因市场忧虑增长前景, 板块过去一年跑输大盘 ; 估值变得更合理

Transcription

1 中国软件 /IT 服务 217 年 1 月 5 日 行业更新 因市场忧虑增长前景, 板块过去一年跑输大盘 ; 估值变得更合理 香港上市的中国 IT 服务公司 216 年跑输大盘 以 216 年的股价表现来看, 香港上市的 IT 服务股份表现逊色 以平均计算, 股价从 216 年年初下跌了 22.7%, 而恒指则在同期上升.39%, 国指则下跌 2.75% 我们认为, 该板块的价格表现不佳是由于 (a) 投资者对 TMT 公司的前景感到担忧, 因为宏观经济的不确定性增加 ;(b) 投资者的兴趣从新经济股转向旧经济股 ;(c) 市场担心流动性偏紧, 因为政府正在增加对保险业和债券市场的监管 我们认为, 在 IT 服务业和宏观经济环境不明朗的情况下, 投资者对板块的投资期已变得较短线, 而由于缺乏短期催化剂, 香港上市的 IT 服务公司的股价在 217 年第一季或会持续波动 然而, 行业的发展势头保持不变, 这是由于企业和政府不断在 IT 方面作出投资 市场向云端服务迁移 智慧城市 PPP 项目日益普及, 加上政府维持行业的支持政策 香港上市的 IT 服务公司的估值已回到合理水平, 预计它们可在 217 年和 218 年实现可观增长, 尤其是考虑到行业发展良好 一些 IT 服务股份的股价疲弱 ( 如神州控股 [861.HK] 金蝶[268.HK] 中国擎天软件[1297.HK] 和中兴通讯 [763.HK]), 将带来再次进场的良机 布家杰, CFA 高级分析员 (852) markpo@chinastock.com.hk 王志文, CFA 研究部主管 根据 IDC, 中国 215 年总 IT 支出达到 2,27 亿美元, 年的年均复合增长率为 11.5% 中国的总 IT 支出占全球 IT 支出的 1.3%, 高于 211 年的 8.2% 我们认为在市场持续作出 IT 投资之下, 中国软件 /IT 服务市场 ( 特别是企业和政府 IT 市场 ) 仍处于长远增长的轨道上 云迁移是一个持续的过程 即使宏观经济存在不确定性, 预计云计算分部仍将在未来几年继续增长 强大的移动互联网用户群, 以及不断扩大的宽带网络, 均推动了中国云计算市场的强劲增长 云计算供应链从 IaaS 到 PaaS 再到 SaaS, 都明显有着本地化现象 神州控股 金蝶和畅捷通等本土 IT 服务公司, 均成功捕捉中国云计算市场增长带来的机遇 智慧城市概念是中国最重要的发展战略之一 中国的城镇化率从 1985 年的 23.7% 上升到 215 年的 56.1% 该快速增长反映中国的城镇化已经到达了周期的成熟阶段, 在未来的城市发展进程中, 智慧城市是必然的趋势 根据 十三五 规划, 预计智慧城市的投资将超过 5, 亿元人民币 预期 PPP 模式的智能城市建设将缓解智慧城市建设的融资压力 中国政府最近重新强调了 PPP 模式的重要性, 这提振市场对智慧城市公司的投资情绪 (852) cmwong@chinastock.com.hk 1

2 1) 香港上市的中國軟件 //IT 服務公司 216 年跑輸大盤 板塊在過去一年跑輸大盤, 估值已 變得更合理 以 216 年的股价表现来看, 香港上市的 IT 服务股份表现逊色 以平均计算, 股价从 216 年年初下跌了 22.7%, 而恒指则在同期上升.39%, 国指则下跌 2.75% 我们认为, 该板块的价格表现不佳是由于 (a) 投资者对 TMT 公司的前景感到担忧, 因为宏观经济的不确定性增加 ;(b) 投资者的兴趣从新经济股转向旧经济股 ;(c) 市场担心流动性偏紧, 因为政府正在增加对保险业和债券市场的监管 我们认为, 在 IT 服务业和宏观经济环境不明朗的情况下, 投资者对板块的投资期已变得较短线, 而由于缺乏短期催化剂, 香港上市的 IT 服务公司的股价在 217 年第一季或会持续波动 然而, 行业的发展势头保持不变, 这是由于企业和政府不断在 IT 方面作出投资 市场向云端服务迁移 智慧城市 PPP 项目日益普及, 加上政府维持行业的支持政策 香港上市的 IT 服务公司的估值已回到合理水平, 预计它们可在 217 年和 218 年实现可观增长, 尤其是考虑到行业发展良好 由于中国的软件 /IT 服务公司的财务状况稳健, 因此即使政府货币政策出现变化引致流动性趋紧, 对这些公司的运营产生的影响应有限 它们也将受益于行业的整合 图 1: 股价相对表现 KINGDEE 金蝶国际 SINOSOFT 中国擎天软件 ZTE 中兴通讯 CHINASOFT 中国软件国际 DC 神州控股 Holdings TENCENT 腾讯 TIAN 天鸽互动 GE NETDRAGON 网龙 KINGSOFT 金山软件 Hang 恒生指数 Seng HSCEI 国企指数 CHANJET 畅捷通 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 来源 : 彭博, 中国银河国际证券研究部 恒指及国指 HSI and HSCEI 216 outperformed 年表现优于大部分香港上市的 most of HK listed IT services IT 服务公司 names in 216 根据 WIND,A 股 TMT 股票占 A 股市场的总投资基金的比例在 216 年第三季末下降至 3.81%,216 年第二季末为 7.91% 这可以反映市场对 TMT 行业的兴趣有所降温 这也解释了为什么香港上市的 TMT 股份 ( 包括软件 / IT 服务公司 ) 股价受压, 特别是在 216 年第四季 2

