china semiconductors · 2019-11-24 · in 2016. domestic semiconductor consumption grew 2.9% in...

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China SemiconductorsNarrowing the gap – China’s great chip challenge

China’s semiconductor industry is making rapid advances but still falls far short of meeting domestic demand

We identify investment opportunities in areas where the technology gap with foreign rivals is narrowing

We initiate coverage on the A-share semiconductor supply chain – Naura (Buy), Han’s Laser (Buy), Tongfu (Buy), and GigaDevice (Hold)

By: Frank He (S1700517120005)

EQUITY RESEARCH REPORTTELECOMS, MEDIA & TECHNOLOGYSeptember 2018

Disclaimer & Disclosures: This report must be read with the disclosures and the analyst certifications in the Disclosure appendix, and with the Disclaimer, which forms part of it

https://www.research.hsbc.com

China’s semiconductor industry is making rapid advances but still falls far short of meeting domestic demand

We identify investment opportunities in areas where the technology gap with foreign rivals is narrowing

We initiate coverage on the A-share semiconductor supply chain – Naura (Buy), Han’s Laser (Buy), Tongfu (Buy), and GigaDevice (Hold)

https://www.research.hsbc.com/R/20/9nzJbZz

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1

EQUITIES ● SEMICONDUCTORS & EQUIPMENT

September 2018

Why read this report?

China’s high-tech economy needs far more home-grown

chips – we explain where they will come from

We identify which A-share companies stand to benefit

most from this move up the technology ladder

We initiate coverage on four major players in China’s

semiconductor supply chain – Naura (Buy), Han’s Laser

(Buy), Tongfu (Buy), and GigaDevice (Hold)


September 2018

2

Narrowing the gap 3

The rise of China’s IC makers 11

Three opportunities 20

Company updates 44

Naura (002371 CH) 45

Han’s Laser (002008 CH) 59

Tongfu Microelectronics

(002156 CH) 72

GigaDevice (603986 CH) 83

Disclosure appendix 98

Disclaimer 101

Contents

3


September 2018

As in so many other industries, the market for semiconductors in

China is the biggest in the world. The problem is that only a

fraction are made by domestic companies, creating a technology

gap that is too wide for comfort. This report looks at how China

plans to close the gap and identifies the most promising A-share

investments linked to this theme. We initiate coverage on Naura

(Buy), Han’s Laser (Buy), Tongfu (Buy), and GigaDevice (Hold).

Few can dispute that China’s tech industry is now a force to be reckoned with. In areas such as

mobile payments, e-commerce and telecom equipment, Chinese companies are already the

envy of the world. Elsewhere, however, a great deal of work remains to be done.

Nowhere is this more apparent than in the realm of semiconductors, the integrated circuits used

in everything from telecom equipment and personal computers to giant servers and applications

for artificial intelligence and robotics. One stat helps to tell the story – while China is the world’s

biggest chip market, an industry estimate suggests that only 13% of the semiconductors

required by the country’s tech industry were manufactured by domestic companies last year

(this figure rises to 42% if the output by foreign companies in China is included).

This reliance on products imported from other countries is a concern for China’s government. It

has made technological independence a policy priority, especially now that trade tensions with

the US are rising. China has no desire to remain the world’s No 1 assembler of electronics. It

wants to be at the forefront of designing and manufacturing the semiconductors that will drive its

new, high-tech and smarter economy in the age of artificial intelligence, 5G telecom, the Internet

of Things (IoT), and autonomous driving. In this report we:

Identify investment opportunities in areas where we believe Chinese companies have

competitive advantages or can gain market share, such as the design of integrated circuits

(ICs), semiconductor equipment, and IC packaging and testing.

Assess the drivers that will help to close the technology gap, including huge investments in

capital expenditure and R&D, as well as supportive government policy.

Look at the obstacles that stand in China’s way, such as restrictions on imports, the

difficulty of making overseas acquisitions, and limited domestic supply of key materials in

the semiconductor supply chain.

Initiate coverage on four A-share companies in that supply chain – Naura (Buy), Han’s

Laser (Buy), Tongfu (Buy) and GigaDevice (Hold).

Narrowing the gap

This reliance on products

imported from other

countries is a concern


September 2018

4

Investment opportunities

China has been looking to accelerate the development its domestic semiconductor market for

several years. According the roadmap outlined in the high-profile “Made in China 2025”

industrial development policy, China’s self-sufficiency in integrated circuits will increase to 49%

in 2020 and 75% in 2030, including production by foreign companies. The recent trade tensions

with the US have underlined the importance of this policy. For example, the ban on US sales to

domestic telecom equipment manufacturer ZTE Corp – since lifted – highlighted the

dependence of Chinese companies on imported chips.

It’s a huge market. China is the biggest consumer and importer of semiconductors, accounting

for USD193bn of USD343bn of global sales of integrated circuits last year. China produced

1.9bn smartphones, 307m PCs and 172m TVs in 2017, accounting for over 90%, 70% and 80%

of global supply, respectively. At the same time, we estimate that Huawei and ZTE share over

50% of the global telecom equipment market. So, given current trade relations with the US, the

need for technological independence has never been greater.

As usual in China, growth has been remarkable. According to data from PWC, China’s

semiconductor consumption growth exceeded worldwide growth for the sixth consecutive year

in 2016. Domestic semiconductor consumption grew 2.9% in 2016 to reach record 60.6% of the

global market, while the worldwide semiconductor market only grew 1.1%. During the past 10

years, semiconductor consumption in China has grown at CAGR of 12%, far ahead of the global

rate of 3.2%.

And, as always in China, policy support is a major factor. To accelerate efforts to gain

self-sufficiency in semiconductors, in 2014 the government set up the China National Integrated

Circuit Industry Investment Fund. According the Ministry of Industry and Information Technology

(MIIT), the goal is to invest in chip manufacturing, boost industrial production and research, and

promote mergers and acquisitions.

The fund operates as a corporate entity under the MIIT and the Ministry of Finance. Commonly

referred to as the “Big Fund”, it has previously backed major projects including a Tsinghua

Unigroup memory chip plant worth USD24bn that is under construction in the city of Wuhan

(source: Reuters, 25 April 2018). A second fund is being put together to provide further support

for the sector.

In another policy move, China’s finance ministry has introduced tax breaks for domestic

chipmakers (Reuters, 30 March 2018). Chipmakers will be exempt from corporate taxes for two to

five years followed by partial deductions. The exemptions cover a range of products, from very

basic to cutting-edge chips, for use in computers, smartphones and other electronic devices.

We think that all these developments create opportunities for investors, especially in areas

where we believe Chinese companies have a competitive edge or are well positioned to gain

market share. They include:

IC design

Ten Chinese companies were ranked in the world’s top 50 IC design companies last year, up

from one in 2009. Their market share has increased from 5% in 2010 to 11% in 2017. Chinese

companies have a particularly strong presence in application-specific integrated circuit (ASIC)

based artificial intelligence (AI) and blockchain as well as the NOR flash memory segment. The

addressable market size of ASIC-based AI chips will surge from USD1bn in 2017 to USD4.6bn

in 2020, according to Frost & Sullivan, and account for 30% of the total chip market in 2020, up

from 19% in 2017. We see a balanced demand and supply outlook for NOR flash in 2018-19,

which would favour leading suppliers such as GigaDevice.

The recent trade tensions

with the US have underlined

the importance of this policy

As always in China, policy

support is a major factor

5


September 2018

Equipment

China’s spending on fab equipment is set to increase by 57% y-o-y in 2018 and 60% in 2019

according to SEMI, a provider of data on the electronics supply chain. This means China is likely to

overtake Korea, the world’s biggest spender in this area, in 2019. Since May last year Chinese

companies have been able to mass produce over 16 kinds of front-end wafer fabrication equipment

(mainly covering 28nm and above). The issue here is that their aggregate market share in equipment

installation in Chinese foundries is still only 5%. The big gap between the high capex cycle and the

low self-sufficiency ratio creates ample opportunities for domestic semi equipment makers. We

believe Naura will be the major beneficiary in this localization trend in wafer fabrication.

Packaging and testing

IC packaging and testing is the sector where the technology gap between Chinese companies

and global rivals is the smallest. Industry consolidation via M&A has increased the competitive

strength of Chinese vendors in the past three years. Among the global top 10 outsourced

assembly and test (OSAT) companies the revenue contribution from China’s three leaders –

JECT, Huatian, Tongfu – has increased from 6.6% in 2011 to 21.2% in 2017, driven by organic

growth and acquisition. We think a shift in industry drivers from smartphones to automobiles and

the Internet of Things (IoT) will change the competitive landscape. We like Tongfu due to its

strategic acquisition of two packaging and test fabs owned by Advanced Micro Devices (AMD),

a US company, and its customer base that includes NXP, MediaTek, Texas Instruments,

Infineon, and STMicro.

Exhibit 1. China IC supply chain

EDA software

Fabless design Foundry OSAT Equipment Material

ICScape

HiSilicon

Allwinner Tech

SMIC

JCET

Naura

Shanghai Sinyang

GigaDevice Goke Micro Huahong Huatian AMEC Ningbo Konfoong Spreadtrum Ingenic Huali Tongfu Zhejiang JingSheng Kumpur RDA Fullhan

WLCSP Han's Laser Suzhou Ruihong

Goodix Bitmain

SJ Semi ACM Research

Guoxin Micro Cambricon

Universal Scientific

Shanghai Micro Electornics

Will Semi Canaan

Piotech

Hangzhou Silan Microelectronics Yangtze Memory/Wuhan XMC Hefei Changxin Fujian Jinhua

Note: listed companies are highlighted red

Source: Company data, HSBC Qianhai Securities

Stock initiations

Naura (002371 CH, Buy)

Naura Technology is a leading advanced electronic equipment and precision component maker, with

products covering the semiconductor, LED, photovoltaic, display, and aerospace industries. It is

China’s largest semiconductor equipment company in terms of revenue, with a comprehensive

product portfolio covering etcher, physical vapor deposition (PVD), chemical vapor deposition (CVD),

oxidation, and cleaning. Its customers include SMIC, Huali Microelectronics, San’An, HC SemiTek,

BOE, and Longi Silicon. The company provides 28nm and above and is in the R&D stage for 14nm.

We forecast Naura to achieve a 52% net profit CAGR over 2017-20e. Catalysts include design wins

from foundry customers, R&D breakthroughs in 28nm, plus IC equipment. We initiate coverage with

a Buy rating and a target price of RMB63.97, based on one standard deviation above the mid-cycle

price to sales (P/S) ratio of 8.4x.

IC packaging and testing is the

sector where the technology

gap is the smallest


September 2018

6

Han’s Laser (002008 CH, Buy)

Han’s Laser is a leading laser and automation equipment and system provider. It supplies

products for laser labeling/cutting/welding equipment for consumer electronics and industrial

applications, PCB/LED/semiconductor special equipment, robots, automation equipment and

system solutions. We believe a recovery in orders for Apple in 2019, structural growth in high

power lasers and wider laser applications, and growing vertical integration will enable the

company to achieve a 29% net profit CAGR over 2017-20e. Moreover, we think the strategic

move into semiconductor equipment through the acquisition of US company Fortrend will be a

new growth driver. Catalysts include order wins in high power and semiconductor equipment, as

well as the self development of high power laser generators. We initiate coverage with a Buy

rating and a target price of RMB50.59, based on 22x mid-cycle PE.

Tongfu Microelectronics (002156 CH, Buy)

Tongfu is the third largest packaging & testing company in China. The company is enhancing its

competitiveness via the acquisition of an 85% stake in AMD’s packaging and testing fabs in

Suzhou and Penang in 2016 (in collaboration with China’s national IC fund). Tongfu now

captures over 80% of AMD’s total packaging & testing business and AMD accounted for 45% of

total revenue in 2017. The company is set to benefit from AMD’s potential market share gains in

PC, server CPU, and graphic cards in the coming years. Meanwhile, new orders from Bitmain

and Broadcom in 2018-19 and its high exposure to auto IC customers also serve as a long-term

driver. We forecast a 44% net profit CAGR in 2018-20e, which is slightly higher than the A-

share sector average CAGR of 37%. Catalysts include new customer acquisitions, improved

product mix, and breakthroughs in advanced packaging. We initiate coverage with a Buy rating

and a target price of RMB12.05, based on 35x (A-share semiconductor sector average) forward

PE.

GigaDevice (603986 CH, Hold)

GigaDevice is China’s primary memory IC design house, with strong exposure to NAND flash,

microcontrollers (MCU), and NOR flash. It had a 13% global market share in NOR flash in 2017.

Its key customers include Spreadtrum, RDA, MediaTek and Samsung. Leveraging its close

relationship with SMIC, we believe the company will continue to gain market share in low-

density NOR flash while seeking opportunities in advanced NOR flash and SLC NAND flash

markets. Moreover, its strategic partnership with the Hefei city government in Anhui Province to

develop 19nm DDR4 DRAM should be a long-term growth driver. We forecast the company will

register a 37% net profit CAGR over 2017-20e; catalysts include R&D progress in DRAM and

NAND flash. We initiate coverage with a Hold rating and a target price of RMB107.19, based on

45.3x historical average forward PE.

Key customers include

Spreadtrum, RDA, MediaTek

and Samsung

7


September 2018

Exhibit 2. 2017 revenue breakdown for covered semiconductor stocks

Product Naura Han's Laser GigaDevice Tongfu

NOR flash 85%

IC Design NAND 0%

MCU 14%

Packaging & testing

99%

Equipment

IC/Semiconductor 18% 2%

LED 23% 5%

Solar 14%

Display 6%

Lithium battery 4%

PCB 10%

Laser 81%

Component 34%

Others 1% 2% 0% 1%

Total 100% 100% 100% 100%


Exhibit 3. Valuation summary table

Ticker Company Name

HSBC Rating

Market cap USDm

ADVT USDm CP TP Upside Valuation methodology

EPS CAGR 2017-20e

002371 CH Naura Buy 3,257 142 53.26 63.97 20% 12m forward PS of 8.4x, +1 std above mid-cycle 52% 002008 CH Han’s Laser Buy 6,427 129 42.77 50.59 18% 12m forward PE of 22x, mid-cycle 29% 002156 CH Tongfu Buy 1,716 22 10.05 12.05 20% 12m forward PE of 35x, A-share sector average multiple 74% 603986 CH GigaDevice Hold 4,514 119 110.00 107.19 -3% 12m forward PE of 45.3x, mid-cycle 37%

Source: Company data, HSBC Qianhai Securities. Note: share prices as at close of 3 Sep 2018.

Where we are different from consensus

Our earnings estimates for 2019-20e for Han’s Laser and Tongfu are generally in-line or higher

than Bloomberg consensus. We are more optimistic on Han’s Laser‘s long-term growth potential

of sales in high power lasers, semiconductors, and OLED equipment sales. We also see

revenue upside for Tongfu as it switches AMD’s two in-house fabs to OSATs, as well as order

wins from domestic customers in the long term.

Our estimates for GigaDevice and Naura are much lower than market expectations. For

GigaDevice, we model a flattish pricing trend for NOR flash as the company focuses on low-

density product categories which are not facing supply shortages. Our 2018 revenue and profit

estimates for Naura are in line with company guidance. For 2019-20, we remain positive on the

sales growth of IC equipment – its core business – but are cautious on solar and LED

equipment revenue.

Exhibit 4. Our EPS growth forecasts vs consensus

Company Stock code CP RMB HSBC rating TP RMB

_______ HSBC Qianhai _______ ________ Consensus _________ ____ HSBC vs Consensus _____ 2018e 2019e 2020e 2018e 2019e 2020e 2018e 2019e 2020e

Naura 002371 CH 53.26 Buy 63.97 0.37 0.62 0.97 0.53 0.81 1.12 -30% -24% -14% Han’s Laser 002008 CH 42.77 Buy 50.59 1.82 2.60 3.55 1.95 2.47 3.19 -6% 5% 5% Tongfu 002156 CH 10.05 Buy 12.05 0.27 0.40 0.55 0.29 0.40 0.51 -8% -1% 8% GigaDevice 603986 CH 110.00 Hold 107.19 1.93 2.69 3.63 2.27 3.12 4.21 -14% -12% -12%

Source: Bloomberg, HSBC Qianhai Securities estimates (priced at close of 3 Sep 2018)


September 2018

8

Risk factors

Restrictions on component, equipment and IP imports from the US

Friction between China and the US over trade and intellectual property have resulted in the US

government imposing sanctions on certain Chinese technology companies. In April, US companies

were banned from exporting products/services to ZTE; the ban was lifted after ZTE paid a USD1.4bn

penalty. Then, in August, sanctions prohibited the export of products and technology to 44 Chinese

technology companies and research institutes with exposure to the military and aviation.

Meanwhile, China’s regulator has still not approved Qualcomm’s proposed acquisition of NXP

Semiconductors, a Dutch company with a high level of exposure to the China market. Any

further escalation of trade tensions might lead to additional tightening measures on Chinese

technology companies that rely on components, equipment and intellectual property (IP) imports

from the US, as well as Chinese exports to the US.

Take IC equipment as an example. US companies such as Applied Materials and Lam

Research have leading positions in making advanced IC equipment which Chinese companies

are not able to produce domestically. Failure to procure IC equipment from US companies may

lead to a significant slowdown in the development of China’s IC foundries. Here we summarise

the risks and potential impact on our covered stocks:

Naura: The company doesn’t disclose details about its sourcing strategy but we believe it sources

some of its components/parts from overseas, including the US. Naura indicates that each

component/part normally has more than one supplier, which gives it some flexibility in terms of

sourcing. Naura doesn’t have US export exposure as it mainly serves domestic customers.

Han’s Laser: Han’s sourced 80% of its high-power lasers from US supplier IPG Photonics for

its high-power equipment segment in 2017, which accounted for 18% of total revenue last year.

This year the company has started to build its own lasers, with power output of 1kw. IPG also

has multiple manufacturing facilities around the world, including in the US, Germany, Russia

and Italy, which could help to avoid any potential import duties and export controls. Han’s has

minimal export sales to the US.

Tongfu: The company mainly sources packaging & testing equipment from Japan, Korea,

Singapore and Europe, with minimal exposure to US. However, its largest customers include

leading US IC fabless and IDMs, such as AMD, Broadcom, and Texas Instruments. We

estimate sales to US customers represent over 50% of its total revenue.

GigaDevice: The company relies mainly on domestic foundry and OSAT in IC manufacturing

and packaging, and its customers are mostly domestic OEMs, so exposure to the US is small.

More broadly speaking, leading semiconductor companies may become more aggressive in

terms of defending their market share and industry positions in the light of technological

advances being made by Chinese peers. For example, leading overseas IC equipment

suppliers have traditionally charged premium prices for equipment that China is not able to

produce. Once Chinese tech companies catch up, foreign suppliers may significantly lower their

selling prices in order to squeeze the margins of domestic companies.

Exposure to US sales and

component supply varies by

company

9


September 2018

Valuation and risks

Valuation Risks

Naura

002371 CH

Current price:

RMB53.26

Target price:

RMB63.97

Up/downside:

20%

We apply 12m forward P/S instead of PE to value Naura as: 1)

Naura’s earnings performance is volatile and largely depends on

government subsidies; 2) Naura is still at the early stage of

attracting foundry customers and offers ample revenue growth

potential. We estimate a 52% earnings CAGR in 2017-20e, vs. 6%

in 2010-17. The stock is trading at 6.8x forward P/S, in line with its

mid-cycle average of 6.3x. In light of Naura’s faster revenue growth

outlook, we think it is reasonable to apply one standard deviation

above mid-cycle of 8.4x to set the target price, which equals

RMB63.97, implying 20% upside. We initiate with a Buy rating.

