ANCHOR REPORT Equity Research China Smart TVs: Take a second look TV Hardware: Neglect breeds upside potential While China’s smartphone sector continues to evolve, our attention turns to what we think will be the next “big thing” in China’s technology space — the transition from conventional to Smart TVs. We expect the Smart TV transition will unlock access to the USD22bn TV contents market, and kick off 4K2K TV adoption on the hardware side, which will benefit hardware vendors in terms of higher ASPs. November 4, 2013 Research analysts China Technology Leping Huang, PhD - NIHK leping.huang@nomura.com +852 2252 1598 David Hao - NIHK david.hao@nomura.com +852 2252 2153 The market so far has been focused on the impact on the content side, with the likes of LeTV up 6x YTD and trading at 130x FY13 consensus EPS. But we see hidden gems on the TV hardware side, with Skyworth (where we initiate with Buy) down 8% YTD and now on 5.7x FY14F EPS. We also see Lenovo (Buy), TCL Multimedia and TPV (both Not Rated) as potential beneficiaries from the transition. Key analysis in this anchor report includes: China Smart TV industry’s value chain and regulatory framework SWOT analysis of key players’ abilities in Smart TV transition Smart TV providers’ business models and growth potential Impact of Smart TVs and 4K2K TVs on China’s TV hardware market See Appendix A-1 for analyst certification, important disclosures and the status of non-US analysts. China Smart TVs EQ U I T Y R E S E A R C H TECHNOLOGY Take a second look November 4, 2013 TV Hardware: Neglect breeds upside potential Hardware vendors deserve as much attention as content providers We believe the transition from traditional to Smart TVs is the new game in China technology after the smartphone revolution. But while the market has been focused on content providers, we believe TV hardware vendors are the hidden gems in the whole Smart TV eco-system, given potential ASP uplift and market share gains. 4K2K is likely to be a key value driver for hardware We expect Smart TV penetration to reach 60% by 2015F from 25% in 2013F. The single biggest impact of Smart TV adoption on TV hardware will be acceleration of 4K2K TV sales, for which we project penetration in China will rise to 27% by 2015F from 2% in 2013F. We estimate TV hardware vendors such as Skyworth will see 2-5% ASP uplift and stable gross margins driven by 4K2K and Smart TV upgrades from 2013 to 2015. Valuations seem to have diverged unreasonably In the past six months, we have witnessed a strong rally in share prices of major content providers such as LeTV (up 6x YTD, at 130x consensus FY13 EPS) in anticipation of the Smart TV boom and a potential USD22bn TV advertisement and paid TV service market in China. That said, TV vendors (eg, Skyworth and TCL) have seen their share prices fall by 43%/47% since April 2013. While we do not dispute the value in content provision, we think the market has unfairly ignored the hardware plays. Anchor themes We believe Smart TVs are the next major trend in China's technology sector after China smartphones. We think TV hardware vendors are the hidden gems in the whole Smart TV eco-system. Nomura vs consensus We provide integrated analysis covering both contents and hardware for the Smart TV ecosystem. Research analysts China Technology Leping Huang, PhD - NIHK leping.huang@nomura.com +852 2252 1598 David Hao - NIHK david.hao@nomura.com +852 2252 2153 Prefer Skyworth: market leader in Smart and 4K2K TVs Among hardware vendors, we prefer Skyworth, the market leader in Smart and 4K2K TVs. We believe Skyworth will be successful during its Smart TV transition, unlike Nokia/Blackberry during their smartphone transitions; the difference, in our view, is pioneering efforts in Smart and 4K2K TV development among Chinese peers, nationwide sales and logistics networks, and experience in supply chain management, in particular TV panels. With Skyworth at a 3-year low, and P/E at a low 5.7x for FY14F on a three-year earnings CAGR of 17%, we initiate with Buy. Fig. 1: Stocks for action Ticker Company Name Rating 751 HK 992 HK Skyworth Lenovo Buy* Buy Price Target (HKD) 6.0 9.8 Price (HKD) 3.6 8.1 Upside 67% 21% Note: Pricing as of October 29, 2013. * Initiating coverage Source: Bloomberg, Nomura estimates See Appendix A-1 for analyst certification, important disclosures and the status of non-US analysts. Nomura | China Smart TVs November 4, 2013 Contents 3 Big picture: TV hardware vendors are the hidden gems in the Smart TV transition 6 Smart TV: the next game after China smartphones 6 Smart TVs provide more content and easier user interfaces 7 Three enablers: Broadband, Google TV, regulation changes 8 Smart TVs to shake up TV market share in China 9 Smart TV itself negative to TV industry’s margins/ASPs 10 But Smart TVs are likely to accelerate 4K2K TV adoption in China 13 Smart TV and 4K2K adoption rates to reach 60%/27% by 2015F 14 Smart TVs to unlock USD22bn TV content market 15 TV vendors lag in content, but their edge in supply chain / sales network remains intact 22 Company Strategies China TV market overview 25 26 Summary of TV subsidy programs 28 TV vendors’ panel sourcing strategies 30 TV exports next: Blue or red ocean? 31 Skyworth 48 Lenovo Group 53 TCL Multimedia 60 LeTV 64 TPV 67 Appendix A-1 2 Nomura | China Smart TVs November 4, 2013 Big picture: TV hardware vendors are the hidden gems in the Smart TV transition Since the start of 2013, we have observed a clear industry trend to launch Smart TVs and Smart TV boxes in China by both existing TV vendors, as well as the newcomers such as IPTV service providers and smartphone vendors. We believe this reflects a shift of the growth driver for China’s technology sector from smartphones to TVs. Fig. 2: Smart TV players Fig. 3: Major events in Smart TV segment Date 12/3/2012 1/24/2013 5/7/2013 7/2/2013 7/4/2013 7/10/2013 7/17/2013 7/18/2013 8/28/2013 9/2/2013 9/3/2013 9/5/2013 9/10/2013 9/13/2013 9/23/2013 9/26/2013 10/10/2013 Skyworth, TCL, Hisense TV Hardware Vendor IPTV Contents Provider Smartphone Vendor LeTV, Baidu, Youku, Alibaba Len ovo, Huawei, Xiaomi Source: Nomura research Com panies Skyw orth Xiaomi Baidu/Haier Coship LeTV Sharp/Lenovo LeTV Alibaba/Wasu Huaw ei/CNTV Konka/CNTV TCL/Baidu (iQIYI) Xiaomi Skyw orth/Alibaba LeTV/Tencent Coship/CIBN Huaw ei/GBS LeTV Ne w products/services Launch hollyw ood express Movie service Launch Xiaomi box Cooperation in Smart TV Launch Smart TV product Super TV S60 Supplying OS solutions for Sharp's TVs Super TV X40 Alibaba box MediaQ STB ( 秘盒) Launch KKTV to be sold on Jingdong Launch TV+ w ith identical price online and offline Launch Xiaomi TV Launch new smart TV models w ith Alibaba service Partner on distribution channel for a new TV model Launch Feikan STB, Mushroom UI, and Fei TV Launch TV dongle w ith 芒果TV Super TV S50 Source: Nomura research Fig. 4: Summary of major Smart TV models Brand LeTV Xiaomi Skyworth Lenovo TCL Hisense Model X40 Xiaomi TV Coocaa TV 42A21 L48F3390A-3D LED40K360X3D Hardware Spec 40 47 42 42 48 40 Resolution 1920 x 1080 1920 x 1080 1920 x 1080 1920 x 1080 1920 x 1080 1920 x 1080 Processor Dual-core Quad-core Hexa-core Dual-core Single-core Dual-core LeTV UI MIUI TV KuUI (Tianci & Ali) Android 4.0 Android Android 3D, Smart TV 3D, Smart TV 3D, Smart TV 3D, Smart TV 3D, Smart TV 3D, Smart TV 1999 2999 2999 2799 4999 4299 in USD 325 488 488 455 813 699 Sales/Marketing Annual Sub. (CNY) strategy Sales Channel 490 Free 360 Free Free Free e-channel e-channel own channel, Gome/Suning own channel; Gome/Suning Outsource Outsource In-house In-house/outsource own or outsourced staff own or outsourced staff CNTV + LeTV CNTV SMC, Voole, others Lenovo JV Wasu Hisense, Wasu Screen Size (inch) Operating System Features Retail price (CNY) Logistics/ after service Industry Partner Content Provider Internet Partner Tencent e-channel and retail e-channel and retail Alibaba iQIYI/Baidu License CNTV CNTV SMC SMG Wasu BesTV TV OEM Hon Hai/TPV Wistron Skyworth TPV TCL Hisense Sharp Samsung, LGD LGD Sharp CSOT/Samsung CSOT, Chimei Panel Source: Company data, Nomura research Major Smart TV content players in the A-Share market such as LeTV, BesTV and Wasu have seen strong rallies in the past six months. However, we believe the market continues to remain cautious on the TV hardware vendors. Skyworth and TCL’s share prices have declined by 43% /47% since April 2013. 3 Nomura | China Smart TVs November 4, 2013 This has resulted in a large difference in P/E multiples between hardware and content providers for Smart TVs. For example, Skyworth has traded at ~7x12-month trailing EPS, vs LeTV at above 100x trailing EPS, and Coship at ~50x trailing EPS. We think this reflects the market’s perception that content providers have a better likelihood of revolutionizing the TV industry and unlocking China’s paid-subscription TV market. At the same time, the market may think traditional TV vendors such as Skyworth and TCL are in situations similar to that of Nokia and Blackberry at the beginning of the smartphone transition in 2009. Fig. 5: Relative price performance comparisons 800% Fig. 6: P/E multiple comparisons PE (x) LeTV LeTV 200 Coship Coship 600% 150 Skyworth 400% 100 200% 50 0% 0 IPTV Skyworth STB Oct-13 Jul-13 Apr-13 Jan-13 Oct-12 Jul-12 Apr-12 Jan-12 Oct-13 Jul-13 Apr-13 Jan-13 Oct-12 Jul-12 Apr-12 Jan-12 Oct-11 Jul-11 Apr-11 Jan-11 TV Re-rating? Source: Bloomberg, Nomura research Source: Bloomberg, Nomura research However, we believe traditional TV vendors also play important roles in the Smart TV eco-system, including TV hardware supply chain management as well as sales and logistics networks. The take-off of 4K2K and Smart TVs should benefit domestic TV players in the acceleration of ASPs and earnings growth, in our view. Fig. 7: Summary of investment themes and timing of 4K2K and Smart TV Infrastructure Segment Changes in market share Growth in market size TV Hardware TV Service Network Service Smart TV China Telecom, China Unicom LeTV, Xiaomi LeTV Gehua, Topway Samsung, Sony iQiYi, Youku Contents Segment Network equipment 4K2K TV Operating System Beneficiary ZTE, Huawei Skyworth, TCL Lenovo, Xiaomi Source: Nomura research In our view, the investment sequence will be infrastructure, hardware, and finally services. We believe the investment theme is currently in the hardware phase, where investors are likely to focus on over the next 12-18 months. Then investors should gradually focus more on services, including content, ads, and applications. The figure below summarizes the key enablers of Smart TVs, including: 1) Smart TV hardware; 2) service providers; and 3) network infrastructure equipment vendors. 4 Nomura | China Smart TVs November 4, 2013 Fig. 8: Smart TV enablers Qualcomm, MStar Chip TV OEM (assembly, branding, channel) Hardware Smart TV Enabler Skyworth, TCL, Hon Hai, TPV, Wistron, Samsung, Haier, Hisense, Konka, Panda, Changhong TV Panel Samsung, LGD, Sharp, AUO, Chimei, CSOT, Chimei, BOE Software OS: Google, Microsoft UI: LeTV, Skyworth, Hisense, Xiaomi, Alibaba, Lenovo IPTV License holder CNTV, BesTV, SMC, CIBN, Wasu, CNBN, GBS Service IPTV content providers Youku, PPLive, LeTV, Voole, iQIYI Telecom service operator Network Infrastructure Telecom Equipment vendor China Telecom, China Unicom, Gehua, Topway Cisco, Huawei, Juniper Network, ZTE, ALU Source: Nomura research Fig. 9: Peer valuation table Code Company Trading Price Curncy 10/29/2013 Target Price M/Caps Nomura USD mn Rating P/E (x) FY13F P/BV (x) FY14F FY13F ROE FY14F FY13F Dividend Yield(%) EPS Growth FY13F HK/China Smart TV 751 HK Skyworth HKD 3.6 6.0 1,279 BUY 5.7 4.7 0.9 0.8 17% 5.50 992 HK Lenovo HKD 8.1 9.8 10,732 BUY 14.5 11.9 3.3 2.8 25% 2.70 18% 19% 1070 HK TCLM HKD 3.2 - 556 Not Rated 8.5 6.0 0.8 0.7 10% 6.59 -31% 41% 300104 CH LeTV CNY 42.0 - 5,407 Not Rated 114.6 80.4 17.0 14.5 18% 0.13 002052 CH Coship CNY 12.6 - 1,475 Not Rated 37.6 28.6 6.8 6.0 36% - 600637 CH BesTV CNY 38.8 - 7,130 Not Rated 60.4 44.2 11.5 9.2 21% 0.19 36% 26.1 20.3 5.1 4.4 0.2 1.4 0.2 Median MXCN MSCI China HSCEI H-Share index na 61.2 10,471 Source: Bloomberg, Nomura research • Skyworth (751 HK, initiate at Buy): We initiate coverage on Skyworth at Buy with a TP of HKD6. We think the market has only factored in negative impacts from the company’s Smart TV transition such as margin pressure, but has not reflected the positive impacts, especially on the acceleration of 4K2K TV adoption in China. We expect Smart and 4K2K TV penetration rates to reach 60%/27% in 2015F from 25%/2% in 2013F, benefiting Skyworth’s ASP growth, which should offset the weakness in TV sales volume in China. We think the current low valuation at 5.7x FY14F EPS provides a good entry point for investors. We value the company at 9x FY14F EPS of HKD0.64, at a 10% discount to China Technology peers due to its slower growth. • Lenovo (992 HK, Buy): Although we believe Smart TVs will remain unprofitable in the short term due to lack of scale and rising R&D expenses, we like Lenovo’s strategic positioning in the Smart TV arena. We believe its channel hardware partnership with Sharp and TPV, channel partnership with Gome and 360Buy, and content partnership via Hony Capital (Lenovo’s parent company Legend Holding’s PE arm)’s recent investment in PPTV are all filling the missing pieces for potentially explosive growth in the future. We maintain our Buy rating and TP of HKD9.8, which is based on 13x FY14F EPS of HKD0.56 plus HKD2.5/share net cash. 5 Nomura | China Smart TVs November 4, 2013 Smart TV: the next game after China smartphones Smart TVs provide more content and easier user interfaces A typical Smart TV provides new features such as: 1) access to interactive video content on the internet; (2) innovative user interfaces to explore the interactive video content more efficiently; (3) application stores to download third-party applications and 4) seamless integration with smartphones/tablets, as illustrated below. Fig. 10: Access to paid video library Fig. 11: Innovative UI to improve the user experience – Skyworth Tianci’s suspension UI User may make menu selections without interrupting the current programme Source: Nomura research Source: Skyworth Fig. 12: App store for expansion of features Fig. 13: Integration of screens: TVs, PCs, tablets, handsets Source: Skyworth Source: Google image • Interactive internet-based media content One major differentiation factor for Smart TVs is providing access to internet-based video content on the TV screen. Smart TVs also enable new features such as time-shift of TV programmes and VoD (Video-On-Demand), which give audiences a new “two-way” interactive experience which goes beyond the traditional “one-way” watching experience. 6 Nomura | China Smart TVs November 4, 2013 Time-shift allows users to “go back in time” and watch any programme within a certain period (eg, the past 7 days). VoD enables viewers to select content from a library collection (eg, a basketball fan may no longer be tied to watching a live NBA game shown by the channel, but can choose from all of the games currently available). One major difference between China and the rest of the world is the availability of “free” IPTV content thanks to the development of the IPTV industry in the last five years. For example, some of the bigger IPTV service providers such as Wasu, BesTV, and Youku, each claim to have several million hours of internet video content. • Innovative user interfaces Most of the Smart TV platforms in China are developed based on Google TV (Androidbased OS). Each vendor develops their own user interface and remote controller to improve the user experience in searching / switching video programmes. For example, Skyworth developed its Smart TV OS Tianci, which provides a unique fullsuspension UI and multi-task capability that allows users to carry out all operations without interrupting the current TV programme. • Application stores In addition to IPTV contents, most Smart TV platforms also have an application store which allows users to download third-party applications and allow for future monetization. • Connectivity: seamless integration with multiple Smart devices New connectivity options are needed to incorporate technologies such as Bluetooth, NFC, WiFi, and wireless display features to enable Smart TVs (the largest screen in a household) to become the main information terminal in these households. For instance, Lenovo provides software and a unified user interface on its Smart TVs, smartphones and tablets to access Lenovo’s cloud services, and seamless exchange of content between those devices. In addition to the added value to users, this also helps Lenovo to increase customer loyalty to its products. Three enablers: Broadband, Google TV, regulation changes We think the emergence of Smart TVs in 2013 has been mainly driven by the following changes in China’s TMT eco-system. • Rising broadband penetration According to MIIT, China’s broadband penetration (2Mbps+) is expected to reach 40% in 2013 and 50% in 2015, with FTTH (20Mbps+) penetration expected to reach 6% in 2013 and 13% in 2015. A 2Mbps+ network connection can transmit high-definition video without much risk of buffering, while a 20Mbps+ network can transmit UHD video. • Google TV provides a free Smart TV platform The launch of Google TV, a Smart TV platform based on Google’s Android OS, has greatly lowered the entry barriers to the Smart TV business. New entrants can easily enter the business by designing own user interface software and integrating propriety applications and services above Google TV. • The introduction of new IPTV regulations in China in 2011 Most important, the release of SARFT (State Administration of Radio, Film, and Television)’s new regulatory document (no. 181 in Dec 2011) has set the framework for China’s Smart TV business, in our view. 7 Nomura | China Smart TVs November 4, 2013 Smart TVs to shake up TV market share in China We expect the shift from traditional TVs to Smart TVs may create a similar magnitude of impact as the shift from feature phones to smartphones in the mobile industry. The figures below illustrate the market structure of China’s TV market and its trends in the last few years. The “big three” domestic TV vendors (Skyworth, TCL, Hisense) and the “small three” domestic TV vendors (Konka, Changhong and Haier) have maintained their total market share at ~80%. In Tier 1-2 cities, major domestic brands are gaining market share from international TV brands (such as Sony, Samsung) because of the improvement in their product quality and brand awareness. On the other hand, domestic brands have lost some market share in rural areas to local or non-brand vendors because of the home appliance subsidy programme, which helps smaller players to survive if their products can be qualified under the subsidy programme. Fig. 14: China LCD TV market share of major vendors (2013) Fig. 15: Market share trend (Big 3, Small 3, Intl, Others) By shipment volume Samsung, 3% Sony, 3% China Big 3 Foreign brand 60% Others, 10% Sharp, 3% Skyworth, 17% 50% 48% 49% 27% 28% China Small 3 Others 51% 50% 29% 29% 14% 15% 2012 1H13 40% Haier, 6% Changhong, 10% Konka, 12% Hisense, 16% 30% 20% TCL, 19% 23% 19% 10% 0% 2010 Source: DisplaySearch, Nomura research 2011 Note: “China Big 3” includes Skyworth, TCL, and Hisense; “China Small 3” includes Changhong, Konka, and Haier. Source: DisplaySearch, Nomura research The transition has created two key challenges for the TV industry. First, we see the rising importance of content, since Smart TV service providers can provide differentiated TV/video programmes once the vertical integration of content, license, and hardware is achieved via partnerships. The ability to negotiate with the content providers and integrate this content into their Smart TVs has become a critical competence for Smart TV hardware vendors. The second difference is the rising importance of software in a TV to develop competent Smart TV OS and attractive user interfaces. This means TV OEMs need to newly build an experienced software OS R&D team, and need to have enough scale in order to cover the software-related R&D costs. We think both requirements will gradually lead to consolidation in the existing TV hardware industry. Smaller players (eg, the one with a combined market share of 10% or below) may lose their market share because they lack the scale to cover the expense of a Smart TV software team and negotiate with content providers. On the other hand, we believe international brands may face difficulties as well since panel quality and visual quality are not the only differentiation factors anymore. Our study shows international brands tend to be cautious in forming partnerships with local content providers due to complicated regulatory issues in China’s TV industry; thus they are lagging behind domestic brands in content offerings. Domestic brands such as Skyworth, TCL, and Hisense have demonstrated their flexibility and speed in forming partnerships with local content and license holders. Skyworth / TCL / Hisense have all already linked up with their chosen content partners. 