Hong Kong Telecom Sector

Transcription

1 China / Hong Kong Industry Focus Hong Kong Telecom Sector Refer to important disclosures at the end of this report DBS Group Research. Equity Spectrum re-assignment putting mobile operation at risk Re-assigning 60% of 900 MHz and 1800 MHz spectrum through auction Expect the related spectrum utilisation fee to increase by more than 100%, impacting mobile operators earnings by 3-14% Potential new entrants such as China Unicom will intensify market competition Maintain cautious view on HK mobile market Expect new entrants into a crowded mobile market. Between November 2020 and September 2021, mobile operators 15- year licences for 49.8 MHz of spectrum in the 900 MHz band and MHz of spectrum in the 1800 MHz band (collectively 2G spectrum) will expire. 40% of the expiring spectrum will be kept by the incumbent operators while 60% of the spectrum will be re-assigned through auction. The auction may introduce new entrants from China such as China Unicom Hong Kong which has indicated its interest to participate in the auction. Higher spectrum utilisation fee puts earnings at risk. Based on the current proposals to determine the new spectrum utilisation fee (SUF) for the 2G spectrum, we expect the SUF to increase from an average of HK$1.45m to HK$3.95m per MHz per year, representing an 100%+ increase. As a percentage of earnings, we expect Hutchison Telecom (HT, 215.HK, HOLD) to be impacted the most by higher SUF followed by SmarTone (SMT, 315.HK, HOLD). We expect the increase in SUF to represent 14% and 9% of HT s FY17F and SMT s FY6/17F earnings respectively. HKT (6823.HK, BUY) will be least impacted as the increase in SUF will only represent 3% of its FY17F earnings. 25 Apr 2017 HSI: 24,139 ANALYST Tsz Wang TAM CFA, tszwangtam@dbs.com Chris KO CFA, chriskof@dbs.com Recommendation & valuation Company Price T arget Rec Mkt FY18F Price Cap Yield HK$ HK$ US$m % Hong Kong Telecom operators HKBN (1310 HK) Buy 1, HKT Trust (6823 HK) Buy 9, Hutchison Telecom (215 HK) Hold 1, Smartone Telecom (315 HK) Hold 1, Source: Thomson Reuters, DBS Vickers Maintain cautious view on HK mobile market. We do not favour telecom operators with large exposure to mobile operation such as SMT and HT in the sector as the 2G spectrum re-assignment may introduce new Chinese entrants into the mobile market and incur higher SUF in the mediumterm. The market has yet to price in the potential earnings risk, in our view. Moreover, industry wide mobile tariff hike is challenging in the near-term as competition remains intense. Maintain HOLD on SMT and HT. We prefer HKT and HKBN (1310.HK, BUY) as they have less exposure to mobile business in terms of percentage of earnings. We also expect them to enjoy ARPU and profitability upside in the duopoly-like residential broadband market in the medium term. Maintain BUY on HKT and HKBN. ed-th/ sa- DL

2 Industry Focus Hong Kong Telecom Sector Background of 900 MHz and 1800 MHz spectrum reassignment Mobile operators 15-year licences for 49.8 MHz of spectrum in the 900 MHz band and MHz of spectrum in the 1800 MHz band (collectively 2G spectrum) will expire between November 2020 and September Together with 0.2 MHz of spectrum in the 900 MHz band and 1.2 MHz of spectrum in the 1800 MHz band which are currently vacant, a total of 200 MHz of spectrum will be re-assigned. The re-assignment is a major reshuffle of spectrum resources as 2G spectrum, totalling MHz of spectrum, accounts for 36% of a total of 552 MHz of spectrum in Hong Kong and 45% of spectrum deployed for 4G network service. Mobile spectrum allocation Frequency band 850/900 MHz 900 MHz 1800 MHz 2100 MHz 2300 MHz 2500/ 2600 MHz Total Unit: MHz CMHK HKT HT SMT Total Source: Office of the Communications Authority, DBS Vickers 2G spectrum was firstly assigned in the 1990s for the provision of 2G services and was re-assigned in the period of 2005/2006. Now, MHz of the 2G spectrum has been refarmed to provide 4G services and 9 MHz of spectrum has been refarmed to provide 3G services. We expect the demand for the spectrum to be high as 4G services will be the major mobile services in the next few years before the 5G era. Application of radio spectrum in the provision of public mobile telecommunications services Frequency band 2G 3G 4G CDMA 2000 Total unit: MHz 850/900 MHZ MHz MHz MHz MHz / 2600 MHz Total Source: Office of the Communications Authority The first consultation on the re-assignment has finished on 18 May 2016 and the second consultation has begun and will finish by the end of 24 Apr Final decision on the arrangement of spectrum re-assignment and the related SUF will be made by the end of Based on our analysis on the current spectrum re-assignment proposal, we expect mobile operators to suffer from higher spectrum utilisation fee (SUF), more competition from new entrants, and loss of spectrum resources. Page 2

3 Industry Focus Hong Kong Telecom Sector Approach to re-assign 2G spectrum After the first consultation, the regulator has proposed that 40% of the expiring spectrum will be kept by the incumbent operators and 60% of the spectrum will be re-assigned through auction (also refer to the graph below). Under the proposed re-assignment: 1. 2 x 10 [=20] MHz of spectrum in the 1800 MHz band will be re-assigned to each of the four incumbent spectrum assignees with the right of first refusal (RFR spectrum). 2. The remaining 70 MHz of spectrum in the 1800 MHz band and all the 50 MHz of spectrum in the 900 MHz band, totalling 120 MHz, will be assigned by through auction (auction spectrum). Proposed band plan for the 1800 MHz frequency band Auction HKT Auction SMT CMHK HT Auction Auction Lower band 1710 MHz MHz Auction HKT Auction SMT CMHK HT Auction Auction Upper band 1,805 MHz ,880 MHz HKT SMT Auction CMHK HT RFR Spectrum to be offered to HKT RFR Spectrum to be offered to SMT Frequency slots to be re-assigned by way of auction RFR Spectrum to be offered to CMHK RFR Spectrum to be offered to HT Source: Office of the Communications Authority Proposed band plan for the 900 MHz frequency band Lower band 890 MHz MHz Upper band 935 MHz MHz Source: Office of the Communications Authority Frequency slots to be assigned by way of auction Risks: introduction of new entrants and loss of spectrum The proportion of auction spectrum for 2G spectrums is proposed to increase to 60%, compared with 2100MHz spectrum re-assignment s 33% back in It was the regulator s intention to encourage more competition through the auction to bring in new players. Chinese mobile operators in Hong Kong such as China Unicom Hong Kong (CUHK), China Telecom Hong Kong (CTHK) as well as HKBN (1310.HK, BUY) are the potential bidders. CUHK has indicated its interest to participate in the auction. We reckon that CUHK and CTHK could form a JV to bid and share the spectrum to increase the economies of scale. Existing mobile operators may lose some of their spectrum. They may need to spend more capex on the mobile network to maintain the same network quality with less spectrum resources. Page 3