Slower-than-expected development in advanced IC

equipment

Slower order inflow and customer concentration of solar

equipment

Uncertainty over government subsidies and income

recognition

Buy

Frank He | [email protected] | +86 755 8898 3136

Han’s Laser

002008 CH

Current price:

RMB42.77

Target price:

RMB50.59

Up/downside:

18%

We apply a 12m forward PE to value Han’s Laser. We project a net

profit CAGR of 29% over 2017-20e, in line with the 32% CAGR

during 2008-17. We think it is reasonable to apply a mid-cycle

average valuation of 22x for the stock, which translates into our

target price of RMB50.59, implying 18% upside. With the growing

diversification of its customer base and a solid earnings growth

outlook, we believe our target multiple valuation is justified. We

initiate with a Buy rating.

Slower innovation progress by key customers

Slower laser source import substitution progress

Regulatory changes in component sourcing policy

Buy


Tongfu

002156 CH

Current price:

RMB10.05

Target price:

RMB12.05

Up/downside:

20%

We apply a 12m forward PE to value Tongfu. The shares have

historically traded in quite a wide range, with an average mid-cycle

forward PE of 60x and one standard deviation of 33x, given its

cyclical earnings trend before 2015. But since the acquisition of

AMD’s packaging and testing fabs in 2016, we believe Tongfu’s

revenue and earnings growth profile has structurally changed and

become less volatile and more predictable. Therefore, we apply the

A-share semiconductor peer group’s valuation matrix to value the

stock. We apply a 35x forward PE to Tongfu, in line with A-share

sector average multiple. Accordingly, we derive a 12m target price

for Tongfu of RMB12.05, implying 20% upside. We initiate with a

Buy rating.

High revenue contribution from single client

High reliance on external sourcing of raw materials and key

components

Market share loss in key customers

Longer-than-expected new customer order wins

Buy


GigaDevice

603986 CH

Current price:

RMB110.00

Target price:

RMB107.19

Up/downside:

-3%

We apply a 12m forward PE to value GigaDevice, with reference to

its historical valuation and earnings growth trend. We forecast a

37% net profit CAGR in 2017-20e, similar to its historical CAGR of

44% during 2012-17. We believe it is reasonable to apply a

historical average forward PE of 45.3x to value the stock.

Accordingly, our 12m target price is RMB107.19, implying -3%

downside. We rate the stock as a Hold.

Upside

Design wins in high-density, high-quality NOR Flash

Higher revenue growth in SLC NAND Flash

Downside

Lower NOR flash pricing and margin

Slower-than-expected DRAM project development

Hold


Priced at 3 Sep 2018 Source: HSBC estimates


September 2018

10

Exhibit 5. Comparable global semiconductor value chain

Ticker Company Currency Price Market cap

USDm DAV

USDm _ PE (x) __ PS (x) PB (x) EPS CAGR

18-20e EV/EBITDA

18e ROE (%)

18e Div yield (%)

18e 18e 19e 18e 18e

A-share 002371 CH NAURA TECH CNY 53.26 3,569 99 101.9 64.3 7.2 6.8 53% 51.4 7.1 0.2 002008 CH HAN'S LASER CNY 42.77 6,677 99 21.4 16.4 3.2 5.2 30% 18.5 25.0 1.0 002156 CH TONGFU MICRO CNY 10.05 1,696 13 30.0 19.9 1.4 1.8 39% 10.6 6.2 0.9 603986 CH GIGADEVICE SEMI CNY 110.00 4,566 86 49.5 34.3 10.2 14.5 45% 46.1 30.9 0.3 600584 CH JCET CNY 15.11 3,539 31 32.9 19.9 0.9 2.3 51% 9.4 7.1 0.3 300316 CH ZHEJIANG JINGSHENG CNY 12.46 2,357 34 23.0 17.9 5.0 3.9 25% 19.6 16.6 1.2 002049 CH UNIGROUP GUOXIN CNY 43.04 3,849 133 66.7 54.4 10.6 6.9 22% 41.8 11.1 0.2 300613 CH SHANGHAI FULLHAN CNY 119.85 801 7 40.4 28.0 8.9 5.0 37% 25.9 12.3 0.2 002185 CH TIANSHUI HUATIAN CNY 5.06 1,584 15 18.0 14.4 1.3 1.8 24% 8.3 10.1 0.9 600703 CH SANAN OPTOELECTRONICS CNY 15.94 9,458 95 16.4 12.8 6.0 2.8 27% 10.4 17.5 2.2 600460 CH HANGZHOU SILAN CNY 11.35 2,179 59 61.8 47.2 4.4 5.0 28% 33.2 8.6 0.8 300672 CH GOKE MICRO CNY 51.04 840 16 76.5 38.8 11.5 0.0 54% - 7.1 0.0 300666 CH KONFOONG MATERIALS CNY 47.00 1,518 36 124.2 85.5 13.6 16.0 38% 80.7 13.0 0.0 300458 CH ALL WINNER TECH CNY 23.67 1,153 21 49.2 35.2 5.1 3.6 38% 32.0 7.1 0.0 603005 CH CHINA WAFER LEVEL CSP CNY 20.23 692 6 37.2 24.7 5.9 2.5 44% 14.7 6.6 0.0 300323 CH HC SEMITEK CNY 11.60 1,872 12 15.9 11.6 3.0 2.4 33% 11.9 16.6 0.5 47.8 32.8 6.1 5.0 37% 27.6 12.7 0.5 Offshore 981 HK SMIC HKD 9.04 5,819 31 60.6 60.6 1.7 1.1 36% 9.0 1.6 0.0 1347 HK HUA HONG SEMI HKD 20.00 2,652 27 16.4 14.9 2.9 1.3 12% 8.3 8.9 1.7 522 HK ASM PACIFIC HKD 82.05 4,228 22 11.6 10.8 1.7 2.6 9% 8.0 24.0 3.6 SNPS US SYNOPSYS INC USD 102.14 15,177 108 26.1 24.2 4.9 4.8 10% 21.2 18.4 - CDNS US CADENCE DESIGN USD 47.04 13,303 65 27.9 25.6 6.4 10.1 9% 18.7 40.9 - INTC US INTEL CORP USD 48.43 223,311 1,211 11.7 11.4 3.2 3.0 3% 7.8 22.2 2.5 005930 KS SAMSUNG ELECTRON KRW 47650.00 274,320 340 6.7 6.6 1.2 1.3 3% 2.6 21.2 3.0 000660 KS SK HYNIX INC KRW 80900.00 52,819 262 3.5 3.7 1.4 1.2 -6% 1.9 39.9 2.0 MU US MICRON TECH USD 52.52 60,913 1,576 4.5 4.5 2.0 2.0 -6% 3.1 55.8 0.0 WDC US WESTERN DIGITAL USD 63.24 18,425 291 5.4 5.2 0.9 1.5 5% 4.0 27.6 3.2 TXN US TEXAS INSTRUMENT USD 112.40 109,275 493 19.6 18.1 6.8 10.4 8% 14.0 52.8 2.3 NXPI US NXP SEMICONDUCTO USD 93.14 32,040 917 13.6 11.8 3.4 2.5 19% 11.2 11.0 0.0 6502 JP TOSHIBA CORP JPY 332.00 19,483 47 1.8 12.5 0.6 1.2 -61% 6.6 88.8 0.8 IFNNY US INFINEON TEC-ADR USD 25.44 28,913 4 23.0 20.7 3.3 3.8 10% 10.9 17.9 1.3 STM FP STMICROELECTRONI EUR 17.72 18,725 48 15.3 13.7 1.9 3.0 9% 8.4 20.7 1.3 QCOM US QUALCOMM INC USD 68.71 100,943 816 19.0 16.3 4.5 5.3 20% 12.3 22.8 3.5 AVGO US BROADCOM INC USD 219.03 94,551 887 10.9 10.6 4.6 3.3 7% 9.2 33.5 3.2 2454 TT MEDIATEK TWD 253.50 13,024 52 18.0 14.2 1.7 1.5 24% 11.9 8.5 3.8 NVDA US NVIDIA CORP USD 280.68 170,653 2,855 35.2 31.7 13.1 15.6 14% 30.7 51.1 0.2 AMD US ADV MICRO DEVICE USD 25.17 24,538 2,169 55.4 39.8 3.7 25.3 40% 29.7 52.4 0.0 MRVL US MARVELL TECH GRP USD 20.68 13,519 146 15.0 14.0 5.4 2.2 7% 14.2 15.9 1.2 XLNX US XILINX INC USD 77.83 19,684 171 22.5 20.9 6.9 8.1 16% 19.3 31.9 1.9 2379 TT REALTEK SEMI TWD 144.50 2,389 17 19.0 16.5 1.6 3.2 14% 10.6 17.1 4.2 DLG GY DIALOG SEMICOND EUR 20.21 1,791 15 9.4 11.6 1.2 1.2 -18% 4.1 12.4 0.0 2330 TT TSMC TWD 256.50 216,382 207 18.7 16.6 6.4 4.0 13% 8.9 22.3 3.2 2303 TT UMC TWD 17.15 7,044 29 19.0 18.7 1.4 1.0 7% 3.8 5.2 4.3 3711 TT ASE TECHNOLOGY H TWD 73.80 10,370 17 14.5 12.6 0.8 1.6 20% 6.5 11.5 3.1 AMKR US AMKOR TECH INC USD 8.73 2,091 9 15.6 10.6 0.5 1.1 27% 3.6 7.8 - 6239 TT POWERTECH TWD 88.40 2,241 7 10.2 9.0 1.0 1.7 9% 4.1 15.6 5.8 AMAT US APPLIED MATERIAL USD 43.02 42,288 547 9.7 9.8 2.5 6.4 7% 8.2 53.6 1.4 ASML US ASML HOLDING-NY USD 205.05 88,472 157 30.4 25.1 7.2 6.4 24% 22.8 22.1 0.9 LRCX US LAM RESEARCH USD 173.09 27,276 498 10.9 9.4 2.6 3.9 17% 7.4 29.6 2.4 KLAC US KLA-TENCOR CORP USD 116.21 18,143 172 12.8 12.1 4.1 8.6 5% 9.6 78.1 2.6 Average 18.0 16.5 3.4 4.5 9% 10.7 28.6 2.1

Share prices as at 3 Sep 2018 Source: Company data, Wind, Bloomberg

11


September 2018

The country needs to be more IC self-sufficient

China is the biggest consumer and importer of semiconductors, accounting for USD193bn of

the USD343bn in global sales of integrated circuits last year. China produced 1.9bn

smartphones, 307m PCs and 172m TVs in 2017, representing more than 90%, 70% and 80% of

global supply, respectively. At the same time, we estimate that Huawei and ZTE share over

50% of the global telecom equipment market. So, given current trade relations with the US, the

need for technological independence has never been greater.

Exhibit 6. China consumes over 50% of global IC supply

Exhibit 7. China’s IC demand by application in 2016

Source: Wind Source: CCID

China’s IC imports totalled USD260bn in 2017, up 15% y-o-y, and represented the country’s No.

1 category of imported goods, higher than crude oil, agricultural products, and iron ore. The

value of domestic IC output was RMB541bn (USD80bn) in 2017 and if we include production by

foreign companies in China we estimate the country’s IC self-sufficiency ratio was 42% in 2017,

up from 24% in 2011. However, according to IC insights, a semiconductor research company, if

products manufactured by foreign enterprises in China are excluded, the ratio falls to 13%.

According to the “Made in China 2025” policy roadmap, the self-sufficiency ratio will increase to

49% in 2020 and 75% in 2030, including foreign output in China. We estimate that China’s

50.6%

57.0%59.3% 60.7%

63.8% 65.1%

56.4%

0%

10%

20%

30%

40%

50%

60%

70%

0

50

100

150

200

250

300

350

400

2011 2012 2013 2014 2015 2016 2017

Global IC sales China IC demand China's market share in demand

(USDbn)

Network communicati

on, 30.6%

Computer, 26.4%

Consumer electronics,

21.9%

Industrial, 12.8%

Auto electronics,

3.9%Others, 4.4%

The rise of China’s IC makers

China is gradually climbing up the IC value chain and is likely to

become a mainstream player in the coming decade

Positive drivers include strong demand, a slowdown in Moore’s Law,

fast-growing domestic investment, and government policy support

We see opportunities in IC design, equipment and OSAT


September 2018

12

domestic IC sales/value output will grow from the current RMB541bn to RMB791bn in 2020 and

RMB1,971bn in 2030, implying a 13% CAGR for 2017-20e and 10% over 2020-30e.

Exhibit 8. China’s major imported product by value: IC is ranked top

Exhibit 9. China’s IC demand, supply and self-sufficiency projection

Import product category in 2017 (USDbn)

Integrated circuits 260.1

Crude oil 162.3

Agricultural product 124.7

Iron ore and concentrates 76.3

Auto 51.0

Plastic 48.5

Copper and concentrates 26.4

Source: Wind Source: China Semiconductor Industry Association, MIIT

Despite this rapid growth, shortages remain in processors/controllers and memory products,

which accounted for 46% and 28% of total import value in 2016. Local suppliers can currently

only provide mid-to-entry level microcontrollers and memory products such as NOR Flash, 2D

NAND Flash and DDR3 DRAM.

Exhibit 10. China’s IC import and export trend

Exhibit 11. China’s IC import by category in 2016

Source: Wind Source: Wind

Moving up the value chain

China’s domestic IC sales increased from RMB193.4bn in 2011 to RMB541.1bn in 2017,

implying a 19% CAGR. This is much faster than the 8% CAGR for China’s IC demand and 6%

CAGR for global IC sales over the same period. The IC design and manufacturing segments are

the key growth drivers, registering CAGRs of 26% and 22%, well ahead of packaging & testing

(12%). The challenge is to move up the value chain.

24% 25% 27%29%

33%36%

41%

49%

75%

0%

10%

20%

30%

40%

50%

60%

70%

80%

-

500

1,000

1,500

2,000

2,500

3,000

2011 2012 2013 2014 2015 2016 2017 2020e 2030e

China IC demand China IC output Self-supply ratio

(RMBbn)

129 120

157 170

192

231 218

230 227

260

24 23 29 33

53

88

61 69

61 67

105 97

128 138 139 144

157 161 166

193

0

50

100

150

200

250

300

2008 2009 2010 2011 2012 2013 2014 2015 2016 2017

Import Export Deficit

(USDbn)

Processor and controller, 105 , 46%

Memory, 64 , 28%

Amplifier, 10 , 5%

Others, 49 , 21%

(USDbn)

13


September 2018

Exhibit 12. China IC sales/value output by segment

Exhibit 13. China IC sales/output value y-o-y by segment vs. global IC sales trend

Source: Wind Source: Wind

As illustrated in Exhibit 14, Chinese IC companies can compete in categories such as smartphone

application processors (AP), base band processors (CP) and network processor units (NPU), but

generally have a weak presence in more advanced areas such as microprocessors (MPU), memory,

field-programmable gate array (FPGA), and graphic processing units (GPU).

At the product level, the domestic companies can meet demand for most lower-end IC chips for

surveillance cameras, set top boxes and home networks, radio frequency identification (RFID)

solutions, identify cards, SIM cards, and bank card, which require simple functionality and

limited computing power.

The technology gap with global rivals is clear, even in areas like the smartphone System on

Chip (SoC). Simply put, overseas companies have a far greater ability to customize components

than their Chinese peers. Qualcomm, Apple, MediaTek, and HiSilicon all license ARM’s

instruction set architecture (ISA) for building their own SoC. But they then customize different

components – CPU, GPU, modem, storage, digital signal processor (DSP), image signal

processor (ISP) – which helps to differentiate the features and performance of smartphones.

For example, Qualcomm’s Snapdragon 845 processor is based on 64-bit ARMv8-A architecture

but has been customized to optimize the performance and power consumption of its CPU, GPU,

and DSP. Apple’s A11 Bionic processor CPU also customizes ARM’s ISA and has developed its

GPU in-house. However, Chinese companies struggle to compete in this area. In the case

Huawei’s HiSilison’s Kirin 970, its CPU and GPU are also licensed from standard ARMv8-A

(Coretex A73 and A53) architecture but there are no subsequent modifications.

However, we believe this creates opportunities for China to catch up in terms of technical know-

how and upgrade products, supported by a slowdown in Moore’s Law, strong government

support and rapid growth in investment.

12 19 23 24 27 36 53 62 81 105 133

164 207

23 31 40 39 34 45

43 50

60 71

90

113

145

34 51

63 62 50 63

98 104

110

126

138

156

189

0

100

200

300

400

500

600

2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017

Design Manufacturing Packaging & testing

(RMBbn)

19% CAGR in 2005-17

-30%

-20%

-10%

0%

10%

20%

30%

40%

50%

60%

2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017

China total China designChina manufacturing China packaging & testingGlobal

The technology gap with

global rivals is clear


September 2018

14

Exhibit 14. China’s presence in key IC product categories

System Device Core IC China market share in 2016

Computing system

Server Microprocessor unit (MPU) 0%

PC Microprocessor unit (MPU) 0%

Industrial application Microcontroller unit (MCU) 2%

General electronic Programmable logic device (PLD) Field-programmable gate array (FPGA) /EPLD

0%

system Digital signal processing device Digital signal processor (DSP) 0%

Telecom equipment Mobile device

Base band processor 18%

Application processor 22%

Embedded MPU 0%

Embedded DSP 0%

Core network equipment Network processor unit (NPU) 15%

Memory DRAM 0%

Semiconductor memory chip NAND Flash 0%

Nor Flash 5%

Display and vision system

High definition / smart TV Graphic processor 5%

Display driver 0%

Source: CISA

15


September 2018

Moore’s Law is slowing down

Moore’s Law states that the number of transistors will double per square millimetre every 18 months

due to innovations in design, material and fabrication technology. Based on this thesis, Moore’s Law

is likely to come to an end in the early 2020s, when nodes should shrink to around 5nm. Any further

shrinkage would create huge technical and economic challenges in terms of over-heating and

leakage issues with transistors, high capex and costs, and less performance gain per watt.

There is already evidence of longer node migration cycles for foundries. For Intel, it took around

27 months to migrate from 45nm to 32nm, 28 months from 32nm to 22nm and 30 months from

22nm to 14nm. The company launched 14nm CPU in 2014 but delayed the commercial launch

of 10nm CPU from the end of 2017 to the end of 2019. TSMC’s former chairman, Morris Chang,

commented in 2017 that Moore’s Law may face significant challenges by 2025 and said he

believes processing costs might increase if foundries continue to shrink nodes beyond 2025.

We believe this creates more time for Chinese foundries such as SMIC to narrow the

technology gap with global leaders. We also think this will also lead to more R&D investment in

new materials such as graphene, III-V compound semiconductors and photonics in the coming

decade, areas where China may have a higher chance of becoming a global leader.

On the other hand, the slowdown in Moore’s Law suggests that the technical challenges are

growing exponentially, which may make it more difficult for Chinese vendors to close the gap

with global leaders. This is why R&D investment and operational excellence remain the key

areas of focus for Chinese companies.

China’s role in the development of technical standards such as 5G, AI and IoT

China is becoming more active in setting technical standards in emerging industry applications

such as 5G, AI, IoT, and autonomous driving. This deeper level of involvement means more

influence and closer collaboration with semiconductor supply chain partners, which over time

should enable leading Chinese companies to move up the value chain from software or system

design to the IC design universe.

For example, in the area of telecoms the 3rd Generation Partnership Project (3GPP), a

collaboration between groups of telecommunications standards associations, has chosen polar

coding as the official coding scheme for the control channels of the 5G New Radio eMBB

interface. Polar coding is the standard supported by Huawei, while Qualcomm and others

support a standard known as LDPC. This provides Huawei with a competitive edge for Huawei

in designing 5G baseband ICs. Elsewhere, in April 2018 Alibaba acquired C-Sky, a Chinese

company engaged in the design of low power embedded 32-bit CPUs applied in IoT and cloud

systems. This creates synergies for Alibaba as C-Sky’s CPU could be integrated with Alibaba’s

AliOS. We discuss China’s presence in AI in a later section.