8 Nomura | China Smart TVs November 4, 2013 As a result, we believe the Smart TV transition will help content providers (eg, LeTV) and Smart OS providers (eg, Lenovo, Xiaomi) to gain market share at the expense of small domestic brands as well as some international brands which cannot quickly form industry alliances. Smart TV itself negative to TV industry’s margins/ASPs The figure below illustrates the cost structure and profitability between LeTV’s S40 and similar TVs from Skyworth’s offline and online channels. In this case, “online channel” rd refers to sales through 3 party e-commerce platforms and the manufacturer’s own website, whereas “offline channel” typically refers to sales through traditional retailers. LeTV requires Super TV buyers to buy the CNY490 annual subscription for the first year to marginally break-even, according to our discussions with LeTV. Thus, by assuming 8% channel cost and breakeven (~0%) margin, we estimate LeTV’s COGS for the S40 Super TV is ~CNY2.3k per unit. Next, we assume Skyworth should have a similar per-unit COGS at CNY2.7k, adjusting for the bigger panel. Then we also assume 7%/23% for online/offline channel costs, and thus estimate Skyworth’s gross margin for online and offline channels is 9%/32%, confirming our view that as Skyworth’s online channel Smart TV sales mix increases, its gross margin will suffer. Fig. 16: Cost analysis between LeTV and Skyworth’s online and offline channel sales LeTV Sales channel Model TV hardware Mandatory 1-yr Subscription Fee Skyworth S40 Coocaa Online Online Offline 40-inch 42-inch 42-inch 1,999 2,999 3,999 490 - 42E7DRS - Total revenue 2,489 2,999 3,999 COGS 2,365 2,729 2,729 124 270 1,270 32% Gross profit GPM (%) Sales and Marketing and Other OPEX Markup (%) 5% 9% 148 222 923 7% 7% 23% Operating Profit (24) 48 347 % of sales -1% 2% 9% Source: Company data, Nomura estimates In light of traditional TV vendors’ launch of Smart TVs exclusive for online channels with a model similar to Super TV, we performed sensitivity analysis on Skyworth (shown below) to assess the impact on revenues, margins and profits when the Smart TV sales mix from online channels increases. For the scenarios where online cloud TV increases to 15%, 25%, and ultimately 50%, operating profit would decline by as much as 16%, due to margin erosion of as much as 0.9bps. We should note that as the sales mix of online Smart TVs goes up, its incremental negative impact on operating profit falls (highlighted in the chart below); we attribute this to the reduction in channel costs by switching from offline to online. 9 Nomura | China Smart TVs November 4, 2013 Fig. 17: Sensitivity analysis on the impact of Smart TVs FY15/3F GPM (%) OPM (%) Of f line TV 3,450 ASP (CNY) 25% 7.0% Online TV 2,800 9% 5.0% Be nchm ark Case 1 Cas e 2 Case 3 95% 85% 75% 50% 5% 15% 25% 50% 34,270 34,036 33,802 33,100 -0.7% -1.4% -3.4% 6,928 6,694 5,992 -3.3% -6.5% -16.3% Price premium ‐19% FY15/3F Of f line Channel % Online Channel % China TV busines s Revenue Impact (%) Gross prof it 7,162 Impact (%) Operating prof it Impact (%) 2,260 2,173 -3.8% 2,096 -7.2% 1,889 -16.4% GPM % 20.9% 20.4% 19.8% 18.1% OPM % 6.6% 6.4% 6.2% 5.7% Source: Nomura estimates The chart below shows the Smart TV pricing strategies between traditional TV vendors and Internet companies in the 40-42 inch and 47-50 inch ranges. Strategy one is to put forth different prices based on sales channel; for example, Skyworth has taken the approach to sell its 42-inch Smart TVs via offline and online channels at different prices; the online price (typically ~30% cheaper than offline) is intended to match products launched by LeTV. This strategy should help Skyworth maintain its market share and maybe margin (if online channel cost is low enough). However, on the one hand, we think the price difference between the online and the offline model may confuse some consumers, and drag down the price of the offline model if Skyworth cannot clearly separate the definition of these two models. On the other hand, strategy two is to set identical prices regardless of sales channel with marketing focus on service and quality, such as TCL’s pricing for its TV+ product against Xiaomi. This strategy may help TCL to avoid price erosion, but at the same time put its market share at risk, in our view. Fig. 18: Illustration of TV vendors’ pricing strategy post LeTV launch (Price USD) 900 700 TCL (online & offline) Skyworth (offline) Strategy one 800 Skyworth (offline) 600 500 LeTV 400 Xiaomi Skyworth Strategy two 300 200 100 39 40 41 42 43 44 45 46 Display size (inch) 47 48 49 50 51 Source: Nomura research But Smart TVs are likely to accelerate 4K2K TV adoption in China Although Smart TVs are negative for TV hardware makers’ margins and ASPs, we believe the attractive media content that Smart TVs provide will accelerate the adoption of higher resolution Ultra High Definition (UHD, 4K2K) TVs in China. 4K2K TVs are the latest TV technology, which provides 4x higher resolution than existing full high definition TVs. Thanks to the low-cost 4K2K panels supplied from Taiwanese panel makers, Chinese TV OEMs have managed to lower the retail price of a 55-inch 4K2K TV below CNY10k (~USD1.5k). 10 Nomura | China Smart TVs November 4, 2013 Skyworth has indicated that 4K2K TVs accounted for ~20% of total TV shipment volumes during the 2013 National Day sales season, despite the more than 40% price premium between 4K2K and FHD TV models. TCL also indicated 10% 4K2K TV share in tier 1-2 cities during the National Day sales. Fig. 19: Video formats Abbrev. Broadcasting Required bandwidth for videostarts from on-demand (Mbps) Picture quality Resolution Disk Media SD Standard-definition <1280*720 VCD 2008 HD High-definition 1280*720 DVD 2012 4 3D HD 3D High Definition 1280*720 DVD 2015 8 Full HD Full High Definition 1.5 1920*1080 Blue Ray 2015 8 UHD (4K2K) Ultra High Definition 3840*2160 Blue Ray n.a. 30 8K 7680*4320 n.a. n.a. 8K Ultra High Definition Note: Bandwidth calculated based on H.264 AVC encoding standard Source: Nomura research We have noticed that there is a cautious view on 4K2K TVs within capital markets, since there is not enough support from both the content sources and TV stations currently. But the sales during the national holiday shows Chinese consumers are actually willing to purchase 4K2K TVs even before the content is ready. This is a phenomenon that we have seen in the 3D TV adoption in China over the past two years. James Kim, Nomura’s Asia Technology analyst covering the global display industry, expects the global 4K2K adoption rate to increase from 1% in 2013 to 8% in 2014 and 18% in 2015; on top of that, he also expects the 4K2K adoption rate in China will be even faster. In addition, we think the popularity of Smart TVs may accelerate 4K2K adoption in China. By using the internet connection in Smart TVs, content providers can offer 4K2K video streams directly to Smart TVs if subscribers’ network speed is fast enough. For example, LeTV stated in August 2013 that it plans to launch a channel with 4K2K programming. According to MPEG (Moving Picture Experts Group), 4K2K requires about 30Mbps bandwidth to deliver on the internet, based on current encoding technology. However, the newly developed HEVC/H.265 technology may further compress UHD streams by 40-50% down to ~15Mbps. According to China’s “Broadband China” strategy, China’s FTTH (fiber-to-the-home, 20Mbps) penetration will reach 13% by 2015, meaning about 70mn broadband subscribers will be able to watch live 4K2K content at home by 2015. Fig. 20: China’s broadband China project Fig. 21: TV price breakdown by features Broadband China target Unit 2013 2015 2020 2013-15 CAGR Household 525 540 571 mn Subscriber target (CNY) 10,000 mn 210 270 FTTH (20Mbps+) mn 30 70 52.8% Urban broadband mn 160 200 11.8% 7,000 Rural broadband mn 50 70 18.3% 6,000 mn 330 450 16.8% 400 5,000 1,200 13.4% Infrastructure target 3G/LTE base station k 950 1,200 % 40 50 FTTH % 6 13 Urban broadband % 55 65 Rural broadband % 20 30 % 25 33 12.4% 3G/LTE 55-inch LED 8,000 3,700 4,000 500 700 500 700 500 4,099 4,099 4,099 up to 65% pricing upside 3,000 Penetration rate Fixed line broadband + Smart TV + 3D 9,000 Fixed line broadband 3G/LTE + 4K2K 70 2,000 4,099 1,000 0 85 Source: Nomura estimates Source: MIIT We expect 4K2K adoption to follow similar patterns as other advanced TV technologies, although at a slower rate, in China. It may take 12 months to reach 10% penetration (early adopter), and 24 months to reach 50%+ (mass adoption). 11 Nomura | China Smart TVs November 4, 2013 Fig. 22: Adoption rate Fig. 23: 4K2K market share in China during 2013 Labour Holiday (15 April to 5 May) LCD 100% Haier, 1% LED LCD 90% 3D TV 80% Changhong, Changhong ,5% 5% Smart TV 70% Foreign, 10% 4K2K 60% TCL, 9% 50% Skyworth, 48% 40% 30% 20% Konka, 11% 10% 0% 1 4 7 10 13 16 19 22 25 28 31 34 37 Hisense, 15% Months Source: Company data, Nomura research Source: Skyworth Historically, a revolutionary innovation in technology leads to several years of ASP growth, as shown in the chart below during the transition from CRT to flat panel TVs. Although 4K2K is more like an upgrade than a revolution, we expect moderate growth in ASP with 4K2K adoption. Fig. 24: Significant ASP growth during CRT to flat panel transition (CNY k) ASP (LHS) Flat panel penetration (RHS) 3.5 3.0 Fig. 25: Slight ASP growth during the 4K2K transition (CNY k) 100% 80% 2.5 60% 2.0 1.5 40% 1.0 20% 0.5 0% 0.0 FY06 FY07 FY08 FY09 FY10 FY11 FY12 Source: Company data, DisplaySearch, Nomura estimates 3.5 ASP (LHS) 4K2K penetration (RHS) Smart TV penetration (RHS) 3.0 100% 80% 2.5 60% 2.0 1.5 40% 1.0 20% 0.5 0.0 0% FY11 FY12 FY13 FY14F FY15F FY16F Source: Company data, DisplaySearch, Nomura estimates Based on our observations in the retail channel, the 4K2K feature may command a price premium of up to 65% for a 55-inch TV at the moment, though products made by domestic vendors are still at least 50% cheaper than those from foreign brands. While the incremental cost for a 4K2K TV is only 20-30% higher, we estimate the premium will gradually decline by 35% over the next two years and help Skyworth to lift its ASP by as much as 5% y-y and to stabilize GPM at ~21% in FY14-15F. We present sensitivity analysis below on Skyworth’s FY15/3F revenue, profit, and margins with regard to 4K2K volume penetration, with the assumption that the average price of a 4K2K TV declines 47% from CNY8,999 to CNY4,800 over the next year. The analysis shows that operating profit would rise up to 12%, led by gross margin expansion by as much as 50bp. 12 Nomura | China Smart TVs November 4, 2013 Fig. 26: Sensitivity analysis on the impact of 4K2K TVs in China’s TV market FY15/3F 4K2K Smart TV 4,800 ASP (CNY) GPM (%) 30% OPM (%) 7.1% HD Smart TV 3,450 25% 7.0% Benchm ark Case 1 Case 2 Case 3 27% 36% 46% 56% Price premium FY15/3F 39% 4K2K Penetration China TV business Revenue 34,270 Impact (%) Gross prof it 35,770 4.4% 37,029 38,349 8.1% 11.9% 7,162 Impact (%) Operating profit 7,543 5.3% 7,864 8,199 9.8% 14.5% 2,260 2,395 6.0% 2,458 2,524 8.8% 11.7% Impact (%) GPM % 20.9% 21.1% 21.2% 21.4% OPM % 6.6% 6.7% 6.6% 6.6% Source: Nomura estimates Smart TV and 4K2K adoption rates to reach 60%/27% by 2015F We forecast Smart TV shipment volume will show a 36% CAGR between 2013F and 2015F, with the Smart TV penetration rate reaching 60% by 2015F, from 25% in 2013F. Meanwhile, we expect a quick ramp-up of 4K2K TVs in China in 2014/2015F, driven by the new 4K2K content via Smart TV providers. We expect the 4K2K penetration rate will reach 27% in 2015F, from 2% in 2013F. On the other hand, we expect the Smart TV user base will show a 38% CAGR, with the penetration rate over total TV users reaching 24% by 2015, from 8% by 2013F. The rapid expansion in the IPTV user base will be critical for IPTV players to monetize nonhardware revenues such as advertising, paid subscriptions, apps, etc. Fig. 27: China’s TV market summary China TV forecast CY11 CY12 CY13F CY14F CAGR CY15F (2013-15) TV User Forecast TV User mn sub 420 437 445 451 457 broadband Sub mn sub 156 174 222 258 289 Smart TV User mn sub 14 23 37 61 95 38% Penetration rate Smart TV/total TV users 3% 5% 8% 14% 24% Smart TV/Broadband sub 9% 13% 16% 24% 34% 23.0 24.6 26.1 27.3 28.3 15% 7% 6% 5% 4% 51.9 54.1 55.4 56.3 6 14 25 34 1 7 15 493 502 China TV market size bn USD y-y Volume mn units 48.9 Smart TV mn units - 4K2K TV mn units - - 471 473 483 0% 13% 25% 45% 60% 2% 12% 27% Total China TV ASP USD 36% Penetration rate Smart TV 4K2K Y-Y Growth China TV volume 12% 6% Smart TV 4% 3% 2% 112% 85% 35% 501% 128% 2% 2% 4K2K ASP 2% 1% 2% Source: AVC, Scotland, IDC, DisplaySearch, Gartner, Nomura estimates 13 Nomura | China Smart TVs November 4, 2013 Smart TVs to unlock USD22bn TV content market According to Digital TV Research, China’s total video service market reached USD23bn in 2012, including USD21bn in TV advertising revenue, USD1bn in paid TV subscription revenue and USD1bn in IPTV advertising. This market is dominated by TV stations and local cable TV service providers currently. New IPTV service providers such as Youku-Tudou and LeTV don't have access to TV screens since they can only reach users via PCs, smartphones, and tablets. By launching Smart TVs, these IPTV service providers may gain access to living room screens, as a result capturing part of the USD22bn TV advertising and paid TV market at the expense of TV stations, in our view. In addition, unlike traditional delivery of TV ads, Smart TV service providers can apply big data analytics to track and analyse viewing behavior to improve accuracy and effectiveness in ad delivery. From the viewpoint of traditional TV vendors, while they lack the expertise in content and subscription services, some TV vendors have formed partnerships to test-trial new business models. In December 2012, Skyworth announced its paid subscription service “Hollywood Express” would provide Hollywood movies to its Smart TV users at an annual subscription fee of CNY360. In this service, Skyworth linked with SMC (the license holder) and Voole (content provider). According to Skyworth’s management, about 2% of new TV buyers have subscribed to this service currently. Fig. 28: Comparison between TV, Telecom, and IPTV market sizes and ARPUs in China (USDbn) 1,000 Fig. 29: Market share of paid-TV, TV ads, and IPTV ads revenue Service Revenue (LHS) (USD) 100% ARPU (RHS) 1,000 90% Others 80% 70% 100 100 60% Provincial Satellite TV (40 channels) 50% 40% 178 10 10 30% 21 20% 1 1 Paid TV 10% 1 TV Ad Telecom 1 Others LeTV Tencent Sohu iQIYI (PPS) CCTV (16 channels) Youku Tudou TV ads (2012) IPTV ads (4Q12) 0% IPTV Ad Source: Digital TV Research, China Mobile, China Telecom, China Unicom, SARFT, Nomura research Source: Enfodesk, SARFT, Nomura estimates Unlike the US, China’s TV market started off as a free-subscription business; thus the nurturing and adoption of paid-TV was painful and slow. Although the penetration rate of paid TV service subscribers in China is 42% in 2012, vs 86% in the US, which doesn’t seem to be far behind, the ARPU gap between China and US audiences is huge, roughly USD7 vs. USD888 per year. The chart below shows an example of the pricing difference between cable and internet video service providers in China and the US. Fig. 30: Comparison of Paid TV service ARPU Operator Country/Region ARPU (CNY) per month OCN Shanghai HK Broadband Network Time Warner Cable 23 73 615 LeTV China 33 Skyworth Hollywood Netflix US Express 30 74 Programme TV Channels 151 50 100+ CNTV n/a Few VOD Yes Yes Yes 100k+ hrs 10k+ hrs 1mn+ hrs Source: Company data, Nomura research 14 Nomura | China Smart TVs November 4, 2013 According to Digital TV Research, at end-2012, China had 187mn paid TV households, 87% more than the 100mn paid TV households in the US. However, China’s paid TV subscription fees in 2012 amounted to only USD1bn, a fraction (1.5%) of the USD89bn paid by US audiences. We believe Smart TVs may help unlock the paid subscription potential in China. Assuming annual APRU will increase to 20% of the amount paid by US households at USD178 by the end of 2020, the incremental growth in China’s paid TV market size could be as much as USD33bn. Fig. 31: Potential room for growth in China paid-TV market [2013-20] (USDbn) Paid TV Potential growth (LHS) ARPU (RHS) 100 888 90 80 (USD) 1,000 USD178 70 100 60 50 40 30 20 10 10 7 USD33bn 1 0 China US Source: Digital TV Research, Nomura estimates TV vendors lag in content, but their edge in supply chain / sales network remains intact We note a TV vendor needs to play more roles in Smart TV business compared with its roles in traditional TV as shown below. Fig. 32: China Smart TV’s value chain Content Delivery Network Chipset Panel Module Assembly Sales & Marketing Smart TV Software Consumer New role in a Smart TV eco-system IPTV Contents IPTV License Existing role in a TV eco-system Source: Nomura research We identify the following six competences: • Funding: it is important to have sufficient financial strength to fight the battle against competitors as Smart TVs are showing signs of becoming a low-margin business due to new competition. • License: the government has issued licenses to legally carry out IPTV services in China. • Content: content is a key differentiating factor for a Smart TV. • Sales networks: due to TVs being heavier and bigger, and with longer replacement cycles, sales and logistics networks are a major consideration when consumers make purchasing decisions. 