3 有反弹潜力 然而, 这个数字是波动的, 并且自 213 年第二季以来一直保持在较低水平 如果行业 的投资情绪改善,A 股市场的投资基金可能会提高在 TMT 行业的持股, 这对香港上市的 TMT 公司 ( 包括软件 / IT 服务公司 ) 是为正面 图 2: 自 212 年第二季以来 TMT 股票占 A 股基金持股量的比例 来源 : WIND, 中国银河国际证券研究部 3

4 China Software/IT Services January 5, 217 Sector update Underperformance due to concerns about growth outlook; Valuation looks more reasonable Mark Po, CFA Senior Analyst (852) Wong Chi Man, CFA Head of Research (852) The HK-listed China IT services sector underperformed in 216. In terms of share -price performance, the HK-listed IT services sector underperformed in 216. On average, share prices dropped 22.7% from the beginning of 216 vs..39% for the HSI and 2.75% for the HSCEl. In our view, the share-price underperformance was due to (a) investor concerns about the outlook for TMT names, given increasing macroeconomic uncertainties; (b) sector rotation from new-economy stocks to old-economy stocks and (c) concern about tight market liquidity, given increasing government controls on the insurance sector and the bond market. Amidst the uncertain sector and macro-economic environment, we believe that investors have become short-term focused and that the share price performance of the HK-listed IT services names might remain volatile in Q1 217 given the lack of near-term catalysts. However, industry development, including higher IT spending by corporates and government, continuous cloud migration, the increasing popularity of the PPP model for smart-city projects and supportive government policies, remains intact. The valuation of HKlisted IT services names has returned to a reasonable level as they are expected to report decent growth in 217 and 218, given favourable industry development trends. The share-price underperformance offers good re-visit opportunities for the IT services names such as DC Holdings [861.HK], Kingdee [268.HK], Sinosoft [1297.HK] and ZTE [763.HK]. According to IDC, China's total IT spending reached US$227.bn in 215, for a CARG of 11.5% in China s total IT spending accounted for 1.3% of global IT spending in 215, up from 8.2% in 211. We maintain the view that the China software/it services market, especially the enterprise and government IT market, is in a secular growth cycle, given continuous IT investment. Cloud migration is a continuous process, and the cloud computing segment is expected to continue to grow in the coming years despite macro-economic uncertainties. The strong growth of the cloud computing segment in China is underpinned by a sizable mobile internet user base and an expanding broadband network. There is strong localization of the cloud-computing supply chain from IaaS to PaaS to SaaS. Local IT services companies, including DC Holdings, Kingdee and Changjet, are capturing the growth potential of the cloud-computing segment in China. The smart-city concept is one of the most important development strategies in China. The urbanization rate in China increased from 23.7% in 1985 to 56.1% in 215. This rapid development indicates that urbanization in China has reached a mature stage in its life-cycle, and the smart-city concept is an inevitable trend in future urban development. According to the Chinese government s 13thFYP, investment in smart cities is predicted to be over RMB5bn. The adoption of the PPP model in smart-city construction is expected to ease funding pressure on smart-city construction in China. The Chinese government has recently re-emphasised the importance of the PPP model, which has boosted sentiment on smart-city names. 4

5 Investment positives 1) HK-listed China software/it services names underperformed in 216 With sector underperformance, valuation looks more reasonable. HK-listed China software/it services names, such as DC Holdings, Changjet, Kingdee, Sinosoft and ZTE, have underperformed since the beginning of 216. In terms of shareprice performance, the HK-listed IT services sector underperformed in 216. On average, share prices dropped 22.7% in 216 vs..39% for the HSI and 2.75% for the HSCEl. In our view, the share-price underperformance was due to (a) investor concerns about the outlook for TMT names, given increasing macro-economic uncertainties; (b) rotational buying from new-economy stocks to old-economies stocks; and (c) concern about tight market liquidity, given increasing government controls on the insurance sector and the bond market. Amidst the uncertain sector and macro-economic environment, we believe that investors have become short-term focused and that the share price performance of the HK-listed IT services names might remain volatile in Q1 217, given the lack of nearterm catalysts. The valuation of HK-listed IT services names has returned to a reasonable level, as they are expected to report decent growth in 217 and 218, given favourable industry development trends. The China software/it services names are in a strong financial position, so tight market liquidity triggered by potential changes in the government s monetary policy should have limited impact on their operations. They will also benefit from any industry consolidation. Figure 1: Relative share-price performance KINGDEE SINOSOFT ZTE CHINASOFT DC Holdings TENCENT TIAN GE NETDRAGON KINGSOFT Hang Seng HSCEI CHANJET HSI and HSCEI outperformed most of HK listed IT services names in 216. 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 Sources: Bloomberg, CGIS Research According to WIND, holdings of A-share listed TMT stocks as a percentage of total investment funds in the A-share market dropped to 3.81% at the end of Q3 216, down from 7.91% at the end of Q This can be treated as indication that interest in the TMT sector is cooling. This also explains why HK-listed TMT names, including software/it services names, were under pressure, especially in Q

6 Potential to rebound However, the figure is volatile and has remained at a relatively low level since Q Investment funds in the A-share market may raise their holdings in the TMT sector if there is improvement in sentiment on the sector, which would be positive for HK-listed TMT names, including the software/it services segment. Figure 2: Holdings of TMT stocks as % total A-share funds since Q2 212 Sources: WIND, China Galaxy, CGIS Research 6