Exhibit 15. Logic IC technology roadmap

2012 2013 2014 2015 2016 2017 2018e 2019e 2020e

TSMC 28nm HKMG 20nm Planar 16nm FinFET 10nm FinFET 7nm FinFET 5nm FinFET

Samsung 28nm PolySION 28nm HKMG 20nm Planar 14nm FinFET 10nm FinFET 7nm FinFET

Global Foundries 28nm PolySION 20nm Planar 14nm FinFET 12nm FinFET 7nm FinFET

Intel 22nm Planar 14nm FinFET 10nm FinFET

SMIC 28nm PolySION 20nm Planar 14nm FinFET

Source: TechInsights, Company data, HSBC Qianhai Securities

China is becoming more active

in setting technical standards


September 2018

16

Investment cycle to boost competitive edge

China’s total IC capex in 2016 grew 31% y-o-y to RMB94.5bn (USD14.2bn), vs. 5% growth in

global IC capex. As a result, China’s share of global IC capex increased from 7% in 2011 to

21% in 2016. As at 2016, China had 72 wafer fabs operating on over 6 inches technology

platforms, 10 fabs of 12 inches, and 20 fabs of 8 inches.

According to IC Insights, aggregate capex by Chinese companies will increase from USD7.9bn

in 2017 to USD11bn in 2018, exceeding the total investment by European and Japanese

companies for the first time. The growth is being driven by capacity expansion for DRAM and

NAND flash memory companies such as Hefei Changxin, Wuhan Xinxin/Yangtze Memory,

Fujian Jinhua, in addition to foundries like SMIC and Huali. This substantial level of investment

helps Chinese companies attract talent, as shown by the number of experienced executives

from Taiwan working for leading Chinese IC companies.

Exhibit 16. China and global IC capex trend

Exhibit 17. China headquartered semi capex vs. Japan and Europe

Source: Wind, China Semiconductor Industry Association Source: IC Insights

Supportive government policies

As mentioned earlier, the Chinese government is offering the industry a great deal of policy

support. For example, the National IC Industry Development Guidelines in June 2014 contained

a number of targets for 2020, including: 1) to keep the annual industry IC sales growth rate

above 20% y-o-y during 2015-20 and reach over RMB870bn in 2020; 2) to reach tier-one level

in IC design worldwide in mobile smart devices, network communication, cloud computing,

Internet of Things and big data; 3) to achieve scale production in 16/14nm ICs by 2020, vs.

32/28nm in 2015; and 4) to achieve global standards in packaging and testing and enter the

global supply chain for key equipment and materials.

Then, in May 2015, the State Council released the “Made in China 2025” plan, which laid out a

detailed technology roadmap for various industries, including IC, covering design,

manufacturing packaging, equipment and materials. We will discuss each segment in detail in

the following section.

5.2 7.2

4.7 5.5 9.4 10.4 11.5

14.2

25.9

56.5

65.8

58.7 57.8

64.6 64.8 68.0

20%

13%

7%

9%

16% 16%

18%

21%

0%

5%

10%

15%

20%

25%

-

10.0

20.0

30.0

40.0

50.0

60.0

70.0

80.0

2009 2010 2011 2012 2013 2014 2015 2016

China IC capex Global IC capex Chnia's share (right)

(USDbn)

6.6

7.57.0

9.5

10.7

1.52.2

3.9

7.9

11.0

0

2

4

6

8

10

12

2014 2015 2016 2017 2018e

Japan and Europe

(USDbn)

The Chinese government is

offering the industry a great

deal of policy support

17


September 2018

Exhibit 18. IC industry development roadmap according to the “Made in China 2025” plan

Source: MIIT

The National IC Investment Fund

Aside from policy support, China’s government is also providing large amounts of capital for the

domestic IC industry. In September 2014, the National IC Industry Fund – known as the Big

Fund – was established with initial capital of RMB138.7bn raised from state-owned enterprises

(SOEs) and the government; investors included the Ministry of Finance, China Tobacco, China

Mobile, China Development Bank, and China Electronics Corporation. The fund mainly invests

in leading private and public listed domestic IC companies, with the focus on manufacturing and

design which accounts for 65% and 17% of the fund’s total investment, respectively.

The Big Fund targets industry leaders across the value chain to help finance advanced capacity

expansion and strategic acquisitions. As at the end of 2017, the first phase of Big Fund financing had

invested in 62 projects, of which 23 are listed companies or affiliates of listed companies. A second

phase of investment by the fund is underway, with funding expected to be in the range of RMB150-

200bn. The aim is to broaden sector coverage to applications for smart vehicles, AI, IoT, and 5G.

2015 2020 2025 2030

Manufacturing

Packaging

Design

65-40nm 28nm 20-14nm In line with global peers

0.2mn wafers/month (12') 0.7mn wafers/month (12') 1mn wafers/month (12') 1.5mn wafers/month (12')

28nm IC design 20-14nm IC design In line with global peers

Market size of US$20bn, 20% global share



Market size of US$10bn, 35% global share Market size of US$20bn, 45% global share

Multi-chip package (MCP) 3D Package Multi-component IC (MCO)

Exhibit 19. Major Big Fund investments in listed companies

Company Related Listco Ticker Investment Ownership Comment

(RMBm)

Design

May-15 Nine Star

002180 CH 500 4.0% To finance the acquisition of Static Control Components Jun-15 Goke Microelectronics

300672 CH 400 15.8% Pre-IPO investment

Nov-15 Sanechips ZTE 000063 CH 2,400 24.0% Invest in IC design unit of ZTE Aug-17 Giga Device

603986 CH 1,450 11.0% Through share transfer from existing shareholders

Nov-17 Goodix

603160 CH 2,829 6.65% Through share transfer from existing shareholders Jan-18 Jingjia

Microelectronics

300474 CH < 1,170 n/a Pending approval. Jingjia specializes in GPU development

Manufacturing

Feb-15 SMIC

981 HK 2,700 15.1% New share issuance 2016-17 SMIC North SMIC 981 HK 9,970 32.0% Focus on 45-28nm IC on 12' wafer Jan-18 SMIC South SMIC 981 HK 5,963 27.0% Focus on 14nm IC manufacturing Jan-18 Hua Hong

1347 HK 2,520 18.9% To issue new shares

Jan-18 Hua Hong (Wuxi) Hua Hong 1347 HK 3,289 29.0% To finance the investment in 12' production line Nov-16 Navtech

300456 CH 1,048 9.1% Through private placement to finance 8' MEMS fab

Packaging

Jan-15 JCET

600584 CH 2,031 9.5% To finance the acquisition of STATS ChipPAC Dec-15 Hua Tian (Xi'An) Hua Tian 002185 CH 500 27.2% Subsidiary of listco Dec-17 China Wafer Level CSP

603005 CH 680 9.3% Bought shares from Engineering and IP Advanced Technologies

Jan-Feb 18 Tongfu Microelectronics

002156 CH 2,561 21.7% Through private placement to acquire AMD’s packaging facilities Equipment

Feb-16 Naura

002371 CH 600 7.5% Through private placement to acquire North Microelectronics Jun-15 Chang Chuan Technology 300604 CH n/a 7.3% Pre-IPO investment Materials

Oct-17 Yoke Technology

002409 CH 550 n/a To finance acquisition on special gas company Dec-17 Zhong Ju Xin Technology Zhejiang

Juhua 600160 CH 390 39.0% To form JV in electronic material development

Others

Jun-15 San’an Optoelectronics

600703 CH 4,839 11.3% Through share transfer; Leading LED supplier Jul-16 BDStar Navigation

002151 CH 1,500 11.5% Through private placement; Satellite navigation



September 2018

18

Apart from the central government, a number of municipal governments are also raising capital

and forming IC investment funds. The total size of these funds – including contributions from

phase one of the Big Fund – amounts to RMB465bn.

Each municipal government has a different focus. For example, Hubei and Anhui are

developing IC manufacturing due to their exposure to start-up memory foundries such as

Yangtze Memory Technologies (NAND flash), Wuhan Xinxin (NOR flash), and Hefei Changxin

(DRAM). Guangdong focuses on design and packaging, while Fujian intends to spend 70% of

its RMB50bn fund on III-V compound semiconductors such as Gallium nitride (GaN), Gallium

arsenide (GaAs), and Indium nitride (InN).

Exhibit 20. China’s IC investment fund map

Source: SemiInsights, HSBC Qianhai Securities

Challenges remain

Despite the considerable amount of progress made in this industry in the last few years, China

still has several hurdles to overcome. We highlight two in particular:

Restrictions on equipment imports and cross-border M&A. Based on the Wassenaar

Arrangement that covers 42 states, there are export controls on certain types of semiconductor

equipment and IC components to China, such as advanced lithography equipment and related

key components, high-performance CPU, FPGA, DSP and MOSFET, among others. In addition,

Chinese companies face growing difficulties in acquiring overseas semiconductor companies,

due to concerns about intellectual property transfer. As a result, China has to rely more on self-

development in order to compete with global peers.

HAINAN

YUNNAN GUANGXI

GUIZHOU

GUANGDONG

FUJIAN

HUNANJIANGXI

QINGHAI

XINJIANG

XIZANG

(TIBET) SICHUAN

HONG KONG

HEILONGJIANG

INNER MONGOLIA

JILIN

LIAONING

BEIJING

HEBEITIANJIN

SHANDONG

JIANGSU

ANHUI

SHANGHAI

ZHEJIANG

HENAN

HUBEI

SHAANXIGANSU

NINGXIA

SHANXI

CHONGQING

RMB10bn

RMB200m/year

RMB10bn

RMB71bn

RMB50bn

RMB50bn

Xia Men RMB16bn

RMB15bn

RMB32bn

RMB250m

RMB30bn

RMB12bn

RMB30bn

Big fund

RMB138.72bn

Total investment

RMB465.17bn

Local governments

investing in the

semiconductor industry

19


September 2018

Semiconductor supply chain. China has limited exposure to semiconductor processing

material, including raw silicon wafer, mask, photoresist, electric gases, chemical-mechanical

planarization (CMP) materials, and packaging substrate. This means there is a heavy reliance

on imports. For silicon wafers, China is only able to make solar-grade 6-inch silicon wafer and

has just trialled the production of 8/12-inch. Domestic technology also trails in the area of

electronic design automation (EDA).

Exhibit 21. Unsuccessful M&A deals involving Chinese companies

Date Acquirer Target company Target company's business

Jul-15 Unigroup Micron DRAM, NAND Flash Oct-15 Unigroup Western Digital SSD, HDD, NAND Flash Oct-15 Unigroup Powertech Technology IC Packaging and testing Dec-15 Unigroup SPIL IC Packaging and testing Dec-15 Unigroup ChipMOS IC Packaging and testing Nov-16 Canyon Bridge Lattice Semiconductor FPGA Dec-16 Fujian Grand Chip Investment Fund Aixtron MOCVD, PECVD Aug-17 GigaDevice ISSI SRAM, DRAM

Source: Company data

In the next section we highlight areas where we believe Chinese companies have a competitive

edge or are well positioned to gain market share.


September 2018

20

We now identify the three parts of the semiconductor value chain where we believe Chinese

companies are gaining strength, implying compelling growth opportunities for A-share listed

semiconductor companies.

Opportunity 1: IC design: AI and NOR flash memory

Fabless IC companies that focus on design, engineering and marketing are playing a more

important role in the industry these days. According to IC Insights, the revenue share of global

fabless IC companies has increased from 18% in 2007 to 27% in 2017, led by Qualcomm,

Broadcom, MediaTek, AMD, Nvidia and Marvell.

China is catching up at a rapid pace. Ten Chinese companies were ranked in the world’s top 50

IC design companies last year, up from one in 2009. Their market share in fabless IC sales has

increased from 5% in 2010 to 11% in 2017 at the expense of rivals in the US and Europe.

If we include output by foreign companies in the country, China’s IC design industry revenue

increased from RMB4.0bn in 2009 to USD30.7bn in 2017 (a CAGR of 29%) and its global

market share has expanded from 7% in 2009 to 30% in 2017. The total number of IC design

companies in China increased from 582 in 2010 to 1,380 in 2017.

Exhibit 22. Market share of fabless company IC sales by company headquarter locations

Exhibit 23. China and global IC design revenue comparison

Source: IC Insights Source: IC Insights, CSIA, HSBC Qianhai Securities

4%

69%

17%

5%

4%

1%

0% 20% 40% 60% 80%

Other countries (mainly Broadcom)

US

Taiwan

China

Europe

Japan

2017 2010

0%

5%

10%

15%

20%

25%

30%

0

10

20

30

40

50

60

70

80

90

100

2009 2010 2011 2012 2013 2014 2015 2016

Global IC design China IC design China's market share

(USDbn)

Three opportunities

China is catching up rapidly in the area of IC design

Semi equipment sales are set to grow rapidly in 2018; China is

emerging as the key driver

Market share gains in packaging and testing

China is catching up at a

rapid pace

21


September 2018

Exhibit 25. Number of IC design companies in China

Exhibit 26. China’s IC design revenue share by industry

Source: CSIA Source: CSIA

The number of Chinese IC design start-ups is also encouraging and some are among the top-

tier players in emerging industries such as AI and block chain. AI chips are mainly used in cloud

data centres and user devices (smartphones, auto, computer vision), which are used for

machine learning (training) and inference. By technology, AI processors includes CPU, GPU,

DSP, FPGA and ASIC. According to Forest and Sullivan, the global AI chip market will grow

from USD5.2bn in 2017 to USD15.3bn in 2020, implying a CAGR of 43.3%.

Recent developments at the company level include:

The neural processing unit (NPU) of Huawei’s Kirin 970 chip, which was developed to

power its latest flagship smartphone Mate 10, is licensed from Cambricon Technologies, a

successful Chinese start-up specialising in AI chips.

In May 2018 Cambricon also launched a cloud-based machine learning processor called

MLU100 and a mobile device NPU 1M based on TSMC’s 7nm technology. Cambricon is the

first company in the world to have AI processors operating in both cloud and devices.

Beijing-based Horizon Robotics has launched an embedded computer vision processor

called Sunrise1.0 and Journey1.0 targeting autonomous driving and smart cities.

Deephi Tech, another Beijing-based company, has developed a proprietary Deep Learning

Processing Unit (DPU) platform that aims to simplify and accelerate deep learning

applications. The company was recently acquired by US AI giant Xilinx.

582 534 569

632 681

736

1,362 1,380

-

200

400

600

800

1,000

1,200

1,400

1,600

2010 2011 2012 2013 2014 2015 2016 2017

Telecommunication45%

Consumer electronics

21%

Multi-media12%

Smart card9%

PC7%

Analog4%

Power2% GPS

0%

Exhibit 24. Top 10 IC design companies in China by revenue

Company 2017 revenue Major business (RMBbn)

HiSilicon 36.1 Smartphone, baseband, set top box, camera, display, home network, IoT Unigroup 11.0 Smartphone application, baseband processor, RF, IoT, CMOS, TV chipset Sanechips 6.6 Smartphone modem, multimedia application, image, power and PA chip, wired network Huada Semiconductor 5.2 Smart card, MCU, RFID, Analog, display Zhixin Microelectronics 4.5 Smart chip used in power, telecom, environmental, finance Goodix 3.7 Fingerprint Silan 2.7 MCU, Power management, LED driver, Power Driver Module, Digital Audio, MEMS Focal Tech (Shenzhen) 2.8 Touch IC Galaxycore 2.5 Image sensor Vimicro 2.1 Surveillance camera SOC, neural processing unit, HD digital image module

Source: CCID, Company data, HSBC Qianhai Securities


September 2018

22

Exhibit 27. AI chip supply chain

Inference on device

Mobile ADAS Computer vision Natural language processing Virtual reality

Apple Mobileye Movidius Chipintelli Microsoft

Qualcomm NVIDIA Unisound

Cambricon Horizon

Samsung Robotics

MTK

Inference on cloud

GPU FPGA ASIC

NVIDIA Altera Google TPU

AMD Xilinx

Training

GPU ASIC FPGA

NVIDIA Google TPU Deephi (Xilinx)

Cambricon

Note: Chinese companies are highlighted in red


Progress is also being made in blockchain technology. Chinese companies such as Bitmain and

Canaan, which specialise in crypto currency mining machines, had market shares of 67% and

21% in the fabless ASIC bitcoin mining equipment shipments in 2017, according to Frost &

Sullivan. The consulting firm also forecasts that the size of the blockchain hardware market will

increase from RMB19.3bn in 2017 to RMB98.5bn in 2020, a CAGR of 98.5%. ASIC-based

hardware accounted for 71% of the blockchain hardware market in 2017.

ASIC chips are gaining popularity in AI due to their computing performance, energy efficiency,

and the fact they can be customised. Frost & Sullivan projects the size of the addressable

market of ASIC-based AI chips will surge from USD1bn in 2017 to USD4.6bn in 2020, and will

account for 30% of the total market in 2020, up from 19% in 2017.

Exhibit 28. Global AI chip market size Exhibit 29. Market size of blockchain hardware

Source: Company data, Frost & Sullivan Source: Company data, Frost & Sullivan

We think the ultimate aim of Chinese companies is to create an eco-system covering computing

architecture, processors, and application development platforms. To do this we believe it is

critical to succeed in the AI processor market, as shown by the dominance of NVIDIA’s CUDA

and Volta architecture and GPU (used by Tesla, DGX, and Titan), and Google’s Tensorflow

platform and TPU processor.

0.0

1.0

4.6

0.3

1.6

3.1

0.2

1.9

5.5

0.1

0.7

2.1

0.0

2.0

4.0

6.0

8.0

10.0

12.0

14.0

16.0

18.0

2012 2017 2020e

ASIC FPGA GPU CPU

(USDbn)15.3

5.2

0.6

52% CAGR

43% CAGR

2.67.3

14.6

24.028.6

0.8

1.4

2.9

5.6

6.9

0.1 0.6 1.3

0

5

10

15

20

25

30

35

40

2013 2014 2015 2016 2017 2018e 2019e 2020e

Total blockchain hardwareNon-ASIC based blockchain hardwareASIC-based blockchain hardware

8.7

17.5

29.6

35.6(RMBbn)

3.4

60% CAGR2017-20

205% CAGR2013-17

23


September 2018

The reality is that despite some encouraging proprietary developments in AI and blockchain, the

technology gap with leading overseas fabless companies such as Qualcomm, Nvidia, AMD and

MediaTek remains wide. We believe IP licensing and customization, plus the recruitment of

talent and education can help Chinese companies catch up.

IP licensing plus customization

There’s a growing trend for China to localize core IPs in PCs, servers and smartphones ICs via

joint ventures with global leaders. For example, ARM sold a 51% stake in ARM Technology

China to a group of Chinese investors for USD775m in June 2018. While the main aim of the

investment is to acquire the sales and distribution business in China, we believe it also creates

a closer tie-up with ARM. This should help Chinese companies better customize ARM IP and

ultimately build their own IP portfolio with the help of ARM’s platform. As discussed above,

Qualcomm and Apple currently have far better customization skills when it comes to ARM

architecture but we think Chinese vendors such as HiSilicon will catch up over time.

Another example of this trend is AMD’s JV with Tianjin Haiguang Advanced Technology

Investment (THATIC) to develop x86 based server CPU technology. AMD will license its x86 IP

to the JV and the Chinese partner will do some customization. The JV started producing

Dhyana series server CPUs in July 2018, based on AMD’s ZEN architecture.

Recruiting talent, strengthening domestic education

Chinese memory companies have been offering attractive compensation and incentive

schemes in order to recruit talent, especially from Taiwan. Around 450 employees from Inotera

and Nanya Technology have joined Chinese memory companies in the past two years. The

chairman of Yangtze Memory, Mr. Gao Qiguan, was previously the general manager of Nanya

Technology and Inotera, and the global executive vice president of Unigroup, Mr. Sun Shiwei,

was the former deputy chairman and CEO of UMC.

China is also enhancing advanced IC education in order to enlarge its domestic talent pool. The IC

industry requires people with a wide range of educational backgrounds, including computer science,

communication engineering, software engineering, electrical engineering, physics, chemistry,

material science, and mechanical engineering. China recruited 589,800 post-graduates and 77,252

PHDs in 2016, up 64% and 33% compared to 2007, the highest number worldwide.