15 Nomura | China Smart TVs November 4, 2013 • Software (OS/UI): OS and UI have direct impacts on user experience. • Supplier chain: one major challenge for TV manufacturers is to manage inventory risk of TV panels, which typically accounts for 70% of BOM costs. Our analysis below shows TV hardware vendors are still lagging behind IPTV content providers and smartphone vendors in software- and content-related competence, but in the meantime it is difficult for content and smartphone vendors to catch up in areas such as supply chain management and sales and logistics network. Fig. 33: Comparison of Skyworth/LeTV’s Smart TV strategy Skyworth License LeTV Sales network 5 4 3 2 1 0 Contents Source: Nomura research Fig. 34: Comparison of Lenovo/Samsung’s Smart TV strategy Lenovo Supplier Chain License Samsung Sales network 5 4 3 2 1 0 Funding Contents Funding Supplier Chain Software(OS/UI) Software(OS/UI ) Source: Nomura research Funding capability The Smart TV hardware market is showing signs of becoming a low-margin business as IPTV players entering the sector are bringing the internet companies’ mindset of providing service gateways to users at low cost or for free to quickly build up a user base with critical mass. Thus, it is important to have a strong funding capability to fight for end users against competitors. So far, capital markets seem willing to give IPTV service providers higher P/E valuations because they are perceived to have a better likelihood of revolutionizing the TV industry and unlocking China’s paid-subscription TV market. The higher valuation will lower the funding costs and enable the companies to further fuel their growth story. For example, LeTV raised CNY1.6bn equity capital at ~130x P/E to purchase Huaer Yingshi (花儿影视 ) and Leshi Xinmeiti (乐视新媒体) in September 2013. For multi-business companies like Lenovo, they also have strong financial strength to penetrate into the Smart TV business. In the case of Lenovo, its PC business, though declining on the macro level, is the cash cow for the group to invade other sectors such as smartphones and Smart TV. On the other hand, companies such as Skyworth, whose core business is selling TV hardware, will be hurt from the disruptive pricing practices by the new entrants, and the capital markets are showing precisely that concern. Fig. 35: Comparison of capital market valuations between IPTV and TV hardware companies IPTV Company Market Cap FY13F P/E FY13F P/B (USD mn) (x) (x) TV Hardware Company LeTV 5,407 117.0 17.0 Skyworth BesTV 7,130 60.4 11.5 TCLM Wasu 4,520 99.6 8.4 Hisense Market Cap FY13F P/E FY13F P/B (USD mn) (x) (x) 1,317 6.2 1.0 556 8.5 0.8 2,370 7.7 1.4 Source: Bloomberg, Nomura research 16 Nomura | China Smart TVs November 4, 2013 License SARFT (State Administration of Radio, Film, and Television), China’s TV industry regulator, published the regulatory framework for Smart TV business in Oct 2011 (document 181) and June 2012 (document 43). According to these two documents, all Smart TV service providers need to co-operate with one IPTV license holder (as listed below) in order to be a legalized IPTV system. • CNTV (China Network Television, private) is a wholly-owned subsidiary of CCTV (China Central Television). CNTV is now the sole national broadcast and control platform provider; through it, viewers not only have access to channel programming nationwide, but also have access to CNTV’s content library, the largest in China. • BesTV (600637 CH, NR) is a publicly listed IPTV service provider. It is a joint-venture between SMG (Shanghai Media Group) and Tsinghua Tongfang (600100 CH, NR). SMG is the IPTV license recipient and through the JV, enables BesTV to become an IPTV service provider. Viewers have access to 31 digital channels from SMG and a digital content library consisting of more than 100k hours of HD video. • Wasu (000156 CH, NR) is a venture owned by HCRT (Hangzhou Culture, Radio, and Television Group) and ZRT (Zhejiang Radio and Television Group). Unlike BesTV, Wasu is the direct recipient of the IPTV license. Viewers have access to more than 80 channels (including CCTV and other provincial satellite channels) and more than 1mn hours of video content. • SMC (Southern Media Corporation, private), is the consolidated entity of Guangdong Province Cable Network, Southern Television Network, and Guangdong Television Network, and others. SMC is the recipient of an IPTV license. • GBS (Golden Eagle Broadcasting System, private) is the entity consisting of television networks in Hunan province, newspapers, and new media. • CIBN (China International Broadcasting Network, private) is wholly owned by China Radio International as its television business arm with its IPTV license. • CNBN (China National Broadcasting Network, private) is a recipient of an IPTV license. Within the framework, private sector firms are now clear on how to carry out their IPTV services without violating any regulations. As shown below, all major domestic TV brands have formed a partnership with at least one license holder. However, we have not seen any announcement of similar partnerships between leading foreign brands (eg, Samsung/Sony/Sharp) and those license holders. As a result, foreign TV vendors are likely to be at a disadvantage in video content offering; we believe this may result in a further decline of their market share in China. On the other hand, we believe small local brands will need to install white-box Smart TV platforms in order to keep with the pace of industry upgrades. In the end, we think these trends will help the bigger vendors such as Skyworth, TCL, and Hisense to gain market share. Fig. 36: TV vendor content partnerships (2013) CNTV BesTV Skyworth TCL Wasu SMC x x x Hisense x Konka x GBS CIBN CNBN x x Changhong x Coship x x LeTV x Xiaomi x Lenovo x Source: Nomura research 17 Nomura | China Smart TVs November 4, 2013 Content is king Content is one major differentiating factor for a Smart TV. In China, TV stations (and their subsidiaries holding the IPTV license) and IPTV service providers (eg, LeTV, iQiYi) are the major owners of copyright for video content. Players such as LeTV took a vertically integrated business model between content and TV hardware by providing propriety content (or content in higher definition) over its own platform. Other players such as iQiYi (content provider) and Skyworth (hardware manufacturer) have chosen to form an alliance with a specific counterpart in order to enrich their Smart TV eco-system. Fig. 37: Comparison of IPTV contents by Smart TV brands (or content libraries) CNTV Skyworth TCL Hisense Konka Changhong Hardware Haier Vendor Coship LeTV Xiaomi Lenovo Microsoft x x BesTV Wasu x x x SMC x Content Provider GBS CIBN LeTV Voole x Youku x iQIYI x x x x x x x x x x x x Source: Nomura research There are some cautious views on the sustainability and effectiveness of those alliances given the conflict of interests between contents providers (which maximize user penetration rates via different devices), and hardware providers (which provide as much content over a single device) as a differentiation factor. At the early stage of industry growth, we think it is useful for both sides to form such alliances in order to quickly gain market share in their specific area. For example, Skyworth has formed a partnership with Voole to provide Hollywood movies in China, and formed a partnership with Baidu/iQiYi to provide set-top boxes, and formed an alliance with Alibaba to integrate Alibaba’s lifestyle-related services. All these services are provided over Skyworth’s Tianci Smart TV platform, which is critical in its providing Skyworth with an understanding of consumers’ preferences and derives ads and paid service revenues from this platform. Fig. 38: Summary of Skyworth’s industry alliances in Smart TV segment Annouced Date Partner Service Name Details Dec-12 SMC, Voole Holllywood Express CNY360 per year, ~2% of cloud TV users subscribed Jun-13 Wasu Sep-13 Baidu/iQiyi Smart TV STB CNY299 to be launched in 4Q13 Sep-13 Alibaba Coocaa TV Smart TV for online channels Strategic partnership (hardware, content, and license) Source: Nomura research Sales networks We think one major difference between the TV hardware business vs the PC and smartphone businesses is the dependency on sales/logistics/after-sales networks because TVs are much bigger and heavier than PCs or handsets, as shown below. 18 Nomura | China Smart TVs November 4, 2013 Fig. 39: Comparison of TV, handset, and PC distribution methods Product Size (width, height, depth) in mm Weight (g) Sales Channel TV 42-inch Smart TV 978 * 638 * 250 15,500 Large chain store (Gome/Suning) Operator IT mall e-channel own franchise Independent consumer electronics shops Logistics Installation service after-sales service Warrenty and after sales service Replacement cycle Mobile Phone PC 5-inch smartphone 14-inch notebook 70 * 140 * 9 245 * 350 * 33 150 2,200 23% 0% 0% 10% 9% 58% 5% 70% 10% 5% 5% 5% 20% 0% 60% 10% 10% 5% Complicated Required Required 3 years (panel), 1 years (set) 10 years Simple not required not required 1 year Simple not required not required 1 year 2 years 2 years Source: Nomura research For example, on the one hand, Skyworth owns one of the most comprehensive sales, logistics, and after-sales service networks in China, including over 20k retail shops and service outlets with nationwide coverage. In FY2013, Skyworth’s own sales channel (speciality stores and other electronics shops) contributed 62% of total TV sales volume. We think the value of this network will remain as one of Skyworth’s major edges vs internet companies like LeTV and international TV vendors. On the other hand, Internet companies either provide minimal offline service or rely on third-party service providers, but service quality is often not guaranteed due to lack of dedication. We believe the sales network that local TV vendors own will remain one major edge that they have over the internet companies. Fig. 41: Skyworth store in 3rd tier cities to rural areas Fig. 40: Skyworth’s sales by channel (2013/3) Other electronics shops cover 3rd tier cities to rural, 58.2% Large scale chain stores, 18.4% Hypermark et, 4.5% Hypermarket, 4.5% Direct sales, 4.9% Online, 9.7% Domestic / Exports distributors, 0.5% Source: Skyworth disclosure, Nomura research Skyworth specialty stores in major cities, 3.8% Source: Skyworth.com Software and user interface Most Smart TV platforms in China are developed based on Google’s Android or Linux’s operating system. TV vendors integrate their own user interface software, IPTV applications and app store to third-party applications, as summarized below: 19 Nomura | China Smart TVs November 4, 2013 User interface • Skyworth’s Tianci OS includes its own user interface supporting a unique fullsuspension UI and multi-task capability to allow users to carry out all operations without interrupting current TV programmes. • Hisense’s VIDDA UI features “waterfall channel switch” which allows audiences to seamlessly and instantly change channels without the time lag that most other Smart TV platforms have. Fig. 42: Tianci – suspension UI and multi-tasking Fig. 43: Hisense VIDAA TV’s “waterfall channel switch” feature Source: Nomura research Source: Nomura research Remote controller • LeTV’s Super remote controller reduces users’ reliance on buttons and features touch screen, voice input, gravity sensor, and gyroscope. Big data and data mining capacity: • Skyworth’s Tianci has a back-end engine to process and analyze content and user behaviour, and data mining for various potential purposes such as content recommendation and targeted advertising. Fig. 44: LeTV’s Super remote controller Fig. 45: Voice command feature Gaming with G-sensor and gyroscope in play Similar to iPhone's Siri Source: LeTV Source: LeTV Supply chain management One major challenge for the TV business is to manage inventory risk of TV panels, which typically accounts for 70% of BOM costs. A typical TV OEM needs to carry roughly three weeks of panel inventory in order to maintain flexibility to changing market demand and to control costs amid fluctuations in panel pricing. 20 Nomura | China Smart TVs November 4, 2013 As shown in the right side figure below, Skyworth has delivered consistent results partly due to this strategy, in our view. On the one hand, whenever there is a sharp decline in panel pricing, Skyworth had been able to maintain a healthy inventory level and stable OPM; on the other hand, TCL has seen volatile OPM partly due to inventory write-offs. 2011 2012 2013 Source: Skyworth Apr-13 2010 Jan-13 10 2009 -40% Jul-12 0 -35% Oct-12 1,000 -30% Apr-12 2,000 -25% Jan-12 20 Jul-11 3,000 -20% Oct-11 20 -15% Apr-11 21 0% -5% -10% Jan-11 21 23 Jul-10 4,000 24 30 Apr-10 5,000 10% 8% 6% 4% 2% 0% -2% -4% -6% -8% -10% Oct-09 Inventory days for unfinished goods (RHS) 6,000 Skyworth (LHS) TCL (LHS) 40-inch panel ASP y-o-y (RHS) (Days) Inventory trend (LHS) Jan-10 (HKDmn) Fig. 47: Relation between TCL/Skyworth’s op margins and panel prices Oct-10 Fig. 46: Skyworth’s inventory trends and inventory days -45% Source: Skyworth Unlike peers such as TCL, whose business model relies on its vertical integration strategy into upstream components such as panels, Skyworth retains the flexibility to shop between suppliers to procure the components to make products that can best meet market trends (eg, a particular display size), whereas TCL may be constrained to make products that best suit its upstream production capabilities, and not necessarily the consumer market. In order to better manage inventory and logistics, major TV vendors have taken the approach to build geographically scattered production capacities throughout both China and the world. The chart below illustrates how some major domestic TV vendors geographically allocate their production capacities to better serve local markets at reduced costs. Fig. 48: Production capacity distribution of major TV vendors Company Skyworth TPV Shipment Capacity volume (mn units) 2012 10.6 15.1 15.5 42 Region Shiyan, Guangzhou, Inner Mongolia, Lishui Beihai, Beijing, Qingdao, Fuqing, and Wuhan Tijuana Manaus and Tierra del Fuego St. Petersburg, Gorzow, and Szekes 7 Hisense 12.1 0.2 Guiyang, Jiangmen South Africa Country China Comment Ramp up to 19mn in 2015 China Mexico Brazil Europe China South Africa 0.25 Algeria Algeria 0.5 Egypt Egypt Source: Company data, Nomura research Brand awareness Due to the long replacement cycle (~10 years) for TVs, intangible measures such as brand reputation and quality are considered when consumers are making a purchasing decision. According to Fortune’s recent ranking of the top 50 most respected brands in th th China, both TCL and Hisense made the list, at 25 and 28 , respectively. A separate survey on consumer awareness of Smart TV brands, conducted by iiMedia, shows that the big 5 domestic vendors (TCL, Skyworth, Hisense, Changhong, and Konka) have a large lead over most other brands. 21 Nomura | China Smart TVs November 4, 2013 In a time of Smart TV transition, we believe favourable brand perception should translate into larger benefits to TV brands than ever before, since consumers need to rely more on a trustworthy brand to have a better likelihood of receiving both a high quality TV with comprehensive post-sales services and a Smart TV with a mature eco-system. Fig. 49: Consumers’ awareness on Smart TV brands in China (2013) 60% Fortune China Brand Ranking 53% 49% 46% 50% 37% 40% 40% 35% 30% 30% Fig. 50: Fortune’s top 50 most respected brands in China 30% 29% 24% 29% 16% 20% 13% Source: iiMedia Others Sony Panasonic Sharp LG Samsung Haier Konka Skyworth Hisense LeTV TCL 0% Changhong 10% 2013 2012 Company 1 2 Alibaba 2 1 Baidu 3 3 Haier 4 4 Huawei 5 7 Lenovo 6 6 Tencent 11 n/a Xiaomi 11 15 BYD 25 28 TCL 28 29 Hisense 35 36 ZTE Source: Fortune magazine Company Strategies Internet content providers • LeTV (300104 CH, NR): LeTV is one internet video provider that also produces its own content. By partnering with CNTV for content integration and license, LeTV first entered the Smart TV arena via its LeTV box. In May 2013, LeTV moved further by announcing the launch of its Super TVs using Foxconn/TPV as OEMs. X60 (60-inch) and S40 (40inch) were priced at CNY6,999/CNY1,999 and their first 10k units were sold out within 49/82 minutes respectively, showing the potential demand behind the new low-price hardware + VAS business model. However, X60 and S40 sales had been slow after the initial wave due to being “too big and too small” according to our discussion with the management. LeTV launched S50 (50-inch Super TV) in October and gained favourable market traction; the companies believes it will become “the product” to break into the Smart TV sector and targets 200k/1mn units in 2013 and 2014, which will translate into a 1.8% market share in China TV in 2014. LeTV uses a “CP2C” (customer planning to customer) model where downstream prepayment orders drive upstream production with transparent manufacturing and delivery lead time constantly fed back to customers. In addition, LeTV partnered with two call centres, 12 post-sale service companies, and 19 logistics companies to provide customer service covering 92 cities (172 cities by end-2013). On the offline retail level, LeTV has Gome as its exclusive partner to sell its Super TVs in stores from 4Q13. On the content front, LeTV announced on 30 September that the company will be acquiring 100% ownership of Huaer Yingshi (花儿影视) and Leshi Xinmeiti (乐视新媒体) for CNY1.6bn. This move is to further fortify its existing advantage in online video content production and copyright collection. After all, content is king. • Baidu/iQIYI (BIDU US, NR): iQIYI started off as Baidu’s independent internet video subsidiary in March 2010, focusing on aggregating content and providing online video services featuring free, copyrighted, and high-definition content. iQIYI acquired PPS in May 2013 for a cash payment of USD370mn, making it one of the largest online video companies in China, equally large as Youku Tudou in terms of market share. Unlike LeTV, its Smart TV strategy is not to make its own hardware, but to co-operate with existing players, such as TCL, to jointly roll out TV+ from September 2013. 22 Nomura | China Smart TVs November 4, 2013 • Alibaba (unlisted): Alibaba announced that its Smart TV strategy is to make TVs a new source of internet traffic for its e-commerce platforms including Taobao and TMall. Thus its strategy is for Alibaba to co-operate with existing players such as Wasu (Alibaba box) and Skyworth (Coocaa TV) and to integrate its e-commerce platform and services. • Tencent (700 HK, NR): LeTV recently announced a partnership with Tencent in Smart TV development; and LeTV will host a major product announcement in October. While details of the partnership are unknown, we think the partnership will be similar to Skyworth/Alibaba, where it will focus mainly on integration of application platforms, utilizing Tencent’s expertise in communication (WeChat/QQ) and games. • Wasu (000156 CH, NR): it is one of seven IPTV license holders and a service provider in interactive TV, mobile TV, and IPTV. Wasu has one of the largest digital TV content libraries in China, with over 1mn hours of TV programming. In addition, Wasu provides digital cable TV services to over 20mn households in Zhejiang province and 18 cities outside of the province. To penetrate into Smart TVs and break geographical barriers, Wasu had partnered with TV hardware vendors such as Skyworth, TCL, Hisense, and Changhong to secure Smart TV gateways for its broadcast platform and content. • BesTV (600637 CH, NR): it is one of seven IPTV license holders and China’s first legitimate IPTV service provider. The company currently has 16mn IPTV users, the largest user base in the world, according to the company. BesTV developed its proprietary Smart TV box in 2013 and received 2mn serial numbers from SARFT. In addition, it has partnered with Lenovo to carry its content on Lenovo Smart TVs. TV vendors • Skyworth (751 HK, initiate at Buy): Skyworth is a leader among domestic traditional TV vendors to test different Smart TV models. In December 2012, it partnered with SMC (license) and Voole (content) to launch a paid subscription service called “Hollywood Express”. Skyworth also designed Tianci OS, an operating system not simply adopted/modified from Android, but built from scratch around TV users’ unique behaviours and TV functionalities. In addition, Tianci can be installed on TVs with other operating systems such as Android, making it the first cross-platform Smart TV OS in China. Facing potentially disruptive price competition from internet players such as LeTV, Lenovo, and Xiaomi, Skyworth co-operated with Alibaba to launch Coocaa TV to compete in similar price ranges. • TCL Multimedia (1070 HK, NR): Based on a survey by iiMedia, TCL is the brand that most people are likely to associate with Smart TVs. TCL in September partnered with iQIYI to launch TV+. Unlike Skyworth, TCL set identical pricing for both offline and online distribution of its TV+ product at CNY4,567 with an emphasis on nationwide service coverage via both online (eg, Jingdong, Suning.com, and TMall) and offline (eg, Gome, Suning, TCL specialty stores) channels. • Hisense (600060 CH, NR): Hisense’s VIDAA TV uses its proprietary operating system that is often regarded as one of the two best TV systems in China, alongside Tianci. However, we have yet to see a major strategic development for the company to address potential threats coming from internet companies. • TPV (903 HK, NR): As a TV OEM vendor, TPV is partnering with various vendors including Lenovo, LG, and Sharp in Smart TV business. In addition, through TP Vision (70% owned joint-venture), TPV has access to strong brand recognition, R&D capabilities, and