7 Figure 3: Peer comparison Ticker Company PE EV/EBITDA P/B ROE ROA Div yield Share Price Performance Price Market Cap 216F 217F 218F 216F 217F 218F F F F F 1M 3M 6M 12M Lcy US$m x x x x x x x x % % % % % % % % % % HK Listed IT Services & Internet Names 268 HK Kingdee International 2.9 1, HK Sinosoft Technology Group Lt HK Chinasoft International Ltd , HK Inspur International Ltd n.a. n.a. n.a. n.a. n.a. n.a..9 n.a.. n.a. -.3 n.a. 1.8 n.a HK DC Holdings Ltd HK Vst Holdings Ltd HK Chanjet Information n.a n.a n.a n.a HK ZTE , HK Boyaa Interactive Internatio HK Kingsoft Corp Ltd , n.a n.a..9 n.a HK Ourgame International Holdin HK Linekong Interactive Group C n.a n.a. n.a. n.a. 1. n.a. -5. n.a n.a HK Baioo Family Interactive Ltd n.a. n.a. n.a. n.a. n.a. n.a..6 n.a. 6.5 n.a. 5.8 n.a.. n.a HK Igg Inc HK Forgame Holdings Ltd n.a. n.a. n.a. n.a..8 n.a n.a n.a.. n.a HK Tian Ge Interactive Holdings n.a HK Pacific Online n.a HK Tencent Holdings Ltd , HK Dx.Com Holdings Ltd n.a. n.a. n.a. n.a. n.a. n.a. n.a. n.a n.a. n.a. n.a.. n.a HK Netdragon Websoft Inc ,369 n.a n.a HK Skyworth Digital Hldgs Ltd 4.4 1, HK Tcl Multimedia Technology HK Huiyin Smart Community Co Lt n.a. n.a. n.a. n.a. n.a. n.a. 1.4 n.a n.a n.a.. n.a HK V1 Group Ltd n.a. n.a. n.a. n.a. n.a. n.a..4 n.a. 4.7 n.a. 2.7 n.a.. n.a HK Gome Electrical Appliances.94 2, HK Cogobuy Group , HK Hc International Inc n.a n.a. 2.8 n.a HK Coolpad Group Ltd n.a n.a HK Alibaba Pictures Group Ltd , n.a n.a. n.a. n.a. 1.8 n.a n.a.. n.a HK Digital Domain Holdings Ltd.5 85 n.a. n.a. n.a. n.a. n.a. n.a. 6.2 n.a n.a n.a.. n.a Average A-share Listed Software plays 3253 CH Winning Health Technology-A 2.5 2, n.a CH Beijing Orient National-A , n.a CH Yonyou Network Technology-A , n.a CH Beijing Thunisoft Corp Ltd-A , n.a CH Beijing Teamsun Technology-A ,799 n.a. n.a. n.a. n.a. n.a. n.a. 2.1 n.a. 2.2 n.a..4 n.a. n.a. n.a CH Neusoft Corp-A , n.a CH Inspur Electronic Informat-A , n.a CH Bringspring Science And Te-A n.a. n.a. n.a CH Ygsoft Inc -A , n.a. n.a CH Digital China Information -A , n.a CH Songcheng Performance Deve-A , CH Baofeng Group Co Ltd-A ,884 n.a. n.a. n.a. n.a. n.a. n.a. 2.3 n.a n.a n.a.. n.a CH Zhejiang People Culture Co-A , n.a. n.a. n.a n.a CH Alpha Group-A , n.a CH Nanji E-Commerce Co Ltd-A , n.a CH Shanghai U9 Game Co Ltd-A ,572 n.a. n.a. n.a. n.a. n.a. n.a. 5.3 n.a. 3.7 n.a. 2.8 n.a. n.a. n.a CH Zhe Jiang Daily Media Grp -A , n.a. n.a. n.a. n.a n.a n.a. n.a CH Bus Online Co Ltd ,236 n.a. n.a. n.a. n.a. n.a. n.a. 4.2 n.a..9 n.a. 4. n.a.. n.a CH Beijing Kunlun Tech Co Ltd-A , n.a..5 n.a CH Wangsu Science & Technolog-A , n.a Average Overseas Listed IT Services Plays SAP GY Sap Se , n.a CRM US Salesforce.Com Inc , IBM US Intl Business Machines Corp , ORCL US Oracle Corp , MSFT US Microsoft Corp , N US Netsuite Inc n.a. n.a. n.a. n.a. n.a. n.a. n.a. n.a. n.a. n.a n.a. n.a. n.a. n.a. n.a. n.a. AMZN US Amazon.Com Inc , HPE US Hewlett Packard Enterpris , Average US Lited China Software & Internet plays RENN US Renren Inc-Adr n.a. n.a. n.a. n.a. n.a. n.a..7 n.a n.a.. n.a CYOU US Changyou.Com Ltd-Adr , KZ US Kongzhong Corp-Adr n.a. n.a. n.a. n.a. n.a. n.a. 1.1 n.a n.a. 1. n.a.. n.a NTES US Netease Inc-Adr , SINA US Sina Corp , SOHU US Sohu.Com Inc ,377 n.a. n.a. n.a BABA US Alibaba Group Holding-Sp Adr , BIDU US Baidu Inc - Spon Adr , FENG US Phoenix New Media Ltd -Adr VIPS US Vipshop Holdings Ltd - Adr , CTRP US Ctrip.Com International-Adr , n.a QUNR US Qunar Cayman Islands Ltd-Adr ,472 n.a n.a n.a DANG US E-Commerce China-Spon Adr -A n.a. n.a. n.a. n.a. n.a. n.a. n.a. n.a. n.a. n.a n.a. 2. n.a. n.a. n.a. n.a. n.a. n.a. n.a. JD US Jd.Com Inc-Adr ,734 n.a ATHM US Autohome Inc-Adr , BITA US Bitauto Holdings Ltd-Adr , JMEI US Jumei International-Adr n.a MOMO US Momo Inc-Spon Adr , n.a WB US Weibo Corp-Spon Adr , YY US Yy Inc-Adr , Average Sources: Company, CGIS Research 7