4 Industry Focus Hong Kong Telecom Sector Approach to set spectrum utilisation fees In 2005/2006 s re-assignment, the SUF of 2G spectrum was set at HK$145k per MHz per annum in the first 5 years. And from the sixth licence year onwards to the expiry (2010/ /2021), SUF was set at 5% royalty over the annual network turnover of the licensee, subject to a minimum fee of HK$1.45m per MHz per year. In the second consultation paper relating to the SUF, the authority, Secretary for Commerce and Economic Development (SCED) proposed: 1. The auction reserve price for both 900 MHz spectrum and 1800 MHz spectrum will be set between HK$19m per MHz (or HK$1.27m per MHz per annum) and HK$54m per MHz (or HK$3.6m per MHz per annum) for 15 years and SCED s present inclination is that the final value would be closer to the higher end. 2. The SUF of the RFR Spectrum should be set at the average SUF of the auction spectrum in the same frequency band, subject to a minimum price and a cap, both to be set by the SCED. 3. For RFR minimum price, SCED proposed that it may be set between HK$38m per MHz (or HK$2.53m per MHz per annum) and HK$67m per MHz (or HK$4.47m per MHz per annum) for 15 years, and SCED s inclination is that the final value would be closer to the higher end. 4. The SCED proposes that the cap should be set at around 30% to 40% higher than the minimum price for the RFR spectrum. Proposed spectrum utilisation fee pricing 900 MHz band 1800 MHz band 50MHz 70MHz 80MHz Re-assigned through Auction (Auction spectrum) Re-assigned to Incumbents with the RFR (RF R spectrum) Reserve price for auction proposed range: HK$19m-HK$54m per MHz for 15 years RFR minimum price proposed range: HK$38m-HK$67m per MHz for 15 years SUF Pricing Auction price Max [Auction price, RFR minimum price ] Max [Reserve price, Auction price] Subject to cap: RFR minimum price x [1 + 40%] Source: Office of the Communications Authority, DBS Vickers Page 4

5 Industry Focus Hong Kong Telecom Sector Risks: higher SUF and higher tax expense Based on our analysis of the current re-assignment proposal in the second consultation paper, we have set out base, bear and bull case scenarios for 2G SUF of the mobile operators. In our base case scenario, we expect the annual SUF for 2G spectrum to increase from an average of HK$1.45m to HK$3.95m, representing a more than 100% increase. We also expect the new SUF to be non-tax deductible and lead to higher tax expense as current SUF for 2G spectrum is tax deductible. We expect HKT (6823.HK, BUY) to be impacted the most in absolute dollar terms with a higher spectrum payment and tax expense of HK$140m and HK$21m per year respectively. However, this only accounts for 3% of its FY17F earnings. We expect Hutchison Telecom (HT, 215.HK, HOLD) to be impacted the most in terms of the percentage of earnings. In our basecase scenario, the incremental SUF and tax expense represent 14% of HT s FY17F earnings. We also estimate that the incremental SUF and tax expense to represent 9% of SmarTone s (SMT, 315.HK, HOLD) FY6/17F earnings. Summary of scenario analysis Change of spectrum resources % of FY17F earnings Bear case Base case Bull case HKT % 3% 0% HT % 14% 2% SMT* % 9% 0% * FY6/17F Source: DBS Vickers We have set out some general assumptions in our scenario analysis: 1. There will be a new entrant taking 10 MHz of 900 MHz bands and 20 MHz of 1800 MHz. 2. For 900 MHz band, we have also assumed, each mobile operator and the new entrant to receive 10MHz. 3. The allocation of 1800 MHz is approximately in accordance to their respective market shares. Our base-case scenario is based on SCED s proposal and inclination. We assume the reserve price to be HK$54m per MHz or HK$3.6m per MHz per annum which is at the higher end of the proposed price range. We also expect the auction price to stay at reserve price. For the RFR price, we expect it to be HK$67m or HK$4.47m per MHz per annum which is the higher end of the range for minimum price [More to see Appendix scenario analysis]. Hong Kong Inland Revenue Department (IRD) has advised that SUF will be regarded as capital expenditure and therefore not tax deductible. This will increase the effective tax rate as the spectrum utilisation fee of current 2G spectrum is tax deductible. The SCED proposed that the spectrum assignees will be given a choice to pay the SUF either by: 1. lump sum payment upfront, which is the lump sum amount obtained in auction and/or via right of first refusal 2. annual instalments, with the first instalment equivalent to the lump sum amount obtained in (a) above divided by 15 (i.e. the number of years of assignment), and subsequent instalments increased every year by a pre-set fixed percentage which aims to reflect the time value of money to the government Page 5