innovative products from Philips. CEC (China Electronics Corporation, 0085 HK, NR) is the major shareholder of TPV as well as Panda, one of several major panel makers in China. According to Reuters, CEC/Panda/TPV has signed an agreement with Sharp to build an 8.5Gen LCD panel line in Nanjin. As a TV OEM, TPV will absorb the panels made by Panda. Given TPV’s large scale, this will increase TPV’s panel sourcing flexibility, in our view. 23 Nomura | China Smart TVs November 4, 2013 Smart Device and Set-top-box vendors • Lenovo (992 HK, Buy): Smart TV is the final piece to complete Lenovo’s PC+ strategy. The company launched K series (flagship) and S series Smart TVs in 2012 as its first attempt to penetrate the market using Wistron and Compal as OEMs. Due to its prohibitive pricing (CNY60k to CNY150k) compared to similar products, it failed to generate meaningful sales. Lenovo announced its A21 series Smart TVs in June with a similar strategy. A21 series features 32-inch and 42-inch models, priced at CNY1799 and CNY2799, respectively via www.JD.com’s e-channel. Lenovo targets to sell 1mn units of A21 series products in three years in JD alone. • Coship (002052 CH, NR): Coship is the largest STB provider in China, according to the company, with product coverage over 17 provinces and more than 100mn users, mainly via its co-operation with local SARFT authorities to promote digital TV migration. On 23 September, Coship launched the Feikan (飞看) box, Mushroom UI (蘑菇 UI) and a 55-inch Fei TV (飞 TV, priced at CNY4698) to kick off its Smart TV strategy. While its offline distribution strategy for STBs and TVs is not yet clear, Coship will be partnering with MTC (002429 CH, NR), a STB manufacturer, to invest CNY10bn to upgrade digital TV STBs to Smart TV STBs for users in 10 major provinces free of charge. Coship partners with CIBN for its license. • Xiaomi (unlisted, NR): Xiaomi launched its Xiaomi box in January 2013 by partnering with CNTV. In addition, Xiaomi TV was announced in September 2013, to be launched around mid-October, using Wistron as an OEM and Samsung/LDG as panel suppliers. Unlike LeTV, Xiaomi lacks the ability to produce and aggregate content. We expect Xiaomi to utilize its expertise in UI design to continue to blossom in its TV product. • Huawei (unlisted): Huawei launched MediaQ M310 STB (秘盒) on 28 August, partnering with CNTV for license and content. Further, Huawei partnered with GBS to launch a Smart TV dongle in September. • China Telecom (728 HK, Buy): CT has 20mn IPTV subscribers now via co-operation with BesTV and other IPTV license holders. In addition to broadband revenue, China Telecom also shares content revenue with content providers. IPTV is a useful approach to stimulate broadband upgrades, which is important to sustain ARPU. 24 Nomura | China Smart TVs November 4, 2013 China TV market overview According to DisplaySearch, in 2012, Chinese vendors had 84% volume share in China’s LCD TV market in total, vs 16% by international brands. In particular, the top 6 China brands captured 80% of the market, while the top 3 foreign brands only captured ~10%. Foreign vendors mainly focused on Tier 1-2 cities, and mid (40-48’’) to premium (50’’ and above) segments. Domestic vendors have dominant presence in mainstream sizes (3048’’) and low-tier cities. Looking at panel sizes, there is a clear trend that demand for larger displays is rising. We believe this trend is positive to drive both Smart TV and 4K2K adoption rates. Fig. 51: Average TV size in China and by vendors Fig. 52: Market share by panel size Skyworth leads the market average The contraction of 40-48 inch TV market share during the past 5 quarters has mainly been due to the energy-saving subsidy focusing on 32-inch TVs. We expect the trend to reverse starting In 3Q13 as the subsidy programme expired in May. China Skyworth - China TCL - China (inch) 40 39 <29'' 100% 90% 80% 70% 60% 50% 38 37 36 35 40% 30% 20% 10% 0% 34 33 32 31 30 1Q11 3Q11 1Q12 3Q12 1Q13 Source: DisplaySearch 5% 41% 43% 32-39'' 40-48'' >50'' 7% 9% 10% 10% 31% 29% 30% 28% 52% 54% 56% 52% 9% 6% 6% 5% 3Q12 4Q12 1Q13 2Q13 48% 11% 15% 1Q12 2Q12 13% 29% Source: DisplaySearch Within domestic vendors, Skyworth, Hisense, and TCL are the top three vendors in terms of market share. Skyworth has a slightly higher market positioning, which results in a higher ASP and gross margin. Fig. 53: ASP comparisons in China market Fig. 54: Gross margin comparisons (USD) 25% 650 600 20% 550 500 15% 450 400 10% 350 China Skyworth 300 TCL Hisense Skyworth TCL Hisense 5% 250 200 1Q11 Source: DisplaySearch 3Q11 1Q12 3Q12 1Q13 0% 1Q11 2Q11 3Q11 4Q11 1Q12 2Q12 3Q12 4Q12 1Q13 Source: DisplaySearch 25 Nomura | China Smart TVs November 4, 2013 Fig. 55: TV technology roadmap in China OLED TV Launch Internet TV Smart TV set-top-box vs. all-in-one Smart TV transition LED LCD TV: Direct vs. Edge transition HD, FHD, 16:9 LED backlight LCD TV becoming mainstream 2009 4K2K, 21:9 3D TV gaining popularity 2010 2011 Smart TV emerging 2012 2013 2014 2015 Source: TCL, Nomura research Fig. 56: Document 43 outlines the specific types of licenses and their functions License License Category IPTV integrated broadcast and control platform Audiovisual Programming Dissemination Permit for IPTV content service platform Information Networks Tier Responsibility Central management, planning, and unified design of National EPG, BOSS, and copyrights Operations, service development, services, and Provincial connections with operators National Content related production, editing, censoring, broadcasting, EPG, pricing, copyright, and ads Provincial placement IPTV transmission service National Provide additional programming and EPG entries to integrated IPTV broadcast and control platforms after review by the platform License holders CCTV (CNTV) CNTV, BesTV, SMC, CIBN, CNBN, Wasu, GBS National TV stations (eligible) Regional TV stations (eligible) China Telecom, China Unicom Source: SARFT, Nomura research Summary of TV subsidy programs The government’s home appliance subsidy programme has always been a major driver of China’s TV market. We summarize the past programmes and expectations for the next programme as below. • Countryside subsidy (家电下乡, February 2009 to January 2013) The government started a home appliance for countryside subsidy programme in December 2007. MoF subsidized 10% of the home appliance’s listing price or up to CNY400 for home-appliance purchases, including air conditioners, TVs, refrigerators, and heaters. This programme expired on 31 January 2013, with a total subsidy payment of CNY66.2bn. • Old for new (以旧换新, May 2009 – December 2011) Starting in June 2009, there was a parallel “old for new” subsidy alongside the countryside subsidy. It promoted the trade-in of old home appliances for 10% or up to CNY400 in subsidy support for new purchases. This programme ended in December 2011 with a total subsidy payment of CNY34bn. • Energy saving subsidy (June 2012 – May 2013) The latest energy-saving subsidy commenced in June 2012, subsidizing homeappliances that meet the tier 1 and 2 energy-saving standards for an amount of CNY100400. A total of CNY26bn was budgeted. • Energy-saving leader (coming soon) According to AVC, the government is exploring the possibility of introducing a new home appliance subsidy programme called Energy-saving leader. In the new programme, the government will only subsidize 2-3 models per OEM with the highest energy saving efficiency in order to improve China’s energy efficiency. Another difference versus the old programme is to subsidize vendors instead of consumers this time. This should reduce working capital overheads for vendors, in our view. 26 Nomura | China Smart TVs November 4, 2013 Fig. 57: Home appliance subsidy summary in China 2009 2010 2011 1Q12 2Q12 3Q12 4Q12 1Q13 2Q13 3Q13 4Q13 Unit Total Countryside subsidy (家电下乡) Up to CNY455 CNY66.2bn Old for New subsidy Up to CNY455 CNY34bn CNY100-400 CNY26bn Energy-saving subsidy Awaiting new subsidy… ? Coming soon Source: Nomura research According to China Video Industry Association (CVIA), 32% of the energy-saving subsidy was used for flat-panel TV products in 1Q13 and more than 90% of LCD TVs meet the energy-saving standard. CVIA also estimated that a total of 21.3mn units of flat panel TVs were purchased using the subsidy (or 43% of LCD TVs sold in China in 2012), generating total sales of CNY75.8bn with subsidy payments totalling CNY6bn. Fig. 58: TVs account for 32% of total energy saving subsidy Fig. 59: Skyworth’s monthly China TV sales Energy-saving subsidy usage by product (1Q13) Washing machine, 17% Flat-panel TV, 32% Refrigerator, 23% Air conditioner, 26% Source: ZDC (1Q13) ('000 units) 1,400 China TV (LHS) Volume Growth (China TV) (RHS) 80% 1,200 60% 1,000 40% 800 20% 600 0% 400 -20% 200 -40% 0 -60% Jan-11 Mar-11 May-11 Jul-11 Sep-11 Nov-11 Jan-12 Mar-12 May-12 Jul-12 Sep-12 Nov-12 Jan-13 Mar-13 May-13 Jul-13 Heater, 2% Source: Skyworth 27 Nomura | China Smart TVs November 4, 2013 TV vendors’ panel sourcing strategies Panels are the most expensive component in an LCD display, and account for 60-70% of a LCD TV’s total bill of material cost (source: Display Search). Although China’s market and Chinese vendors contributed 22.3% and 21.8% of global TV shipment volumes in 2012, respectively, China only produced 8.4% of global panel supply, according to DisplaySearch. Fig. 60: Trend between TVs and panels made in China (mn units) Fig. 61: Global share between TVs and panels made in China ('000 m2) China TVs 18 China Panels (RHS) 4,500 16 4,000 14 3,500 12 3,000 10 2,500 8 2,000 6 1,500 4 1,000 2 500 - 1Q11 2Q11 3Q11 4Q11 1Q12 Source: DisplaySearch 2Q12 3Q12 4Q12 1Q13 TV Market share (China) 30.0% Panel Market share (China) 25.0% 20.0% 15.0% 10.0% 5.0% 0.0% 1Q11 2Q11 3Q11 4Q11 1Q12 2Q12 3Q12 4Q12 1Q13 Source: DisplaySearch To resolve the mismatch, the government provides favourable financial and taxation conditions to attract the development of the domestic TV panel industry. Raise panel import tax to 5% to support domestic panel industry On 1 April, 2012, the Ministry of Finance (PRC) raised the import tax rate for panels to 5%, from 3%. The government expects the 5% price difference due to taxation and additional transportation costs will create cost advantages for domestically produced TV panels, and encourage the relocation of the panel industry into China. According to news published by Sohu.com in June 2013, China may further raise the panel import tax rate from 5% to 8-12% to accelerate this trend. Financial subsidies to promote domestic panel industries In addition to the taxation scheme, local governments also provide financial subsidies to China-based panel vendors such as BOE (00725 CH) and TCL Corp (000100 CH)’s panel arm CSOT. • BOE (00725 CH, NR) BOE is currently constructing a second 8.5G line in Hefei and planning a third 8.5G line in Chongqing. In addition, BOE established a 5.5 generation AMOLED line in Ordos (Inner Mongolia, ~770 kms west from Beijing) in 2011. The government there provided ~1bn tonnes of coal mining rights to BOE in order to attract this investment of CNY22bn. BOE had transferred part of the rights and cashed in CNY3.6bn, which was used as part of the up-front capital for the project. • TCL Corp (000100 CH)’s CSOT It established a 50-50 JV with SIHC (Shenzhen Investment Holding Corp, which is an investment vehicle for the city of Shenzhen) to establish CSOT (China Star Optoelectronics Technology) in Shenzhen. In June 2013, SIHC announced it would forgive CSOT’s CNY5.1bn in debt because CSOT had achieved the production capacity requirement originally set by SIHC. The CNY5.1bn debt will be treated as deferred revenue and recognized over seven years. CSOT is planning its second 8.5G line in Shenzhen. • CEC/Panda/TPV CEC Group and Nanjing Panda are partnering with Sharp to build its first 8.5G line in Nanjing, aiming to commence production in 1Q15. 28 Nomura | China Smart TVs November 4, 2013 • LGD/Skyworth’s 8.5G Fab Skyworth expects the new fab to start operations from summer 2014 with a monthly capacity of 6k pieces of mother glass, which is equivalent to 60k 42-inch TV units. Fig. 62: Summary of TV panel production lines in China Tianma BOE Infovision LGD Samsung CSOT Innolux Nanjing Panda Truly Plant Shanghai 1 Chengdu 1 Wuhan 1 Chengdu B2 Beijing B1 Hefei B3 Beijing B4 Hefei B5 Chongqing B6 Beijing B7 Beijing B8 Ordos KunShan Guangzhou Suzhou Shenzhen 1 Shenzhen 2 Shenzhen Nanjing Nanjing Shanwei Gen 4 4 4 4.5 5 6 8.5 8.5 8.5 8.5 8.5 5.5 5 8.5 8.5 8.5 8.5 5 6 8.5 2.5 Capacity (k/mo.) Started Operation 30 30 30 45 100 100 90 90 ??? ??? ??? 54 110 60 110 120 ??? 110 60 ??? ??? 3Q06 3Q10 1Q11 3Q09 2Q06 4Q10 2Q11 4Q13 Planning ??? ??? Construction 1Q06 2Q14 1Q14 4Q11 Planning 3Q06 1Q10 1Q15 2Q08 Source: Display Search Implication for TV vendors Within domestic TV vendors, only TCL adopts a vertically integrated business model including a TV panel arm CSOT. When there is shortage in TV panels, TCL Multimedia will benefit from priority supply from CSOT, but may be under pressure to lower TV prices in order to maintain CSOT’s utilization rate. Other TV vendors such as Skyworth and HiSense adopt an asset-light business model and rely on external panel suppliers in Taiwan and Korea. In our view, the asset-light business models have advantages in terms of flexibility to adopt the newest panel technology in the market and launch products with the most popular panel sizes. 29 Nomura | China Smart TVs November 4, 2013 TV exports next: Blue or red ocean? Chinese TV vendors were suffering from export business till now due to lack of brand awareness and channels. However, Chinese vendors see the retreat of Japanese TV vendors as an opportunity to expand their footprints. We summarize Chinese TV vendors’ overseas business strategies as below. Fig. 63: Summary of Chinese TV vendors’ overseas business (FY12) Total TV Shipment (2012) CNY mn Revenue Y-Y% ASP (CNY) Volume ('000) Market Share (%) Gross Profit GPM (%) Operating Profit Skyworth 24,498 26% 2,144 11,425 3.6% 4,564 19% 1,393 TCL 28,540 21% 1,626 17,556 5.6% 4,746 17% 863 TPV 30,759 34% 3,829 8,034 2.6% 2,967 10% 415 HiSense 20,400 3% 2,145 9,509 3.0% - China TV Shipment (2012) CNY mn Revenue Y-Y% ASP (CNY) Volume ('000) Market Share (%) Gross Profit GPM (%) Operating Profit Skyworth 21,977 22% 2,526 8,702 17.4% 4,461 20% 1,405 TCL 18,828 16% 2,126 8,857 17.8% 3,871 21% 734 TPV 4,122 45% 4,752 867 1.7% HiSense Changhong 7,971 16.0% 6,821 13.7% Overseas TV Shipment (2012) CNY mn Revenue Y-Y% ASP (CNY) Volume ('000) Market Share (%) Gross Profit GPM (%) Operating Profit Skyworth 2,520 77% 926 2,723 0.7% 103 4% (12) TCL 9,712 34% 1,116 8,699 2.1% 876 9% 129 TPV 26,637 33% 3,717 7,166 1.7% 3,831 Changhong 17,122 -3% 2,338 7,322 2.3% 3,040 Konka 13,876 12% 2,333 5,949 1.9% 2,299 Konka 13,876 12% 2,333 5,949 11.9% 2,299 HiSense Changhong 1,538 0.4% 501 0.1% Konka Source: Company data, DisplaySearch, Nomura research • Skyworth is becoming more aggressive in international expansion. The company said during its annual analyst briefing in July 2013 that it targets to raise its non-China TV shipments to 4mn units in FY14, from 2.7mn units in FY13, growth of 47% y-y. On top of volume growth and scale, Skyworth also aims to become profitable overseas. • TCL Multimedia is looking to strengthen its existing overseas presence on top of its 2.1% market share in 2012. The company shipped 8.7mn LCD TVs overseas in 2012 and is targeting 7.8mn units (+17% y-y) in 2013. • TPV: after acquiring Philips’ TV business in April 2012 (via a 70-30 JV with Philips), TPV has 7.9% market share in Europe, and 4.1% market share in Latin America in 2012. But TPV is still restructuring this business in 2013 by shutting down some factories in Europe and expanding the product offering from high-end to mid-to-low-end models. 30 Skyworth 0751.HK 751 HK EQ U I T Y R E S E A R C H TECHNOLOGY Initiate at Buy with HKD6.0 TP November 4, 2013 Rating Starts at Buy for Smart TV and 4K2K TV upgrade Action: Initiate with Buy, TP of HKD6.0 for Smart TV/4K2K upgrade We initiate coverage on Skyworth at Buy with a TP of HKD6. We think the market has only factored in negative impacts from the industry’s smart TV transition such as margin pressure, but has not reflected the positive impacts, especially on the acceleration 4K2K TV adoption in China. We expect smart and 4K2K TV penetration rates to reach 45%/12% in 2014F from 25%/2% in 2013F, benefiting Skyworth’s ASP growth, which should offset the weakness in TV sales volume in China. We think the current low valuation at 5.7x FY14F EPS provides a good entry point for investors. Buy Target price Starts at HKD 6.00 Closing price October 29, 2013 HKD 3.59 Potential upside +67.1% Anchor themes We believe Smart TVs are the next major trend in China's technology sector after China smartphones. We think TV hardware vendors are the hidden gems in the whole Smart TV eco-system. Nomura vs consensus We are more bullish on the positive impacts of smart TV on the TV product upgrade cycle. Catalysts: Monthly data, especially ASP and smart TV adoption rate Skyworth’s key assets during its smart TV transition We believe Skyworth will be successful during its smart TV transition, unlike Nokia/Blackberry during their smartphone transitions; the difference, in our view, is pioneering efforts in smart TV development among Chinese peers, nationwide sales and logistics network, and experience in supplier chain management, in particular TV panels. Service revenue should provide long-term upside to earnings for Skyworth as smart TV adoption rises. Currently 2% of its smart TV buyers have subscribed to its paid-TV service “Hollywood Express”. Skyworth has also established revenue-sharing plans with Internet players such as Alibaba. Research analysts China Technology Leping Huang, PhD - NIHK leping.huang@nomura.com +852 2252 1598 David Hao - NIHK david.hao@nomura.com +852 2252 2153 Valuation: 9x FY14F EPS of HKD0.64 We expect Skyworth to achieve 18%/18% y-y earnings growth in FY14/15F driven by 8%/17% sales growth of its core China TV business. We derive our TP of HKD6 based on 9x FY14F EPS of HKD0.64, a 10% discount to China Technology peers due to its slower growth. The risk to our forecast is write-off of panel inventory. 