8 2) The sector is sizable and growing China accounts for 1.3% of global IT spending. According to IDC, China's total IT spending reached US$227.bn in 215, for a CAGR of 11.5% in China s total IT spending accounted for 1.3% of global IT spending in 215, up from 8.2% in 211. China IT spending is expected to grow at a 4.4% CAGR for F, according to IDC. Among the three major segments (hardware, software, and IT services), software and IT services are forecast to grow at a CAGR of 1.3% and 13.2%, respectively, in F, much faster than hardware s CAGR of 2.6%. Figure 4: China IT spending in USDm China IT Spending % of global IT spending % 25, 12 2, 1 15, 8 6 1, 4 5, Sources: Bloomberg, IDC, CGIS Research The enterprise/government IT market is a growth driver. Despite concerns of a slowdown in IT spending in China, triggered by increasing macroeconomic uncertainty, the long-term outlook for local software/it services remains positive. China s software/it services market is still in a structural growth phase and the penetration rate of software applications will continue to increase. The slowdown in growth of IT spending on hardware is a result of several factors, including a slowdown in the macro economy, the saturation of smartphones, and the government's anti-corruption measures. The China software/it services market, especially the enterprise and government IT market, which are in a secular growth cycle, are growing areas in the industry. According to WIND, R&D expenses as a percentage of total sales of all A-share-listed companies (excluding the financial sector) were about 4.44% in 215, up from 3.62% in 211. We believe that R&D expenses as a percentage of total sales will continue to increase, which is expected to drive growth in IT spending. 8

9 ERP is a growing segment. According to Gartner, China s enterprise software market will grow at a CAGR of 13.9% in The enterprise resource planning (ERP) segment is one of the fast-growing components of China s software market. According to Gartner, China s ERP market is expected to grow at a CAGR of 11.1% According to Technavio, China s ERP market is expected to deliver a 14.2% CAGR from 214 to 219E. Figure 5: R&D expenses as a percentage of turnover of A-share-listed companies % H1 216 Sources: Bloomberg,, IDC, CGIS Research The software/it services industry is expected to maintain high growth. The average wage of employed persons in urban areas in China has been growing at a fast pace since 28. Chinese enterprises are upgrading their ERP systems mainly to improve management efficiency and achieve cost savings, especially in the current challenging macro environment. We share the view the ERP market in China is in a transitional period from the traditional licensing model to the SaaS model. The transition has had a negative impact on sales of ERP software under the traditional model. However, we note that local ERP software suppliers such as Changjet and Kingdee resumed growth in sales of traditional ERP software in 216. This shows that concerns about earnings pressure on Changjet and Kingdee are somewhat overdone. Despite the slowdown in the growth rate in recent years, the top line of the software industry in China has been growing at a double-digit rate since 27. In Jan-Oct 216, turnover in the Chinese software industry grew at 14.7% YoY, reaching RMB3,97.3bn. Given the business dynamics, the software industry in China is expected to continue to grow in the coming years. 9

10 Figure 6: China Enterprise Software Market Figure 7: China ERP Software Market Sources: Gartner, CGIS Research Figure 8: YoY increase in the wages of employed persons in urban areas in China % Sources: WIND, CGIS Research 1

11 Figure 9: Turnover in the Chinese software industry RMB bn Turnover of China software industry YoY Growth (%) % 4,5 35 4, 3,5 3, 2,5 2, 1,5 1, Jan-Oct Sources: WIND, CGIS Research Figure 1: China software exports USD bn China software exports YoY growth (%) % Sources: WIND, CGIS Research 11

12 3) Cloud computing remains a growth driver The SaaS model requires less up-front spending on IT. The SaaS model is growing fast in China. China s cloud-computing market is still small compared to the US market. Cloud computing, which involves storing, managing and processing data on a network of remote servers on the Internet rather than on a local server, is now an important growth driver for China s IT industry. Since the data, software and processing power is held in a remote location instead of an individual s work station, cloud computing offers users the advantages of low initial investment and maintenance costs, and easier access. Cloud computing has grown fast in the past several years in China as both businesses and individuals have rapidly adopted cloud services. As discussed later in the report, the Chinese government has been very supportive of cloud development by releasing favourable policies to increase the use of cloud computing. State-owned enterprises (SOEs) have been encouraged to shift their systems to the cloud. Through the adoption of cloud services, the Chinese government will have more direct control of SOEs. There are three major business models under cloud computing: (a) infrastructure as a service (IaaS), (b) platform as a service (PaaS), and (c) software as a service (SaaS). PaaS is capital intensive and requires a huge investment in hardware. SaaS requires less upfront IT spending and is suitable for companies without sufficient in-house resources. The global cloud-computing market reported solid growth in the past several years, reaching US$52.2bn in 215. The global cloud-computing market size is expected to grow at a CAGR of 2.6% in and to reach US$143.5bn in 22. The global cloud-computing market is led by US market which accounted for 56.5% of global market share in 215. The US cloud-computing market is expected to grow at a CAGR of 15% in Cloud computing in China has been growing faster than the global average. China's cloud-computing market reached RMB37.8bn in 215, up 31.7% YoY. The public cloud-services market in China reached RMB1.2bn, up 45.8% YoY. The cloudcomputing market is expected to reach RMB15bn in 216. The overall cloudcomputing market in China is expected to grow strongly in the coming years. IDC estimates that the China cloud market will see a five-year CAGR of 29.4% from F. By 22, the size of China s cloud market might be only about 4.2% of that of the US cloud market, which implies considerable growth potential for cloud-computingrelated names. The strong growth of the cloud-computing market in China has encouraged all of China's internet giants, such as Alibaba, Tencent and Kingsoft, together with overseas software companies such as Microsoft, to launch public, private and hybrid cloud services in China. Since Alibaba released information on its cloud-computing segment Ali Cloud, the market has treated it as reference for the performance of the overall cloudcomputing market in China. Ali Cloud is a good market indicator. Ali Cloud established an open cloud-computing infrastructure platform that benefits corporations and developers in the fast-growing cloud-computing market. Ali Cloud business reported triple-digit top-line growth in six quarters since Q2 215, which shows that the cloud-computing market in China is growing fast. 12

