs of any individual recipients. Investors should consider whether the analysis and recommendations in this report is suitable for their particular circumstances and if appropriate, seek professional advice. While we have made all reasonable endeavour to ensure the information in this report is true and up-to-date at the time of publication, we cannot guarantee its accuracy and completeness. The value of the securities referred to in this report may fluctuate. Neither Platinum Broking Company Limited, nor any of its holding or affiliated companies, nor any of its or their directors or employees, represent or warrant the accuracy or completeness of the information in this report, and will not accept any responsibility or liability for any use of or reliance upon any of the content of this report. The use of any information herein is at the sole discretion and risk of the investors. This report is produced and published by Platinum Broking Company Limited Hong Kong Office: 21/F LHT Tower, 31 Queen s Road Central, Hong Kong Telephone: Fax: Website: Shanghai Office: Platinum Holdings Company Ltd (Shanghai Representative Office), 11B Jin Ming Building, Block 2, 8 South Zun Yi Road, Shanghai Tel: Fax: Singapore Office: Platinum Securities Company Ltd, 1 Scotts Road, #24-14 Shaw Centre, Singapore Tel: Fax: Platinum Broking Company Limited. All rights reserved. This publication may not be reproduced, distributed or published by any person for any purpose without the prior express consent of Platinum Broking Company Limited. Platinum Broking 12