Exhibit 30. Comparison of major AI chips

Chip type

Pros Cons Training rank

Inference rank

CPU General-purpose, already in servers and PVs, sufficient for inferencing

Series-processing is less efficient than parallel-processing N/A N/A

GPU Highly parallel, high performance, uses popular AI framework (such as CUDA)

Inefficient unless fully utilized 1 3

FPGA Reconfigurable functionality, good for constantly evolving workloads, efficient

Difficult to program, lower performance versus GPUs, no major AI framework

2 2

ASIC High computing performance, highly energy efficient, fully customizable

Expensive, requires high volumes to be practical, quickly outdated, less flexible

3 1



September 2018

24

Exhibit 31. China’s post-graduate and PHD recruitment

Exhibit 32. IC industry recruitment by category in China in 2017

Source: Ministry of Education Source: White Paper of China IC Industry Talents

Memory – gaining presence in DRAM, NAND and NOR flash

China is in the process of ramping up DRAM and NAND flash memory production lines and

gaining share in NOR Flash memory.

NAND flash

Yangtze Memory, an entity invested in by Unigroup, the National IC Fund and the Hubei

municipal government, is a pioneer in developing 3D NAND Flash in China. The company was

established at the end of 2016 and is the parent company of Wuhan Xinxin (XMC). XMC is a

major NAND and NOR flash memory foundry in China, which is jointly developing 32L 3D

NAND with Spansion. The company has also partnered with the Institute of Microelectronics of

Chinese Academy of Sciences in 3D NAND R&D. To speed its development, the company is

recruiting experienced management and talent from leading global memory companies.

Total investment amounts to USD24bn, with phase one capacity of 300,000 pieces of

wafer/month (12-inch), in the range of 14-20nm. The company started equipment installation in

April 2018 and expects to start producing 32 layer 3D NAND in 4Q18, with initial orders being

for 8GB USB flash cards. The company also plans to mass produce 128Gb and 64 layer 3D

NAND from 2019.

Exhibit 33. 2D and 3D NAND flash node migration roadmap

Source: TechInsights, HSBC Qianhai Securities

30

35

40

45

50

55

60

65

70

75

80

300

350

400

450

500

550

600

650

2007 2008 2009 2010 2011 2012 2013 2014 2015 2016

Post-graduate (LHS) PHD (RHS)

('000) ('000)

R&D, 58%

Sales and customer

support, 18%

Foundry, 3%

Packaging & testing, 6%

General purpose,

10%

Others, 5%

Toshiba

Western Digital

Samsung

Micron/Intel

SK Hynix

Yangtze

Memory

2014 2015 2016 2017 2018 2019 2020

2D 19nm 16nm 14nm

3D V-NAND 32L (20nm) 48L (20nm) 64L (20nm) 96/128/192L

2D

3D

19nm 15nm 1st 15nm 2nd

48L (19nm) 64L (19nm) 96/128L

2D 16nm

3D 64T (20nm) 96T (20nm), 128T

2D

3D

16nm 14nm

32T (40nm)

36L (31nm) 48L 72L 96L-128L

3D 32L 64L

25


September 2018

DRAM

Fujian Jinhua, Hefei Changxin, and Ziguang Guoxin Microelectronics are the leaders in

developing DRAM in China. Fujian Jinhua licenses 20nm DRAM IPs from UMC and intends to

start mass production in 4Q18. Total investment amounts to RMB37bn, with phase 1 capacity of

60,000 pieces/month (12-inch). Ziguang Guoxin is a fabless IC design house. In 2015 it moved

into DRAM by acquiring the Xi’an subsidiary of Qimonda, a memory company that is an affiliate

of German tech company Infineon. Ziguang Guoxin is currently able to mass produce DDR3

DRAM (25nm process node), and plans to complete the development of DDR4 in 2018. We

discuss Hefei Changxin in a later section of this report.

Exhibit 34. DRAM migration schedule by major DRAM vendors


NOR flash: favourable demand/supply outlook

Memory can be divided into volatile and non-volatile, based on the dependence on active power

connection to function and persistence in storage. Non-volatile memory, which does not lose

stored data when the power is off, includes flash and read-only memory (ROM). The prevailing

form is flash memory. Based on a structure of interconnections between memory cells, flash

memory is divided into NOR and NAND. NOR generally has low density, faster read speed, and

good endurance, while NAND has high density, fast write and erase speeds and lower bit cost.

Depending on interfaces, NOR flash can be further categorized into serial and parallel types.

Volatile memory mainly refers to random access memory (RAM). Based on the design

architecture, RAM can be divided into dynamic (DRAM) and static (SRAM) type. RAM is used to

temporarily hold data. DRAM uses transistors and capacitors in an array of repeating circuits

(where each circuit is one bit), whereas SRAM uses several transistors in a circuit to form one

bit. SRAM offers a faster data input/output rate and is less sensitive than DRAM to disturbance

such as electrical noise. It also does not require refresh, a process involving the periodic

reading of information from a certain section of the memory and the immediate rewriting of that

information to the same area without making any changes. But SRAM is generally more

expensive than DRAM.

DRAM and NAND flash are the primary memory type, with their market size reaching

USD72.8bn and USD47.2bn in 2017, accounting for 58% and 38% of the global memory market

in terms of value. The NOR flash market reached USD2.0bn in 2017, representing only 1% of

the total memory market.

1H14 2H14 1H15 2H15 1H16 2H16 1H17 2H17 1H18 2H18

Samsung

SK Hynix

Micron

25nm 20nm 20nm 17nm

25nm 21nm 18nm

25nm 20nm 17nm

Hefei

Changxin

Fujian

Jinhua

2019e 2020e

19nm

20nm

17nm

18nm

Volatile memory mainly

refers to random access

memory (RAM)


September 2018

26

Exhibit 35. Memory product classifications Exhibit 36. Market size of memory industry in 2017

Source: Company data Source: DramExchange, HSBC Qianhai Securities

Exhibit 37. Comparison of NOR and NAND flash

NOR flash NAND flash

Interface in NOR allows random access for reading NAND allows only page access

reading/writing

Fast read and random access times Higher density

Higher endurance and data retention Higher storage capacity

Features Reliable code and data storage Fast write and erase speeds

Low standby power Lower bit cost

Lower density and wrote speed Higher read latency

Code storage in PCs, feature phones, USB drives, SSD in tablets, smartphones,

Applications consumer electronics, PCs, servers, etc.

set-top boxes, autos, industrials, etc.

Density Up to 4Gb Up to 1TB

Node up to 45nm up to 12nm

Source: Industry data

Demand for NOR flash is expanding

NOR Flash’s low read latency characteristics allow it to be widely used in read only, code

storage/execution applications such as PC BIOS systems, feature phones, consumer

electronics, autos, TV set-top boxes, surveillance cameras, and industrial machines.

The size of the NOR flash market declined from a peak of USD8.6bn in 2006 to a trough of

USD1.5bn in 2015, but has started to pick up again in the past two years. This is primarily due

to: 1) the decline in the unit selling price. According to WSTS, the average selling price of NOR

flash has fallen from USD2.32 in 2006 to USD0.34 in 2017, an annualized decline of 16%; and

2) a structural change in demand. NOR flash was widely used in feature phones but has lost

ground in the smartphone cycle since 2007.

Smartphones require much higher data storage capacity than feature phones, and also have

more functions and a slimmer form factor, making NAND flash the preferred choice. But since

2016 NOR flash has started to pick up in both volume and price thanks to demand from new

applications such as AMLOD panels, touch and display driver integration (TDDI) and advanced

driver assistance system (ADAS), gaming consoles, as well as limited new supply.

Memory

Non-volatile Volatile

FlashOTP

ROM

EPROM

EEPROM

Nor

FlashNAND

Flash

ParallelSerial

DRAM SRAM

Red box represents the GigaDevice’ product offering

DRAM, 72.8, 58%

NAND Flash, 47.2,

38%

NOR Flash, 2.0, 1%

Others, 3.5 , 3%

(USDbn)

27


September 2018

Exhibit 38. Global market size of NOR Flash memory

Exhibit 39. NOR flash shipments and ASP worldwide

Source: WSTS Source: WSTS

Looking ahead, we highlight the key demand drivers for NOR flash:

AMOLED panels: smartphones

The Mura effect, which refers to each pixel not being able to output colours identically in a

display, is an issue for active-matrix organic light-emitting diode (AMOLED) panels. It results in

poor colour and brightness consistency from one pixel to the next. Liquid crystal display (LCD)

is generally better at minimizing the Mura effect. To ensure consistency in product quality,

manufacturers have to set up automated inspection and repair processes. Codes that

compensate for possible defects in each panel are stored in a separate, implanted NOR flash

memory as it is not an economical solution to integrate a de-Mura function into an AMOLED

driver IC. That said, NOR flash has become an essential part of AMOLED. A typical high-

definition OLED smartphone panel contains an 8-16MB NOR flash chip.

We see an increase in the penetration rate of OLED smartphones in the coming years. OLED

offers several advantages over LCD display: 1) slimmer form factor without backlight as it is

self-emissive; 2) low power consumption; and 3) more vibrant colour, deeper blacks and

brighter whites and better contract ratio. More smartphone models have recently started using

OLED display, including Vivo X21, OPPO R15, and Xiaomi 8. Apple is also planning to launch

two OLED iPhone models (5.8- and 6.5-inch) in 4Q18, vs. one model in 2017, according to

Appleinsider.com. HSBC’s Korean technology team forecasts that the global smartphone OLED

penetration rate will increase from 23% in 2017 to 29% in 2018e and 32% in 2019e. This

suggests a y-o-y unit growth rate of 30% in 2018 and 15% in 2019.

On the supply side, we forecast OLED monthly production capacity will growth from 164,000

sheets in 2017 to 327,000 in 2018 and 494,000 in 2019, with a large part of the incremental

supply coming from Samsung and Chinese vendors such as BOE, Tianma, China Start

Optoelectronics Technology (CSOT), Visonox, and EverDisplay. The diversification of OLED

supply will help to reduce the cost of OLED panels and accelerated adoption rates.

-35%

-30%

-25%

-20%

-15%

-10%

-5%

0%

5%

10%

15%

20%

-

1,000

2,000

3,000

4,000

5,000

6,000

7,000

8,000

9,000

2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017

Market size Yoy

(USDmn)

-

0.50

1.00

1.50

2.00

2.50

-

1,000

2,000

3,000

4,000

5,000

6,000

2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017

Shipment volume (LHS) ASP (RHS)

(mn) (USD)

We see an increase in the

penetration rate of OLED

smartphones


September 2018

28

Exhibit 40. Global OLED smartphone adoption rate

Exhibit 41. OLED capacity expansion trend

Source: HSBC Research Source: Company data, HSBC Research

Touch display driver integration (TDDI)

Integrating display and touch driver solutions was introduced by Synaptics in 2015. It combines

the display and touch driver IC into one chip, which simplifies design and improves the device’s

reliability. TDDI has other advantages, including: 1) preventing electrical display noise from

interfering with touch sensing; 2) lower BOM (bill of materials). The in-cell display driver IC and

touch sensor are mounted on the thin film transistor (TFT) glass, which enables one flexible

printed circuit (FPC) for interfacing with display and touch. This means TDDI requires one less

FPC and IC than a conventional design; and 3) a slim form factor as it has narrower borders to

support narrow bezels, reflecting the popularity of bezel-less, full-screen phones.

WitsView, a market research company, expects bezel-less phones’ penetration to surge from 8.7%

in 2017 to 44.6% in 2018 and 92.1% in 2021. Meanwhile, IHS forecasts that TDDI chip demand will

grow from 220m in 2017 to 280m in 2018 and 410m in 2022, implying a 13% CAGR over 2017-22.

We estimate TDDI’s penetration rate will increase from 15% in 2017 to 24% in 2022. TDDI is mainly

used in Android models such as Huawei P, Honor, the Nova series, and Vivo X series.

The program to run display and touch drivers is quite large, especially for notched full screen as

a more sophisticated algorithm is required to calculate the shaped corner areas’ parameters.

This means that an external NOR flash memory is needed to store the code for TDDI. The

memory density is around 4-16MB.

Exhibit 42. Illustration of TDDI and discrete touch/display solution

Source: HSBC Qianhai Securities

10%

13%

20%

23% 23%

28%

0%

5%

10%

15%

20%

25%

30%

-

100

200

300

400

500

600

2014 2015 2016 2017 2018e 2019e

Global OLED smartphone shipmentGlobal OLED smartphone adoption ratio

(mn)

33 55 143

189 239 269

--

10

25

45 60

1

4

54

145

249

-

100

200

300

400

500

600

700

2015 2016 2017 2018e 2019e 2020e

Samsung flexible OLED capacity LGD OLED capacity China flexible OLED capacity

3356

157

269

578('000 sheets/month, 6G eqiuiv.)

430

Main Board

Display FPC

Display Driver

Touch IC

Touch FPC

Touch panel

Display panel

Full In-cell Panel

TDDI

Display FPC

Main Board

Connector

TDDI solutionDiscrete display and touch driver

29


September 2018

Exhibit 43. TDDI chip demand forecast Exhibit 44. Full screen phone penetration

forecast

Source: IHS, HSBC Qianhai Securities Source: WitsView

Automotive: growing density and wider applications drive growth

NOR flash was initially used in vehicles’ radio systems due to its low density and reliability. With

the growing electrification trend, more auto components need high-performing memory to

improve the user experience and facilitate autonomous driving functions. NOR flash’s fast read

nature (up to 500MB per second) boots up a vehicle’s operating system and turns on functions

(such as infotainment and ADAS) instantly. NOR flash also offers a more stable performance in

harsh environments such as extreme temperatures than NAND and DRAM. In addition, its

longevity makes it ideal for use in dashboard display, front/rear cameras, and the power train,

and may also suit light detection and ranging (LIDAR) in the future.

Different auto electronics systems require varied types and densities of memory. NOR flash

is preferred for powertrain systems as it known for reliability and endurance. It requires

memory to work at extreme temperatures (from -40 to +125 degree Celsius). Memory

enhances conventional engines and enables new types of engines such as electric

vehicles. NOR flash also improves transmission shift control, start/stop and advanced

thermal schemes.

Communication systems need multi-chip packages (MCP), which combine more than one

type of memory technology. It needs to fit into tight spaces in communication modules and

integrate with smartphones and other wireless devices.

For infotainment and cluster systems, DRAM NOR and NAND and MCP are all needed to

meet a variety of applications. NAND is used for storage such as contacts, maps, and

media, while DRAM supports the bandwidth demands associated with high-resolution

video. NOR flash provides head-up displays.

For ADAS, multiple types of memory are needed to complete three stage computing

performance (sense, perceive, and act). Functions such as night vision, traffic sign

recognition, adaptive cruise control, and parking assistance demand memory with the

highest performance standards.

Central control operating systems are currently equipped with 128-256MB NOR flash memory,

while driving recorder, infotainment, GPS, and ADAS functions (such as all-round vision, lane

departure warning system, automatic braking system) generally need 512MB NOR flash or SLC

NAND, plus 1-2GB DRAM.

Cypress Semiconductors, a leading US company, expects ADAS inclusion in mid-end vehicle

models to be the key drivers for NOR flash memory in the coming years. The company

forecasts that ADAS system shipments will increase from 133m in 2017 to 280mn in 2021.

4

50

220

280

320

350380

410

0%

5%

10%

15%

20%

25%

30%

0

50

100

150

200

250

300

350

400

450

2015 2016 2017 2018e 2019e 2020e 2021e 2022e

TDDI TDDI Penetration (RHS)

(mn)

8.7%

44.6%

71.6%

87.7%92.1%

2.4%

15.7%

22.6%25.1% 26.9%

0%

10%

20%

30%

40%

50%

60%

70%

80%

90%

100%

2017 2018e 2019e 2020e 2021e

Bezel less phone penetration Shaped cutting phone penetration


September 2018

30

Accordingly, NOR Flash revenue should increase from USD58m in 2017 to USD121m in 2021,

a 20% CAGR.

Cypress claims to have a 65% market share in the automotive NOR flash in 2017. Macronix is

also increasing its exposure to auto, industrial and medical segments but the contribution from

consumer electronics fell from 31% in 1Q16 to 24% in 1Q18.

Exhibit 46. NOR flash market size in ADAS system

Exhibit 47. Macronix NOR flash revenue breakdown

Source: Cypress Semiconductor Source: Company data

IoT the long-term driver

IoT systems contain an SoC chip comprising a microcontroller, RF, memory, sensor and other

components. IoT chips generally need to be low cost, small in size with low power consumption,

low density, fast read/execution and secure access to handle frequent communications between

various types of devices.

An SoC normally has embedded non-volatile memory (NVM) such as Flash (eFlash) as it saves

energy and time to copy code from external memory, which is widely applied in wearable

devices. NOR flash is a preferred choice of eFlash due to its low cost, fast read and reliability.

NOR flash offers lower cost for densities below 512MB, while NAND flash has bit cost

advantage for higher density memory. External memory is also needed for devices that need

high density, such as smart homes, e-readers, home gateways, set-top boxes, and WiFi routers.

Devices that need to execute in place (XIP) functionality require code execution directly from

Flash memory without shadowing it to DRAM. NOR flash is a more robust technology that can

reliably operate without the need for Error Correction Code (ECC). NAND flash requires a

controller to manage the operation, including detecting and correcting errors in random memory

location, managing blocks of that memory that have errors in them and relocating or mapping

locations with errors to new locations that are error-free.

The IoT is still in the early stage of growth. Ericsson forecasts that the number of connected IoT

devices will reach 19.8bn by 2023, up from 7bn in 2017, implying a CAGR of 19%. GSMA

projects a total of USD1.8trn in IoT application service revenue by 2026, led by smart homes

(USD441bn), consumer electronics (USD276bn), connected vehicles (USD273bn) and

connected industry (USD164bn).

88

133

280

28

58

121

0

20

40

60

80

100

120

140

0

50

100

150

200

250

300

2015 2017 2021e

ADAS systems shipment (LHS) NOR Flash market size in ADAS (RHS)

(USDm)(mn)

31%

34%

36%

34%

29%

29%

31%

27%

24%

22%

26%

25%

29%

30%

32%

31%

31%

30%

16%

14%

11%

11%

12%

10%

9%

10%

13%

4%

8%

8%

6%

7%

7%

8%

10%

13%

10% 17%

18%

20%

20%

22%

22%

21%

22%

20%

0% 20% 40% 60% 80% 100%

1Q16

2Q16

3Q16

4Q16

1Q17

2Q17

3Q17

4Q17

1Q18

Consumer Communication

Auto Industrial, medical and automation

Handset and others Computer

31


September 2018

Exhibit 48. Embedded NVM comparison Exhibit 49. IoT connected devices forecast

Source: Company data, HSBC Qianhai Securities Source: Ericsson

Apart from the demand drivers mentioned above, we also see bit density increasing and new

applications driving demand. These include: 1) PC BIOS upgrade. The 8th generation Intel Core

CPU requires an upgrade of NOR Flash memory from 64MB/128MB to 256MB; 2) Nintendo

Switch has NOR flash memory inside the game console.

NOR flash shipments in 2017 totalled around 5.7bn units, according to WSTS. We forecast that

volume demand for NOR flash will rise at a CAGR of 5-10% over 2018-20e.

Supply chain consolidation favours Chinese vendors

The NOR flash supply chain has migrated from the US and Korea to the Greater China region in

the past few years. In 2007, Spansion, Intel, Samsung and ST Microelectronics were the largest

NOR flash suppliers with over 80% market share. In 2008, Micron acquired Intel and

STMicroelectronics’ NOR flash business to become the No. 2 vendor.

Micron and Samsung Electronics have since switched their focus from NOR flash to 3D NAND

flash and the DRAM market, and their market share has declined over the past decade.

Samsung discontinued NOR flash production in 2012. Meanwhile, Cypress entered the NOR

flash industry by taking over Spansion in 2014. But since its strategy is to keep its overall gross

margin at around 50%, it has phased out some low-margin NOR flash business and now

focuses on the auto and industrial market; its gross margin for the segment is over 40%.