13 Figure 11: Global cloud-computing market size USD bn Global Cloud Computing maket size YoY growth (%) % F 217F 218F 219F 22F Sources: Gartner, CGIS Research Figure 12: China s public cloud-computing market size RMB bn China Public Cloud Market Size YoY growth (%) % F Sources: China Academy of Information and Communications Technology, CGIS Research 13

14 Figure 13: Ali Cloud s quarterly turnover RMB bn Ali Couds' quarterly turnover YoY growth (%) % 1,6 2 1,4 1,2 1, Q1 214 Q3 214 Q1 215 Q3 215 Q1 216 Q3 216 Sources: China Academy of Information and Communications Technology, CGIS Research 14

15 4) PPP model to solve the funding issue for Smart City projects Growing demand for smart city development Funding sources an issue PPP model a possible solution The smart-city concept is currently one of the most important development strategies in China. The urbanization rate in China increased from 23.7% in 1985 to 56.1% in 215. This rapid development indicates that urbanization in China has reached a mature stage in its lifecycle, and smart cities are the inevitable choice for future urban development. Smart cities use information technology to sense, analyze, and integrate a city s key information, in order to provide intelligent responses to various needs, including environmental protection, public safety, urban services, and industrial and commercial activities. By the end of 215, in order to promote the healthy development of smart cities, the Chinese government had planned eight categories and 686 pilots. In addition to the Bohai, Yangtze River Delta, and Pearl River Delta economic circles, smart city projects in the Chengdu-Chongqing Economic Circle, Wuhan Urban Agglomeration, Poyang Lake Ecological Economic Zone, Guanzhong-Tianshui Economic Circle and other mid-western areas are showing positive development trends. The nationwide smart-city plan started in 213 with 193 cities. The investment in smart-city projects was RMB148bn in 215, and the annual growth rate was about 2.4%. According to the Chinese government s 13 th- FYP, investment in smart cities is forecast to be over RMB5bn. IDC predicts that investment in smart cities will exceed RMB2tn in the next 1 years. Progress in smart-city development has been slow in last two years, as securing financing has been one of the biggest challenges. Smart-city construction requires a large initial capital outlay and has long pay-back period. It is difficult to support projects based solely on government financing and subsidies, especially with the already high local government debt. By introducing social capital, government-enterprise cooperation can inject vitality, competition can improve efficiency, and the market can play a greater role in the efficient allocation of public resources. 216 marks the third year of the Chinese government s promotion of PPP. The model has been accepted by most industries and is gradually becoming standardized. Data from the China Public Private Partnership Center (CPPPC) shows that the number of smart city PPP projects is increasing and that PPP is gradually becoming the major smart-city construction mode. At the end of Aug 216, the National PPP Integrated Information Platform Project included 1,33 in-process and to-be-developed projects, with total investment of RMB12.3tn, covering 19 industries. According to the Ministry of Finance s third group of PPP Innovation Model Projects, there was a big improvement in project quality, especially for the smart-city industry. Due to the high quality, advanced technologies and innovative modes, the smart-city concept has received universal praise and been the subject of hot discussions. From the investment and technical application perspective, as a result of the promotion of the Internet + big data and China-made 225 concepts, as well as PPP reforms, government outsourcing services and data-sharing policies, the smart-city concept is showing the following major trends: (a) Internet+ has become a fundamental characteristic of the smart-city concept; (b) big data will support smart-city development; (c) an open platform will be used to share government data and resources; and (d) IT security will be a major focus of smart-city construction projects. 15

16 Figure 14: China smart-city project investment RMB bn 1,8. 1,6. 1,4. 1,2. 1, F 215F 216F 217F 218F Sources: Gartner, CGIS Research Figure 15: IT-related spending for China smart-city projects RMB bn Smart City projects IT related spending YoY growth (%) % F 217F 218F Sources: CNNIC, CGIS Research

17 New smart cities have to deal with issues such as interoperability, information islands and fragmentation. PPP enterprises have benefited from smart-city projects. Since the Chinese government has been keen on promoting smart-city projects in recent years, the PPP model has great attraction to private enterprise. The PPP urban construction model has become mainstream. Companies that want to participate in smart-city projects must vigorously embrace the PPP model. It is expected that PPP smart-city projects will be more mature in financing, operations, performance evaluation and process management. PPP projects will be combined with other financing methods, including changes from government credit financing to the government credit and project assets financing mode. The risk-assessment system will continue to be refined to offer a better combination of risk analysis and project operations, and to avoid capital risks by combining financing with related legal structures. Capital sources will be mainly commercial loans and capital markets, supplemented by regional development banks, industrial funds and financial funds to form a diversified financial services system. There will be a more scientific evaluation of operating rights. The operation mode will be based on the unique characteristics of local governments: e.g., (a) government procurement services + social capital investment + professional company operations, or (b) operating income + government subsidies + purchased services. The PPP model will (a) enhance the efficiency of government funds, (b) protect the interests of both government and investors, and (c) support the construction and operation of healthy urban development projects. Figure 16: General framework of smart-city PPP projects in China Sources: China Galaxy, CGIS Research 17