31 Mar Currency (HKD) Revenue (mn) FY13 Actual FY14F Old New FY15F Old New FY16F Old New 37,824 44,203 53,800 62,324 Reported net profit (mn) 1,501 1,766 2,089 2,469 Normalised net profit (mn) 1,501 1,766 2,089 2,469 54.36c 63.95c 75.66c 89.42c 17.5 17.6 18.3 18.2 4.0 FD normalised EPS FD norm. EPS growth (%) FD normalised P/E (x) 6.6 N/A 5.7 N/A 4.7 N/A EV/EBITDA (x) 7.6 N/A 6.1 N/A 5.4 N/A Price/book (x) 1.0 N/A 0.9 N/A 0.8 N/A Dividend yield (%) 4.7 N/A 5.5 N/A 6.6 N/A 4.4 0.7 7.7 ROE (%) 16.3 16.7 17.5 18.3 Net debt/equity (%) 35.2 30.6 31.9 24.4 Source: Company data, Nomura estimates Key company data: See page 2 for company data and detailed price/index chart. See Appendix A-1 for analyst certification, important disclosures and the status of non-US analysts. Nomura | Skyworth November 4, 2013 Key data on Skyworth Income statement (HKDmn) Year-end 31 Mar Revenue Cost of goods sold Gross profit SG&A Employee share expense Operating profit EBITDA Depreciation Amortisation EBIT Net interest expense Associates & JCEs Other income Earnings before tax Income tax Net profit after tax Minority interests Other items Preferred dividends Normalised NPAT Extraordinary items Reported NPAT Dividends Transfer to reserves Relative performance chart (one year) FY12 28,137 -22,181 5,956 -4,677 FY13 37,824 -30,418 7,406 -5,942 FY14F 44,203 -35,548 8,655 -6,876 FY15F 53,800 -43,266 10,534 -8,403 FY16F 62,324 -50,121 12,203 -9,662 1,279 1,464 1,779 2,131 2,541 1,516 -237 1,766 -302 2,179 -400 2,590 -459 3,054 -513 1,279 -88 1,464 -55 1,779 -73 2,131 -62 2,541 -44 385 1,576 -308 1,268 -16 517 1,926 -332 1,594 -93 557 2,262 -390 1,872 -106 600 2,669 -460 2,209 -120 648 3,145 -542 2,603 -134 1,252 1,501 1,766 2,089 2,469 1,252 -381 871 1,501 -464 1,037 1,766 -546 1,220 2,089 -646 1,443 2,469 -763 1,706 Valuation and ratio analysis Reported P/E (x) Normalised P/E (x) FD normalised P/E (x) FD normalised P/E at price target (x) Dividend yield (%) Price/cashflow (x) Price/book (x) EV/EBITDA (x) EV/EBIT (x) Gross margin (%) EBITDA margin (%) EBIT margin (%) Net margin (%) Effective tax rate (%) Dividend payout (%) Capex to sales (%) Capex to depreciation (x) ROE (%) ROA (pretax %) 7.7 7.7 7.7 8.6 4.0 8.1 1.1 7.9 9.4 21.2 5.4 4.5 4.4 19.5 30.4 3.0 3.5 16.1 7.1 6.6 6.6 6.6 7.4 4.7 na 1.0 7.6 9.2 19.6 4.7 3.9 4.0 17.2 30.9 2.9 3.7 16.3 6.3 5.7 5.7 5.7 6.3 5.5 9.5 0.9 6.1 7.5 19.6 4.9 4.0 4.0 17.2 30.9 2.3 2.5 16.7 6.6 4.7 4.7 4.7 5.3 6.6 22.7 0.8 5.4 6.5 19.6 4.8 4.0 3.9 17.2 30.9 1.9 2.2 17.5 7.0 4.0 4.0 4.0 4.5 7.7 6.0 0.7 4.4 5.3 19.6 4.9 4.1 4.0 17.2 30.9 1.6 2.0 18.3 7.5 Growth (%) Revenue EBITDA EBIT Normalised EPS Normalised FDEPS 15.6 9.9 14.9 4.8 4.8 34.4 16.5 14.5 17.5 17.5 16.9 23.4 21.5 17.6 17.6 21.7 18.9 19.8 18.3 18.3 15.8 17.9 19.2 18.2 18.2 46.28c 46.28c 46.28c 3.21 0.14 54.36c 54.36c 54.36c 3.64 0.17 63.95c 63.95c 63.95c 4.09 0.20 75.66c 75.66c 75.66c 4.62 0.24 89.42c 89.42c 89.42c 5.24 0.28 Per share Reported EPS (HKD) Norm EPS (HKD) Fully diluted norm EPS (HKD) Book value per share (HKD) DPS (HKD) Source: ThomsonReuters, Nomura research (%) 1M 3M 12M Absolute (HKD) -4.0 -10.0 -12.4 Absolute (USD) -4.0 -10.0 -12.5 Relative to MSCI China Market cap (USDmn) Estimated free float (%) 52-week range (HKD) 3-mth avg daily turnover (USDmn) Major shareholders (%) Weiping Lin -2.9 -17.8 -17.0 1,278.5 6.0 6.67/3.39 11.60 34.5 Source: Thomson Reuters, Nomura research Notes Source: Company data, Nomura estimates 32 Nomura | Skyworth November 4, 2013 Cashflow (HKDmn) Year-end 31 Mar EBITDA Change in working capital Other operating cashflow Cashflow from operations Capital expenditure Free cashflow Reduction in investments Net acquisitions Reduction in other LT assets Addition in other LT liabilities Adjustments Cashflow after investing acts Cash dividends Equity issue Debt issue Convertible debt issue Others Cashflow from financial acts Net cashflow Beginning cash Ending cash Ending net debt FY12 1,516 -1,158 841 1,199 -839 360 0 FY13 1,766 -2,012 -278 -524 -1,111 -1,635 0 FY14F 2,179 -140 -989 1,050 -1,000 50 0 FY15F 2,590 -1,632 -522 436 -1,000 -564 0 FY16F 3,054 -830 -555 1,669 -1,000 669 0 -33 103 -359 71 -199 23 -208 -406 204 700 -1,137 -177 13 1,512 0 -500 1,000 550 -464 0 800 0 0 500 -64 -546 0 -500 0 0 500 1,169 -646 0 -800 -47 -431 -360 2,524 2,164 2,119 -74 1,274 137 2,164 2,301 3,505 0 336 886 2,301 3,187 3,419 0 -1,046 -1,110 3,187 2,077 4,029 0 -1,446 -277 2,077 1,801 3,505 FY12 2,164 0 12,725 3,191 860 18,940 0 2,328 FY13 2,301 0 16,036 5,648 648 24,633 0 3,068 FY14F 3,187 0 15,879 5,071 1,298 25,436 0 3,668 FY15F 2,077 0 19,430 7,501 980 29,989 0 4,208 FY16F 1,801 0 21,474 5,879 880 30,034 0 4,695 0 956 22,224 3,568 5,064 3,489 12,121 715 0 720 13,556 199 0 269 7,202 998 0 1,362 29,063 5,581 7,387 4,710 17,678 225 0 924 18,827 267 0 280 8,569 1,120 0 1,362 30,466 6,381 7,164 4,710 18,255 225 0 424 18,904 373 0 280 9,789 1,120 0 1,362 35,559 5,881 10,546 5,358 21,785 225 0 424 22,434 493 0 280 11,232 1,120 0 1,362 36,091 5,081 9,970 5,426 20,477 225 0 424 21,126 627 0 280 12,938 1,120 8,469 22,224 9,969 29,063 11,189 30,466 12,632 35,559 14,338 36,091 Liquidity (x) Current ratio Interest cover 1.56 14.5 1.39 26.6 1.39 24.3 1.38 34.4 1.47 58.4 Leverage Net debt/EBITDA (x) Net debt/equity (%) 1.40 25.0 1.98 35.2 1.57 30.6 1.56 31.9 1.15 24.4 149.4 48.3 70.9 126.7 138.8 53.0 74.7 117.1 131.8 55.0 74.7 112.1 119.8 53.0 74.7 98.1 120.1 48.9 74.9 94.1 Notes Source: Company data, Nomura estimates Balance sheet (HKDmn) As at 31 Mar Cash & equivalents Marketable securities Accounts receivable Inventories Other current assets Total current assets LT investments Fixed assets Goodwill Other intangible assets Other LT assets Total assets Short-term debt Accounts payable Other current liabilities Total current liabilities Long-term debt Convertible debt Other LT liabilities Total liabilities Minority interest Preferred stock Common stock Retained earnings Proposed dividends Other equity and reserves Total shareholders' equity Total equity & liabilities Activity (days) Days receivable Days inventory Days payable Cash cycle Notes Source: Company data, Nomura estimates 33 Nomura | Skyworth November 4, 2013 Catalysts ahead Catalyst one: ASP uplift driven by 4K2K adoption Due to the high benchmark set in FY13 riding on the energy-saving subsidy programme, China’s TV industry is currently feeling the after-effects of the subsidy programme (which expired in May 2013), as purchasing decisions made during what is a typically seasonal cycle have been pushed forward. Thus we expect 2H14F volume growth to remain challenging, at least until a new subsidy programme is implemented, something we expect in 4Q13. The chart below shows differences in growth rates before and after the energy-saving subsidy programme. The black dotted circle indicates periods covered by the subsidy and the red circle indicates periods after subsidy expiration. Fig. 64: Volume growth remaining challenging 2H14F volume growth is likely to remain challenging due to high base in 2H13 China TV (LHS) ('000 units) 1,400 y-o-y Volume Growth (China TV) (RHS) 80% Dec-13 Nov-13 Oct-13 Sep-13 Aug-13 Jul-13 Jun-13 Apr-13 -60% May-13 0 Mar-13 -40% Feb-13 200 Jan-13 -20% Dec-12 400 Oct-12 0% Nov-12 600 Sep-12 20% Jul-12 800 Aug-12 40% Jun-12 1,000 May-12 60% Apr-12 1,200 Note: TV shipments for October, November, and December are Nomura estimates, as indicated by the black dotted bars. Source: Company data, Nomura research Innovation in technology is a key driver of ASP for Skyworth. Historically, mass adoption and transition from CRT to LCD TV that drove the LCD TV penetration rate from ~25% to 99% from 2H08 to 1H10 marked a significant improvement in ASP (+40%). In turn, Skyworth’s share price increased 12x during that period. Fig. 65: ASP uplift should accelerate (CNY k) 4 4K2K/Smart TV 100% CRT --> Flat Panel 80% 3 60% 2 27% 16% 4K2K Penetration Smart TV Penetration 1 40% 6% China TV ASP (LHS) China TV ASP Forecast (LHS) 33% 36% 36% FY14F FY15F FY16F 20% 18% 0 0% FY09 FY10 FY11 FY12 FY13 Source: Company data, Nomura estimates 34 Nomura | Skyworth November 4, 2013 We believe we are currently at a similar crossroad, this time driven by the adoption of 4K2K/smart TV; although we do not think the magnitude of the upcoming ASP growth will be as dramatic as before, we forecast 12% growth in ASP over the next two years. Catalyst two: New energy-leader subsidy programme coming soon Besides technology innovation and ASP growth, subsidy programmes also serve as an important catalyst to boost stock performance. Historically, shown in the chart below, a company’s stock price tends to react strongly after the announcement of a subsidy programme. After the expiration of the energy-saving subsidy programme, we expect a new “energy-saving leader” subsidy programme to be officially announced in 4Q13F. Price peaks within 12-months of a subsidy announcement: • Countryside subsidy (announced in December 2008): HKD0.45 HKD7.92 (+1,670%) • Old-for-new subsidy (announced in May 2009): HKD0.79 HKD9.91 (+1150%) • Energy-saving subsidy (announced in May 2012): HKD3.27 HKD6.65 (+103%) Upcoming energy leader subsidy programme: According to AVC, the government is exploring the possibility of introducing a new home appliance subsidy programme called energy-saving leader. In the new programme, the government will only subsidize 2-3 models per OEM with the highest energy saving efficiency in order to improve China’s energy efficiency. Another difference versus the old programme is to subsidize vendors instead of consumers this time. This should reduce working capital overheads for vendors, in our view. Fig. 66: Share price and subsidy-related news (HKD) 12 10 Official announcement Industry wide inventory build-up 8 LCD TV penetration from 50%-99% 6 Official announcement 4 Official announcement ? Energy-saving subsidy Old for new subsidy 2 Country side subsidy Oct-13 Jul-13 Apr-13 Jan-13 Jul-12 Oct-12 Apr-12 Jan-12 Oct-11 Jul-11 Apr-11 Jan-11 Jul-10 Oct-10 Apr-10 Jan-10 Oct-09 Jul-09 Apr-09 Oct-08 Jan-09 Jul-08 Apr-08 Jan-08 Oct-07 Jul-07 Apr-07 Oct-06 Jan-07 Jul-06 Apr-06 0 Jan-06 Energy-saving leader subsidy coming soon Source: Bloomberg, Nomura research 35 Nomura | Skyworth November 4, 2013 Earnings forecasts China TV and digital set-top boxes are two major earnings drivers for Skyworth. In FY13, China TV business contributed 72% of the sales and 76% of operating profit, while the digital set-top box business contributed 10% of sales and 17% of profits. In addition, Skyworth also entered the overseas TV and white-goods business markets recently, but the earnings contribution remains trivial now. Fig. 67: Revenue breakdown, FY13 White Property appliances rental 5% income 0% Other electronics 3% Fig. 68: Operating profit breakdown, FY13 Sales of properties 1% LCD module 1% Other electronics, -5% White Property appliances, rental 4% income, 2% LCD module, 6% Digital Settop boxes 10% Digital Settop boxes, 17% Overseas TV 8% China TV 72% Source: Company data, Nomura research China TV, 76% Overseas TV, -1% Source: Company data, Nomura research Fig. 69: Segment forecast summary (HKDmn) China TV Overseas TV China Digital STB Overseas digital STB LCD module White appliances Others FY13/3 Sales 27,104 3,108 1,898 2,008 535 1,691 1,480 GPM 21% 4% 28% 20% 11% 14% 2013-16 CAGR 12% 26% 5% 20% 50% 49% Market Position No.1 (18% share) <2% market share No.1 (12.7% share) No.4 market share new business Major competitor TCL, Hisense, Konka, Changhong Samsung, LGE, Sony Coship, Jiuzhou Elec, Cisco, Changhong Technicolor, Pace, Motorola, Huawei, ZTE BYDE Haier, Changhong Source: Nomura estimates We estimate Skyworth to achieve 17% y-y revenue growth driven by 8% y-y revenue growth of Skyworth’s China TV business, and 70% y-y sales growth in its white appliances business. In addition, we expect Skyworth’s overseas TV business to turn profitable in FY14F driven by scalability and higher LCD TV penetration. Overall, we believe Skyworth’s GPM and OPM will be stable over the next three years, driven by innovations in 4K2K and Smart TV. 36 Nomura | Skyworth November 4, 2013 Fig. 70: Earnings forecast summary (CNYmn) 1H14 NOM 2H14 NOM FY12A Turnover 19,532 24,671 19% 15% COGS (15,598) (19,950) Gross Profit 3,934 4,721 OPEX (3,257) (3,619) Operating Incomes 677 1102 % chg y-o-y 11% 29% Other revenue 152 237 Pretax income 875 1,387 % chg y-o-y 13% 20% Taxes (176) (214) Minority adjustments (60) (46) Net income 638 1,127 % chg y-o-y 12% 21% EPS (HKD, cents) -Dilluted (HKD, cents) 23.3 41.2 Ratios (%) Gross margin 20.1% 19.1% SG&A / revenue 16.7% 14.7% Operating Profit margin 3.5% 4.5% Pretax income/revenue 4.5% 5.6% Tax rates -20.2% -15.4% Net Income margin 3.3% 4.6% FY13A FY14F (NOM) 28,137 37,824 44,203 16% 34% 17% (22,181) (30,418) (35,548) 5,956 7,406 8,655 (4,677) (5,942) (6,876) 1279 1464 1779 15% 14% 21% 297 462 459 1,576 1,926 2,262 5% 22% 17% (308) (332) (390) (16) (93) (106) 1,252 1,501 1,766 7% 20% 18% % chg y-o-y FY15F (NOM) FY16F (NOM) 53,800 62,324 22% 16% (43,266) (50,121) 10,534 12,203 (8,403) (9,662) 2131 2541 20% 19% 404 470 2,669 3,145 18% 18% (460) (542) (120) (134) 2,089 2,469 18% 18% 0.46 0.54 0.64 0.76 0.89 21.2% 16.6% 4.5% 5.6% 19.5% 4.4% 19.6% 15.7% 3.9% 5.1% 17.2% 4.0% 19.6% 15.6% 4.0% 5.1% 17.2% 4.0% 19.6% 15.6% 4.0% 5.0% 17.2% 3.9% 19.6% 15.5% 4.1% 5.0% 17.2% 4.0% Source: Company data, Bloomberg, Nomura estimates We are slightly below FY14 consensus revenue and profit forecasts due to the not yet clear impact from Internet/IT companies. We are bullish on FY15F due to our anticipation of large demand for 4K2K and Skyworth’s market-leading position in the segment. Fig. 71: Nomura vs. Consensus FY2013 Actual Revenue FY2014 (NOM) (CON) FY2015 diff (NOM) (CON) FY2016 diff (NOM) (CON) diff 37,824 44,203 44,981 -2% 53,800 51,052 5% 62,324 58,098 7% 1,464 1,779 2,216 -20% 2,131 2,546 -16% 2,541 2,848 -11% Pretax Profit 1,926 2,262 2,303 -2% 2,669 2,678 0% 3,145 3,288 -4% Net Profit 1,501 1,766 1,802 -2% 2,089 2,112 -1% 2,469 2,594 -5% 0.54 0.64 0.64 -1% 0.76 0.75 1% 0.89 0.85 5% OperatingProfit EPS Source: Company data, Bloomberg, Nomura estimates 37 Nomura | Skyworth November 4, 2013 China TV business to grow 8%/17% in FY14F and FY15F We expect Skyworth’s China TV business to grow 8%/17% in FY14F/15F driven by 3%/11% volume growth and 5%/5% ASP growth. We expect Skyworth to increase its China TV market share by 0.6pp/0.8pp driven by market share in smart and 4K2K TV. Fig. 72: Earnings forecasts of China TV business (HKD mn) Assumption China TV Volumen (mn) % chg yoy Sales % chg yoy Gross Profit % of sales Operating profit Y-Y % of sales KPI Volume % chg yoy Market Share ASP % chg yoy 1H14 NOM 2H14 NOM FY12 A FY13 A FY14F (NOM) FY15F (NOM) FY16F (NOM) 27 6% 13,535 11% 2,883 21% 678 1% 5.0% 29 -3% 15,830 6% 3,254 21% 1,258 18% 7.9% 49 12% 21,920 15% 4,779 22% 1,510 17% 6.9% 55 13% 27,104 24% 5,665 21% 1,733 15% 6.4% 55 1% 29,365 8% 6,137 21% 1,936 12% 6.6% 58 4% 34,270 17% 7,162 21% 2,260 17% 6.6% 59 3% 38,445 12% 8,035 21% 2,535 12% 6.6% 4,221 8% 15.6% 3,207 3% 4,779 0% 16.5% 3,312 6% 7,024 10% 14.3% 3,121 5% 8,702 24% 15.8% 3,115 0% 9,000 3% 16.4% 3,263 5% 10,000 11% 17.2% 3,427 5% 11,000 10% 18.6% 3,495 2% Source: Company data, Nomura estimates Set-top box business to maintain ~13%/12% OP growth in 2014/15F We expect Skyworth’s set-top business to achieve 13%/12% y-y revenue growth, driven by the strong export sales as well as the emergence of smart TV box sales in China. Skyworth has announced to list its set-top box business in A-share via asset swap. After the completion of this transaction, Skyworth’s ownership in the set-top box business unit will decline from 70% to 58%. Fig. 73: Earnings forecast for Set-top box business (HKD mn) Sales % chg yoy Gross Profit % of sales Operating profit Y-Y % of sales 1H14 NOM 2,251 12% 502 22% 242 12% 10.7% 2H14 NOM 2,163 14% 482 22% 206 14% 9.5% FY12 A 3,270 -12% 700 21% 347 -6% 10.6% FY13 A 3,906 19% 871 22% 396 14% 10.1% FY14F (NOM) 4,414 13% 984 22% 447 13% 10.1% FY15F (NOM) 4,943 12% 1,102 22% 501 12% 10.1% FY16F (NOM) 5,487 11% 1,224 22% 556 11% 10.1% Source: Company data, Nomura estimates We note that there is a large difference in the valuation in A-shares (~47x of FY13F EPS) and H-share (~6x of FY13F EPS) listed TV/set-top box vendor. Skyworth’s share price may be positively affected because of the re-rating post the listing of its set-top box business in the A-share market. If Skyworth’s set-top business is traded at the same valuation as Coship’s, the largest STB vendor supplying the domestic market in China (according to a statement released by Coship), the market cap of the set-top-box business in A-share will become USD2.3bn or equivalent to a whopping 172% of Skyworth’s H-share market cap, from 22% before the spin-off. 38 Nomura | Skyworth November 4, 2013 Fig. 74: Market cap potential for Skyworth’s set-top-box business spin-off (CNYm n) Coship Revenue Gross Profit OPEX Operating Income Net Profit GPM OPM Before Spin-off Market Cap (USDmn) P/E (FY13 EPS) Post Spin-off Market Cap (USDmn) P/E (FY13 EPS) Skyw orth 2,084 545 382 164 193 26% 8% Set-top box 3,476 775 423 352 299 22% 10% Group 34,806 6,815 5,414 1,401 1,391 20% 4% STB/Group 10% 11% 8% 25% 1,487 47.3x 287 5.9x 1,336 5.9x 22% 1,487 47.3x 2,302 47.3x 1,336 5.9x 172% Market cap is calculated based on 29 October 2013 closing price Source: Bloomberg, company data, Nomura estimates • Experience in Digital China We saw a similar phenomenon in Digital China in August 2013. Digital China spun-off its IT software business and listed it on the A-share market at the IT software peers’ average P/E is of ~25x FY14F EPS (IT software peers’ average using consensus estimates) when Digital China was valued at 7.7x FY14F EPS of HKD1.13. Post the spin-off, we have observed a 200%+ increase in SZ Techno (DCITS’s A-share holding company)’s price, which in turn helped to re-rate and drive up DC’s share price in Hshare by ~17% in the two months from August to October 2013. The chart below shows the correlated trend in both companies’ market cap. We believe a similar trend may be observed in the Skyworth spin-off. 295 33 9,751 % of DC 102% 30% 10 25% 8 20% 6 15% 4 10% 2 5% 0 0% 7-Aug Source: Nomura research 24% 12 30-Oct Corporate 35% 23-Oct DCITS 14 16-Oct 9,576 9-Oct HKDmn 8 2-Oct (x) 1,241 25-Sep HKDmn Nomura 18-Sep Source Digital China Digital China (LHS) SZ Techno (LHS) SZ Techno vs. DC Mkt Cap (RHS) (HKDbn) 11-Sep Market Cap 4-Sep Valuation 28-Aug Net Profit 21-Aug FY14 Fig. 76: Correlation between Digital China and SZ Techno (DCIT’s parent company)’s market cap 14-Aug Fig. 75: Comparison of DCITS Source: Bloomberg, Nomura research Discussion on comparisons between Smart TV and Smart TV box Although STB is a higher-margin business than TVs, it has seen rapid growth in the past five years as the cheap complementary upgrade to enable digital and smart TVs. However, over the long term, we believe the potential still resides with TVs as STBs are easily replaceable with little consumer loyalty, especially when all-in-one TVs (with the STB features imbedded) are introduced, they will ultimately erode the market for STBs. 39 Nomura | Skyworth November 4, 2013 Overseas TV business to achieve breakeven We forecast Skyworth to achieve 38%/27% revenue growth in its overseas TV business, in FY14-15F, driven by volume growth of own-brand TV sales and higher LCD TV penetration in emerging markets. We expect Skyworth’s overseas TV business to turn profit in 2014F thanks to improved economies of scale. Fig. 77: Earnings forecast of overseas TV business (HKD mn) Global TV volume % chg yoy Sales % chg yoy Gross Profit % of sales Operating profit Y-Y % of sales KPI Volume (k units) % chg yoy ASP (HKD) % chg yoy 1H14 NOM 105 -5% 1,735 47% 80 5% 1 47% 0.1% 2H14 NOM 120 -1% 2,554 32% 0% 4 -122% 0.1% FY12 A 243 -2% 1,728 58% 105 6% (11) na. -0.6% FY13 A 231 -5% 3,108 80% 131 4% (15) na. -0.5% FY14F (NOM) 224 -3% 4,289 38% 202 5% 5 na. 0.1% FY15F (NOM) 221 -2% 5,426 27% 282 5% 39 673% 0.7% FY16F (NOM) 223 1% 6,267 16% 326 5% 51 32% 0.8% 1,378 23% 1,259 20% 1,888 18% 1,353 12% 2,227 21% 776 31% 2,721 22% 1,142 47% 3,266 20% 1,313 15% 3,755 15% 1,445 10% 4,131 10% 1,517 5% Source: Company data, Nomura estimates LCD module business Skyworth’s LCD module business includes a handset LCD module business for external smartphone OEM customers (eg, Samsung) and an internal TV module business. We forecast LCD module revenue to maintain 50% CAGR revenue growth and ~10% OPM in 2014F/2015F, driven by strong demand for handset LCD modules for Korean smartphone customers, and internal TV LCD modules. Fig. 78: Earnings forecast for LCD module business (HKD mn) Sales % chg yoy (External sales) Gross Profit % of sales Operating profit Y-Y % of sales 1H14 NOM 942 50% 323 106 11% 104 50% 11.0% 2H14 NOM 1,292 50% 480 0% 119 50% 9.2% FY12 A 905 11% 285 111 12% 123 1657% 13.6% FY13 FY14F A (NOM) 1,489 2,234 65% 50% 535 803 161 241 11% 11% 148 222 20% 50% 9.9% 9.9% FY15F (NOM) 3,350 50% 1,204 362 11% 333 50% 9.9% FY16F (NOM) 5,025 50% 1,806 543 11% 500 50% 9.9% Source: Company data, Bloomberg, Nomura estimates White-goods and other business Skyworth’s white-goods business currently includes (1) refrigerator; (2) washing machine; (3) Other electronics such as LED lighting and automotive electronics. We believe Skyworth has its natural advantages in rolling out its white goods products via its nationwide 20k distribution outlet and brand image. We estimate the segment’s contribution to total revenue will increase to 15% in 2015F with ~6% earnings contribution. Skyworth’s refrigerator and washing machine business line turned profitable in FY13F for the first time with 0.5% OPM, but other electronics remains in loss making status. We expect its revenue to grow 70%/50% in FY14F/15F with further improvement in OPM behind scalability. 