These changes in industry terrain are creating opportunities for Taiwan- and China-based

companies such as Macronix, Winbond and GigaDevice to gain market share. We now take a

closer look at the three companies’ capacity and product strategy.

Exhibit 50. Market share of NOR flash Exhibit 51. NOR flash product offering comparison

Node Density Voltage

Micron 46nm 128Mb-2Gb 1.65-3.6V Cypress 110-45nm 8Mb-4Gb 1.8-3.0V Winbond 90-46nm 512Kb-512Mb 1.2-3.0V Macronix 130-55nm 512Kb-2Gb 1.8V-5.0V GigaDevice 130-45nm 512Kb-1Gb 1.8-3.0V

Source: Company data, SemiInsights, HSBC Qianhai Securities Source: Company data

eFlash

One-time

programmable

(OTP)

Multi-time programmable

(MTP)

Electrically erasable programmable

read-only memory

EEPROMeFuse

Customized

Density

Endurance

4MB

2MB

256Kb

4Kb

1 1K 20K 100K 0.62.4

6.4

17.4

1.6

1.7

7.5

8.8

1.4

1.3

0

5

10

15

20

25

30

35

2017 2023e

Fixedphones

Mobilephone

PC/laptop/tablet

Short-rangeIoT

Wide-areaIoT

19% CAGR for IoT devices

(bn)

10% CAGR for connected devices

0.0%

5.0%

10.0%

15.0%

20.0%

25.0%

30.0%

35.0%

40.0%

2008 2009 2010 2011 2012 2013 2014 2015 2016 2017

Macronix

Cypress/Spansion

Micron

Winbond

GigaDevice

Others

The NOR flash supply chain

has migrated from the US

and Korea to the Greater

China region


September 2018

32

Macronix

Macronix, a Taiwan company, provides NOR flash, NAND Flash and ROM products. NOR flash

accounts for 44% of its 1Q18 revenue. Due to competition from Chinese competitors, it is

shifting its focus to high quality, high density NOR flash. The company ran at full capacity

utilization in 1Q18 and does not plan to expand production capacity in the foreseeable future.

That said, product mix optimization and a focus on high value-added products will be the key drivers.

Its NOR flash bit shipments declined 21% y-o-y and 27% q-o-q (chip volume times density). This was

mainly because of a fall in volume shipments in low-density products. Macronix expects 55nm plus

NOR flash will account for 18% of its total sales in 2018, up from 3% in 2017.

Macronix has two major fabs for NOR flash. The 8-inch fab (Fab 2) focuses on 130-75nm nodes,

with monthly capacity of 46,000 pieces of wafer. The 12-inch fab (Fab 5) mainly produces 75-55nm

NOR Flash and 36-19nm SLC NAND, with monthly capacity of 20,000. The company indicates it can

switch 55nm NOR flash capacity to 36nm NAND based on market demand.

Exhibit 52. Macronix NOR flash sales by node technology

Exhibit 53. Macronix NOR flash density shipment index

Source: Company data Source: Company data

Winbond

Winbond, listed in Taiwan, focuses on low- to medium-density Flash (NOR and NAND) memory, as

well as specialty and mobile DRAM products. Flash memory accounted for 52% of its revenue in

4Q17. Winbond’s capacity will increase from 46,000 in 2017 to 52,000 pieces/month (12 inch) in

2018, of which 26,000 are related to Flash (NOR plus NAND). Given Winbond has a longer track

record in NOR flash, we estimate it to account for over half of the total Flash capacity.

The auto and industrial segments are the main revenue drivers, with the percentage of total

revenue increasing from 2% in 2012 to 19% in 2017. Winbond focuses on 90nm and 58nm

NOR flash. It specializes in series NOR flash, an area where it is the No. 2 supplier in the world.

0% 1% 1% 1% 2% 2% 3% 5% 6%1% 3%

13%

42%46% 49% 46% 43%

48%51%

55% 51%

46%50%

50%

58%53% 50% 53% 55%

50% 46%40% 43%

53%47%

37%

0%

10%

20%

30%

40%

50%

60%

70%

80%

90%

100%

1Q16 2Q16 3Q16 4Q16 1Q17 2Q17 3Q17 4Q17 1Q18 2016 2017 2018e

≤55nm ≤75nm ≥0.1um

100

113

127

114 112

127

144135

126

142153 151 150

160170 164

119

-25%

-20%

-15%

-10%

-5%

0%

5%

10%

15%

20%

25%

0

20

40

60

80

100

120

140

160

180

1Q14

2Q14

3Q14

4Q14

1Q15

2Q15

3Q15

4Q15

1Q16

2Q16

3Q16

4Q16

1Q17

2Q17

3Q17

4Q17

1Q18

Density shipment Yoy

(1Q14=100)

33


September 2018

Exhibit 54. Winbond revenue breakdown by application

Exhibit 55. Flash revenue by geometry


GigaDevice

Unlike peers that have in-house wafer fabrication facilities, Beijing-based GigaDevice uses a

fabless model and relies on third party foundries and packaging companies to manufacture its

products. It mainly uses SMIC and Wuhan Xinxin’s 12-inch fabs. SMIC has total capacity of

447,750 wafers (8-inch equivalent) in 1Q18.

GigaDevice signed an agreement with SMIC in September 2017 to purchase not less than

RMB1.2bn of wafers by the end of 2018. In 2017, GigaDevice’s transactions with its top two

material suppliers amounted to only RMB621m and RMB228m. We therefore believe

GigaDevice plans to increase procurement from SMIC significantly in 2018.

Wuhan Xinxin is a dedicated Flash memory foundry and has monthly capacity of 10,000 pieces

(12-inch) for NOR flash. Customers include ESMT, Cypress (Spansion), and GigaDevice. But due to

supply constraints in raw wafers, it is not able to allocate additional capacity to GigaDevice. We

believe GigaDevice may also partner with Huali Microelectronics for additional capacity.

While GigaDevice does not disclose detailed capacity data, by gauging the revenue size and

capacity of Macronix and Winbond, we estimate GigaDevice’s actual production output required

around 12,000 pieces/month capacity (12-inch) in 2017. We believe GigaDevice’s fabless

model offers flexibility in terms of expanding and cutting capacity during the industry cycle.

Given the strong outlook, we think the company will benefit from an increase in demand.

Balanced demand & supply outlook in 2018-20

Global NOR flash capacity was around 88,000 wafers a month in 2017. Winbond said at its

4Q17 analyst meeting that total wafer capacity for NOR has increased 13% y-o-y in 1H18 to

approximately 100,000 pieces. We think this estimate factors in 25,000 pieces a month capacity

from SMIC for GigaDevice (source: Taiwan Economic Daily, 13 November 2017).

However, given GigaDevice’s revenue growth (20% y-o-y growth in 1Q18), we believe the

actual capacity is much less than reported. We forecast that GigaDevice’s utilized capacity will

increase from 12,000 pieces in 2017 to 21,600 pieces in 2020. Other key suppliers may include

Powerchip as the company started producing 65nm NOR flash from 4Q17 at its Hefei plant. We

model 5,000/10,000/15,000 pieces in 2018/19/20. Given that US peers are phasing out

capacity, we project a 5% decline in annual capacity over 2018-20e. As a result, the total NOR

flash capacity will increase by 7%, 8%, and 8% in 2018/19/20, which fits in with our forecast of a

5-10% growth in demand during this period.

As node migration in NOR flash is quite slow these days, the increase in demand for a certain

product category will generally translate into wafer volume growth. But since individual memory

29% 28%28%

28%25% 29%

34%

37% 34% 33%32%

29%

35%

30% 31%

28%25% 23%

2%

5%7%

11%

18% 19%

0%

5%

10%

15%

20%

25%

30%

35%

40%

2012 2013 2014 2015 2016 2017

Consumer Communication Computer Car & Industrial

42% 37% 35%

57%56%

53%

1% 7%12%

0%

10%

20%

30%

40%

50%

60%

70%

80%

90%

100%

2014 2015 2016

90nm 58nm 46nm


September 2018

34

chip density varies, the total wafer equivalent capacity is not able to precisely reflect bit density

changes due to product mix shift.

Exhibit 56. NOR flash capacity forecast

('000 12-inch pieces) 2017 2018e 2019e 2020e 2017-20 CAGR

Macronix 30.4 30.4 30.4 30.4 0% Winbond 16.0 16.0 17.0 18.0 4% GigaDevice 12.0 15.0 18.0 21.6 22% Powerchip - 5.0 10.0 15.0 n/a Others 29.6 28.1 26.7 25.3 -5% Total 88.0 94.5 102.1 110.4 8% y-o-y 7% 8% 8%


Opportunity 2: Semi equipment – import substitution potential

Semi equipment sales to grow rapidly in 2018, China emerging as the key driver

According to SEMI, the global semiconductor equipment market increased 37% y-o-y to

USD56.6bn in 2017 and is expected to grow 11% y-o-y to a record high of USD63bn in 2018.

The rapid growth is being driven by: 1) memory fab capacity expansion by Samsung and SK

Hynix in Korea; and 2) a growing number of fab investments in China, including both domestic

and foreign enterprises. As a result, equipment sales in China increased 27% y-o-y to

USD8.23bn in 2017. China’s global share in equipment sales has risen from 7% in 2012 to 15%

in 2017, making it the third largest equipment sales market worldwide.

While capex is likely to decline in Korea and Taiwan in 2018-19, SEMI forecasts that China’s

spending on fab equipment will increase by 57% and 60% y-o-y in 2018 and 2019, and the

country is likely to overtake Korea to become world’s biggest spender in 2019. This creates

ample growth opportunities for Chinese semi equipment makers.

Exhibit 57. Global semi equipment sales Exhibit 58. Global semi equipment market share

Source: SEMI Source: SEMI

In China, 12 volume fabs have been constructed since 2014-15, increasing the level of equipment

purchases. In the past, foreign companies dominated fab investment in China. However, with the

launch of Chinese fabs such as NAND Flash Fab by Yangtze Memory Technologies, the DRAM fab

run by Hefei Changxin, and Huahong’s 12-inch fab in Wuxi, domestic companies’ share of

equipment spending in China will increase from 33% in 2017 to 45% in 2019. Our analysis shows the

total capex of the 12-inch fabs currently under construction in China amounts to USD77.8bn,

exceeding the total sales of equipment globally in 2017.

8.2 5.3 8.25.1 4.5 5.6

8.7

5.2

6.87.5 7.7

18.02.5

3.4

4.44.9 6.5

8.29.5

10.6

9.49.6

12.2

11.5

3.4

3.4

4.2 5.54.6

6.5

2.6

1.9

2.4 2.02.2

3.7

2.1

2.1

2.2 2.0

3.6

3.2

0.0

10.0

20.0

30.0

40.0

50.0

60.0

2012 2013 2014 2015 2016 2017

North America Korea China Taiwan Japan Europe Others

(USDbn)

22%17%

22%14% 11% 10%

23%

16%18%

20%19%

32%

7%

11%

12%13%

16%

15%

26%33%

25%26% 30%

20%

9% 11% 11% 15% 11% 11%

7% 6% 6% 5%5% 6%

6% 7% 6% 5% 9% 6%

0%

10%

20%

30%

40%

50%

60%

70%

80%

90%

100%

2012 2013 2014 2015 2016 2017

North America Korea China Taiwan Japan Europe Others

35


September 2018

While Chinese vendors are now only able to provide 28nm and above node equipment, we

understand a sizable part of the capacity of the new fabs under construction is targeting below

28nm. As a result, we estimate the addressable market size for Chinese equipment on 28nm

and above node is USD4bn in 2018 and USD6bn in 2019.

Exhibit 59. Number of fabs starting construction

Exhibit 60. IC equipment sales in China

Source: SEMI Source: SEMI

5

11

1312

10

3

11

16

9

15

10

4

0

2

4

6

8

10

12

14

16

18

2014 2015 2016 2017 2018e 2019e

China All other regions

2.53.4

4.4 4.9

6.5

8.2

12.9

20.7

0%

10%

20%

30%

40%

50%

60%

70%

0.0

5.0

10.0

15.0

20.0

25.0

2012 2013 2014 2015 2016 2017 2018e 2019e

China Yoy

(USDbn)

Exhibit 61. List of 12-inch fabs in China

Company Location Project Technology node Capex Capacity Date of construction Date of operation

(USDbn) (k/month)

Under construction / planning

SMIC Shanghai South China JV 14nm 10.2 70 Oct-16 2019 Beijing North China JV 28nm HKMG 3.6 35 n/a n/a

Huahong Wuxi 65-90nm 2.5 40 Mar-18 2019 Huali Microelectronics Shanghai 28-14nm n/a 40 2016 2018 Samsung Xi'an NAND Flash 10nm 7.0 80 Mar-18 2019 SK Hynix Wuxi DRAM 10nm 8.6 60 Nov-17 2018

Yangtze Memory Wuhan NAND Flash / DRAM 24.0 300 Dec-16 2019 Nanjing NAND Flash n/a 300 n/a n/a

Global Foundries Chengdu Logic 0.18-0.13um/22nm SOI 9.1 65 Feb-17 2019 JHICC Jinjiang DRAM 32nm 5.7 60 Jul-17 3Q18 Hefei Changxin Hefei DRAM 19nm 7.2 125 May-17 2019 Current 12 inch fab in China

SMIC

Shanghai 45/40nm-28nm n/a 17 Oct-05 Dec-07 Beijing 0.18um-28nm n/a 46 Sep-02 Sep-04 Shenzhen 65-55nm n/a 3 Nov-16 4Q17 Beijing North China JV 40/28nm Polysion 3.6 29 Jul-13 4Q15

Huali Microelectronics Shanghai 55-40-28nm n/a 35 Jun-10 Apr-11 Samsung Xi'an NAND Flash 10.0 120 Apr-12 May-14 SK Hynix Wuxi DRAM 10.5 140 2005 2006 Intel Dalian 3D NAND Flash/ CPU 65nm 8.0 60 2007 2010 TSMC Nanjing 16nm FinFET 3.0 20 Jul-16 May-18 Wuhan Xinxin Wuhan NOR Flash 32nm 4.5 30 2011 2012 Powerchip Hefei Driver IC 90nm 2.0 40 Oct-15 Oct-17 UMC Xiamen Logic 55-40nm 2.1 50 Mar-15 Dec-17 Tacoma Huai An Image sensor 65/55nm 2.4 20 Mar-16 2017



September 2018

36

Of this, wafer fabrication equipment (WFE), which is used in front-end semiconductor

manufacturing, represents over 80% of the total spending, with the balance going on back-end

processes such as probing, assembly and testing. The wafer fabrication process includes

deposition, lithography, etching, stripping, and cleaning.

US and Japanese vendors are the leading semi-equipment suppliers while European

companies such ASML have a dominant position in lithography equipment. Chinese companies

are catching up but still lag behind global peers in terms of technical know-how, product range,

and revenues.

Exhibit 63. Global semi equipment market by segment

Exhibit 64. Semi equipment capex breakdown in 2016

Source: ASM, VLSI Source: SEMI

China’s government has assigned a number of R&D projects to leading domestic semiconductor

companies, research institutes, and universities since 2008, an initiative known as the “02

special project”. This project covers advanced equipment and materials and has achieved

several breakthroughs. As at May 2017, China was able to mass produce over 16 types of front

end wafer fabrication equipment, mainly 28nm and above. In particular, AMEC’s 7nm etch

equipment is now part of TSMC’s supply chain.

Naura is also able to provide a wide range of equipment and it supplies 28nm etch equipment to

SMIC’s Beijing fab. Meanwhile, Shanghai Micro Electronics Equipment (SMEE) is one of the

few vendors worldwide able to provide 90nm lithography equipment.

Lithography, 10.5, 19%

Etch and clean, 14.8, 26%

Deposition, 11.5, 20%

Process diagnostics,

6.5, 12%

Other wafer processes, 4.1,

7%

Test, 4.7, 8%

Assembly, 4.4, 8%(USDbn)

Wafer , 32.8, 80%

Packaging & assembly,

3.0, 7%

Test, 3.7, 9%

Others, 1.7, 4%

(USDbn)

Exhibit 62. Front-end wafer fabrication process


Incoming

WAFERDEPOSITION LITHOGRAPHY ETCH STRIP CLEAN DEPOSITION

Put down the

insulating layers

to be patterned

Create the

pattern mask

Deposit conducting

materials for the

device

Remove residues

and particles

Remove the

photoresist mask

Selectively

remove material

to create features

37


September 2018

Chinese companies are also catching up in back-end packaging and test equipment. They are

able to produce 15 kinds of equipment and aim to lift the self-supply ratio to 50% by 2020 from

30% in 2015. In the 13th Five-Year Plan (2016-20) the target is to penetrate the 20-14nm

segment and increase the self-supply ratio in equipment and material.

Exhibit 66. “Made in China 2025” technology roadmap for semi equipment industry

Source: MIIT, HSBC Qianhai Securities

2015 2020 2025 2030

Manufacturing

Equipment

Lithography

Manufacturing

Materials

Package equipment

& materials

90-32nm equipment, to

reach 50% self-sufficiency 20-14nm equipment, with

30% self-sufficiency ratio18-inch wafer equipment

90nm equipment Immersion Lithography EUV Lithography

65-32nm equipment, to

reach 50% self-sufficiency

22-14nm equipment, with

50% self-sufficiency ratioTo realize full self-

sufficiency

30% self-

sufficiency ratio

30% self-sufficiency

ratio To realize full self-sufficiency

Exhibit 65. Product mapping of major semi equipment vendors

Applied ASML Tokyo Lam KLA ASM Advantest Naura AMEC

Materials Electron Research Tencor Pacific AMAT US ASML US 8035 JP LRCX US KLAC US 522 HK 6857 JP 002371 CH Private

FY17 revenue (USDbn) 14.5 10.3 10.2 8.0 3.5 2.2 1.9 0.3 0.2 Headquarter US Netherland Japan US US China Japan China China Product category

Lithography No Yes No No No No No No No Etch Yes No Yes Yes No No No Yes Yes Clean Yes No Yes Yes No No No Yes No Deposition Yes No Yes Yes No No No Yes Yes Process diagnostics Yes No No Yes Yes No Yes No No Other wafer processes Yes No Yes Yes Yes Yes No Yes No Test No No Yes No Yes Yes Yes No No Assembly No No No No Yes Yes No No No



September 2018

38

Exhibit 67. List of major Chinese semi equipment vendors

Company name Major products

Naura

Plasma etcher, physical and chemical vapor deposition (PVD/CVD)

oxidate/diffusion, cleaning tool, indexer, gas measuring control

LCD, LED, and solar equipment

AMEC Plasma etcher on dielectric and polysilicon film, including reactive ion

etching (RIE), through-silicon via (TSV), MOCVD.

Shanghai Micro 90nm lithography, wafer optical inspection, material transport robot

Electronics Equipment wafer aligner/bonder, wafer edge exposure equipment

CETC Electronics Ion implanter, Chemical mechanical planarization (CMP)

Equipment Group Electrochemical deposition (ECD), packaging equipment

Piotech Plasma enhanced electric chemical vapor deposition (PECVD)

Atomic layer deposition (ALD)

Raintree Scientific Optical inspection equipment

Instruments

Han’s Laser Ultraviolet laser slicing, wafer modification cutting, laser stripping

ACM Research Single-wafer megasonic cleaning tools

KingSemi Coater, developer, cleaner, wet etcher, striper


Laser source’s self-sufficiency ratio is increasing

As at 2016, China was able to produce 85% and 50% of its low-power (<100W) and mid-power

(100-1,000W) laser source needs, but had limited capabilities in the high-power (>1,000W)

category, which is dominated by overseas vendors such as IPG, Coherent, Trumpf, and nLight.

Chinese companies such as Raycus Laser and Han’s Laser have started to penetrate the high

power market, with output up to 10KW. This could significantly lower the overall manufacturing

cost for Chinese laser equipment makers and reduce reliance on imports at a time of rising

trade tensions between the US and China.