18 Figure 17: Number of smart-city PPP projects in the Chinese government list No. of project Sources: China Public Private Partnership Center, CGIS Research 18

19 5) The Chinese government continues to promote the sector The Chinese government is supportive of the industry. Despite cooling interest in the sector, the China software/it services sector remains a sector promoted by the Chinese government. Through different departments, such as the State Council, Ministry of Finance (MoF) and Ministry of Industry and Information Technology (MIIT), the government has issued supportive policies and commentaries in the past few years to promote the development of the software industry, especially cloud computing and Internet+. In early 211, the State Council released a circular by the State Council titled Printing and Distributing Certain Policies on Further Encouraging the Development of the Software Industry and the Integrated Circuit Industry" to promote the industry's development. The document set up a framework of government policies on software industry development covering different areas such as tax, investment and financing, R&D, import and export, talent, and the protection of intellectual property (IP). The MOF issued two notices related to the value-added tax (VAT) and enterprise income tax for software companies: (a) a "Notice of the Ministry of Finance and the State Administration of Taxation on Value-added Tax Policies for Software Products" in Oct 211, and (b) a "Notice of the Ministry of Finance and the State Administration of Taxation on Enterprise Income Tax Policies for Further Encouraging the Development of Software and Integrated Circuit Industries" in Apr 212. The policies outlined tax treatment for the software industry regarding the value-added tax refund and a preferential income tax arrangement. In 212, the MITT published the Information IP strategic plan, which addressed the implementation of state Intellectual Property scheduled tasks according to "212 China IPR Protection Action Plan" and "212 State Council on further improving the fight against IPR infringement and selling counterfeit goods". In 213, the State Council issued suggestions to improve information consumption to boost domestic demand. The government aimed to achieve a 2% YoY increase in public-sector and household spending on information consumption in In 212, the MIIT published the 12th Five Year Plan (FYP) for the Internet industry, emphasizing the acceleration of system design and other key areas in the development of cloud-computing standards, supporting new application software for the Internet and IT software, and addressing cloud-computing developments in IaaS, PaaS and SaaS. In 213, the MIIT stated that the government would support the local software industry in five key areas, including (a) promoting M&A in the industry, (b) hastening the process of setting standards, and (c) promoting use of IT in manufacturing. The MoF said it would fully support the development of cloud services in China. Government agencies and departments increased their adoption of cloud services after the release of industry standards. We also note that the government has been driving the industry's development in cloud computing and Internet+. In 213, the NDRC, MIIT and MOF issued a document titled Interim Measures for the Recognition and Administration of the Key Software Enterprises and Integrated Circuit Design Enterprises Covered by the National Planning Layout Scheme, which aimed to support SMEs and public services in upgrading to cloud-computing services, such as introducing cloud-computing data centres, migrating to cloud models, and providing cloud-computing services. 19

20 The State Council published a notice titled "The promotion of innovation and development of the cloud-computing industry to cultivate a new formation", addressing its 217 target of deepening key areas in cloud computing, encouraging innovation from leading enterprises and breakthroughs in core technology, optimizing data-centre layout, and building up security services. The long-term target is to achieve full popularity of cloud computing by 22. The MIIT also issued a Notice of Promotion of Internet+ in Nov 215 with the aim of promoting core technology in basic software, and supporting the development of selfcontrolled real-time operating systems and database software, and other infrastructure. According to the notice, the government will focus on pilot cities for cloud computing and accelerating the deployment of Internet-based infrastructure. Industry development is one of the key parts of 12th and 13th FYP. In Dec 216, the State Council issued the 13th FYP for a national informationalization industry, emphasizing independent innovation of new-generation network technologies, the Internet of Things (IoT), integrated circuits (IC) and cloud computing, the further promotion of the Broadband China strategy, and the coordinated implementation of an Internet power strategy, big data strategy and Internet+ initiatives. The State Council suggested reinforcing the design and R&D of chips in the fields of new computing, 5G, intelligent manufacturing, the Internet industry and IoT, promoting the construction of 32/28nm and 16/14nm production lines, and accelerating R&D of 1/7nm production techniques. The State Council also encouraged speeding up the transformation of FTTH networks and the upgrade of backbone networks, enlarging coverage of 4G networks, more R&D on the 5G standard and related commercial use, and taking the lead in formulating a unified global 5G standard. The State Council goal is that by 218, innovations in the cloud computing and IoT sectors should be significantly improved, with power usage effectiveness (PUE) of newly constructed large cloud computing data centers not above 1.5; and that by 22, China s cloud computing and IoT industries should be internationally competitive with PUE of newly constructed large cloud computing data centers 1.4 or lower. 2