6 Industry Focus Hong Kong Telecom Sector Estimation of current spectrum utilisation fee 900 MHz 1800 MHz Total Current SUF Calc ulat ion A B C [=A+B] D [=CxHK$1.45m] Unit MHz MHz HK$m p.a. HK$m p.a. CMHK HKT HT SMT New Entrant Total Source: Office of the Communications Authority, DBS Vickers Scenario analysis base case Assumptions: 15 y ears per y ear Reserve price (HK$m per MHz) RFR minimum price (HK$m per MHz) RFR cap (HK$m per MHz) Auction spectrum price (HK$m per MHz) RFR spectrum price (HK$m per MHz) MHz 1800 MHz Total Current SUF Renewal SUF through RFR Renewal SUF through auction Total SUF Annual change of SUF Increase in tax expense Total financial impact Calculation A B C [=A+B] D E [=20xHK$4.5m]* F [=(C-20) xhk$3.6m]* # G [=E+F] H [=G-D] I [=Dx16.5 %] J [=H+I] Unit MHz MHz MHz HK$m HK$m p.a. HK$m p.a. HK$m p.a. HK$m p.a. HK$m p.a. HK$m p.a. CMHK HKT HT SMT New Entrant Total Av erage SUF HK$m per MHz p.a *2x10 (=20) MHz of spectrum is subject to RFR spectrum price and rest (c-20) is subject to auction spectrum price. #Calculation of renewal SUF through auction for New Entrant is CxHK$3.6m. Source: Office of the Communications Authority, DBS Vickers Page 6

7 Industry Focus Hong Kong Telecom Sector Does increase in administration fee help? HKT has claimed that it would have to increase the administration fee by HK$12 from the current HK$18 to HK$30 to offset the impact from increasing network cost. The administration fee should be only applicable to the post-paid subs. HKT should benefit the most as it has the largest customer base. We estimate the additional revenue for HKT to be HK$451m while that for SMT and HT to be HK$214m and HK$202m respectively. The additional revenue through the HK$12 increase in administration is higher than the incremental SUF and tax expense due to the 2G spectrum reassignment in our base case scenario analysis. Additional revenue through HK$12 increase in administration fee Number of post paid subs (k) Additional revenue (HK$m) HKT 3, HT 1, SMT 1, Conclusion We do not favour telecom operators with large exposure to mobile operation such as SMT and HT in the sector as the 2G spectrum re-assignment may introduce new Chinese entrants into the mobile market and incur higher SUF in the mediumterm. The market is yet to price in the potential earnings risk, in our view. Moreover, industry wide mobile tariff hike is challenging in the near-term as competition remains intense. Maintain HOLD on SMT and HT. For the Hong Kong telecom sector, we prefer HKT and HKBN as they have less exposure to mobile business in terms of percentage of earnings. We also expect them to enjoy ARPU and profitability upside in the duopoly-like residential broadband market in the medium term. Maintain BUY on HKT and HKBN. Source: Companies, DBS Vickers However, the ability to pass the increased network cost to consumer by increasing the administration fee (or mobile service plan tariff hike) will depend on the intensity of market competition. If there are new Chinese mobile operators entering the mobile market through the auction of spectrum, we reckon that competition will be more intense as the new entrants will focus on market share first. This will prevent the full transfer of increased spectrum costs to consumers. Page 7

8 Industry Focus Hong Kong Telecom Sector Peers valuation Mkt PE PE Yield Yield P/Bk P/Bk EV /EBITDA F CF Yield Currency Price Cap Fiscal 17F 18F 17F 18F 17F 18F 17F 18F 17F 18F Company Name Code Local$ US$m Y r x x % % x x x x % % China telecom operators China Mobile* 941 HK HKD ,933 Dec China Unicom* 762 HK HKD ,597 Dec China Telecom 'H'* 728 HK HKD ,734 Dec Average Hong Kong telecom operators HKT Trust* 6823 HK HKD ,675 Dec Hutchison Telecom* 215 HK HKD ,419 Dec Smartone Telecom* 315 HK HKD ,454 Jun HKBN* 1310 HK HKD ,054 Aug Average Taiwan telecom operators Chunghwa Telecom 2412 TT TWD ,458 Dec n.a. n.a. Taiwan Mobile 3045 TT TWD ,517 Dec n.a. n.a. Far Eastone Telecom TT TWD ,028 Dec n.a. n.a. Average n.a. n.a. Singapore telecom operators Starhub* STH SP SGD 2.8 3,481 Dec (0.3) M1* M1 SP SGD ,420 Dec (1.7) Average (1.0) Malay sia telecom operators Axiata Group* AXIATA MK MYR ,322 Dec (0.1) 4.0 Digi.Com* DIGI MK MYR ,138 Dec Maxis* MAXIS MK MYR ,995 Dec Telekom Malaysia* T MK MYR ,536 Dec Average Indonesia telecom operators Telekomunikasi Indo* TLKM IJ IDR ,537 Dec Indosat* ISAT IJ IDR ,986 Dec Xl Axiata* EXCL IJ IDR ,414 Dec (5.8) 5.0 Average Thailand telecom operators Advanced Info Ser.* ADV ANC TB THB ,102 Dec Total Access Comms.* DTAC TB THB ,912 Dec True Corporation TRUE TB THB 6.4 6,216 Dec n.a (7.8) (8.6) Average (0.7) (1.6) # FY17: FY18; FY18: FY19 Source: Thomson Reuters, *DBS Vickers Page 8

9 Industry Focus Hong Kong Telecom Sector Appendix scenario analysis Based on the second consultation paper, we have set out bear base and bull case scenarios for 2G SUF of the mobile operators. We have set out some general assumptions in all three cases: 1. There will be a new entrant taking 10 MHz of 900 MHz bands and 20 MHz of 1800 MHz 2. For 900 MHz band, we have also assumed, each mobile operator and the new entrant to receive 10MHz Base case Our base-case scenario is based on SCED s proposal and inclination. We expect the reserve price to be HK$54m per MHz or HK$3.6m per MHz per annum which is the higher end of proposed price range. We also expect the auction price to stay at reserve price. For the RFR price, we expect it to be HK$67m which is the higher end of the range for minimum price. 3. The distribution of 1800 MHz is approximately in accordance to their respective market shares. Estimation of current spectrum utilisation fee 900 MHz 1800 MHz Total Current SUF Calc ulat ion A B C [=A+B] D [=CxHK$1.45m] Unit MHz MHz HK$m p.a. HK$m p.a. CMHK HKT HT SMT New Entrant Total Source: Office of the Communications Authority, DBS Vickers Page 9