40 Nomura | Skyworth November 4, 2013 Fig. 79: White-goods and others (HKD mn) Sales % chg yoy % of group sales Operating profit Y-Y % of sales 1H14 NOM 1,652 100% 8% (22) na. -1.3% 2H14 NOM 3,598 53% 15% 22 na. 0.6% FY12 A 934 153% 3% (14) na. -1.5% FY13 A 3,088 231% 8% (26) na. -0.8% FY14F (NOM) 5,250 70% 12% 79 na. 1.5% FY15F (NOM) 7,874 50% 15% 118 50% 1.5% FY16F (NOM) 10,237 30% 16% 205 73% 2.0% Source: Company data, Bloomberg, Nomura estimates In addition, Skyworth also established a finance company (创维集团财务有限公司) in September 2013, strategically partnering with seven major banks including China Development Bank, ICBC, BOC and CCB. We think Skyworth can leverage this platform to provide funding to its own supplier chain as well as retailers and consumers in order to improve the efficiency of its cash usage. Balance sheet analysis Skyworth has a very liquid balance sheet, as cash, accounts receivable and inventory combine to account for 82% of its assets. Despite its significant increase in AR and inventory from FY11 to FY13, its AR turnover days have declined by 12 days (from 134) and inventory days have remained stable at 53 days, indicating strong earnings quality associated with top-line growth. Its negative operating cash flow in FY13 is mainly the result of an aggressive sales strategy and inventory building, which together translate into a high benchmark year in FY13 in terms of sales volume. Thus we think the negative operating cash flow is only temporary and is likely to reverse in FY14 as inventory build-up is digested and net accounts receivable decrease. Fig. 80: Skyworth asset structure Cash & Equivalent AR 100% 6% 16% 13% 7% 80% 11% 17% 60% Inventory Fig. 81: Skyworth operating cash-flow and free cash flow PP&E Others 8% 9% 10% 7% 11% 14% 14% 19% 8% (HKDmn) 3000 Operating cash flow (LHS) Capital Expenditure (LHS) Free Cashflow (LHS) Capex-sales (RHS) 3.5% 3.0% 2000 2.5% 1000 2.0% 0 40% 57% 48% 55% 57% 55% 20% 0% 1.5% -1000 1.0% -2000 13% 11% 14% 10% 8% 2009 2010 2011 2012 2013 Source: Company data, Nomura research 0.5% 0.0% -3000 2009 2010 2011 2012 2013 2014F Source: Company data, Nomura research 41 Nomura | Skyworth November 4, 2013 Fig. 82: Skyworth working capital trend (Days) 16,000 2009 2010 2011 Fig. 83: Skyworth operating turnover days 2012 2013 (Days) 2009 2010 2011 2012 2013 160 14,000 140 12,000 120 10,000 100 8,000 80 6,000 60 4,000 40 2,000 20 0 Inventory AR Source: Company data, Nomura research AP Working Capital 0 Inventory Days AR Days AP Days Cash Days Source: Company data, Nomura research 42 Nomura | Skyworth November 4, 2013 Share price analysis and valuation Skyworth’s share price has traded between 5-10x times of 12-month forward P/E and 1 – 1.8x of 12-month forward P/B multiples in the past year. Due to the combination of concerns around LeTV’s Super TV launch and weak monthly sales post the expiration of the energy-saving subsidy, Skyworth’s price is currently trading near its three-year low, as shown below. Fig. 84: 12-month P/E bands Fig. 85: 12-month P/B bands (HKD) 12 (HKD) 12 15x 10 3x 10 8 4 Jul-13 Jan-13 Jul-12 Jan-12 Jul-11 Jan-11 Jul-10 Jul-13 Jan-13 Jul-12 Jan-12 Jul-11 Jan-11 Jul-10 Jan-10 Jul-09 0 Jan-09 0 Jul-08 2 Jan-08 2 1x Jan-10 5x Jul-09 4 2x 6 Jan-09 6 Jul-08 10x Jan-08 8 Source: Bloomberg, Nomura research Source: Bloomberg, Nomura research Fig. 86: Share price vs. Monthly China TV shipment volume Fig. 87: Share price vs. Monthly China TV ASP growth trends 1,200 6 1,000 5 800 4 Source: Bloomberg, Nomura research Sep-13 May-13 Jan-13 Sep-12 Jan-12 May-12 Sep-11 May-11 Jan-11 Sep-10 May-10 Jan-10 0 Sep-09 0 May-09 200 Jan-09 2 15% 10% 3 5% 2 0% 1 -5% 0 -10% Sep-13 400 20% Jun-13 600 4 30% 25% Mar-13 6 7 ('000 units) ASP growth y-o-y (RHS) Dec-12 8 1,400 Series5 Sep-12 10 (HKD) Jun-12 ('000 units) Mar-12 12 Price (LHS) Dec-11 China Volume (RHS) Sep-11 (HKD) Source: Bloomberg, Nomura research The largest share price hike (~16x appreciation) that took place from January 2009 to March 2010, was during the period when flat-panel TV went into a fast growth cycle (50% to 99% penetration) and completely replaced CRT TV, and the “countryside subsidy” and “old-for-new subsidy” were both announced. Similarly, we are now at a time when smart TV is heading into an up-cycle, replacing “feature-TV”, 4K2K TV is replacing HD TV, and “energy-leading subsidy” is expected to be announced soon. 43 Nomura | Skyworth November 4, 2013 Fig. 88: Skyworth: Share price vs. news flow (HKD) HKD900mn Equity Offering 12 SSDT asset swap JV with LGD (10% stake) 10 Growth slowing, severe inventory build-up on World Cup demand misjudgement Inside scandal 8 Mr. Zhang Xuebin as new Chairman 6 LeTV launches Super TV Mr. Zhang Xuebin left LCD TV penetration from 50%-99% 4 Subsidy expired 2 Oct-13 Jul-13 Apr-13 Oct-12 Jan-13 Jul-12 Mr. Wong returns to Skyworth Apr-12 Jan-12 Jul-11 Smart TV launches Oct-11 Apr-11 Jan-11 Oct-10 Jul-10 Apr-10 Jan-10 Oct-09 Jul-09 Apr-09 Jan-09 Oct-08 Jul-08 Apr-08 Jan-08 Oct-07 Jul-07 Apr-07 Jan-07 Oct-06 Jul-06 Apr-06 0 Jan-06 3D TV launches Source: Bloomberg, Nomura research Fig. 89: Share price and subsidy-related news (HKD) 12 10 Official announcement Industry wide inventory build-up 8 LCD TV penetration from 50%-99% 6 Official announcement 4 Official announcement ? Energy-saving subsidy Old for new subsidy 2 Country side subsidy Oct-13 Jul-13 Apr-13 Oct-12 Jan-13 Jul-12 Apr-12 Jan-12 Oct-11 Jul-11 Apr-11 Jan-11 Oct-10 Jul-10 Apr-10 Jan-10 Oct-09 Jul-09 Apr-09 Oct-08 Jan-09 Jul-08 Apr-08 Jan-08 Oct-07 Jul-07 Apr-07 Jan-07 Oct-06 Jul-06 Apr-06 0 Jan-06 Energy-saving leader subsidy coming soon Source: Bloomberg, Nomura research 44 Nomura | Skyworth November 4, 2013 Fig. 90: Peer comparison valuations Code Company Trading Price Target M/Caps Curncy 29-Oct Price USDmn Nomura P/BV (x) P/E (x) ROE Dividend Rating FY13F FY14F FY13F FY14F FY13F Yield (%) EPS Growth FY13F HK/China Smart TV 1169 HK Haier Elec HKD 15.6 - 5,153 Not Rated 15.5 13.0 4.2 3.3 30% 751 HK Skyworth HKD 3.6 6.0 1,317 BUY 5.7 4.7 0.9 0.8 17% 1070 HK TCL Multimedia 0.6 12% 5.5 18% -31% HKD 3.2 - 556 Not Rated 8.5 6.0 0.8 0.7 10% 6.59 600060 CH Hisense CNY 11.2 - 2,370 Not Rated 7.7 6.7 1.4 1.5 20% 1.09 21% 300104 CH LeTV CNY 42.0 - 5,407 Not Rated 114.6 80.4 17.0 14.5 18% 0.13 41% 600839 CH Changhong CNY 3.0 - 2,190 Not Rated 26.3 22.2 0.9 0.9 7% 0.00 38% 002052 CH Coship CNY 12.6 - 1,475 Not Rated 37.6 28.6 6.8 6.0 36% 0.00 na 600637 CH BesTV CNY 38.8 - 7,130 Not Rated 60.4 44.2 11.5 9.2 21% 0.19 36% 903 HK HKD 1.6 - 478 Not Rated na 8.2 na na na 5.9 na TPV 000156 CH Wasu CNY 24.9 - 4,520 Not Rated 99.6 81.5 8.4 6.0 15% 0.52 65% 700 HK Tencent HKD 418.6 - 101,980 Not Rated 37.6 29.5 11.1 8.3 34% 0.18 26% YOKU US Youku Tudou USD 27.9 - 4,619 Not Rated n/a n/a n/a n/a n/a 0.00 na 31.9 22.2 5.5 4.6 0.2 0.4 26% Median MXCN MSCI China HSCEI H-Share index 61.2 10,471 Source: Bloomberg estimates for NR stocks, Nomura estimates for Skyworth 45 Nomura | Skyworth November 4, 2013 Company background Skyworth was established by Mr Wong Wangsang in 1988, and listed on the Hong Kong stock exchange in 2000. As of end FY13, Mr Wong and his wife Ms Lin still owned 34.53% of Skyworth’s shares. Fig. 91: Major corporate events Date 4/7/2000 Event IPO in HK 11/1/2004 Trading suspended 7/13/2006 Legal issue 4/1/2007 Management Change Amount HKD1bn Comment HKD2.07 per share 9/19/2007 Divestiture CNY21mn Trading suspended for 14 months when Mr. Wong Wangsang was investigated for insider trading Mr. Wong Wangsang was found guilty and sentenced to 6 years in jail by HK court Mr. Zhang Xuebin was appointed as Chairman to replace Mr. Wong Wangsang Sell 11.7% stake of Set-top box business unit to its management 12/31/2007 6/18/2008 Divestiture Divestiture CNY118mn CNY1 Sell 16% stake of Set-top box business unit to its management Skyworth Mobile Communication Shenzhen 80% sold to founder 100mn shares at HKD9 per share 7/4/2009 Legal issue 4/12/2010 Equity offering HKD900mn Mr. Wong Wangsang was bailed out of jail 2/15/2012 5/22/2012 Management Change JV BEF133mn 8/9/2012 4/1/2013 Management Change Management Change 4/23/2013 Divestiture 9/9/2013 Management Change CNY3.4bn Yang Dongwen is apointed as CEO Setup with TV panel JV with LG Display in Guangzhou (Skyworth owns 10% of JV) Mr. Wong WangSang is appointed as Skyworth's advisor Chairman Mr. Zhang Xuebin resigned, Ms. Lin Weiping is appoointed as his sucessor. List set-top box business unit in A-share via asset swap CFO Ferderick Leung resigned, effective on 12/31/2013 Source: Company disclosure, Nomura research Skyworth management changes From 2006 to 2013, Skyworth was managed by a professional management team (Mr Zhang Xuebin, Mr Yang Dengwen, Mr Ferderick Leung, etc.), after its founder Mr Wong WangSang was sentenced to six years in jail by a Hong Kong court following an insider trading scandal investigation. During Mr Wong’s absence, his wife Mrs Lin Weiping remained an executive director of the company. In 2013, Chairman Zhang Xuebin and CFO Ferderick resigned their positions, and Mrs. Lin was appointed as the group’s chairman. We think this reflects that the founding family is gradually becoming more involved with Skyworth’s daily operation again. We have noticed some negative concerns from investors on the return of Mr Wong’s influence on the company. Based on our research, we believe Mr Wong is helping Skyworth group in accelerating its diversification strategy, which includes Skyworth’s finance service license, and the approval Skyworth obtained in 2012 to construct a semiconductor building. We believe his contribution to Skyworth is positive for minority shareholders. Senior current management profile Ms Lin Weiping (Age 55): Ms Lin Weiping, Chairman (from 1 April 2013), spouse of Mr Wong Wangsang (Stephen), founder of Skyworth group. Ms Lin joined the Group in 1993. Ms Lin was the deputy manager of the purchasing department and administration manager for Skyworth in Hong Kong as well as head of the human resources department of the Group. Mr Yang Dongwen CEO (Age 48): Mr Wang joined Skyworth in May 1998 as the financial controller, and rejoined the group in September 2005 as the president of the 46 Nomura | Skyworth November 4, 2013 China TV business unit of the Group. Mr Yang was appointed as CEO in 15 February 2012. Fig. 92: Skyworth corporate structure Wong Wangsang & Weiping Lin Public shareholder Other Management team 34.53% 0.8% 64.67% Skyworth Digital Holdings (751 HK) 100% Skyworth Holdings Ltd 100% 100% Skyworth Investment (Holdings) 100% Skyworth TV Holdings Shenzhen Skyworth Jingmi Technology 100% Xin Skyworth Home Appliance (Shenzhen) 100% Skyworth Enterprises 100% 100% Skyworth Overseas Development Skyworth Automobile Electronics Company Limited 100% 49% Skyworth Electronics 100% Skyworth LCD Technology Limited Shenzhen Chuangwei-RGB Electronics Co. 51% 49% Guangzhou Skyworth Flat Display Technology 70% Shenzhen Skyworth Digital Technology (SSDT) (Inner Mongolia) Skyworth Flat Display Technology (Shenzhen) 100% 51% Incorporated in Bermuda Incorporated in Samoa Incorporated in BVI Incorporated in Hong Kong Incorporated in PRC Source: Company data, Nomura research 47 Lenovo Group 0992.HK 992 HK EQ U I T Y R E S E A R C H PC HARDWARE Smart TV as part of the PC+ strategy November 4, 2013 Rating Remains Accumulate for PC+ driven earnings expansion Action: Maintain Buy at HKD9.8 for PC+ strategy We maintain our Buy recommendation on Lenovo at a TP of HKD9.8 for its PC+ strategy. We think Smart TV is an important part of Lenovo’s PC+ strategy. By providing a unified user experience and cloud services over four screens (PC, tablet, smartphone, TV), we believe Lenovo can increase customer loyalty toward its products and improve the total market share in the global smart connected devices market. Revenue (mn) FY13 FY14F FY15F Actual Old New Old New 37,171 40,493 40,493 752 752 917 917 Normalised net profit (mn) 635 752 752 917 917 6.07c 7.19c 7.19c 8.77c 8.77c FD norm. EPS growth (%) 32.7 18.5 18.5 21.9 21.9 FD normalised P/E (x) 17.2 N/A 14.5 N/A 11.9 7.4 N/A 6.8 N/A 5.2 Price/book (x) 3.8 N/A 3.3 N/A 2.8 Dividend yield (%) 2.3 N/A 2.7 N/A 3.3 24.2 24.6 24.6 25.7 25.7 net cash net cash net cash net cash net cash Source: Company data, Nomura estimates Key company data: See page 2 for company data and detailed price/index chart. +21.4% David Hao - NIHK david.hao@nomura.com +852 2252 2153 37,171 Net debt/equity (%) Potential upside Leping Huang, PhD - NIHK leping.huang@nomura.com +852 2252 1598 635 ROE (%) HKD 8.07 China Technology 33,873 EV/EBITDA (x) Closing price October 29, 2013 Research analysts Reported net profit (mn) FD normalised EPS HKD 9.80 Nomura vs consensus We are in-line with consensus on FY14F earnings and 4% above on FY15F earnings. Lenovo’s weaknesses in Smart TV business Compared with other new entrants such as LeTV, BesTV, and Wasu, we think Lenovo lags behind in its video content offering. We note Hony Capital, Legend Group (Lenovo’s parent company)’s private equity unit, and Suning have invested USD420mn to acquire 30%/44% stakes in PPTV, one of the largest IPTV service providers in China. If Lenovo can leverage PPTV’s content resources and distribution capability from this investment, this may greatly improve Lenovo’s competitiveness in the Smart TV market, in our view. Currency (USD) Target price Remains Anchor themes We believe Smart TVs are the next major trend in China's technology sector after China smartphones. We think TV hardware vendors are the hidden gems in the whole Smart TV eco-system. Lenovo’s strengths in the Smart TV business We think Lenovo has the following edges in Smart TV: 1) Smart device related software assets such as cloud-based storage and security service, and seamless connectivity between multiple devices; 2) solid distribution channel and brand awareness in China and globally; and 3) solid financial strength that Lenovo’s PC business provides the resources essential for the company to strike other competitors in the smart TV arena. 31 Mar Buy See Appendix A-1 for analyst certification, important disclosures and the status of non-US analysts. Nomura | Lenovo Group November 4, 2013 Key data on Lenovo Group Income statement (USDmn) Year-end 31 Mar Revenue Cost of goods sold Gross profit SG&A Employee share expense Operating profit EBITDA Depreciation Amortisation EBIT Net interest expense Associates & JCEs Other income Earnings before tax Income tax Net profit after tax Minority interests Other items Preferred dividends Normalised NPAT Extraordinary items Reported NPAT Dividends Transfer to reserves Relative performance chart (one year) FY12 29,574 -26,128 3,446 -2,863 FY13 33,873 -29,799 4,074 -3,294 FY14F 37,171 -32,035 5,136 -4,257 FY15F 40,493 -34,722 5,771 -4,682 583 780 879 1,088 948 -135 -230 583 3 1,043 -150 -113 780 16 1,231 -218 -133 879 -9 1,503 -271 -144 1,088 -9 -4 582 -107 475 -2 5 801 -170 631 4 63 933 -197 736 16 63 1,143 -242 901 16 0 473 0 473 -183 290 0 635 0 635 -248 387 0 752 0 752 -293 459 0 917 0 917 -358 560 Valuation and ratio analysis Reported P/E (x) Normalised P/E (x) FD normalised P/E (x) FD normalised P/E at price target (x) Dividend yield (%) Price/cashflow (x) Price/book (x) EV/EBITDA (x) EV/EBIT (x) Gross margin (%) EBITDA margin (%) EBIT margin (%) Net margin (%) Effective tax rate (%) Dividend payout (%) Capex to sales (%) Capex to depreciation (x) ROE (%) ROA (pretax %) 22.3 22.3 22.8 27.6 1.7 5.6 4.4 7.4 12.1 11.7 3.2 2.0 1.6 18.4 38.7 1.1 2.4 22.3 5.9 16.9 16.9 17.2 20.8 2.3 544.8 3.8 7.4 9.9 12.0 3.1 2.3 1.9 21.2 39.0 1.3 3.0 24.2 6.1 14.3 14.3 14.5 17.6 2.7 na 3.3 6.8 9.6 13.8 3.3 2.4 2.0 21.1 39.0 1.0 1.7 24.6 6.2 11.7 11.7 11.9 14.4 3.3 5.6 2.8 5.2 7.2 14.3 3.7 2.7 2.3 21.1 39.0 1.2 1.8 25.7 7.4 Growth (%) Revenue EBITDA EBIT Normalised EPS Normalised FDEPS 37.0 40.6 27.4 64.7 70.0 14.5 10.0 33.8 31.9 32.7 9.7 18.0 12.7 18.5 18.5 8.9 22.2 23.8 21.9 21.9 4.67c 4.67c 4.57c 0.24 0.02 6.16c 6.16c 6.07c 0.27 0.02 7.30c 7.30c 7.19c 0.32 0.03 8.90c 8.90c 8.77c 0.37 0.03 Per share Reported EPS (USD) Norm EPS (USD) Fully diluted norm EPS (USD) Book value per share (USD) DPS (USD) Source: ThomsonReuters, Nomura research (%) 1M 3M 12M Absolute (HKD) -2.3 12.9 29.1 Absolute (USD) -2.3 12.9 29.1 Relative to MSCI China Market cap (USDmn) Estimated free float (%) 52-week range (HKD) 3-mth avg daily turnover (USDmn) Major shareholders (%) LEGEND HOLDINGS LTD RIGHT LANE LTD -1.2 5.1 24.5 10,731.7 52.6 9.07/6.13 34.59 25.9 7.8 Source: Thomson Reuters, Nomura research Notes Source: Company data, Nomura estimates 49 Nomura | Lenovo Group November 4, 2013 Cashflow (USDmn) Year-end 31 Mar EBITDA Change in working capital Other operating cashflow Cashflow from operations Capital expenditure Free cashflow Reduction in investments Net acquisitions Reduction in other LT assets Addition in other LT liabilities Adjustments Cashflow after investing acts Cash dividends Equity issue Debt issue Convertible debt issue Others Cashflow from financial acts Net cashflow Beginning cash Ending cash Ending net debt FY12 948 1,348 -356 1,940 -329 1,611 FY13 1,043 -965 -58 20 -446 -426 FY14F 1,231 -1,479 63 -185 -360 -545 FY15F 1,503 795 -346 1,952 -500 1,452 -385 -4 0 -300 -106 1,120 -115 0 -212 196 -234 -195 0 0 139 -406 -248 0 0 1,152 -293 0 -242 11 -316 804 2,954 3,758 -3,695 125 -70 -304 3,758 3,454 -2,975 0 -248 -654 3,454 2,800 -2,321 -535 616 2,800 3,416 -2,937 FY12 3,758 477 2,994 1,218 3,373 11,820 0 496 FY13 3,454 218 3,458 1,965 3,295 12,390 0 664 FY14F 2,800 218 4,641 1,602 3,295 12,555 0 934 FY15F 3,416 218 4,182 1,666 3,295 12,777 0 1,163 3,091 453 15,860 63 4,178 7,569 11,810 0 3,326 502 16,882 176 3,724 8,191 12,091 303 3,535 502 17,527 176 3,064 8,191 11,431 303 3,792 502 18,235 176 3,055 8,601 11,831 303 1,603 13,413 39 1,807 14,201 -153 2,653 14,387 -153 2,401 14,535 -153 33 2,376 34 2,800 33 3,259 33 3,818 -1 2,408 15,860 2,834 16,882 3,292 17,527 3,852 18,234 1.00 na 1.02 na 1.10 97.6 1.08 120.8 net cash net cash net cash net cash net cash net cash net cash net cash 29.4 14.2 45.2 -1.6 34.8 19.5 48.4 5.9 39.8 20.3 38.7 21.4 39.8 17.2 32.2 24.8 Notes Source: Company data, Nomura estimates Balance sheet (USDmn) As at 31 Mar Cash & equivalents Marketable securities Accounts receivable Inventories Other current assets Total current assets LT investments Fixed assets Goodwill Other intangible assets Other LT assets Total assets Short-term debt Accounts payable Other current liabilities Total current liabilities Long-term debt Convertible debt Other LT liabilities Total liabilities Minority interest Preferred stock Common stock Retained earnings Proposed dividends Other equity and reserves Total shareholders' equity Total equity & liabilities Liquidity (x) Current ratio Interest cover Leverage Net debt/EBITDA (x) Net debt/equity (%) Activity (days) Days receivable Days inventory Days payable Cash cycle Notes Source: Company data, Nomura estimates 50 Nomura | Lenovo Group November 4, 2013 Lenovo’s Smart TV strategy Smart TV is the final piece to complete PC+ Smart TV is the final piece to complete Lenovo’s PC+ strategy. The company launched its K series (flagship) and S series smart TVs in 2012 as its first attempt to penetrate the market using Wistron and Compal as OEMs. Due to its prohibitive pricing (CNY6-15k) compared to similar products, it failed to generate meaningful sales. Lenovo announced its A21 series smart TVs in June 2013 with a similar pricing strategy to LeTV. A21 series features 32-inch and 42-inch models priced at CNY1.8k and CNY2.8k. Lenovo’s Smart TV partners: TPV, Sharp, Gome, 360Buy, BesTV Lenovo partners with TPV and Sharp for its A21 series smart TV, with Gome and 360Buy for offline/online distribution, and with BesTV (600637 CH, Not rated) in providing a CNY399/year video-on-demand subscription. Lenovo management targets to sell 1mn smart TVs through 360Buy channels alone by 2015. Lenovo is the third-largest smart-connected device vendor globally Lenovo is one of the few companies in the world that has products positioned throughout all smart-connected-device value chains. In our view, it is capable of creating compatible products that interact across devices, platforms and ecosystem with a unified user experience. Over the past few years, we have observed the emergence of