IPG’s gross margin was 57% in 2017, which suggests that is should be possible to reduce laser

sourcing cost via domestic production. The total market size of laser sources increased from

USD9.0bn in 2013 to USD12.4bn in 2017, a CAGR of 8.5%.

Opportunity 3: IC packaging and testing – market share gains

Outsourcing and consolidation favours leading OSAT

The packaging and testing market accounts for a mid-teens percentage of global IC industry

output. In China, however, the figure was 35% in 2017, indicating its heavy reliance on this

segment. Packaging and testing is the IC segment where China’s technology gap with global

peers is the smallest.

The global market can be divided into IDM in-house packaging and testing, and OSAT.

According to Gantner, in 2016 the share of IDM in-house and OSAT was 48% and 52%,

respectively. We think IDM will outsource or spin off some of the packaging and testing services

in an environment of rising investment in advanced packaging technology. Hence, the market

growth of OSAT should be slightly faster than for IDM.

As the semiconductor industry enters a mature stage, competition is intensifying. Similar to the

upstream design house and foundry industry, the OSAT market is also consolidating as the

leaders seek larger economies of scale and better technology to remain competitive.

39


September 2018

Earlier this year ASE, the largest OSAT company, merged with SPIL, the No. 4 company. The new

giant has nearly 30% of the OSAT market. In 2016, Amkor acquired J-Device, the largest OSAT in

Japan, and Nanium, a leading OSAT company in Europe, in 2017. PTI ( ) acquired Micron Akita

in 2017, a packaging and testing site of Micron in Japan. JCET acquired STATS ChipPAC in 2014,

and Tongfu bought an 85% stake in two AMD packaging and testing fabs in 2016.

According to TechSearch, the number of OSAT companies worldwide is over 100, but the top 10

represent nearly 75% of the market. Taiwan now has the strongest presence in OSAT, followed

the US, China, and Singapore. China’s IC packaging and testing market reached RMB189bn in

2017, a 15.2% CAGR since 2005, outpacing the global packaging and testing market. Among the

top 10 global OSATs, revenue generated by China’s top three OSATs – JECT, Huatian, and

Tongfu – increased from 6.6% in 2011 to 21.2% in 2017.

Exhibit 68. Market share among top 10 global OSATs

Exhibit 69. OSAT M&A activity

Year M&A events

2013 Amkor acquired Toshiba's P&T operations in Malaysia.

2014

UTAC acquired Panasonic's P&T operations in Singapore, Indonesia and Malaysia.

2015

Tianshui Huatian acquired FlipChip International. JECT acquired STATS ChipPAC. Amkor acquired J-Devices.

2016 Tongfu and National IC Fund acquired 85% stake of AMD's P&T operations in Malaysia and China.

2017

PTI increased its stake in Tera Probe to nearly 60% and acquired Micron Akita. Amkor acquired NANIUM.

2018 ASE merged with SPIL.

Source: Company data, HSBC Qianhai Securities Source: HSBC Qianhai Securities

China is benefiting from upstream capacity expansion

We expect growth in China’s packaging and testing market to remain robust in the coming years

thanks to upstream capacity expansion. SEMI estimates that 62 wafer fabs will come start

operations between 2017 and 2020, of which 26 are located in China. These new fabs will bring

new orders to Chinese packaging and testing companies.

Exhibit 70. China packaging and testing market trend

Exhibit 71. China top 10 packaging and testing companies by revenue (RMBbn)

Ranking Company Revenue

1 Xinchao Group (JCET's parent Co)

24.26

2 Huada Group (Tongfu's parent Co)

19.88

3 Tianshui Huatian Group (Huatian's parent Co)

9.00

4 Qorvo 7.89 5 NXP 6.45 6 Intel 4.00 7 Amkor 3.95 8 Hitech 3.50 9 KaiHong 3.00 10 SanDisk 2.94

Source: CSIA Source: CSIA

40.3% 40.5% 42.6% 43.3% 43.6%37.0% 36.6%

17.7% 17.0% 17.0% 16.0% 14.1%16.9% 16.1%

13.3% 13.5% 13.4% 14.0% 12.7%11.5% 10.5%

6.6% 7.5%8.7% 9.8% 13.2% 19.1% 21.2%

22.1% 21.5% 18.2% 17.0% 16.4% 15.5% 15.6%

0.0%

20.0%

40.0%

60.0%

80.0%

100.0%

2011 2012 2013 2014 2015 2016 2017

ASE Amkor SPIL China top 3 OSATs Others

34

51

63 62

50

63

98 104

110

126

138

156

189

-

20

40

60

80

100

120

140

160

180

200

2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017

15.2% CAGR

(RMBbn)


September 2018

40

Advanced packaging is moving into the mainstream as manufacturers seek ways to improve

device performance. The semiconductor industry is also witnessing increasing investment from

packaging houses in terms of capabilities, capacity, and infrastructure. This is driven by the

need to deliver integrated, high-performance devices while addressing concerns about cost,

power consumption, and size.

Advanced packaging has two development paths: 1) size reduction, i.e. reducing chip size close

to the die size; typical platforms include FC (Flip-Chip) and Fan-in/Fan-out WLP (Wafer Level

Packaging); and 2) functional development, i.e. emphasis on integration to provide multi-

functions in system miniaturization; platforms include TSV (Through-Silicon Visa) technology +

SiP (System in Package).

Exhibit 72. IC packaging technology trend


Yole Development, a consulting firm, estimates that the global advanced packaging market was

worth USD24bn in 2017 and will reach USD34bn in 2022, accounting for 45% of the total

packaging market and representing a CAGR of 7%. This outpaces the 3-4% CAGR of the

overall packaging market and the 4-5% CAGR of the semiconductor market.

Yole expects the growth in the advanced segment to be led by smartphones and tablets. Other

high-volume applications include servers, PC, game stations, HDD/USB, WiFi hardware, base

stations, TVs and set top boxes. FC is the mostly used platform with 81% market share in 2017,

while Fan-out is the fastest growing advanced packaging platform with a 36% CAGR, followed

by the 2.5/3D TSV platform (28% CAGR). By 2022, the market size of Fan-out and 2.5D/3D

TSV is expected to exceed USD3bn and USD1bn, respectively.

1970s 1980s 1990s 2000s

Through hole

mounting

Increasing I/O; Increasing Functionality

Surface

mounting

Area array

surface

High density

packaging

- TO, DIP

- Mounted on the PCB

though holes, the

packaging size is

increased with

number of I/O

- ≤10 I/Os/cm2

- Strong, reliable,

good heat dissipation,

easy wiring

- SOP,QFP

- Lead replaces pin,

packaging size is

fixed and peripheral

I/Os pitch changes

according to

requirements

- 10-50I/Os/cm2

- Improved I/O

number and assembly

density

- BGA, CSP

- Solder ball replaces

lead, area array

surface mounting

- 40-60I/Os/cm2

- Greatly improved

I/O number, low

power consumption

- WLP, 3D stacking

- Reduce packaging

thickness or stack

more than two dies in

the same packaging

without changing the

packaging size

- ≥60I/Os/cm2

- High integration, low

power consumption

41


September 2018

Exhibit 73. Advanced packaging revenue by platform

Exhibit 74. Advanced packaging wafer share by manufacturer

Source: Yole Source: Yole

According to Yole, the advanced packaging revenue generated from Chinese companies was

USD2.2bn in 2015, and will reach USD4.6bn in 2022, a 16% CAGR and about 2x faster than

the growth in the global advanced packaging market.

Through in-house R&D and acquisition, domestic packaging and testing companies have

broadly caught up with international peers in terms of technology. They are still lagging behind

in some specific platforms, such as high density Fan-out.

At present, the top three Chinese OSATs – JCET, Huatian and Tongfu – have mastered the

16/14nm FC packaging technology. JCET now owns leading-edge Fan-in/Fan-out and SiP

technology through the acquisition of STATS ChipPAC. It has shipped more than 1.5bn low-

density Fan-out chips.

Tongfu obtained high IOs density FC-BGA packaging technology through the acquisition of

AMD Suzhou and Penang fabs. Huatian’s TSV+SiP fingerprint identification packaging product

has been used in Huawei smartphones. Meanwhile, WLCSP ( ) has become one of the

world’s largest image sensor WLP (Wafer-Level Packaging) suppliers. According to the China

Semiconductor Industry Association, domestic packaging and testing companies contributed

32% of China advanced packaging market in 2016.

Exhibit 75. Advanced packaging revenue from Chinese companies

Exhibit 76. Fan-out packaging applications focus for player

Source: Yole Source: Yole

0.0

5.0

10.0

15.0

20.0

25.0

30.0

35.0

40.0

2017 2022

Fan-in Fan-out Flip Chip 2.5D/3D

7% CAGR

* CAGR 2017-2020

(2.5D/3D 28%*)

(Flip Chip 5%*)

(Fan-in 8%*)

(Fan-out 36%*)

(USDbn)

Intel12%

SPIL12%

JCET/STATS ChipPAC

8%

ASE8%

ChipBond8%

Samsung7%

TSMC7%

Amkor6%

Others33%

2.21

2.56

2.97

3.45

4.01

4.66

-

0.50

1.00

1.50

2.00

2.50

3.00

3.50

4.00

4.50

5.00

2015 2016 2017e 2018e 2019e 2020e

16% CAGR

(USDbn)

2x2 5x5 10x10 15x15 20x20 >20x20 >>20x20

Package size

(mm x mm)

100

1000

10000

IO count

Core Fan-out

High density, Fan-out,

First level, APE

High density, Fan-out, Second

level, networking, etc…

SPIL

AmkorTSMC

ASETSMC

SamsungNepes

JCET/

STATSChipPAC

ASE

SPIL

Deca Technologies

Amkor/

Nanium

Different Fan-out platforms for different applications…and different suppliers.


September 2018

42

The potential to improve margins and ROE

The top Chinese OSATs on average generated a gross margin of 14.7% and ROE of 5% ROE

in 2017. This is considerably lower than their Taiwan/US peers, which recorded average gross

margins of 19.2% and ROE of 14.3%.

We believe this is primarily due to: 1) product mix differences, as fabless and IDM customers

normally place new orders to offshore OSATs and gradually migrate orders to onshore peers as

products become more commoditized; and 2) it will take time for JCET and Tongfu to integrate

their newly-acquired assets. With the ongoing product upgrades and cost structure optimization,

we expect to see improvements in margin and ROE in the years ahead.

Exhibit 77. Gross margin comparison of OSATs

Exhibit 78. ROE comparison of OSATs

Note: offshore companies include ASE, SPIL, Amkor, and Power Tech

Onshore companies include JCET, Huatian and Tongfu


Growth drivers shifting from mobile to auto and IoT

Although the PC and mobile segments will remain the largest part of the IC market, automotive

and IoT are expected to be the fastest semiconductor growth segments in the coming years.

Due to the slowdown in the smartphone market, OSATs’ margins face downward pressure.

Despite the long qualification process, the packaging technology applied in auto and IoT is not

as advanced as in smartphones, making the competitive landscape more competitive.

Traditional lead frame products are by far the largest type of automotive packaging as they have

proved to be very reliable components. Due to the long product life cycle, lead frame packages

selected over a decade ago are still being manufactured for the same applications. This is not to

say that non-lead frame packaging is absent from today’s vehicles.

Due to the increasing complexity and higher performance, pin count, power, and cost

requirements of automotive applications, the packaging industry is moving towards high

performance packages such as flip chip or wafer level fan-out packaging for automotive

infotainment, GPS, and radar applications.

Since IoT products are driven by the need for the smallest form factor (think wearables) and

ultra-low power (for longer battery life), the electronic components for these products must also

meet these criteria. System-in-package (SiP) technology is the trend, it allows multiple die to be

placed within a package molding in a variety of configurations to help solve these size and low-

power design challenges.

17.6%18.2%

20.1% 19.9% 20.4%19.2%

15.8%

19.3%

20.7%20.1%

16.0%14.7%

0.0%

5.0%

10.0%

15.0%

20.0%

25.0%

2012 2013 2014 2015 2016 2017

Offshore Onshore

0.0%

2.0%

4.0%

6.0%

8.0%

10.0%

12.0%

14.0%

16.0%

18.0%

ASE SPIL Power Tech JCET Huatian Tongfu

2012 2013 2014 2015 2016 2017

43


September 2018

Exhibit 79. Share of 2017 IC sales and market size CAGR (2016-21)

Source: IC Insights

-5.0%

0.0%

5.0%

10.0%

15.0%

20.0%

25.0%

30.0%

-3.0% 0.0% 3.0% 6.0% 9.0% 12.0% 15.0%

Automotive $28.0

Cellphones $89.7

IoT $20.9Medical $5.9

Wearables $3.5

Servers $16.7

Standard PCs $69.0

Gov/Military $2.6

Digital TVs $13.8

Set-Top Boxes $5.8

Game Consoles$10.5

Tablets $11.6

(US$ bn)

2016-21 CAGR

Sh

are

of

2017

IC s

ales


September 2018

44

Company updates

45


September 2018

China’s largest semiconductor equipment company

Naura Technology Group is a leading manufacturer of advanced electronic equipment and

precision components. Its products cover a range of industries, including semiconductors, LED,

photovoltaic, display, and aerospace. The company was established in 2001 and was listed on

the Shenzhen Stock Exchange in 2010. It was previously known as Sevenstar Electronics, an

SOE owned by Beijing SASAC that engaged in semiconductor cleaning and oxidation/diffusion

equipment, lithium battery, vacuum equipment for PV, as well as high-precision electronic

components.

In 2016, Sevenstar merged with North Microelectronics (part of the parent company) and

expanded its semiconductor equipment product portfolio to etching, PVD, CVD advanced

packaging and LED equipment. This enabled Naura to become China’s largest semiconductor

equipment company in terms of revenue. Key customers include SMIC, Huali Microelectronics,

San’An, HC SemiTek, BOE, and Longi Silicon. The company has four manufacturing centres in

Beijing – Yizhuang, Shunyi, Pinggu, and Chaoyang – and one in the US.

Exhibit 80. Naura organization chart Exhibit 81. Naura’s business portfolio

Source: Company data Source: Company data, HSBC Qianhai Securities

R&D investment in 2015-17 accounted for between 29% and 47% of its total revenue. Naura is

heavily involved in the government’s “02” R&D initiative and has undertaken 12 research

projects. As a result it has completed the development and commercialization of a number of

products and processes, including 12 inch 90-28nm etcher, PVD, oxidation, cleaning and low

pressure chemical vapour deposition (LPCVD). As at end 2017, Naura had applied for over

3,000 patents, and more than1,600 have been granted.

Beijing Electronics Holding Co

Beijing SASAC

Beijing Sevenstar Huadian

Technology GroupNational IC Investment Fund

Naura (002371 CH)

100%

100%

9.23%38.9% 7.5%

Naura Technology Group

Semiconductor equipmentVacuum

equipment for PV

Lithium battery

equipment

Precision

component

Etch

PVD

CVD

Cleaning

Oxidation/

Diffusion

Mass flow

controllerAssets from North Microelectronics

LED

equipment

Display

equipmentMEMS

Power IC

Naura (002371 CH)

Leading IC equipment vendor with a comprehensive product portfolio

The company invests heavily in R&D. Multiple growth drivers in IC,

display, PCB, and electronic components

Initiate with a Buy rating and a target price of RMB63.97


September 2018

46

Exhibit 82. Revenue and profit trend Exhibit 83. Naura’s patents – applied for and authorized


Semiconductor equipment: gaining traction with customers

In 2017, sales of semiconductor equipment totalled RMB1,134m in 2017 – RMB400m from IC

equipment, RMB500m from LED, RMB130m from display and the rest from solar equipment. Its

IC equipment product portfolio covers etch, PVD, CVD, oxidation/diffusion furnace, cleaning

tools, and mass flow controllers. Naura has accumulated abundant proprietary know-how and

IP in IC equipment in the past decade and can now commercially scale a portfolio covering 90-

28nm technologies and is currently undertaking R&D for 16/14nm.

Exhibit 84. Major milestones of Naura’s IC equipment business

Year Events

2012 The first 300mm diffusion furnace passes customer qualification and starts commercial sales

R&D of 300mm mass flow controller (MFC) completed and enters commercialization phase

2013

300mm oxidation furnace enters mass production

300mm MFC realizes commercial sales; 65mn cleaning tool receives national qualification

Sample shipment of 45-32nm LPCVD equipment

2014 28nm 300mm oxidation furnace meets technical requirements of SMIC

Complete testing of 65-45nm cleaning tool for SMIC; 45-32nm LPCVD under development

2015

Completes 7 equipment sales of 300mm 90/65nm oxidation furnace and MFC

Continues to test 32-28nm LPCVD project within SMIC

Starts R&D of 28-14nm Atom Layer Deposition (ALD)

2016

Completes the merger with North Microelectronics, thus expanding product portfolio to etching,

PVD, CVD

Accelerates its R&D in 16/14nm equipment

2017 Proposes to acquire Akrion System, US based semi cleaning equipment company, for USD15mn

Signs over RMB1.2bn supply contract with Longi on mono silicon furnace

2018 Completes the acquisition of Akrion, US-based cleaning equipment company


-

500

1,000

1,500

2,000

2,500

2010 2011 2012 2013 2014 2015 2016 2017

Semiconductor Electronic component Vacuum Lithium battery Others

(RMBmn)

835

1,055

1,340

1,701

2,226

2,627

2,937 3,013

348 475

619 790

1,018

1,233 1,371

1,621

-

500

1,000

1,500

2,000

2,500

3,000

3,500

2010 2011 2012 2013 2014 2015 2016 2017

Accumulative patents applied Accumulated patent authorized

47


September 2018

Exhibit 85. Naura’s major products and functions

Name Description

Etch A process for removing material in a specific area through a chemical reaction or physical bombardment. The process can be performed using liquid-phase (wet) etchants or under vacuum (dry) typically using a plasma to generate gas-phase reactants

PVD A process technology in which atoms of conducting materials are sputtered from a target of pure material then deposited on the substrate to create the conducting circuitry within an IC or a flat panel display.

CVD A process for depositing thin films by exposing the substrate to one or more volatile precursors, which react and/or decompose on the substrate surface

Oxidation A way to produce a thin layer of oxide (usually SiO2) on the surface of a wafer. This forces an oxidizing agent to diffuse into the wafer at high temperature and react with it

Cleaning A process to remove unwanted material or contaminants from substrates


Its major customers include SMIC, Huali Microelectronics, Yangtze Memory, and Shanghai IC

R&D Center. SMIC accounted for over 60% of Naura’s IC equipment revenue last year. The

company started to supply IC equipment to SMIC in 2011 and began testing 28nm equipment in

2014; its PVD has become the baseline equipment for SMIC.

Naura and AMEC’s etcher products are based on dry etching technology that uses plasma to

remove unwanted material from silicon wafers. Based on the type of plasma, it can be divided into

inductively coupled plasma (ICP), capacitively coupled plasma (CCP) and microwave electron

cyclotron resonance (ECR) plasma. Naura specializes in ICP, while AMEC focuses on CCP.

Exhibit 86. Naura’s IC equipment shipments

Exhibit 87. AMEC’s accumulative IC equipment sales

Source: Company data, HSBC Qianhai Securities Source: Company data, HSBC Qianhai Securities

Looking ahead, we believe capacity expansion by key customers and the construction of new

fabs is creating opportunities for Naura. For example:

In 2018 SMIC has budgeted USD1.9bn in capex for foundry, with USD500m and USD400m

to be spent on expanding the capacity of its majority-owned Beijing 300mm fab and its new

200mm Tianjin fab.

Naura delivered an oxidation furnace to Yangtze Memory in November 2017 and recently

won bids to supply the company with etcher and PVD in 2018.

For Huali, the company has installed a 14-20nm advanced lithography equipment from

ASML in May 2018 in Shanghai, suggesting that Huali is in process of ramping up its new

300mm fab.