10 Industry Focus Hong Kong Telecom Sector Scenario analysis base case Assumptions: 15 years per year Reserve price (HK$m per MHz) RFR minimum price (HK$m per MHz) RFR cap (HK$m per MHz) Auction spectrum price (HK$m per MHz) RFR spectrum price (HK$m per MHz) MHz 1800 MHz Total Current SUF Renewal SUF through RFR Renewal SUF through auction Total SUF Annual change of SUF Increase in tax expense Total financial impact Calc ulat ion A B C [=A+B] D E [=20xHK$4.5m]* F [=(C-20) xhk$3.6m]* # G [=E+F] H [=G-D] I [=Dx16.5 %] J [=H+I] Unit MHz MHz MHz HK$m HK$m p.a. HK$m p.a. HK$m p.a. HK$m p.a. HK$m p.a. HK$m p.a. CMHK HKT HT SMT New Entrant Total Average SUF HK$m per MHz p.a *2x10 (=20) MHz of spectrum is subject to RFR spectrum price and rest (c-20) is subject to auction spectrum price. #Calculation of renewal SUF through auction for New Entrant is CxHK$3.6m. Source: Office of the Communications Authority, DBS Vickers Page 10

11 Industry Focus Hong Kong Telecom Sector Bear case In our bear case scenario, we have assumed the reserve price to be HK$54m per MHz or HK$3.6m per MHz per annum which is the higher end of suggested price range. However, the final auction price may be bid higher. We assume it is bid to 40% higher than the reserve price. For the RFR price, we assumed it to be HK$93.8m which is 40% higher than the higher end of the range for minimum price. Scenario analysis bear case Assumptions: 15 years per year Reserve price (HK$m per MHz) RFR minimum price (HK$m per MHz) RFR cap (HK$m per MHz) Auction spectrum price (HK$m per MHz) RFR spectrum price (HK$m per MHz) MHz 1800 MHz Total Current SUF Renewal SUF through RFR Renewal SUF through auction Total SUF Annual change of SUF Increase in tax expense Total financial impact Calculation A B C [=A+B] D E [=20xHK$6.3m]* F [=(C-20) xhk$6.3m]*# G [=E+F] H [=G-D] I [=Dx16.5 %] J [=H+I] Unit MHz MHz MHz HK$m HK$m p.a. HK$m p.a. HK$m p.a. HK$m p.a. HK$m p.a. HK$m p.a. p.a. CMHK HKT HT SMT New Entrant Total Average SUF HK$m per MHz p.a *2x10 (=20) MHz of spectrum is subject to RFR spectrum price and rest (c-20) is subject to auction spectrum price. #Calculation of renewal SUF through auction for New Entrant is CxHK$6.3m Source: Office of the Communications Authority, DBS Vickers Page 11

12 Industry Focus Hong Kong Telecom Sector Bull case In our bull-case scenario, we have assumed the reserve price to be HK$19m per MHz or HK$1.26m per MHz per annum which is the lower end of suggested price range. We also expect the auction price to stay at reserve price. For the RFR price, we expect it to be HK$38m which is the lower end of the suggested range for minimum price. Scenario analysis bull case Assumptions: 15 y ears per y ear Reserve price (HK$m per MHz) RFR minimum price (HK$m per MHz) RFR cap (HK$m per MHz) Auction spectrum price (HK$m per MHz) RFR spectrum price (HK$m per MHz) MHz 1800 MHz Total Current SUF Renewal SUF through RFR Renewal SUF through auction Total SUF Annual change of SUF Increase in tax expense Total financial impact Calculat ion A B C [=A+B] D E [=20xHK$2.5m]* F [=(C-20) xhk$1.3m]*# G [=E+F] H [=G-D] I [=Dx16.5 %] J [=H+I] Unit MHz MHz MHz HK$m HK$m p.a. HK$m p.a. HK$m p.a. HK$m p.a. HK$m p.a. HK$m p.a. p.a. CMHK HKT HT SMT New Entrant Total Av erage SUF HK$m per MHz p.a *2x10 (=20) MHz of spectrum is subject to RFR spectrum price and rest (c-20) is subject to auction spectrum price. #Calculation of renewal SUF through auction for New Entrant is CxHK$1.3m Source: Office of the Communications Authority, DBS Vickers Page 12