21 6) Co-operation instead of competition There is market concern that leading Chinese TMT companies such as Baidu, Alibaba, Tencent (BAT) and Huawai pose a threat to other software/it service names, especially those providing cloud-based services. However, the enterprise software/it services segment requires a high level of customization and integrity. Thus, the Chinese software/it service names don t see keen competition from the Internet giants; in fact, the leading software/it services names are co-operating with Alibaba and Tencent in exploring new business opportunities. In mid Dec 216, Huawei Technology Co., Ltd. and Kingdee ERP signed an agreement for a project contract involving the Internet, such as cloud computing, social media, intelligent products and other advanced technology for R&D of strategic ERP products. Kingdee will provide support to Huawei Technologies Co. in building a world-class retail terminal channel control platform. In 214,Kingdee announced, together with Tencent, that its product for small and micro business KIS and Tencent s corporate QQ had jointly launched an application for small and micro businesses, enabling Internet transformation and upgrading. In addition to the software innovation portfolio, both parties will focus on channel construction, market interaction and business model innovation, and will jointly explore Internetrelated small business market opportunities. For corporate clients, the combined version of the Kingdee KIS and corporate QQ is a solution to meet the needs of both business operations and communication. It has effectively reduced the human and financial costs of software purchasing and maintenance, based on the same set of service providers. In terms of corporate management, the seamless integration of corporate QQ and the Kingdee KIS helps meet the needs of corporate management. In Nov 216, Sinosoft entered into a strategic cooperative framework agreement with Ali Cloud, the cloud-computing arm of Alibaba, Ant Financial Services Group and the Zhenjiang Government to build the Low Carbon Zhenjiang Mode. Under the agreement, the four parties will jointly develop a low carbon, eco-city establishment, industrial big-data application, and new smart city development for the Low-Carbon Zhenjiang Mode. 21

22 DC Holdings [861.HK] A leader in the China IT service segment. DC Holdings (DCH) [861.HK] is one of the beneficiaries of increased IT spending and smartcity project development, as DCITS [555 CH], DCH s A-share-listed IT services arm, is a leading player in the IT services segment in China, especially in the verticals, such as banking and telecommunications, as well as government and other industries. After discussion with GRG Banking Equipment (GRG) [2152.CH], we believe that both parties are highly likely to come up with a solution to satisfy the interests of all parties. We also note the synergy between GRG and DCH, and there is limited overlap between the businesses of the two entities. We maintain the view that (a) formal discussions between DCH management and GRG and (b) DCH s release of its future investment strategy will be re-rating catalysts for DCH shares. The recent share-price weakness may indicate that concerns about DCH s weak 216 results have been priced in and that speculation about a bidding war between GRG and DCH management is coming to an end. We maintain our BUY rating with a target price of HK$7.93 (based on 28x 217E PER). DCH should benefit, given its holding in DCITS and its well-recognized name among Mainland investors. Investment Highlights After the disposal of its hardware-distribution business, DCH is now involved in three key business segments: (a) IT services through DCITS; (b) supply-chain management; and (c) new business, such as Sm@rt City services and financial services. The three segments contributed 77%, 18% and 5% of its 1H 216 revenue, respectively. DCITS 216 operating performance was affected by a decline in margins because of: (a) the dilution effect of its lowermargin systems-integration business; and (b) the Company s strategy of gaining market share in IT services by cutting prices. DCITS also invested more in developing IT services solutions for import substitution, which also put pressure on its near-term profitability. However, DCITS 216 results were not really a surprise to the market, as DCH management had already communicated with the market regarding its DCITS strategy. Currently, GRG holds a 26.2% of stake in DCH and is the largest DCH shareholder. GRG is a subsidiary of a local SOE, Guangzhou Radio Group. According to GRG management, its investment in DCH is in line with its strategy of expanding its business portfolio from traditional business to becoming a pan financial IT solutions and services provider. According to GRG management, there is synergy between DCITS (high-end software focus) and GRG (hardware focus), especially in the banking sector and limited overlapping business. GRG management also believes that its SOE background may help DCH/DCITS secure Sm@art City projects. GRG has no plan to reduce its stake in DCH, as GRG has a positive view of DCH s medium-long term development. The recent share-price weakness may indicate that concerns about DCH s weak 216 results have been priced in and that speculation about a bidding war between DCH management and GRG is coming to an end. We believe that the share-price weakness may offer a good revisit opportunity, as it is likely that both DCH management and GRG will come up with a solution to satisfy the interests of all parties. Key Financials (in HKDm) 214* 215* 216E* 217E* 218E* Revenue 12, , , , ,169.7 Change (YoY %) (76.7) (12.5) Gross Profit 1, ,216. 2, ,9.4 3,51.2 Gross Margin % Net Profit Net Margin % EPS (Basic) Change (YoY %) (76.3) (36.9) DPS $.192 $. $3.2 $.57 $.78 ROE (%) Dividend Yield (%) PER (x) adjusted for special dividend declared in PBR (x) adjusted for special dividend declared in FCF Yield (%) 21.34% 39.77% % 3.38% 5.85% Mark Po, CFA Senior Analyst (852) markpo@chinastock.com.hk Wong Chi Man, CFA Head of Research (852) TMT Sector Software BUY Close: HK$6.16 (Jan 4, 217) Target Price: HK$7.93 (28.7%) Share Price Performance (HK$) Source: Bloomberg. Market Cap Shares Outstanding Auditor cmwong@chinastock.com.hk US$981m 1,274.3m Ernst & Young Free Float 44.2% 52W range 3M average daily T/O Major Shareholding Source: Bloomberg, Company data January 5, 217 Jan16 Mar16 May16 Jul16 Sep16 Nov16 Turnover (RHS) Price (LHS) (HK$ million) HK$ US$4.8m GRG Banking Equipment (26.23%) Allianz SE (7.84%) Guo Wei (1.76%) Legend Holdings (4.79%) Capex (m) (167.5) (2.) (5.) (3.) (3.) Free cash flow per share (.7).2.4 Net Gearing (%) Source: Bloomberg, CGIS Research, *: data include the company s continuing operations as well as discontinued hardware distribution business; forecasts for 217 only includes its continuing operations. 22