smartphones and tablets, both of which have disrupted the traditional handset and PC markets by redrawing the boundaries of functionality, mobility and connectivity. In times of multi-device convergence, hardware vendors that do not focus on the ecosystem and multi-device connectivity are likely to face increasingly more pressure, in our view, since it is becoming more difficult for consumers to differentiate based on hardware and user experience. Based on IDC’s 2Q13 data, Lenovo is ranked third in the world in smart-connected devices, with 7.2% market share, behind Samsung and Apple. There are several differentiating benefits for this kind of horizontal integration: Fig. 93: Lenovo’s product positioning vs. peers, 2013 Feature phone Smartphone Tablet Laptop Desktop Storage Lenovo Apple Samsung Huawei ZTE Dell HP Asus Acer TV Strong presence Material presence Some presence Source: Nomura research • Interface/user experience harmonization: Lenovo is able to harmonize interface and device-connectivity across different platforms and products to ensure the best possible user experience • Cross-selling: Consumers are likely to purchase other Lenovo products after the initial purchase. As noted in Nomura Global Telecommunication Equipment analyst Stuart Jeffrey’s report (Apple, Inc. - Initiating at Neutral: The Pie Is Almost Baked): “once a consumer buys one Apple product, there seems to be a gravitational force that convinces them to buy another – ie, Mac sales got a boost from the iPod and the iPhone, while many iPhone users were first to buy an iPad.” 51 Nomura | Lenovo Group November 4, 2013 • Brand loyalty: We believe Lenovo is in the ranks of Apple and Samsung as one of the few companies that appears well positioned to offer products in every smart-connected device category. That said, Lenovo is in relatively good shape compared to traditional PC vendors such as HP and Dell; as we estimate the PC market to shrink, Lenovo is capable of penetrating into new growth areas (smartphones and tablets) as a way to come back and fortify its stance in the PC market. Fig. 94: Sales breakdown in 1QFY14 Fig. 95: MIDH sales trend and growth rates MIDH includes smartphones and Smart TVs Other 9% MIDH 14% (USD mn) MIDH (LHS) 1,400 MIDH % y-y (RHS) 160% 1,200 140% 1,000 120% 100% 800 80% 600 60% 400 40% 200 Source: Company data, Nomura research Jun-13 Mar-13 Dec-12 Sep-12 Jun-12 Mar-12 Dec-11 Sep-11 PC 77% 20% Jun-11 0 0% Source: Company data, Nomura research Fig. 96: Lenovo’s A21 series vs. peers (as of October 2013) Brand Model Hardware Spec Screen Size (inch) Resolution Processor Operating System Features Retail price (CNY) Sales/Marketing strategy in USD Sales Channel Logistics/ after service Content Provider License Industry Partner TV OEM Panel Lenovo 32A21 Lenovo 42A21 LeTV X40 Xiaomi Xiaomi TV Skyworth Coocaa TV 32 1920 x 1080 Dual-core 42 1920 x 1080 Dual-core 40 1920 x 1080 Dual-core 47 1920 x 1080 Quad-core 42 1920 x 1080 Hexa-core Android 4.0 3D, Smart TV Android 4.0 3D, Smart TV LeTV UI 3D, Smart TV MIUI TV 3D, Smart TV KuUI (Tianci & Ali) 3D, Smart TV 1,799 2,799 1,999 2,999 2,999 293 455 325 488 488 e-channel and retail e-channel and retail e-channel e-channel e-channel and retail In-house/outsource In-house/outsource Outsource Outsource In-house Lenovo JV SMG TPV Sharp Lenovo JV SMG TPV Sharp CNTV, Proprietary CNTV Hon Hai/TPV Sharp CNTV CNTV Wistron Samsung, LGD SMC, Voole, others SMC Skyworth LGD Source: Nomura research 52 TCL Multimedia 1070.HK 1070.HK EQUITY RESEARCH Technology PN Strike with TV+ and IMAX November 4, 2013 4K2K and Smart TV to drive ASP expansion NOT R AT ED TCL's Smart and 4K2K TV strategy TCL’s Smart TV business mainly includes: (1) TV+ series Smart TV jointly developed together with Baidu/iQiYi, (2) TCL’s own Smart TV user interface software (MagicCube); and (3) TCL’s premium Internet-based home theatre solution jointly developed by IMAX. TCL believes the rising mix of Smart TV should help TCL to achieve ASP and margin expansion in long term. Company description TCL Multimedia Technology Holdings Limited manufactures television sets, trades television related components, and manufactures audio visual products. The company was the third-largest LCD TV manufacturer globally behind Samsung and LG as of 2Q13, according to DisplaySearch. Closing price TV+: TCL’s Smart TV business model In September 2013, TCL launched a new 4K2K Smart TV series called TV+ together with Baidu/iQIYI, with positive market feedback including shipment of 22k units in October. Unlike other TV vendors, TCL adopted a new marketing strategy for its 48-inch TV+ at a uniform price of CNY4,567 for both online and offline channels. Research analysts IMAX cooperation: first 4K2K IPTV premium content delivery TCL Multimedia announced on 30 October a joint venture with IMAX to provide premium high-end private theatre systems and also high quality, upto-date content consisting of Chinese and foreign films, TV channels, music and gaming. This is one of the first trials to deliver 4K2K content directly from the source to end users. China Technology Leping Huang, PhD - NIHK Leping.huang@nomura.com +852 2252 1598 David Hao - NIHK David.hao@nomura.com +852 2252 2153 4K2K and Smart TV shipment target TCL’s Smart TV penetration rate reached 30% by September 2013, and TCL management targets to increase this to more than 50% by year-end. In addition, TCL’s 4K2K penetration rate reached 10% in tier 1-2 cities during the National Day, exceeding the company’s expectations. TCL expects 4K2K penetration to reach 5% in 2H13 and 8% in 2014, positive for TCL’s ASP trend. Currency: HKD FY09 FY10 FY11 FY12 30,343 26,949 32,932 39,685 Ope profits (mn) 685 -725 463 1,039 EPS 0.39 -.92 0.42 0.69 P/E (x) 21.7 n/a 5.9 6.2 EV/EBITDA (x) 10.2 n/a 12 8 P/B (x) 2.4 1.1 0.8 1.2 Dividend yield (%) 1.6 n/a 7.4 6.5 Sales (mn) Source: Company data Key company data: See page 2 for company data, and detailed price/index chart. HKD3.16 October 29, 2013 See Appendix A-1 for analyst certification, important disclosures and the status of non-US analysts. Nomura | TCL Multimedia November 4, 2013 TCL’s unique advantage in vertical integration TCL Multimedia is the TV OEM arm of TCL Corp. (000100 CH, NR). By cooperating with TCL group's internal panel arm CSOT (panel), mobile phone arm TCL Com (2618 HK, Neutral) audio device arm Tonly (1249 HK, Not rated), TCL multimedia targets to differentiate itself from other TV OEMs in 1) faster time-to-market via tight integration of the TV value chain; and 2) seamless integration between TVs and smartphones. Fig. 97: TCL’s vertical integration TCL Group China Star Optoelectronics Technology (CSOT) 8.5 Generation LCD Panel Production volume: 120,000 glass pieces per month in Dec. 2012 Yield rate: 95.9% TCL Multimedia TCL Optoelectronics Technology TV Manufacturing End user Distribution & Service LCD Module TCL Optoelectronics Technology TCL Coretronic Huizhou Bri-King Optronics LED Backlight Modules Source: Nomura research Fig. 98: Earnings summary (HKD mn) Turnover % chg yoy COGS Gross Profit OPEX EBIT % chg yoy Pretax income % chg yoy Taxes Net income % chg yoy Gross margin SG&A / revenue Operating Profit margin Pretax income/revenue Tax rates Net Income margin Volume ('000 units) Global TV China LCD Overseas LCD Fig. 99: Segment summary 3Q12 A 10,865 16% (9,058) 1,807 (1,641) 166 1409% 217 -30% (14) 201 -23% 16.6% 15.1% 1.5% 2.0% -6.5% 1.8% 4Q12 A 12,440 19% (10,444) 1,996 (1,853) 143 -33% 297 148% (19) 276 345% 16.0% 14.9% 1.1% 2.4% -6.4% 2.2% 1Q13 A 10,260 24% (8,597) 1,663 (1,458) 205 11% 306 -13% (96) 196 -37% 16.2% 14.2% 2.0% 3.0% -31.4% 1.9% 2Q13 A 8,693 8% (7,400) 1,293 (1,439) (146) -228% 21 -84% 59 -53% 14.9% 16.6% -1.7% 0.2% 0.0% 0.7% 2011 (A) 32,932 22% (27,643) 5,289 (5,009) 280 -129% 613 -173% (151) 453 -146% 16.1% 15.2% 0.9% 1.9% -24.6% 1.4% 2012 (A) 39,685 21% (33,107) 6,578 (5,933) 645 130% 994 62% (73) 911 101% 16.6% 15.0% 1.6% 2.5% -7.3% 2.3% 4,758 4,372 1,738 5,050 4,678 1,793 4,255 3,912 1,378 4,232 3,906 1,899 15,036 10,860 4,127 17,556 15,526 6,669 Source: Company data, Nomura research (HKD mn) Turnover y-y Segment turnover PRC TV Overseas TV Tonly (AV) Others Segment GP PRC TV Overseas TV Tonly (AV) Others Segment OP PRC TV Overseas TV Tonly (AV) Others OPM PRC TV Overseas TV Tonly (AV) Others 3Q12 A 10,865 16% 4Q12 A 12,440 19% 1Q13 A 10,260 24% 2Q13 A 8,693 8% 2011 (A) 32,932 22% 2012 (A) 39,685 21% 6,601 2,874 969 421 7,904 3,282 1,170 84 6,683 2,561 876 140 5,479 2,985 229 19,615 8,743 3,880 694 23,146 11,939 3,574 1,025 1,348 271 127 61 1,553 223 134 87 1,326 217 117 4 1,035 225 4,040 849 380 20 4,916 1,112 404 146 33 140 44 33 49 289 7 (4) 66 363 (53) 46 - 76 (60) (16) 527 (1) 102 13 903 159 73 87 2% 2% 3% 12% 4% 0% 0% 79% 5% -2% 5% 0% 1% -2% 2.7% 0.0% 2.6% 1.8% 3.9% 1.3% 2.0% 8.5% -7% Source: Company data, Nomura research 54 Nomura | TCL Multimedia November 4, 2013 TCL’s Smart TV strategy TCLM’s Internet TV + Smart TV penetration reached 78% in December 2012, the last month TCLM reported Internet TV numbers. Starting in January 2013, Smart TV penetration continued to show growth, peaking at 32% in June (last month of subsidy) from 21% in January. Management expects it to reach more than 50% by year-end. Fig. 100: TCL's Smart TV strategy Source: TCL Multimedia Aug-13 Jul-13 Jun-13 May-13 Apr-13 Mar-13 Feb-13 0% Jan-13 5% Source: Company data, Nomura research Source: Company data, Nomura research Fig. 103: TCL TV+ Fig. 104: TCLM Smart TV controller Source: Company presentation, Nomura research Source: Company presentation, Nomura research Dec-12 10% Sep-12 15% Jun-12 20% Mar-12 25% Dec-11 30% 90% 80% 70% 60% 50% 40% 30% 20% 10% 0% Sep-11 35% Jun-11 Fig. 102: TCLM Internet TV + Smart TV penetration Mar-11 Fig. 101: TCLM Smart TV penetration 55 Nomura | TCL Multimedia November 4, 2013 Operating performance After spinning off Tony Holdings, its AV unit, TCL Multimedia will mainly have two business units: China TV and overseas TV, as shown below. Fig. 105: TCL Corp revenue breakdown by segments (1H13) Fig. 106: TCL Multimedia GP breakdown by segments (1H13) Others 2% Overseas TV 16% Overseas TV 31% Others 1% PRC TV 67% Source: Company data, Nomura research PRC TV 83% Source: Company data, Nomura research According to DisplaySearch, TCLM is the second-largest TV OEM in China in terms of shipment volume, and the second-largest TV OEM in terms of revenue in 2Q13. Samsung, 4% (USDmn) 1,400 Skyworth, 16% 2Q12 3Q12 4Q12 1Q13 2Q13 Haier Others, 12% Fig. 108: Comparison of major TV OEM LCD TV sales in China Changhong Fig. 107: Comparison of major TV OEM LCD TV shipment volume in China (2Q13) 1,200 1,000 Sony, 4% 800 Sharp, 2% Hisense, 15% Haier, 6% 600 400 Source: DisplaySearch, Nomura research Konka Konka, 12% TCL TCL, 16% Hisense 0 Skyworth 200 Changhong, 12% Source: DisplaySearch, Nomura research TCLM has a large presence in the overseas TV market, especially in Europe, APAC-ex China and MEA. TCLM established its overseas business mainly through its acquisition of Thomson Electronics in 2003. 56 Nomura | TCL Multimedia November 4, 2013 Fig. 109: TCLM TV shipment volume by region and market share (2012) 18% 14% GPM (RHS) 14% OPM (RHS) 12% 12,000 12% 10% 8% 10% 10,000 8% 8,000 6% 4% 6% 4% 2% Revenue (LHS) (HKD mn) 14,000 15.9% 16% Fig. 110: TCLM overseas business performance 1.8% 2.1% 0.3% 0.9% 1.4% Europe China APAC-ex China LA MEA Source: Company data, DisplaySearch Nomura research 2% 4,000 0% -2% 2,000 0% NA 6,000 -4% 0 -6% 2010 2011 2012 Source: Company data, DisplaySearch, Nomura research 57 Nomura | TCL Multimedia November 4, 2013 China Star Optoelectronics Technology China Star Optoelectronics Technology (CSOT) is TCL Corp’s TV panel arm. By end2012, CSOT had an 8.5G LCD panel line (from Oct 2011) with a monthly production capacity of 120k glass substrate. The project is located in Guangming New District Hitech Zone, Shenzhen with a total investment of CNY24.5bn. The company plans to build the second line focusing on both small-size AMOLED and large-size LCD panels. CSOT was founded on 16 November 2009 by TCL Corp, SIHC (Shenzhen Investment Holding Corporation) and Samsung, with an ownership allocation of 55%, 30% and 15%, respectively. On 3 May 2013, SIHC transferred its share to TCL Corp. for CNY3.182bn. Post the transaction, the remaining two shareholders, TCL Corp and Samsung, have 85% and 15% of the shares, respectively. Fig. 111: CSOT development milestone and honours Source: CSOT 58 Nomura | TCL Multimedia November 4, 2013 Company background Fig. 112: TCL corporate structure Huizhou Investment Holdings Mr. Li Dongsheng 9.8% China Asset Management 6.04% E Fund Management 2.1% Others 2.04% 80.02% TCL Corp (00100 CH) Mr. Li Dongsheng 2.89% 3.53% 61.31% Dimensional Fund Advisors Others 85% 50.15% 1.07% 3.34% TCL Multimedia (1070 HK) Mr. Zhao Zhongyao 61.31% Mr. Li Dongsheng Mr. Leung Laibing TCL Communication (2618 HK) Tonly Holdings (1249 HK) 0.56% 1.75% CSOT (unlisted) 34.17% MAG Investment Others 41.23% Samsung 15% Source: Company disclosure, Nomura research Senior management profile Chairman Mr Li Dongsheng (Age 55) is the founder of TCL Multimedia. In addition, Mr Li is the founder and chairman of TCL Multimedia’s parent company, TCL Corp, as well as Chairman and an executive director of TCL Communication, another subsidiary of TCL Corp. CEO: Mr Zhao Zhongyao (Age 50) is currently the CEO and an Executive Director of the company, also an Executive Director and Senior Vice President of TCL Corporation. Mr Zhao has over 20 years of experience in sales and marketing and management of consumer electronics business. On 5 June 2013, TCLM announced that Mr Zhao Zhongyao would leave the post due to personal health issues. Chief Sales Officer Mr Hao Yi will be the acting CEO during his absence. Acting CEO and Chief Sales Officer Mr Hao Yi (Age 39) a member of the Executive Committee, is currently Vice President of TCL Corporation, the Chief Sales Officer and General Manager of Overseas Business Group of the Company. Mr Hao joined TCL in March 2004. He had held the positions of Assistant to Board Chairman of TCL Corporation, Vice President of the company and General Manager of the Emerging Market Business Center of the company. Mr Hao graduated from York University, Toronto, with a Bachelor’s degree in Economics, and also holds an EMBA degree from Cheung Kong Graduate School of Business. 59 Leshi Internet Information & Technology Corp Beijing 300104.CH 300104.CH EQUITY RESEARCH PN TECHNOLOGY Reinventing the TV business November 4, 2013 Innovator in Smart TVs NOT R AT ED Closing price CNY41.95 October 29, 2013 LeTV is a pioneer in Internet video content aggregation and creation LeTV (300104 CH, NR) is a major IPTV (Internet-Protocol TV) service provider in China. By leveraging one of the most comprehensive copyright video libraries in China, LeTV is a leader in Internet video copyright acquisition and distribution. LeTV offers both free and paid video-ondemand services to its more than 700k smartphone, PC and TV users. Unlike most of its peers, LeTV is heavily involved in the content production business (eg, recent acquisition of Huaer Yingshi), an upstream move to further solidify its collection of original Internet video copyrights. LeTV’s Smart TV Strategy: SuperTV and LeTV Box LeTV entered the hardware business in December 2012 by launching LeTV Box, an Android-based Smart TV box. In May 2013, LeTV launched its Smart TV product line called Super TV, including one 60-inch, 50-inch, and 40-inch model. The significance of Super TV is LeTV’s strategy to sell TV hardware at cost levels online (30-50% cheaper than the average retail price), and to generate profit via service revenue in the future. In particular, LeTV believes its S50 50-inch Super TV is gaining viable market traction and targets to sell 200k/1mn units in 2013/14 to obtain a 1.8% China TV market share in 2014. For Smart TV hardware, LeTV mainly cooperates with TPV, Foxconn and Qualcomm. On the distribution side, LeTV mainly sells TVs through its own online channel, and distributes TVs via partnering with 3rd-party distributors. Company description Leshi Internet Information & Technology (Beijing) Co., Ltd. Researches and develops Internet video and mobile networking video technology. The company's service includes network infrastructure services and the services for video platform. Research analysts China Technology Leping Huang. PhD - NIHK Leping.huang@nomura.com +852 2252 1598 David Hao - NIHK David.hao@nomura.com +852 2252 2153 Re-inventing the TV business CP2C production strategy: LeTV’s customer planning to customer (CP2C) model drives upstream production, with downstream prepayment orders to reduce inventory and liquidity risks. Ecosystem: LeTV plans to reach a subscriber critical mass on its IPTV platform via both STB and Smart TV sales. According to management, LeTV currently has 1mn STB and 20k Smart TV users on the platform. Subscriber strategy: LeTV focuses on long-term revenue streams from: 1) paid-content subscription, 2) ads and 3) applications. Currency: CNY Sales (mn) Ope profits (mn) EPS FY09 FY10 FY11 FY12 139 228 568 1122 52 77 163 240 0.07 0.11 0.17 0.24 P/E (x) n/a 76.6 47.3 40.9 EV/EBITDA (x) n/a 46.3 19.9 13.2 P/B (x) n/a 6.9 5.9 6.3 Dividend yield (%) n/a 0.2 0.3 0.3 Source: Company data Key company data: See page 2 for company data, and detailed price/index chart. See Appendix A-1 for analyst certification, important disclosures and the status of non-US analysts. Nomura | Leshi Internet Information & Technology Corp Beijing November 4, 2013 Product line-up and Smart TV ecosystem Fig. 113: LeTV product offerings Brand Model LeTV X40 LeTV S50 LeTV S60 LeTV C1 40 1920 x 1080 Dual-core LeTV UI 3D, Smart TV 1999 325 490 50 1920 x 1080 Dual-core LeTV UI 3D, Smart TV 2999 488 490 60 1920 x 1080 Quad-core LeTV UI 3D, Smart TV 6999 1138 Dual-core Android Smart TV 399 65 e-channel e-channel 490 e-channel e-channel Outsource Outsource Outsource CNTV + LeTV Tencent CNTV Hon Hai/TPV Sharp CNTV + LeTV Tencent CNTV Hon Hai/TPV LGD CNTV, Proprietary Tencent CNTV Hon Hai/TPV Sharp Hardware Spec Screen Size (inch) Resolution Processor Operating System Features Retail price (CNY) in USD Sales/Marketing Annual Sub. (CNY) strategy Sales Channel Logistics/ after service Industry Partner Content Provider Internet Partner License TV OEM Panel CNTV + LeTV CNTV Source: LeTV, Nomura research Fig. 114: LeTV eco-system Smart TV Ecosystem Super TV LeTV Box LeTV Cloud Broadcast Platform LeTV UI Source: LeTV, Nomura research 61 Nomura | Leshi Internet Information & Technology Corp Beijing November 4, 2013 Company summary From 2010 to 2012, LeTV’s revenue grew 390%, mainly driven by growth in copyright distribution and advertising, utilizing its IPTV content library and growing is user base. During the same period, copyright distribution and advertising revenue grew 947% and 522%, respectively. In 2013, the company expects Super TVs to become a new revenue driver for the company. Fig. 115: Earnings summary (CNY mn) Turnover % chg yoy COGS Gross Profit OPEX EBIT % chg yoy Pretax income % chg yoy Taxes Net income % chg yoy Gross margin SG&A / revenue Operating Profit margin Pretax income/revenue Tax rates Net Income margin Fig. 116: Segment summary 2010 A 238 63% 80 158 85 73 54% 75 57% 5 70 58% 66% 36% 31% 31% 6% 29% 2011 A 599 151% 275 323 162 161 121% 164 119% 33 131 87% 54% 27% 27% 27% 20% 22% Source: Company data 2012 A 1,167 95% 684 483 286 197 22% 228 39% 38 190 45% 41% 24% 17% 20% 17% 16% (CNY mn) Turnover Internet video service Copyright distribution HD video service UD video service Video platform VAS Ads distribution Inter-streaming Software development Revenue structure Internet video service Copyright distribution HD video service UD video service Video platform VAS Ads distribution Inter-streaming Software development 2010 A 238 158 53 104 1 80 67 13 - 2011 A 599 484 356 121 7 114 114 - 2012 A 1,167 746 555 152 38 422 419 2 66.3% 22.3% 43.7% 0.4% 33.7% 28.3% 5.4% 80.9% 59.5% 20.3% 1.1% 19.1% 19.1% 63.9% 47.6% 13.0% 3.3% 36.1% 35.9% 0.2% Source: Company data Potential impact of Super TV on LeTV’s sales LeTV sold 10k units of S60 at an average price of CNY7,489, consisting of the TV (CNY6,999) and a one-year subscription fee (CNY490). Thus, cash flow on 3 June alone was roughly CNY75mn, or 6% of LeTV’s 2012 sales. Thus, LeTV is using the mandatory one-year subscription charge to subsidizing its TV hardware, one of the reasons for its cheap Smart TV pricing. Fig. 117: LeTV’s revenue breakdown by segment (2012) Other 0.2% HD video 13.0% Fig. 118: LeTV’s revenue trend by segment (2012) (CNY mn) 600 2010 555 2011 500 400 Advertising 35.9% 300 Copyright distribution 47.6% UD video 3.3% Source: Company data, Nomura research 419 2012 356 200 152 104121 100 114 53 1 7 38 67 0 HD video Copyright distribution UD video Advertising Source: Company data, Nomura research 62 Nomura | Leshi Internet Information & Technology Corp Beijing November 4, 2013 Fig. 119: Company structure Jia Yaoting Jia Yaofang 46.8% Liu Hong 6.3% Others 3.5% 43.4% Leshi Internet Information and Technology Corp Beijing (300104 CH) APP developers Qualcomm (QCOM US) LeTV.com Set-top-box Foxconn (2354 TT) Super TV Sakai Display Products (SDP) (unlisted) Nanjing Sharp Electronics Corp (NSEC) (unlisted) PC Tablet Smartphone CNTV Broadcast Platform CNTV Content library End user Source: Nomura research LeTV founder profile Mr Jia Yaoting (Age 40), Chairman & CEO Mr Jia Yaoting founded LeTV in 2004. His prior entrepreneur experiences include founding Xbell Union Communication Technology (Beijing) Co. in 2003 and Shanxi Xi Bei Er Tong Xin You Xian Gong Si (山西西贝尔通信科技有限公司) in 2002. Mr. Jia Yaoting was CEO for Shanxi Yuanqu Xian Zhuo Yue Shi Ye Gong Si (山西垣曲县卓越实 业公司) from 1996 to 2002. From 1995 to 1996, he was the network administrator for the tax department of Yuanqu County in Shanxi Province. 