13 China / Hong Kong Company Guide HKBN Ltd. Version 9 Bloomberg: 1310 HK Equity Reuters: 1310.HK Refer to important disclosures at the end of this report DBS Group Research. Equity 25 Apr 2017 BUY Last Traded Price ( 24 Apr 2017):HK$8.15 (HSI : 24,139) Price Target 12-mth: HK$12.20 (50% upside) Potential Catalyst: ARPU increase and market share gain Where we differ: We focus more on the long-term prospects despite the volatility in short-term free cash flow due to higher customer acquisition cost for sub net-adds Analyst Tsz Wang TAM CFA, tszwangtam@dbs.com Chris KO CFA, chriskof@dbs.com Price Relative HK$ Mar-15 Sep-15 Mar-16 Sep-16 Mar-17 HKBN Ltd. (LHS) Relative HSI (RHS) Relative Index Forecasts and Valuation FY Aug (HK$ m) 2015A 2016A 2017F 2018F Turnover 2,341 2,784 3,169 3,615 Core EBITDA 979 1,009 1,044 1,353 Pre-tax Profit Net Profit Net Pft (Pre Ex) (core profit) Net Profit Gth (Pre-ex) (%) EPS (HK$) EPS Gth (%) Diluted EPS (HK$) AFCF DPS (HK$) BV Per Share (HK$) PE (X) P/Cash Flow (X) P/Free CF (X) EV/EBITDA (X) Net Div Yield (%) P/Book Value (X) Net Debt/Equity (X) ROAE (%) Earnings Rev (%): 0 0 Consensus EPS (HK$) Other Broker Recs: B: 7 S: 0 H: 0 Source of all data on this page: Company, DBSV, Thomson Reuters, HKEX Looking up to a clearer sky Significant upside potential in ARPU under duopoly We have a BUY rating on HKBN, and TP of HK$12.20 based on dividend discount model (DDM). HKBN offers a dividend yield of 5%+, and we forecast dividend CAGR of 20%+ from FY8/17-FY8/19F. The company increased its market share from c.16% in FY8/08 to c.33% in FY8/16, and is now the second largest residential broadband operator in Hong Kong. We expect it to enjoy upside to residential broadband ARPU (average revenue per user) and profitability in a duopoly-like market. Switching focus from sub to revenue market share HKBN achieved its 100k sub net-add target in FY8/16, and now has a total sub base of 857k. In 2015, it initiated a price war in the residential broadband market and gained 100k sub net-adds in FY8/16, and targets to add another 100k in FY8/17F. It is now shifting its focus from sub to revenue market share and has started raising tariffs in Jan This will result in lower customer acquisition cost and higher ARPU, which is positive to free cash flow. HKBN s residential broadband ARPU is c.40% below HKT's (6823.HK), offering significant upside potential for ARPU and profitability improvement. A growth stock with decent dividend yield We expect the company to grow its revenue by c.14% p.a. from FY8/17-FY8/19F, driven by residential market share gain and expansion in the enterprise segment. We estimate that its core EBITDA will grow at a CAGR of c.15%+ from FY8/17-FY8/19F. The company intends to pay out % of its adjusted free cash flow (AFCF), which is estimated to grow at a CAGR of 20%+ from FY8/17-FY8/19F. The stock offers 5.1% dividend yield for FY8/17F and 7.0% for FY8/18F. Valuation: We have a BUY rating on HKBN for its dividend growth potential. Our TP of HK$12.2 is based on DDM, assuming 7.9% cost of equity and 1% terminal growth rate. Key Risks to Our View: Price war. Competitors irrationally cutting prices to be lower than that offered by HKBN for a prolonged period. Increase in finance cost due to interest rate up-cycle. Increase in interest rates will decrease AFCF and dividend yield. At A Glance Issued Capital (m shrs) 1,006 Mkt. Cap (HK$m/US$m) 8,196 / 1,054 Major Shareholders Canada Pension Plan Investment Board (%) 18.0 GIC Private Limited (%) 9.1 The Capital Group Companies, Inc. (%) 8.0 Matthews International Capital Management, LLC (%) 6.0 Mondrian Investment Partners Limited (%) 5.6 Free Float (%) m Avg. Daily Val. (US$m) 2.1 ICB Industry : Telecommunications / Fixed Line Telecommunications ed-js/ sa- DL

14 Company Guide HKBN Ltd. CRITICAL DATA POINTS TO WATCH Earnings Drivers: Expanding market share through tactical pricing strategy. HKBN has been gaining market share from competitors through aggressive pricing strategy. It strategically offers deep discounts to gain new subscribers, and has been capable of raising back tariffs upon contract renewal. It has a track record of managing decent ARPU growth over a longer period of time despite short-term volatility. Going forward, HKBN has switched its focus from sub to revenue market share and started raising tariffs in Jan Therefore, we expect to see low single-digit growth rates for sub numbers in the next few years Residential broadband sub (k) Residential broadband ARPU (HK$) ARPU improvement. HKBN has switched its focus from sub to revenue market share and started to raise tariffs. HKBN s residential broadband ARPU is around HK$170 which is 40% below HKT s c.hk$300, offering significant upside potential for ARPU and profitability improvement. HKBN may selectively narrow the differences in some areas without losing its customers. We also expect HKBN to continue upselling higher-tier plans to its customers Migration to fibre. Consumers are looking for faster broadband connection due to rising demand for internet multimedia content, and therefore are migrating to fibre network (FTTx), from other slower technologies such as Hybrid Fibre Coaxial (HFC) and Digital Subscriber Line (xdsl) for broadband services. HKBN s Metro Ethernet network supports symmetric upstream/downstream transmission speeds from 100-1,000Mbps, while HFC and xdsl offer only up to a maximum of 100Mbps downstream speed with limitations such as lower upstream speeds. We expect HKBN to gain market share from operators providing HFC and xdsl network services. Replication of success in residential market to enterprise market. HKBN is replicating its success in the residential broadband market to the enterprise market. HKBN focuses on the small enterprise segment, of which broadband penetration is expected to increase due to the robust development of cloud services, enterprise internet applications and e-commerce. Expansion of enterprise broadband business through acquisition. HKBN acquired an enterprise broadband business (New World Telecom) on 18 February This will double the scale of HKBN s enterprise broadband business. The acquisition will enable HKBN to penetrate into a higher-tiered enterprise customer group. New revenue opportunities from extended coverage and new services such as data centres will also help business growth. Page 14