Naura signed a framework contract with Hefei Changxin in April 2018. The company will

fully assess, test and jointly develop equipment with Naura.

-

200

400

600

800

1,000

1,200

2013 2014 2015 2016 2017

Etch PVD CVD Oxidation Cleaning

(cavity)

0

100

200

300

400

500

600

700

800

2009 2010 2011 2012 2013 2014 2015 2016 2017

D-etch TSV/ICP MOCVD Total


September 2018

48

Naura estimates that domestic equipment represents only 5% of the spending on equipment by

major Chinese foundries, suggesting opportunities for Naura in the coming years. It takes

around four years from R&D to commercialization – two years’ in-house development and two

years’ on-site testing and review. The average selling price (ASP) for etcher, PVD and CVD is

around RMB20-30m and RMB10m for cleaning and oxidation equipment.

Exhibit 88. Etcher equipment classification

Product Key customers Accumulative sales

Etcher SMIC, Yangtze Memory Over 600 cavities

PVD SMIC, Leadcore Technology, Yangtze Memory Over 100 cavities

CVD SMIC, Shanghai IC R&D Center Over 200 cavities

Oxidation/Diffusion SMIC, Huali Microelectronics, Yangtze Memory Over 100 cavities

Cleaning SMIC, Yangtze Memory Over 100 cavities


Apart from organic growth, Naura also relies on M&A to drive revenue growth. In 2017, Naura

offered to acquire 100% of Akrion Systems, a US-based semiconductor equipment vendor, for

USD15m and the transaction was completed in January 2018. Akrion is a leading supplier of

surface preparation equipment (such as cleaning/stripping) for silicon wafer, semiconductor

devices, flat panel displays, MEMS, and solar.

Akrion has over 20 years of experience and has installed over 1,000 systems worldwide. Seven

out of the top 10 foundries, and five out of top 10 MEMS manufacturers are Akrion customers,

including Globalfoundries, and STMicroelectronics. It has over 80 employees and 8,500 square

inches of manufacturing facilities and 2,000 square inches of labs.

This acquisition is helping Naura to broaden its customer base and enhance its service

capability (Naura intends to introduce Akrion’s products to SMIC in 2018). Akrion also

announced strong bookings in 1Q18, indicating it will ship to existing and new customers in the

US, China and Southeast Asia this year. While Akrion generated RMB106m and RMB80m in

revenue in 2015 and 2016 it incurred net losses of RMB20m and RMB23m, respectively, after

stripping out interest-bearing loans and cash (which are not within the scope of the acquisition).

Exhibit 89. Chinese equipment supplier for front-end IC manufacturing

Category Product Supplier

Lithography Lithography Shanghai Microelectronics equipment

Coater/developer Kingsemi (Shenyang)

Photoresist Strip Naura, Mattson (Beijing)

Etch Etcher Naura, AMEC, Mattson (Beijing)

Surface treatment Clean Naura, ACM Research (Shanghai),

Thermal treatment

Oxidation/diffusion Naura

Single-wafer anneal Naura

Fast anneal Mattson (Beijing)

Ion implantation Ion implantation Kingstone

CVD

LPCVD Naura

ALD Naura, Piotech (Shenyang)

PECVD Naura, Piotech (Shenyang)

PVD PVD Naura


49


September 2018

LED equipment: riding the wave of capacity expansion by Chinese chip makers

Revenue from LED equipment surged 50% y-o-y to around RMB500m in 2017. The

manufacturing process for LED chips can be divided into front-end epitaxy wafer processing,

middle-end chip manufacturing and back-end packaging. Metal organic chemical vapour

deposition (MOCVD) is the key equipment in epitaxy wafer processing, with vendors such as

Veeco, Aixtron and AMEC. Mid-end chip manufacturing involves multiple steps including

lithography, etching, cleaning, metallization, and anneal.

Naura supplies ICP etcher, plasma-enhanced chemical vapour deposition (PECVD) and PVD to

LED chip manufacturers. Its patterned sapphire substrate (PSS) etcher has captured over 80%

market share in China in the past four years. Its overall market share in the three product lines

is over 70%, with the remaining supply coming from Oxford Instrument and Evatec.

Exhibit 90. LED manufacturing process


Its key customers include leading Chinese LED chip makers such as San’An Optoelectronics,

HC Semitek, Sinopatt, Elec-Tech International, and Changelight. Chinese LED makers are

gaining market share by expanding capacity and raising capex. The fixed asset investment of

the top four LED chip makers surged 155% y-o-y in 2017 to RMB7bn. The rapid capacity

expansion last year was mainly due to undersupply and strong demand.

LED Inside, an industry media platform, forecasts that China’s total LED chip production capacity will

increase by 49% y-o-y, from 8.56m pieces (2-inch equivalent) in 2017 to 12.76m pieces in 2018. This

growth is in line with our 45% y-o-y revenue growth forecast for Naura in 2018.

Although the top Chinese LED chip makers are aggressively expanding capacity, lower-tier

Chinese and overseas vendors are more conservative due to the lack of cost advantage and

scale effect. Therefore, we believe China will continue to increase their market share in LED

capacity in 2018-20 from the 58% level in 2017. This will benefit Chinese LED equipment

vendors such as Naura.

Substrate

Epitaxy wafer

MOCVD

PVD (ITO)

Mask/lithography

Cleaning

Cleaning

GaN Etch

Anneal

SiO2 Etch

(PECVD)

Grinding

LED dies on

wafer

LED chips on

wafer

Die

singulation

Test

Inspection

Packaging

Encapsulati

on

Packaged

LED

Back end Middle end Front end

Sapphire/SiC/Si/

GaAs

LED structure


September 2018

50

Exhibit 91. Major LED chip makers’ capex trend

Exhibit 92. Capacity expansion plans of LED makers in China

Source: Company data, HSBC Qianhai Securities Source: LEDInside

On the demand side, we believe lighting, digital display and automotive will continue to be the

key drivers in 2018-19. LEDInside forecasts that the LED packaging market will increase from

RMB65.9bn in 2017 to RMB76.8bn in 2021, a 4% CAGR. In the longer term, mini LED and

micro LED will become the new growth drivers for the LED market as they require more

advanced knowledge and new technology. An upgrade cycle for equipment is likely to take

place in the coming years, creating new opportunities for equipment makers.

The size of mini LED and micro LED is much smaller than LED, providing lower latency, higher

contrast ratio and greater colour saturation. LEDInside forecasts that the mini LED and micro

LED markets will reach a combined USD1.38bn in 2022 and USD2.89bn in 2025. Micro AR

projector, head-up display (HUD), and large-size display panels are likely to be the applications

for the new technologies. Nichia, a Japanese company, already announced it will mass produce

mini LED by end 2018 and micro LED in 2022. San’An has also formed a strategic partnership

with Samsung for micro LED supply.

Exhibit 93. Mini LED and Micro LED market size

Exhibit 94. Technical features of Mini and Micro LED

Mini LED Micro LED

Application LCD backlight, Organic light emitting display

short range display Micro projection display Quantities to be used in TV

Thousands Millions

Time of commercial launch

2018 2019-2022

Advantages Curve and abnormity display

High power efficiency, higher contrast ratio

Price compared to LCD

20% higher 3 times at initial stage

Source: LEDInside Source: LEDInside

Flat panel display: increasing exposure to BOE

Naura’s flat panel display equipment includes ultraviolet curing, indexer, and cleaning tools,

which are mainly applied in BOE’s thin film transistor-liquid crystal display (TFT-LCD) fabs,

(G10.5, G8.5, G6, G5.5, and G4.5). Its ultraviolet cure is used to cure and dry a glue in the

frame using ultraviolet light. An indexer mainly facilitates glass substrate movement and

transportation along production lines. Naura also provides other equipment for display

-

1,000

2,000

3,000

4,000

5,000

6,000

7,000

8,000

2009 2010 2011 2012 2013 2014 2015 2016 2017

San'An HC Semitek Changelight Aucksun

(RMBm)

1,400

2,700

4,000

700

1,700

3,000

170

1,000

2,000

2,930

3,160

3,760

-

500

1,000

1,500

2,000

2,500

3,000

3,500

4,000

4,500

2016 2017 2018e

San'An HC Semitek Aucksun Others

('000 pieces/month, 2 inch)

-

200

400

600

800

1,000

1,200

1,400

1,600

2018 2019 2020 2021 2022

Mini LED Micro LED

(USDm)

51


September 2018

customers, including units for air cooling, solvent recycling, thermal recycling, and gas

measuring controls.

Naura’s revenue from BOE has increased from RMB35m in 2015, RMB86m in 2016 to

RMB130m in 2017. But its products only account for 1.0-1.5% of BOE’s total production line

spending, suggesting ample opportunities to gain market share ahead.

Looking ahead, we identify the capacity ramp-up of BOE’s G10.5 fab in Hefei, G8.5 in Fuzhou,

and upcoming new G10.5 fab in Wuhan as the key revenue drivers for Naura in 2018-20. The

Hefei fab commenced commercial production in March 2018 and its designed capacity amounts

to 120,000 sheets/month. BOE has budgeted RMB46bn to build the Wuhan TFT-LCD fab and

construction started in March 2018. The construction period lasts two years and the project

targets the 65/75 inch TV market.

Exhibit 95. Production capacity of BOE

Location Fab/Gen Product Tech Capacity Capex Status

('000/month) (RMBbn)

Beijing G5 LCD a-Si 70 11.0 In operation

Ordos G5.5 LCD/OLED LTPS/OLED 30 22.0 In operation

Hefei G6 LCD a-Si 120 17.5 In operation

Beijing G8.5 LCD a-Si 150 28.0 In operation

Hefei G8.5 LCD a-Si 120 28.5 In operation

Chongqing G8.5 LCD a-Si 150 32.8 In operation

Fuzhou G8.5 LCD a-Si 150 30.0 In operation

Hefei G10.5 LCD a-Si 120 40.0 In operation

Chengdu G6 AMOLED OLED 48 46.5 In operation

Wuhan G10.6 LCD a-Si 120 46.0 Construction

Mianyang G6 AMOLED OLED 48 46.5 Construction


Vacuum equipment: resilient growth outlook despite near-term headwind

The products in this segment include crystal growing, brazing, heat treatment and sintering

furnaces. Naura is a major supplier of vacuum equipment to mono-crystalline wafer maker Longi

Green Energy. Longi has increased its wafer manufacturing capacity from 5GW in 2015, to

7.5GW in 2016 and 15.0GW in 2017, and plans to reach 28GW in 2018 and 45GW in 2020.

Naura accounts for 50% of Longi’s vacuum equipment purchases (Dalian Liancheng is the other

supplier).

Although China’s solar market installation may decline y-o-y in 2018 due to changes in subsidy

policy announced in May, we believe the following factors will enable Naura to deliver stable

revenue growth in vacuum equipment:

Installation growth overseas to offset China’s slowdown: IHS forecasts that global PV

installation will grow 11% y-o-y in 2018 to 105GW despite downward revisions to China’s

estimates from 53GW to 38GW. Countries such as Australia, Mexico, Canada, and Brazil

are the growth drivers.

Market share gains of mono-crystalline over multi-crystalline: Mono-crystalline silicon wafer

has a higher power conversion efficiency than multi-crystalline silicon and its production

cost has declined rapidly in recent years, thanks to the adoption of diamond wire cutting

and efficiency gains through technology innovation.


September 2018

52

Naura’s current order backlog with Longi is around RMB1bn, mainly for ingot capacity

expansion projects in Ningxia and Yunnan. Naura expects to recognise RMB500m of this

revenue in 2018.

Exhibit 96. Longi capacity expansion plan Exhibit 97. Market share breakdown of mono- and multi-crystalline wafer

Source: Company data Source: ITRPV, HSBC Qianhai Securities

Exhibit 98. Contracts with Longi

Contract size

Date Project (RMBm)

Sep-17 Yunnan Ingot capacity expansion 344 Jun-17 Yunnan Ingot capacity expansion 345 Mar-17 Ningxia Zhongning ingot capacity expansion 168 Mar-17 Ningxia Yinchuan ingot capacity expansion 165 Jul-16 Ningxia Yinchuan ingot capacity expansion 161 Total 1,183


Precision components: steady and sustainable growth

High precision electronic components are Naura’s traditional business. Its products include

precision resistors, microwave modules, tantalum capacitors, crystal devices, and power supply

modules used in aerospace, aviation, shipping, and railways. Its customers are mainly in the

defence industry and include China Aerospace Science and Technology Corporation, China

Aerospace Science & Industry Corporation, and China North Industries Group.

Naura has limited competition in this business and enjoys premium margins. The segment’s

revenue has increased steadily from RMB192m in 2010 to RMB763m in 2017, a 31% CAGR.

Meanwhile, gross margin has consistently stayed above 40%. Looking ahead, Naura expects a

10-15% revenue CAGR in the coming 3-5 years, thanks to increases in defence spending,

product upgrades, import substitution, and R&D initiatives in new applications.

7.5

15.0

28.0

36.0

45.0

2.5

7.5

13.0

8.0 9.0

0

5

10

15

20

25

30

35

40

45

50

2016 2017 2018e 2019e 2020e

Mono wafer installed capacity Incremental capacity

(GW)

0%

10%

20%

30%

40%

50%

60%

70%

80%

90%

100%

2017 2018 2020 2022 2025 2028

P-type multi P-type mono N-type mono

53


September 2018

Exhibit 99. Revenue and growth trends of the precision components business

Exhibit 100. Gross profit and margin of the precision components business


Forecasts and valuation

Earnings forecasts

We forecast that Naura will record a 52% net profit CAGR over 2017-20e, driven by a 27%

revenue CAGR, gross margin expansion and operating leverage. We expect IC equipment will

be the major revenue driver, with a 46% CAGR, followed by 37% in display and 35% in vacuum

equipment. We believe IC equipment will account for 27% of total revenue by 2020, up from

18% in 2017. The company guides for RMB3.2bn revenue for 2018, which is supported by a

robust order backlog. As at end-2017, Naura had an order backlog of over RMB2bn and

received an additional RMB500-600m in new orders in 1Q18.

IC equipment has a gross margin of over 40%, vs. over 30% for LED and over 20% for solar

equipment. With a higher revenue contribution from high-margin IC equipment, we expect the

overall gross margin to increase from 36.6% in 2017 to 38% in 2020e. As its revenue increases,

we believe Naura can deliver operating leverage in the coming years.

We now analyse the impact of government subsidies on net profit. Naura’s SG&A expenses

surged from RMB203m in 2015 (before the acquisition of North Microelectronics) to RMB904m

in 2016 but declined to RMB795m last year. This volatility is mainly due to the booking of R&D

expenses. The government provides annual subsidies to Naura to support R&D for advanced IC

equipment as part of the “02 Project”. The subsidies are reflected in the deferred income

balance in non-current liabilities.

At the end of 2017, Naura had RMB1.25bn in deferred income on its balance sheet. Naura

indicates that the government subsidy will continue at the level of RMB500-600m over 2018-20.

We note that Naura’s annual subsidy income recognised on the income statement is largely in

line with the R&D expenses booked. Therefore, we believe the fluctuation in R&D expenses and

subsidies is neutral to our net profit forecast for Naura.

174 169192

242280

317349

400

608

763

-10%

0%

10%

20%

30%

40%

50%

60%

0

100

200

300

400

500

600

700

800

900

2008 2009 2010 2011 2012 2013 2014 2015 2016 2017

Revenue Yoy

(RMBm)

70 75 78

116

157

186204

235

271

334

40%

44%

41%

48%

56%58% 59% 59%

45% 44%

0%

10%

20%

30%

40%

50%

60%

70%

0

50

100

150

200

250

300

350

400

2008 2009 2010 2011 2012 2013 2014 2015 2016 2017

Gross profit Gross margin

(RMBm)


September 2018

54

Exhibit 101. Revenue and gross profit forecasts

2017-20

Revenue (RMBm) 2016 2017 2018e 2019e 2020e CAGR

IC 300 400 552 828 1,242 46% LED 336 504 731 877 1,052 28% Solar 91 100 100 100 100 0% Display 86 130 182 246 332 37% Semiconductor equipment 813 1,134 1,565 2,051 2,726 34% Vacuum 88 201 500 500 500 35% Lithium battery 96 100 160 176 194 25% Precision component 608 763 862 992 1,140 14% Others 18 25 28 30 33 10% Total 1,622 2,223 3,114 3,748 4,593 27% y-o-y 37% 40% 20% 23% -15% Gross profit

Semiconductor equipment 332 401 553 759 1,063 38% Vacuum 20 56 130 130 130 32% Lithium battery 19 19 30 33 37 25% Precision component 271 334 388 446 513 15% Others 3 3 4 4 4 13% Total 645 813 1,105 1,372 1,747 29% Gross margin

Semiconductor equipment 40.9% 35.4% 35.4% 37.0% 39.0%

Vacuum 22.7% 28.0% 26.0% 26.0% 26.0%

Lithium battery 19.6% 19.2% 19.0% 19.0% 19.0%

Precision component 44.6% 43.7% 45.0% 45.0% 45.0%

Others 14.7% 13.1% 13.1% 13.1% 13.1%

Total 39.7% 36.6% 35.5% 36.6% 38.0%

Source: Company data, HSBC Qianhai Securities estimates

Exhibit 102. Key assumptions in income statement

(RMBm) 2015 2016 2017 2018e 2019e 2020e

G&A expenses 203 904 795 1,061 1,107 1,166 R&D expenses booked 41 585 357 500 500 500 R&D investment capitalized 207 173 380 250 250 250 Total R&D investment 248 758 736 750 750 750 G&A to revenue excl. R&D 19.0% 19.7% 19.7% 18.0% 16.2% 14.5% Government subsidies booked 51 612 388 500 500 500 Deferred income balance 1,117 1,410 1,246 1,246 1,246 1,246


Sensitivity analysis

We think the revenue from the vacuum segment and IC equipment revenue growth are the two

critical swing factors for earnings. Our earnings sensitivity analysis for 2018e shows that for

every RMB200m difference in revenue from the vacuum segment, earnings would change by

1.2%; for every 5% difference in IC equipment revenue growth, earnings change by 0.6%, on

our estimates.

Exhibit 103. Sensitivity analysis for 2018e earnings

__________________________ Vacuum revenue (RMBm) __________________________ 100 300 500 700 900

IC equipment revenue growth

28% 164 166 168 170 172 33% 165 167 169 171 173 38% 166 168 170 172 174 43% 168 170 172 174 176 48% 169 171 173 175 177

Source: HSBC Qianhai Securities estimates

Balance sheet and cash flow

Naura had RMB65m in net cash as at the end of 2017. Except for 2015, Naura has consistently

registered a net cash position since listing. Its operating cash flow turned positive in 2017 and

we expect this to continue thanks to an improving margin and working capital cycle.

55


September 2018

We expect 2018-20 capex to be comparable to 2017. The company has already started work on

expanding its new manufacturing facility (phase 2 of the Beijing Yizhuang Economic and

Technology Development Zone). The gross floor area of phase 1 is 40,000 square metres and

phase 2 is much larger at 140,000 sqm. This will enable Naura to operate China’s largest IC

equipment manufacturing base. Accordingly, we expect Naura to be cash flow positive in 2020.

The company has maintained a 10% cash dividend pay-out ratio since 2016.