63 TPV 0903.HK 0903.HK EQUITY RESEARCH TECHNOLOGY PN Leading Smart TV platform provider November 4, 2013 Benefiting from vertical integration of LCD TV business NOT R AT ED Smart TV strategy: platform suppliers As the largest TV OEM in the world, TPV provides Smart TV solutions to both traditional TV vendors and new entrants such as Lenovo and LeTV. In addition, through TP Vision, a 70-30 joint venture between TPV and Philips, TPV is also selling Smart TVs under the Philips brand, mainly in the international market (eg, in Europe). Company description TPV Technology Limited is a display solutions provider. The Group designs and produces a full range of PC monitors and LCD TVs on ODM basis for its distribution worldwide. The company also sales TVs under its brands AOC and Philips. Closing price HKD1.59 October 29, 2013 TPV’s background: largest PC monitor and TV OEM in the world According to Display Search and TPV's own research, TPV is ranked No.1 globally in terms of PC monitor shipments, and is the largest TV OEM in the world and fourth-largest within all TV brands and OEM makers in terms of TV shipments. In addition, TPV is a major subsidiary of CEC (China Electronics Corporation, 0085 HK, NR). CEC also owns Panda (600775 CH, NR), one of the major panel manufacturers in China. CEC group has decided to build an 8.5Gen LCD panel line in Nanjin in cooperation with Sharp (6753 JP, Neutral). Business overview PC Monitor business Research analysts China Technology Leping Huang, PhD - NIHK Leping.huang@nomura.com +852 2252 1598 David Hao - NIHK David.hao@nomura.com +852 2252 2153 In the PC monitor business (47% of 1H13 overall sales), the company mainly focuses on the OEM business (63% of 1H13 segment sales). Its main customers include all of the world’s major PC vendors; in addition, it also sell PC monitors under its own brand, AOC. TV business In the TV business (41% of 1H13 overall sales), TPV mainly focuses on the OEM business (74% of 1H13 segment sales, excluding TP Vision) for Japanese and domestic TV brands. In April 2012, TPV and Philips formed TP Vision, which is exclusively licensed to sell Philips brand TVs worldwide. Currency: USD FY09 FY10 FY11 FY12 8,032 11,632 11,040 11,975 Ope profits (mn) 144 144 36 155 EPS Sales (mn) 0.06 0.06 0.05 0.05 P/E (x) 9.2 8.7 3.6 5.7 EV/EBITDA (x) 5.5 7.3 3.5 1.7 P/B (x) 0.9 0.8 0.2 0.3 Dividend yield (%) 3.0 3.4 8.4 5.3 Source: Company data Key company data: See page 2 for company data, and detailed price/index chart. See Appendix A-1 for analyst certification, important disclosures and the status of non-US analysts. Nomura | TPV November 4, 2013 TPV in Smart TV Fig. 120: Shareholders’ structure and relationship with CEC/Panda (1H13) China Electronics Corporation (0085 HK) China Greatwall Computer (000066 CH) Mitsui & Co. Ltd 20.2% CEIEC HK Ltd. 10.7% China Greatwall Co. Chi Mei Optoelectronics Panda Electronics Group 36.63% 15.8% TPV (903 HK) Nanjing Panda (600775 CH) 8.5% 6.4% Source: Nomura research Fig. 121: Revenue by segment (1H13) AIO, Chassis, CKD/SKD, 8.1% Rest of the world, 14.4% Others, 4.3% LCD TV, 40.6% Fig. 122: Revenue by geography (1H13) Monitor, 47.0% SA, 11.7% NA, 16.1% PRC, 29.3% Europe, 28.5% Source: Company data, Nomura research Source: Company data, Nomura research Fig. 123: LCD TV revenue by segment (1H13) Fig. 124: LCD TV revenue by geography (1H13) Rest of the world, 3.1% OBM, 9.9% ODM, 28.0% Source: Company data, Nomura research SA, 22.3% TP Vision, 62.1% NA, 14.4% PRC, 15.9% Europe, 44.3% Source: Company data, Nomura research 65 Nomura | TPV November 4, 2013 Fig. 125: Earnings summary Fig. 126: Segment summary (USDmn) 2010 2011 2012 (HKDmn) 2010 2011 2012 Turnover 11,632 45% 11,007 624 414 211 17% 202 16% 43 159 12% 5% 4% 2% 2% 21% 1% 11,040 -5% 10,382 658 514 144 -31% 136 -32% 26 111 -30% 6% 5% 1% 1% 19% 1% 11,975 8% 11,076 899 727 172 19% 115 -16% 31 83 -25% 8% 6% 1% 1% 27% 1% Turnover 11,632 45% 4,043 6,300 85,721 637% 3,722 6,080 94,071 10% 5,002 5,734 624 184 89% 11% 658 186 82% 18% 415 65% 35% 26 428 64% 36% 44 899 483 33% 13% 55% 375 66% 34% 41 17 167 -59 188 67 118 56.5 14.8 59.1 13.4 56.2 15.1 5.8 % chg y-o-y COGS Gross Profit OPEX EBIT % chg y-o-y Pretax income % chg y-o-y Taxes Net income % chg y-o-y Gross margin SG&A / revenue Operating Profit margin Pretax income/revenue Tax rates Net Income margin % chg y-o-y LCD TV Monitor Gross profit LCD TV ODM OBM TP Vision Monitor ODM OBM Other Operating Profit LCD TV Monitor Source: Company data, Nomura research Shipment (mn units) Monitor LCD TV TP Vision Source: Company data, Nomura research Directors and Senior Management Dr Jason Hsuan (Age 69), Chairman and CEO Dr Hsuan joined the Group in 1990 and has been the chairman and chief executive officer of the company since 1999. Before joining the company, he had over 20 years of managerial experience in well-known multinational listed enterprises, which include General Electric Company and PepsiCo Inc. Dr Hsuan is also a non-executive director of Nanjing Panda Electronics Company Limited, and chairman of Standard Investment (China) Limited. Dr Hsuan is the brother-in-law of Dr Chen Nai-Yung, vice president and chief information officer of the company. Mr. Shane Tyau (Age 56), CFO Mr Tyau joined the group in 1998, is responsible for managing the financial risks and investor relations of the group. Prior to joining the group, he had over 15 years of experience in commercial and corporate banking. Mr. Lee Neng-Sung (Age 62), CTO Mr Lee joined the Group in 2002, and is in charge of new products research and development. Prior to joining the Group, he worked for Sampo Electronic Company for over 20 years and was in charge of products manufacturing, research and development. Dr Chen Nai-Yung (Age 62), CIO Dr Chen joined the Group in 2008, is in charge of the information technology and human resources of the group. Prior to joining the Group, he worked for the Texas Instruments Incorporated and Semiconductor Manufacturing International Corporation. Dr Chen is the brother-in-law of Dr Hsuan, the chairman and chief executive officer of the group. 66 Nomura | China Smart TVs November 4, 2013 Appendix A-1 Analyst Certification I, Leping Huang, hereby certify (1) that the views expressed in this Research report accurately reflect my personal views about any or all of the subject securities or issuers referred to in this Research report, (2) no part of my compensation was, is or will be directly or indirectly related to the specific recommendations or views expressed in this Research report and (3) no part of my compensation is tied to any specific investment banking transactions performed by Nomura Securities International, Inc., Nomura International plc or any other Nomura Group company. Issuer Specific Regulatory Disclosures The term "Nomura Group" used herein refers to Nomura Holdings, Inc. or any of its affiliates or subsidiaries, and may refer to one or more Nomura Group companies. Materially mentioned issuers Issuer TCL Communication Tech Sharp China Telecom Skyworth Lenovo Group Ticker 2618 HK 6753 JP 728 HK 751 HK 992 HK Price HKD 7.34 JPY 292 HKD 4.06 HKD 3.89 HKD 8.44 Price date 01-Nov-2013 01-Nov-2013 01-Nov-2013 01-Nov-2013 01-Nov-2013 Stock rating Neutral Neutral Buy Buy Buy Sector rating N/A N/A N/A N/A N/A Disclosures A1,A3,A4,A5,A6,A7,A8,A11 A10,A11 A1,A2,A3 A1 The Nomura Group has received compensation for non-investment banking products or services from the issuer in the past 12 months. A2 The Nomura Group had a non-investment banking securities related services client relationship with the issuer during the past 12 months. A3 The Nomura Group had a non-securities related services client relationship with the issuer during the past 12 months. A4 The Nomura Group had an investment banking services client relationship with the issuer during the past 12 months. A5 The Nomura Group has received compensation for investment banking services from the issuer in the past 12 months. A6 The Nomura Group expects to receive or intends to seek compensation for investment banking services from the issuer in the next three months. A7 The Nomura Group has managed or co-managed a publicly announced or 144A offering of the issuer's securities or related derivatives in the past 12 months. A8 Nomura Securities Co., Ltd., has lead managed a public offering of equity or equity linked securities of the issuer in the past 12 months. A10 The Nomura Group is a registered market maker in the securities / related derivatives of the issuer. A11 The Nomura Group holds 1% or more of any class of common equity securities of the issuer. Skyworth (751 HK) HKD 3.89 (01-Nov-2013) Buy (Sector rating: N/A) Chart Not Available Valuation Methodology We derive our TP of HKD6 based on 9x FY14F EPS of HKD0.64, a 10% discount to China Technology peers due to its slower growth. The benchmark index for this stock is MSCI China. Risks that may impede the achievement of the target price Downside risks may include 1) slower than expected growth in 4K2K TV and smart TV; 2) intensified competition from Internet players; 3) Inability to create a mature smart TV eco-system and to monetize; and 4) Overseas and other business segments incur bigger than expected losses. 67 Nomura | China Smart TVs Lenovo Group (992 HK) November 4, 2013 HKD 8.44 (01-Nov-2013) Buy (Sector rating: N/A) Rating and target price chart (three year history) Date 30-Jan-13 22-Jan-13 22-Jan-13 08-Nov-12 16-Aug-12 23-May-12 06-Feb-12 02-Nov-11 19-Aug-11 20-Apr-11 17-Feb-11 01-Dec-10 01-Dec-10 Rating Target price 9.80 Buy 9.40 7.50 7.20 7.40 6.50 5.70 5.10 4.70 5.40 Neutral 5.80 Closing price 8.30 7.68 7.68 6.58 6.60 6.78 6.17 5.60 4.56 4.43 4.92 5.27 5.27 For explanation of ratings refer to the stock rating keys located after chart(s) Valuation Methodology We derive our TP of HKD9.8 based on 13x of FY14F EPS of HKD0.56 plus HKD2.5 per share net cash. The benchmark index for this stock is MSCI China. Risks that may impede the achievement of the target price Downside risks include: 1) weaker-than-expected global PC and China smartphone demand; 2) worse-than-expected operating margin performance due to irrational price competition from leading PC OEMs or China smartphone players; 3) slow market share gains in the consumer segment; 4) disappointing cost control if restructuring and resource integration are protracted; 5) rising component prices or shortages, which could affect gross margin and shipment schedules; 6) intensifying competition in the China PC/smartphone market; and 7) a hard landing in China's economy. TCL Communication Tech (2618 HK) HKD 7.34 (01-Nov-2013) Neutral (Sector rating: N/A) Rating and target price chart (three year history) Date 20-Feb-13 14-Aug-12 14-Aug-12 29-May-12 01-Mar-12 12-Oct-11 25-Feb-11 24-Jan-11 24-Jan-11 Rating Target price 2.40 Neutral 1.80 4.70 6.00 8.00 12.00 Buy 11.00 Closing price 2.39 1.65 1.65 2.67 4.18 3.02 8.25 7.92 7.92 For explanation of ratings refer to the stock rating keys located after chart(s) Valuation Methodology We derive our TP of HKD2.40 based on 1.0x of FY13F P/B of HKD2.36. We believe P/B is a fair valuation metric since we expect TCL's FY13 earnings will be around break-even point.The benchmark index for this stock is MSCI China. Risks that may impede the achievement of the target price Downside risk includes further margin erosion in the high-end feature-phone market. Upside risk includes faster-than-expected transition to smartphones. 68 Nomura | China Smart TVs Sharp (6753 JP) November 4, 2013 JPY 292 (01-Nov-2013) Neutral (Sector rating: N/A) Rating and target price chart (three year history) Date 05-Nov-12 03-Aug-12 30-Apr-12 10-Apr-12 27-Mar-12 02-Feb-12 27-Oct-11 28-Apr-11 Rating Target price 150 300 494 505 560 600 790 810 Closing price 154 192 516 530 495 528 694 741 For explanation of ratings refer to the stock rating keys located after chart(s) Valuation Methodology We think deteriorating earnings will continue to damage BPS in 13/3. Our target price of ¥150 is our end-13/3 adjusted BPS forecast, which factors in a private placement of new shares to Hon Hai Precision Industry. Risks that may impede the achievement of the target price Risk factors for Sharp include changes in macroeconomic conditions and fiercer international competition. In particular, while we base our target price on BPS, we note that shareholders’ equity may be affected by a change in the private placement contract with Hon Hai Precision Industry and a pension deficit as well as earnings deterioration. As factors that could cause the share price to exceed our target price, we note stronger-thanexpected shipments of large LCD TVs and small LCDs. China Telecom (728 HK) HKD 4.06 (01-Nov-2013) Buy (Sector rating: N/A) Rating and target price chart (three year history) Date 14-May-13 18-Feb-13 07-Mar-12 18-Nov-11 22-Mar-11 Rating Target price 4.80 Buy 5.10 5.20 4.90 Closing price 4.11 4.08 4.55 4.80 4.49 For explanation of ratings refer to the stock rating keys located after chart(s) Valuation Methodology Our target price of HKD4.80 is based on DCF analysis. We assume a WACC of 10.3% and a longterm growth-to-perpetuity rate of 0.5%. Our DCF is based on 10 years of free cash flow and is discounted back to December 2013.The benchmark index for this stock is MSCI China. Risks that may impede the achievement of the target price Risks to our investment view include the following: 1) irrational tariff competition — if China Mobile or China Unicom were to lower mobile tariffs in an attempt to gain market share, we believe that China Telecom might respond by launching similar tariff plans. 2) Regulatory environment — any significant change in the regulatory environment could have important implications for mainland telecom operators. 3) Introduction of new technologies — these could disrupt the industry landscape and could complement or cannibalise existing technologies (e.g., GSM, GPRS, and EDGE). Given that telecom operators have invested heavily in their existing networks, the potential obsolescence of networks could lead to asset write-offs, in our view. 4) Mobile data may increasingly eat into mobile voice revenue. 69 Nomura | China Smart TVs November 4, 2013 Rating and target price changes Issuer Ticker Old stock rating New stock rating Old target price New target price Skyworth 751 HK Not rated Buy N/A HKD 6.00 Important Disclosures Online availability of research and conflict-of-interest disclosures Nomura research is available on www.nomuranow.com/research, Bloomberg, Capital IQ, Factset, MarkitHub, Reuters and ThomsonOne. Important disclosures may be read at http://go.nomuranow.com/research/globalresearchportal/pages/disclosures/disclosures.aspx or requested from Nomura Securities International, Inc., on 1-877-865-5752. If you have any difficulties with the website, please email grpsupport@nomura.com for help. 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Explanation of Nomura's equity research rating system in Europe, Middle East and Africa, US and Latin America, and Japan and Asia ex-Japan from 21 October 2013 The rating system is a relative system, indicating expected performance against a specific benchmark identified for each individual stock, subject to limited management discretion. An analyst’s target price is an assessment of the current intrinsic fair value of the stock based on an appropriate valuation methodology determined by the analyst. Valuation methodologies include, but are not limited to, discounted cash flow analysis, expected return on equity and multiple analysis. Analysts may also indicate expected absolute upside/downside relative to the stated target price, defined as (target price - current price)/current price. STOCKS A rating of 'Buy', indicates that the analyst expects the stock to outperform the Benchmark over the next 12 months. A rating of 'Neutral', indicates that the analyst expects the stock to perform in line with the Benchmark over the next 12 months. A rating of 'Reduce', indicates that the analyst expects the stock to underperform the Benchmark over the next 12 months. A rating of 'Suspended', indicates that the rating, target price and estimates have been suspended temporarily to comply with applicable regulations and/or firm policies. Securities and/or companies that are labelled as 'Not rated' or shown as 'No rating' are not in regular research coverage. Investors should not expect continuing or additional information from Nomura relating to such securities and/or companies. Benchmarks are as follows: United States/Europe/Asia exJapan: please see valuation methodologies for explanations of relevant benchmarks for stocks, which can be accessed at: http://go.nomuranow.com/research/globalresearchportal/pages/disclosures/disclosures.aspx; Global Emerging Markets (ex-Asia): MSCI Emerging Markets ex-Asia, unless otherwise stated in the valuation methodology; Japan: Russell/Nomura Large Cap. SECTORS A 'Bullish' stance, indicates that the analyst expects the sector to outperform the Benchmark during the next 12 months. A 'Neutral' stance, indicates that the analyst expects the sector to perform in line with the Benchmark during the next 12 months. A 'Bearish' stance, indicates that the analyst expects the sector to underperform the Benchmark during the next 12 months. Sectors that are labelled as 'Not rated' or shown as 'N/A' are not assigned ratings. Benchmarks are as follows: United States: S&P 500; Europe: Dow Jones STOXX 600; Global Emerging Markets (ex-Asia): MSCI Emerging Markets ex-Asia. Japan/Asia ex-Japan: Sector ratings are not assigned. 70 Nomura | China Smart TVs November 4, 2013 Explanation of Nomura's equity research rating system in Japan and Asia ex-Japan prior to 21 October 2013 STOCKS Stock recommendations are based on absolute valuation upside (downside), which is defined as (Target Price - Current Price) / Current Price, subject to limited management discretion. In most cases, the Target Price will equal the analyst's 12-month intrinsic valuation of the stock, based on an appropriate valuation methodology such as discounted cash flow, multiple analysis, etc. A 'Buy' recommendation indicates that potential upside is 15% or more. A 'Neutral' recommendation indicates that potential upside is less than 15% or downside is less than 5%. A 'Reduce' recommendation indicates that potential downside is 5% or more. 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