15 Company Guide HKBN Ltd. Balance Sheet: Strong free cash flow. The company generates strong free cash flow with an expected CAGR of 20%+ p.a. The company intends to pay out % of its adjusted free cash flow (AFCF) as dividends. AFCF is derived from core EBITDA adjusted for capex, net interest, non-recurring items, non-cash items, tax paid and changes in working capital Leverage & Asset Turnover (x) Healthy balance sheet. HKBN had total borrowings of HK$3.7bn with a debt-to-ebitda ratio of 3.6x at end-fy8/16, which is manageable. We expect the company to maintain the debt level and forecast debt-to-ebitda to be 3.3x in FY8/17F. Share Price Drivers: Stronger sub growth. Going forward, HKBN has switched its focus from sub to revenue market share and has started to raise tariffs. Therefore, we expect to see low single-digit growth rates for sub numbers in the next few years. Faster sub net-adds will be positive for the company's share price. ARPU improvement. HKBN has switched its focus from sub to revenue market share and started raising tariff in Jan HKBN s residential broadband ARPU is around HK$170, which is 40% below HKT s c.hk$300, offering significant upside potential for ARPU and profitability improvement. HKBN may selectively narrow the differences in some areas without losing its customers. We also expect HKBN to continue upselling higher-tier plans to its customers. Stronger dividend growth. Strong business growth and operating leverage could lead to stronger EBITDA growth. Reduction in capex as a percentage of revenue will further enhance AFCF and therefore dividend distribution. Key Risks: A real price war Competitors irrationally cut prices to be lower than that offered by HKBN for a prolonged period. Increase in interest rates Increase in interest rates will decrease the AFCF and the dividend yield. Company Background: HKBN is a broadband service provider in Hong Kong. It is the second largest player in the residential segment with a market share of c.30% Gross Debt to Equity (LHS) Asset Turnover (RHS) Capital Expenditure HK$m Capital Expenditure (-) ROE 40.0% 35.0% 30.0% 25.0% 20.0% 15.0% 10.0% 5.0% 0.0% Forward PE Band +2sd: 50.9x +1sd: 43.5x Avg: 36.1x 1sd: 28.7x 2sd: 21.4x (x) Mar-15 Sep-15 Mar-16 Sep-16 Mar-17 (x) PB Band +2sd: 7.47x +1sd: 6.98x Avg: 6.49x 1sd: 5.99x 2sd: 5.5x Mar-15 Sep-15 Mar-16 Sep-16 Mar-17 Page 15

16 Company Guide HKBN Ltd. Key Assumptions FY Aug Residential broadband sub (k) Residential broadband ARPU (HK$) Income Statement (HK$ m) FY Aug Revenue 2,132 2,341 2,784 3,169 3,615 Cost of Goods Sold (287) (306) (451) (618) (651) Gross Profit 1,844 2,035 2,333 2,551 2,964 Other Opng (Exp)/Inc (1,552) (1,588) (1,857) (2,081) (2,218) Operating Profit Other Non Opg (Exp)/Inc Associates & JV Inc Net Interest (Exp)/Inc (188) (257) (141) (132) (132) Dividend Income Exceptional Gain/(Loss) Pre-tax Profit Tax (51) (86) (90) (90) (142) Minority Interest Preference Dividend Net Profit Net Profit before Except EBITDA ,044 1,353 Growth Revenue Gth (%) EBITDA Gth (%) Opg Profit Gth (%) (1.1) 58.4 Net Profit Gth (%) N/A Margins & Ratio Gross Margins (%) Opg Profit Margin (%) Net Profit Margin (%) ROAE (%) ROA (%) ROCE (%) Div Payout Ratio (%) Net Interest Cover (x) Page 16

17 Company Guide HKBN Ltd. Interim Income Statement (HK$ m) FY Aug 1H2015 2H2015 1H2016 2H2016 1H2017 Revenue 1,126 1,215 1,226 1,558 1,535 Cost of Goods Sold (129) (177) (137) (315) (304) Gross Profit 997 1,038 1,089 1,244 1,231 Other Oper. (Exp)/Inc (806) (782) (839) (1,018) (1,026) Operating Profit Other Non Opg (Exp)/Inc Associates & JV Inc Net Interest (Exp)/Inc (197) (61) (66) (75) (117) Exceptional Gain/(Loss) Pre-tax Profit (6) Tax (41) (44) (48) (42) (44) Minority Interest Net Profit (47) Net profit bef Except. (47) Growth Revenue Gth (%) Opg Profit Gth (%) (11.7) (17.8) Net Profit Gth (%) N/A N/A (27.5) (66.0) Margins Gross Margins (%) Opg Profit Margins (%) Net Profit Margins (%) (4.1) Balance Sheet (HK$ m) FY Aug Net Fixed Assets 1,957 1,970 2,420 2,389 2,354 Invts in Associates & JVs Other LT Assets 3,044 2,954 3,359 3,236 3,114 Cash & ST Invts Inventory Debtors Other Current Assets Total Assets 5,719 5,551 6,605 6,474 6,425 ST Debt Creditors Other Current Liab LT Debt 2,994 3,019 3,721 3,721 3,721 Other LT Liabilities Shareholder s Equity 1,643 1,514 1,363 1,191 1,145 Minority Interests Total Cap. & Liab. 5,719 5,551 6,605 6,474 6,425 Non-Cash Wkg. Capital (270) (190) (355) (399) (396) Net Cash/(Debt) (2,558) (2,690) (3,366) (3,367) (3,283) Debtors Turn (avg days) Creditors Turn (avg days) (18.0) (19.5) (376.4) 1, ,397.4 Inventory Turn (avg days) (24.3) (38.8) (214.1) Asset Turnover (x) Current Ratio (x) Quick Ratio (x) Net Debt/Equity (X) Net Debt/Equity ex MI (X) Capex to Debt (%) Z-Score (X) NA NA NA NA NA Page 17

18 Company Guide HKBN Ltd. Cash Flow Statement (HK$ m) FY Aug Pre-Tax Profit Dep. & Amort Tax Paid (43) (86) (58) (107) (159) Assoc. & JV Inc/(loss) (Pft)/ Loss on disposal of FAs Chg in Wkg.Cap. 74 (115) 0 44 (3) Other Operating CF Net Operating CF ,186 Capital Exp.(net) (346) (324) (393) (420) (450) Other Invts.(net) Invts in Assoc. & JV Div from Assoc & JV Other Investing CF 22 0 (649) 2 2 Net Investing CF (324) (324) (1,042) (418) (448) Div Paid 0 (230) (402) (425) (520) Chg in Gross Debt (256) (105) Capital Issues Other Financing CF (169) (108) (137) (134) (134) Net Financing CF (425) (443) 144 (559) (654) Currency Adjustments 0 2 (3) 0 0 Chg in Cash 126 (107) 26 (1) 84 Opg CFPS (HK$) Free CFPS (HK$) Target Price & Ratings History HK$ S.No. Date Closing 12-mth Rating Price Target Price 1: 27-Apr-16 HK$9.42 HK$12.50 Buy 2: 13-May-16 HK$9.00 HK$11.80 Buy 3: 14-Sep-16 HK$9.32 HK$11.80 Buy 4: 27-Oct-16 HK$9.05 HK$12.60 Buy 5: 10-Nov-16 HK$9.05 HK$12.20 Buy 6: 15-Nov-16 HK$8.77 HK$12.20 Buy 7: 14-Dec-16 HK$8.59 HK$12.20 Buy 7.0 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 Source: DBS Vickers Analyst: Tsz Wang TAM CFA, Page 18