23 Figure 18: Earnings projection Income Statement (HKDm) FY214* FY215* FY216F* FY217F* FY218F* Cash Flow Statement (RMBm) FY214* FY215* FY216F* FY217F* FY218F* Revenue 12,156 1,631 12,33 13,948 16,17 Net Income Growth yoy% (76.7%) (12.5%) 13.2% 15.9% 15.9% Depreciation & Amort Gross Profit 1,852 2,216 2,399 2,9 3,51 Change in Working Capital 1,529 3,32 (612) (39) (452) Growth yoy% (45.2%) 19.7% 8.3% 2.9% 21.% Cash from Ops. 2,243 4,154 (317) Selling General & Admin Exp. (1,479) (1,89) (2,464) (2,339) (2,711) Capital Expenditure (167) (2) (5) (3) (3) Others Operating Expenses/Items Sale of Property, Plant, and Equipment Operating Income (65) Change in Investing Acitivities (3,524) (2,959) 3,24 (1,12) (614) Growth yoy% n.a. (12.6%) (12%) (96%) 42.2% Cash from Investing (3,691) (3,159) 2,74 (1,42) (914) Interest Expense (6.8) (73.7) (253.1) (188.9) (28.3) Net increase in bank borrowings 293 Interest and Invest. Income Income/(Loss) from Affiliates Issuance of Common Stock 55 Other Non-Operating Inc. (Exp.) (1,216) Common Dividends Paid (19) (21) (4,78) (72) Impairment of Goodwill Special Dividend Paid Gain (Loss) On Sale Of Invest Other Financing Activities 1,999 (1,911) 1, Gain (Loss) On Sale Of Assets Cash from Financing 2,12 (2,121) (2,249) Income Tax Expense (9) (27) (59) (81) (114) Minority Int. in Earnings (21) (264) (95) (128) (177) Net Change in Cash 654 (1,126) 138 (328) 369 Net Income Growth yoy% 733.6% (5.6%) (59.4%) n.a. 38.4% Balance Sheet (RMBm) FY214* FY215* FY216F* FY217F* FY218F* Ratios FY214* FY215* FY216F* FY217F* FY218F* ASSETS Profitability Cash And Equivalents 4,12 3,379 2,967 3,189 3,558 Return on Assets % 2.2% 1.9%.9% 1.6% 2.1% Receivables 13,285 5,284 6,352 7,362 8,535 Return on Capital % 3.1% 2.% 2.4% 2.6% 3.4% Inventory 6, ,66 1,236 Return on Equity % 8.6% 7.6% 3.8% 6.9% 8.8% Other Current Assets 1,595 19, Total Current Assets 25,175 29,52 1,762 12,168 13,922 Margin Analysis Net Property, Plant & Equipment 1, ,88 1,163 1,218 Gross Margin % 15.2% 2.8% 19.9% 2.8% 21.7% Long-term Investments SG&A Margin % 12.2% 17.8% 2.5% 16.8% 16.8% Other Intangibles EBIT Margin % 3.1% 3.1% (.5%) 4.% 4.9% Deferred Tax Assets, LT EBITDA Margin % 4.4% 4.7% 1.2% 5.6% 6.5% Other Long-Term Assets 7,21 7,748 9,6 9,585 1,22 Net Income Margin % 5.8% 6.2% 2.2% 2.6% 3.1% Goodwill Accounts Receivable Long-Term Asset Turnover Total Long Term Assets 8,532 8,541 1,94 1,748 11,42 Total Asset Turnover.4x.3x.6x.6x.6x Total Assets 33,78 37,593 2,856 22,916 25,343 Fixed Asset Turnover 1.4x 1.2x 1.2x 1.3x 1.4x Accounts Receivable Turnover.9x 1.1x 2.1x 2.x 2.x LIABILITIES & EQUITY Inventory Turnover 2.x 13.1x 13.1x 13.1x 13.1x Accounts Payable 14,323 4,261 4,823 5,59 6,481 Accrued Exp Liquidity Short-term Borrowings 7,6 4,335 4,97 5,687 6,593 Current Ratio 1.2x 1.2x 1.1x 1.1x 1.1x Curr. Port. of LT Debt Quick Ratio.6x.3x.8x.7x.7x Curr. Income Taxes Payable Avg. Days Sales Out Unearned Revenue, Current Avg. Days Inventory Out Other Current Liabilities , Avg. Days Payable Out Total Current Liabilities 21,742 23,874 9,822 11,379 13,186 Avg. Cash Conversion Cycle Long-Term Debt 1,65 2,177 3,177 3,177 3,177 Net Debt to Equity 47% 35% 11% 14% 16% Def. Tax Liability, Non-Curr Other Non-Current Liabilities Growth Over Prior Year Total Liabilities 22,844 26,192 13,152 14,724 16,546 Total Revenue (76.7%) (12.5%) 13.2% 15.9% 15.9% Common Stock Net Income 733.6% (5.6%) (59.4%) 34.5% 38.4% Additional Paid In Capital Payout Ratio % 66.7%.% 1,421% 2.% 2.% Retained Earnings 8,491 8,763 4,954 5,315 5,742 Treasury Stock Comprehensive Inc. and Other Minority Interest 2, , , ,75. 2,926.8 Total Equity 1,864 11,41 7,74 8,192 8,796 Total Liabilities And Equity 33,78 37,593 2,856 22,916 25,343 Sources: Company, CGIS Research*: data include the company s continuing operations as well as discontinuing hardware distribution business ; forecasts for 17 and 18 only includes its continuing operations. 23