19 China / Hong Kong Company Guide HKT Trust Version 5 Bloomberg: 6823 HK Equity Reuters: 6823.HK Refer to important disclosures at the end of this report DBS Group Research. Equity 25 Apr 2017 BUY Last Traded Price ( 24 Apr 2017):HK$9.94 (HSI : 24,139) Price Target 12-mth: HK$13.50 (36% upside) Potential Catalyst: Availability of popular handsets, price hikes and more cost savings from HKT/CSL merger Where we differ: HKT has low incentive to lead mobile tariff hikes as steady AFF growth can be driven by cost savings from HK/CSL merger Analyst Tsz Wang TAM CFA, tszwangtam@dbs.com Chris KO CFA, chriskof@dbs.com Price Relative HK$ Apr-13 Apr-14 Apr-15 Apr-16 Apr-17 Forecasts and Valuation FY Dec (HK$ m) 2015A 2016A 2017F 2018F Turnover 34,729 33,847 35,840 36,447 EBITDA 12,098 12,613 12,963 13,317 Pre-tax Profit 4,586 5,698 6,099 6,369 Net Profit 3,949 4,889 5,208 5,440 Net Pft (Pre Ex) (core profit) 3,949 4,889 5,208 5,440 Net Profit Gth (Pre-ex) (%) EPS (HK$) Core EPS (HK$) EPS Gth (%) Core EPS Gth (%) Diluted EPS (HK$) DPS (HK$) BV Per Share (HK$) PE (X) Core PE (X) P/Cash Flow (X) P/Free CF (X) EV/EBITDA (X) Net Div Yield (%) P/Book Value (X) Net Debt/Equity (X) ROAE (%) Earnings Rev (%): Nil Nil Consensus EPS (HK$) Other Broker Recs: B: 10 S: 0 H: 1 Source of all data on this page: Company, DBSV, Thomson Reuters, HKEX ed- JS / sa- DL HKT Trust (LHS) Relative HSI (RHS) Relative Index Cost savings to drive higher dividends Incumbent operator with attractive dividend yield We have a BUY rating on HKT Trust (HKT), with a dividend discount model (DDM)-based TP of HK$13.5. HKT offers a dividend yield of c.7% with potential upside from lower capex and more cost savings arising from the HKT/CSL merger. It is an incumbent player in the fixedline segment, and became the largest mobile operator after merging with CSL in FY14. HKT intends to pay out 100% of its adjusted fund flows (AFF) which is expected to grow by c.5% p.a. from FY17-18F. Continuous cost savings from lower capex ahead and CSL integration We expect mobile ARPU (average revenue per user) and subscriber base to record flat to low single digit growth amid intense competition. We expect HKT to reap further cost savings from (1) exiting 52 low usage mobile value-added services, (2) reduction in spectrum expenses by retaining only half of the 2.1GHz spectrum, and (3) lower capex due to network integration. We also forecast mid to low-single digit growth for the fixed-line business driven by (1) less competition in the residential broadband market, and (2) increasing bandwidth demand for corporates and international carriers. Stable growth with upside potential from the next iphone We forecast AFF, which is fully distributed as dividends, to grow by c.5% p.a. in FY17-18F, driven by cost savings from reduction in capex and the continuous cost synergies from HKT/CSL merger. The stock currently offers an attractive dividend yield of c.7% which should be sustainable in the medium term. The launch of next iphone at its 10th anniversary in 2H17 could potentially offer the next window of mobile tariff hikes and drive stronger handset sales. Valuation: We have a BUY rating on HKT for its attractive dividend yield with further growth potential. Our TP of HK$13.5 is based on DDM assuming 6.9% cost of equity and 1% terminal growth rate. Key Risks to Our View: Irrational market competition. Hong Kong s mobile market is crowded with four major players and the penetration is more or less saturated. Irrational pricing may lead to a price war. Interest rate up-cycle. Any increase in interest rates will reduce the AFF and therefore the dividend distribution. At A Glance Issued Capital (m shrs) 7,572 Mkt. Cap (HK$m/US$m) 75,263 / 9,675 Major Shareholders PCCW Limited (%) 52.0 Free Float (%) m Avg. Daily Val. (US$m) 48.2 ICB Industry : Telecommunications / Fixed Line l i i

20 Company Guide HKT Trust CRITICAL DATA POINTS TO WATCH Fixed-line sub growth (%) Earnings Drivers: Cost savings from CSL integration and capex reduction. HKT has been integrating CSL s networks as well as optimising the retail channels. As the network integration has largely been completed, we expect reduction in capex to support dividend growth. We also expect further cost savings from (1) exiting 52 low usage mobile value-added services, and (2) lower spectrum expense by retaining only half of the 2.1GHz spectrum. Further optimisation in retail outlets, human resources, and network backhaul will bring in more cost synergies in the next few years. Fixed-line ARPU improvement. We believe that smaller operators HT and i-cable have lost their competitiveness and therefore pricing power. The residential broadband market is effectively dominated by two players, HKBN and HKT. HKBN has switched its focus from subscribers to revenue market share and will start to raise prices, which is positive to industry ARPU. We expect ARPU and profitability upside under the duopoly. Mobile tariff hikes. The mobile market is crowded with four major players, namely HKT, Hutchison Telecom (HT), SmarTone (SMT) and China Mobile Hong Kong (CMHK). Despite increasing data usage partly due to over-the-top (OTT) content data consumption, the market lacks a price leader to take the initiative to raise the tariff for higher-end mobile data packages. HKT has the largest market share of mobile subscriber base and stands to benefit the most from a tariff hike. However, it has been focusing on network and brand integration as well as cost savings after the acquisition of CSL in May We reckon that the cost synergies should be able to support its free cash flow or dividend growth target in the coming few years. Therefore, HKT lacks incentive to improve dividend growth by raising mobile tariff and we expect it to be a price follower in the near term. It has the market power to take the lead to raise the tariff when the timing is appropriate. Mobile sub growth. Hong Kong's mobile market is more or less matured with low single-digit sub growth in the past two years. HKT, HT, SMT and CMHK commanded market shares of c.31%, c.22%, c.14% and c.20% respectively in June We expect HKT to continue optimising its customer mix to align its new rebranding (csl., 1O1O and SUN mobile) Broadband sub growth (%) A 2015A A 2017F 2018F Mobile sub growth (%) A 2016A 2017F 2018F Mobile ARPU EBITDA margin (%) Page 20

21 Company Guide HKT Trust Balance Sheet: Healthy financials with a debt-to-ebitda ratio of 3.0x. HKT had bank borrowings of HK$38bn and its debt-to-ebitda ratio remained healthy at c.3.0x at end-fy16. Average debt maturity is around five years with an effective interest rate of c.2.5%. The company intends to pay out 100% of its AFF (which is basically free cash flow), and to maintain its debt level. Share Price Drivers: Cost savings from CSL integration and capex reduction. HKT has been integrating CSL s networks as well as optimising the retail channels. As the network integration has largely been completed, we expect reduction in capex to support dividend growth. We expect further cost savings from (1) exiting 52 low usage mobile value-added services and (2) reduction in spectrum expense by retaining only half of the 2.1GHz spectrum. Further optimisation in retail outlets, human resources, and network backhaul will bring in more cost synergies in the next few years. Leverage & Asset Turnover (x) Gross Debt to Equity (LHS) Asset Turnover (RHS) Capital Expenditure HK$m 3, , , , , , Tariff hike in the mobile market. Industry-wide tariffs for mobile operators are competitive and requires one major player to take the lead. HKT has the largest market share of mobile subscriber base and stands to benefit the most from a tariff hike. It has the market power to take the lead to raise the tariff when the timing is appropriate. Mobile sub growth. HKT has rebranded SUN Mobile to focus on the mass market, and csl. and 1O1O to focus on mid- to highend postpaid customers. The brands have clear target markets and price differentials. We believe this market repositioning may lead to some marginal postpaid subscriber loss in the near term but the impact should be limited. Signs of this bottoming out will be positive to the share price. 12.0% 10.0% 8.0% 6.0% 4.0% 2.0% 0.0% (x) Capital Expenditure (-) ROE Forward PE Band +2sd: 20.1x Key Risks: Irrational market competition. Hong Kong s mobile market is crowded with four major players and the penetration is more or less saturated. Irrational pricing may lead to a price war. Interest rate up-cycle. Any increase in interest rates will reduce the AFF and therefore the dividend distribution. Company Background: HKT is an integrated telecom service provider in Hong Kong, with the largest market share in the fixed-line and mobile market. The broadband services are provided via the brand Netvigator and the mobile services are provided via the brands SUN Mobile, csl. and 1O1O. HKT is 63.07% owned by PCCW sd: 18.5x Avg: 16.9x sd: 15.4x sd: 13.8x 12.1 Apr-13 Apr-14 Apr-15 Apr-16 Apr-17 (x) 2.7 PB Band +2sd: 2.33x +1sd: 2.08x Avg: 1.84x 1sd: 1.59x 2sd: 1.35x Apr-13 Apr-14 Apr-15 Apr-16 Apr-17 Page 21

22 Company Guide HKT Trust Key Assumptions FY Dec Fixed-line sub growth (%) (0.2) Broadband sub growth (%) (0.3) 0.1 (0.3) Mobile sub growth (%) N/A (0.6) (1.0) (0.3) (0.3) Mobile ARPU EBITDA margin (%) Segmental Breakdown (HK$ m) FY Dec Revenues (HK$ m) TSS 19,913 20,877 21,414 21,820 22,355 Mobile 8,950 14,317 13,063 14,552 14,636 Other businesses Elliminations (604) (672) (867) (731) (744) Total 28,823 34,729 33,847 35,840 36,447 Income Statement (HK$ m) FY Dec Revenue 28,823 34,729 33,847 35,840 36,447 Cost of Goods Sold (12,053) (15,539) (14,445) (16,210) (16,336) Gross Profit 16,770 19,190 19,402 19,630 20,112 Other Opng (Exp)/Inc (12,416) (13,287) (12,523) (12,400) (12,583) Operating Profit 4,354 5,903 6,879 7,229 7,529 Other Non Opg (Exp)/Inc (51) 0 0 Associates & JV Inc (29) (25) (23) (23) (23) Net Interest (Exp)/Inc (1,124) (1,310) (1,107) (1,107) (1,136) Dividend Income Exceptional Gain/(Loss) Pre-tax Profit 3,300 4,586 5,698 6,099 6,369 Tax (242) (600) (771) (854) (892) Minority Interest (67) (37) (38) (38) (38) Preference Dividend Net Profit 2,991 3,949 4,889 5,208 5,440 Net Profit before Except. 2,991 3,949 4,889 5,208 5,440 EBITDA 10,310 12,098 12,613 12,963 13,317 Growth Revenue Gth (%) (2.5) EBITDA Gth (%) Opg Profit Gth (%) Net Profit Gth (%) Margins & Ratio Gross Margins (%) Opg Profit Margin (%) Net Profit Margin (%) ROAE (%) ROA (%) ROCE (%) Div Payout Ratio (%) Net Interest Cover (x) Page 22