Exhibit 104. Balance sheet statement

RMBm 2013 2014 2015 2016 2017 2018e 2019e 2020e

Cash and equivalents 263 213 229 964 1,020 894 871 922 Net receivables 613 608 675 989 1,210 1,536 1,849 2,265 Inventory/stocks 615 566 593 1,178 2,033 2,752 3,255 3,898 Other current assets 85 79 73 215 198 198 198 198 Total Current assets 1,576 1,466 1,570 3,346 4,461 5,380 6,172 7,283 Net PP&E/Fixed assets 552 621 1,007 1,383 1,449 1,550 1,643 1,729 Net intangibles 511 687 1,095 1,061 1,027 982 983 978 Total investments 2 - - - - - - - Other long-term assets 1,105 1,112 508 751 1,209 1,209 1,209 1,209 Total non-current asset 2,170 2,420 2,610 3,195 3,685 3,740 3,835 3,915 Total assets 3,746 3,886 4,180 6,541 8,145 9,120 10,007 11,198 Accounts payable 422 481 533 865 1,333 1,982 2,344 2,807 Short-term debt and current portion of long-term debt

117 195 339 437 520 520 520 520

Other current liabilities 188 126 163 404 1,130 1,339 1,610 1,939 Current liabilities 727 801 1,035 1,707 2,984 3,841 4,473 5,266 Long-term debt - - - 60 436 400 400 400 Other long-term liabilities/creditors

1,093 1,121 1,117 1,410 1,246 1,246 1,246 1,246

Total long-term liabilities 1,093 1,121 1,117 1,470 1,681 1,646 1,646 1,646 Total liabilities 1,820 1,922 2,153 3,177 4,665 5,486 6,119 6,911 Common stock 352 352 352 458 458 458 458 458 Treasury stock - - - - - - - - Reserve 1,472 1,479 1,518 2,735 2,850 3,004 3,258 3,657 Other common equity (0) (0) (1) (1) (1) (1) (1) (1) Total common equity 1,824 1,831 1,869 3,192 3,308 3,461 3,715 4,114 Minority interest 102 133 158 172 173 173 173 173 Total equity 1,926 1,964 2,027 3,364 3,480 3,634 3,888 4,287 Total liabilities and equity 3,746 3,886 4,180 6,541 8,145 9,120 10,007 11,198



September 2018

56

Exhibit 105. Cash flow statement

RMBm 2013 2014 2015 2016 2017 2018e 2019e 2020e

Net income 103 42 39 93 126 170 282 443 Minority interest and impairment add-back

37 70 68 81 73 57 94 147

Depreciation and amortization add-back

43 67 82 192 198 221 236 250

Investment Loss - (0) - - - - - - (Increase)/decrease in working capital :

(219) (100) (245) (587) (389) (397) (453) (597)

Other operating cash flow items

10 15 13 20 24 - - -

Cash flow from operations

(26) 93 (44) (201) 32 51 159 243

Capital expenditure (166) (196) (67) (178) (232) (230) (230) (230) (Acquisitions)/divestitures 3 0 0 1 0 - - - Investments (2) 2 - - - - - - Other investment cash flow items

- - - - - - - -

Cash flow from investing (164) (194) (67) (178) (232) (230) (230) (230) Dividends paid (45) (27) (19) (49) (62) (48) (51) (63) Share repurchase/issue - - 0 917 - - - - Increase/(decrease) in debt

(90) 78 144 99 332 100 100 100

Other financing cash flow items

(0) - - - (6) - - -

Cash flow from financing (135) 51 125 967 264 52 49 37 Effect of foreign exchange rate changes

(0) 0 0 0 (1) - - -

Total cash flow (326) (50) 15 588 63 (126) (23) 50 Free cash flow (192) (103) (111) (380) (201) (179) (71) 13


Valuation

We apply a 12m forward price-to-sales (P/S) methodology to value Naura, rather than PE, for

two key reasons. 1) First, Naura’s earnings performance is volatile and largely depends on the

government subsidy. The company is now trading at a high forward PE multiple of 100x, in line

with the mid-cycle 98x but much higher than the industry average. That said, despite the bumpy

earnings trend, we think investors are still willing to apply a valuation premium to Naura. This is

not because of the near-term earnings performance, but due to its long-term growth outlook and

its strategic importance in semiconductor equipment. 2) And second, Naura is still at the early

stage of gaining traction with foundry customers and offers ample revenue growth potential, in

our view.

We forecast accelerated revenue growth – 52% CAGR in 2017-20e, up from 6% in 2010-17.

The stock is trading at 6.8x forward P/S, in line with the shares’ historical mid-cycle average of

6.3x. In light of Naura’s faster revenue growth outlook, we think it is reasonable to apply one

standard deviation above the mid-cycle, hence a target P/S multiple of 8.4x, to set the target

price. This equals RMB63.97, implying 20% upside.

Downside risks

Advanced IC equipment: Naura can produce 28nm and above IC equipment for foundries.

Failure to improve technical know-how and mass produce more advanced nodes may reduce

future growth opportunities.

Solar: The solar industry is highly dependent on government subsidy policies, so changes in

policy may affect order flows. As most of Naura’s vacuum products are sold to Longi, any

change in the customer’s sourcing strategy and operational performance may affect Naura.

57


September 2018

Government subsidy and income recognition. Naura’s earnings are sensitive to government

subsidies. Policy changes would create uncertainty about the company’s earnings.

Exhibit 106. Historical 12m forward P/S Exhibit 107. Historical 12m forward PE


-

2.00

4.00

6.00

8.00

10.00

12.00

14.00

16.00

18.00

20.00

20

10

/3

20

10

/9

20

11

/3

20

11

/9

20

12

/3

20

12

/9

20

13

/3

20

13

/9

20

14

/3

20

14

/9

20

15

/3

20

15

/9

20

16

/3

20

16

/9

20

17

/3

20

17

/9

20

18

/3

+1 STD

Mean

-1 STD

0.0

50.0

100.0

150.0

200.0

250.0

300.0

350.0

400.0

20

10

/3

20

10

/9

20

11

/3

20

11

/9

20

12

/3

20

12

/9

20

13

/3

20

13

/9

20

14

/3

20

14

/9

20

15

/3

20

15

/9

20

16

/3

20

16

/9

20

17

/3

20

17

/9

20

18

/3

+1 STD

Mean

-1 STD


September 2018

58

Financial statements

Year to 12/2017a 12/2018e 12/2019e 12/2020e

Profit & loss summary (CNYm)

Revenue 2,223 3,114 3,748 4,593

EBITDA 42 35 233 510

Depreciation & amortisation -198 -221 -236 -250

Operating profit/EBIT -157 -186 -3 260

Net interest -27 -35 -34 -34

PBT 206 279 463 726

HSBC Qianhai PBT 206 279 463 726

Taxation -38 -52 -86 -136

Net profit 126 170 282 443

HSBC Qianhai net profit 126 170 282 443

Cash flow summary (CNYm)

Cash flow from operations 32 51 159 243

Capex -232 -230 -230 -230

Cash flow from investment -232 -230 -230 -230

Dividends -13 -17 -28 -44

Change in net debt 402 91 23 -50

FCF equity -645 -679 -571 -487

Balance sheet summary (CNYm)

Intangible fixed assets 1,027 982 983 978

Tangible fixed assets 2,657 2,758 2,851 2,937

Current assets 4,461 5,380 6,172 7,283

Cash & others 1,020 894 871 922

Total assets 8,145 9,120 10,007 11,198

Operating liabilities 3,709 4,566 5,199 5,991

Gross debt 956 920 920 920

Net debt -65 26 49 -2

Shareholders' funds 3,308 3,461 3,715 4,114

Invested capital 3,416 3,660 3,937 4,285

Ratio, growth and per share analysis

Year to 12/2017a 12/2018e 12/2019e 12/2020e

Y-o-y % change

Revenue 37.0 40.1 20.4 22.5

EBITDA -15.6 561.4 118.8

Operating profit

PBT 18.2 35.6 65.8 56.8

HSBC Qianhai EPS 24.6 35.6 65.8 56.8

Ratios (%)

Revenue/IC (x) 0.7 0.9 1.0 1.1

ROIC -1.8 -2.2 2.1 7.2

ROE 3.9 5.0 7.9 11.3

ROA 2.6 3.0 4.2 5.8

EBITDA margin 1.9 1.1 6.2 11.1

Operating profit margin -7.0 -6.0 -0.1 5.7

EBITDA/net interest (x) 1.6 1.0 6.8 14.8

Net debt/equity -1.9 0.7 1.3 0.0

Net debt/EBITDA (x) -1.5 0.7 0.2 0.0

CF from operations/net debt 196.8 325.7

Per share data (CNY)

EPS Rep (diluted) 0.27 0.37 0.62 0.97

HSBC Qianhai EPS (diluted) 0.27 0.37 0.62 0.97

DPS 0.03 0.04 0.06 0.10

Book value 7.22 7.56 8.11 8.98

Valuation data

Year to 12/2017a 12/2018e 12/2019e 12/2020e

EV/sales 10.9 7.8 6.5 5.3

EV/EBITDA 582.6 693.0 104.9 47.8

EV/IC 7.1 6.7 6.2 5.7

PE* 194.2 143.2 86.3 55.1

PB 7.4 7.0 6.6 5.9

FCF yield (%) -2.6 -2.8 -2.3 -2.0

Dividend yield (%) 0.1 0.1 0.1 0.2

* Based on HSBC Qianhai EPS (diluted)

Issuer information

Share price (CNY) 53.26 Free float 78%

Target price (CNY) 63.97 Sector Electronic Equipment

Reuters (Equity) 002371.SZ Country China

Bloomberg (Equity) 002371 CH Analyst Frank He

Market cap (USDm) 3,576 Contact +86 755 8898 3136

ESG metrics

Environmental Indicators Governance Indicators

GHG Intensity (kg/USD) na No. of board members 12

Energy Intensity (kWh/USD) na Average board experience (years) 2.9

CO2 reduction policy Yes Female board members (%) 16.7

Social Indicators Board members Independence (%) 33.3

Employee costs as % of sales na

Employee turnover (%) na

Diversity policy Yes


Price relative

Source: HSBC Qianhai Securities Note: Priced at close of 03 Sep 2018

14.00

24.00

34.00

44.00

54.00

64.00

14.00

24.00

34.00

44.00

54.00

64.00

2016 2017 2018

Naura Technology Group Co Rel to CSI 300 Index

Financials & valuation: Naura Technology Group Co Buy

59


September 2018

Riding on the smart manufacturing trend

Han’s Laser, established in 1996, provides laser, robotics and automation equipment and

system solutions in smart precision manufacturing industries in China. Its product portfolio

includes laser labelling/cutting/welding equipment, PCB/LED/semiconductor special equipment,

robots, automation equipment and system solutions. The products are mainly used in metal or

non-metal processing of consumer electronics, automobiles, shipbuilding, aerospace, rail

transportation, electrical vehicle (EV) batteries, PCB, appliance industries. Its key customers

include Apple, Samsung, BOE, Yutong Bus, and Shennan Circuits. The company was listed on

the Shenzhen Stock Exchange in 2004.

In the last 30 year Han’s Laser has moved steadily up the value chain after starting as a

manufacturer of low-power laser equipment. It now serves dozens of industries and is the

market share leader in laser processing equipment in China. Over 2004-17, it achieved a 29%

revenue CAGR and 32% net profit CAGR.

Exhibit 108. Corporate milestones

Year Events

1996 Develops and manufactures low-power laser labelling equipment 2000 Extends downstream application from traditional leather, garment, electronics to other industries like jewellery, home

appliances 2004 Listed on Shenzhen Stock Exchange; starts low-power laser cutting/welding equipment and platemaking printing

equipment business 2005 Starts PCB equipment business 2009 Starts LED and solar equipment business; become a supplier to Apple with 70% laser equipment allocation in 2017 2010 Starts high-power laser equipment business 2012 Changes strategy to focus on laser processing business and large customers, starts to spin off non-core businesses

like solar, platemaking printing equipment business 2014 Starts robotics business in a bid to provide integrated automation solutions to customers; low-power laser equipment

market extends to display panel, EV battery industries 2015 Starts in-house supply of part of low-power laser and picosecond laser source; high-power laser equipment market

extends to auto, aviation, shipping industries 2017 Starts semiconductor equipment business through acquisition of Fortrend Engineering


The core business can be separated into laser processing equipment and industry special

equipment. Laser processing equipment, representing 81% of revenue in 2017, can be further

categorized as low-power and high-power. Low-power laser equipment revenue streams are

generated from equipment orders by Apple, the EV battery industry, and the display panel

industry. Special equipment covers PCB, LED manufacturing and the company aims to gain

more exposure in the semiconductor industry.

Han’s Laser (002008 CH)

Multiple revenue growth drivers with a diversified customer base

Margin upside on growing in-house laser manufacturing

Initiate with a Buy rating and target price of RMB50.59


September 2018

60

Exhibit 109. Historical revenue/net profit Exhibit 110. Revenue breakdown in 2017


Historical gross profit margin and operating profit margins are about 40% and 12% respectively.

Margin expansion in 2017 was driven by high-margin Apple business and enhanced operating

efficiency. The gross profit margin of low-power laser equipment is higher than for high-power

as the company makes some critical pieces of equipment, such as the laser source, in-house.

Exhibit 111. GPM trend by segment Exhibit 112. GPM and EBIT margin trend


Han’s Laser attaches great importance to R&D, and the ratio of R&D expense to revenue has

consistently remained above 5% (it was 7.4% in 2017). The company has nearly 4,000 R&D

staff, 32% of total employees, covering laser source, automation system integration, linear

motor, visual recognition, software, and mechanical controls. By the end of 2017, the company

had obtained 2,486 patents, nearly ten times more than ten years ago. We believe the high

level of R&D investment will help the company improve its competitiveness and maintain its

market leader position in the long run.

Laser industry overview

Light is passed through a lens to form a laser beam with extremely high energy density. The

material (including metal and non-metal) is cut, welded, surface treated, and punched using the

characteristics of interaction between the laser beam and the material.

Compared to traditional methods, laser processing has advantages such as no contact process,

and high positioning accuracy; it’s also quiet and clean. Laser technology plays an increasingly

important role in improving product quality, labour productivity, automation, reducing pollution,

and material consumption.

The laser industry supply chain is composed of laser material/component manufacturers, laser

source manufacturers, and laser equipment manufacturers. Upstream are the optical materials,

-

200

400

600

800

1,000

1,200

1,400

1,600

1,800

-

2,000

4,000

6,000

8,000

10,000

12,000

14,000

2013 2014 2015 2016 2017

Low-power equipment High-power equipment

PCB equipment LED Equipment

Laser printing equipment Others

(Rmb m)

High-power laser equipment

18%

PCB equipment

10%

LED Equipment

5%

Others4%

Apple35%

Display panel4%

EV battery

5%Others19%

Low-power laser

equipment63%

40.3%

44.1%

41.5%

42.7%

28.5%

31.4% 30.9%29.4%

39.1% 38.8%

36.3%

37.6%

22.5%23.6%

27.8%

31.5%

20.0%

25.0%

30.0%

35.0%

40.0%

45.0%

50.0%

2013 2014 2015 2016

Low-power equipment High-power equipmentPCB equipment LED Equipment

41.0%39.2%

44.2%

36.2%

39.6%37.9% 38.2%

41.3%

10.9% 11.3%13.9%

8.0%

13.0%10.1% 9.5%

16.2%

0.0%

5.0%

10.0%

15.0%

20.0%

25.0%

30.0%

35.0%

40.0%

45.0%

50.0%

2010 2011 2012 2013 2014 2015 2016 2017

Gross margin EBIT margin

61


September 2018

optical components, mechanical and numerical control components. Optical materials include

laser crystal material, and special optical fiber. Optical components include laser optics,

galvanometers, modulators, and laser processing heads; others include mechanical, numerical

control, and power supply equipment.

The laser source is the critical part of laser equipment. By power, the laser source can be categorised

as low-power (<1.5KW) and high power (>1.5KW). By pump energy source, they can be

classified into CO2, YAG, fiber, and semiconductor lasers. The laser source can also be divided

into continuous laser and pulsed laser. According to pulse width, the pulsed laser can be further

divided into millisecond, microsecond, nanosecond, picosecond, and femtosecond lasers.

Mid-stream laser equipment that can be used in multiple downstream industries such as

machinery, automobiles, aerospace, steel, shipbuilding, electronics and military.

Exhibit 113. Laser equipment supply chain


China is the hot spot

According to Optech Consulting, the global market for laser systems for materials processing

reached USD12.6bn in 2016, a 5% CAGR since 2006. As the world’s factory, China is the main

laser system market. China is also the main growth contributor thanks to macroeconomic

development, manufacturing upgrades, and policy support.

According to laser.ofweek.com, a professional laser industry portal, the sale of laser system

(including imports) in China for the industry manufacturing, communication, medical and scientific

research was RMB42.2bn in 2016, a 23% CAGR since 2010. Of this, the laser systems for materials

processing is an important segment with a market of about RMB25bn in 2015.

According to Optech Consulting, the high-power (>1.5kW) laser system, mainly used in the

automobile, shipbuilding and machinery industries, represents 75% of the market. The

remaining 25% is for low-power (<1.5kW), mainly used in the microelectronics, semiconductor

and display industries.

Optical

component

Numerical

control systemServo motor Auxiliary gas

Laser source

CO2 laser

source

Solid-state

laser source

Fiber laser

source

Other laser

sources

Laser cutting Laser labelingLaser

communicationLaser welding

Military Mechanical TelecomMetallurgyAviationAutomobileElectronics

Up-stream core

components

Mid-stream

equipment

Down-stream

industries


September 2018

62

Exhibit 114. Global laser system market size Exhibit 115. China laser system market size

Source: Optech Consulting, HSBC Qianhai Securities Source: Ofweek, HSBC Qianhai Securities

Lowering costs to stimulate demand

The laser source is the core part of laser equipment. It accounts for 30-40% of the cost of low-

power laser equipment, rising to nearly 60% for high power as only a few companies, including

IPG, SPI, and Coherent, have the technological know-how.

Fiber laser, the third generation laser source noted for high efficiency levels and low

maintenance costs, is gaining market share. The price has decreased 50% since 2012 as a

result of a higher localization rate in China. We expect the cost will continue to fall as

localization increases.

China high-power laser source producers are making technical breakthroughs. For instance,

Wuhan Raycus developed the first 6kW fiber laser source in 2017. As costs fall and

manufacturing upgrades continue, we believe laser equipment demand will remain robust.

Moreover, the combination of laser equipment and automation is improving product quality,

production efficiency and reducing labour costs. We think the system integration of laser and

automation will become a mainstream trend.

Exhibit 116. Fiber laser source localization rate

Exhibit 117. Fiber laser source price

Source: Zhixun Consulting, HSBC Qianhai Securities Source: Zhixun Consulting, HSBC Qianhai Securities

Han’s Laser: market share

In the global market, Trumpf is the market share leader in the laser processing industry with

30%, followed by Coherent, Han’s Laser, and IPG. As Han’s Laser’s 2017 sales exceeded

RMB10bn, we estimate its global market share is now above 10%. Trumpf has over 50% gross

margin because of its vertically-integrated business model (from laser source to integrated

automation solutions). IPG also achieves a gross margin of over 50% by leveraging its nearly

70% market share in the high-power fiber laser source market.

7.7

8.79.4

5.2

7.9

10.0 10.210.7

11.8 11.812.6

0.0

2.0

4.0

6.0

8.0

10.0

12.0

14.0

2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016

(USDbn)5% CAGR

9.711.7

16.919.5

26.0

34.5

38.5

42.2

0.0

5.0

10.0

15.0

20.0

25.0

30.0

35.0

40.0

45.0

2010 2011 2012 2013 2014 2015 2016 2017

23% CAGR

(RMB bn)

72%

63%

68%

89%

17%

27%

42%

58%

1% 1% 4%7%

0%

10%

20%

30%

40%

50%

60%

70%

80%

90%

100%

2013 2014 2015 2016

Low-power (<100W) Mid-power (100W-1.5kW) High-power (>1.5kW)

7.5 10.5 12

68

90

145

3.5 4.5 6.7

65

103

120

0

20

40

60

80

100

120

140

160

10W 20W 30W 500W 1000W 2000W

2012 2016

(RMB 10000)

63


September 2018

In China, Han’s Laser has a 35-45% market share in both the high-power and low power laser

equipment markets. Compared with foreign players, Han’s Laser has advantages in term of

product cost performance, customization capability, sales service network and close

relationships with local clients. Trumpf, the global market leader, has a 25-35% market share in

China behind Han’s Laser.

Besides Han’s, other well-known domestic laser equipment makers include GreatStar Industrial

( ), HG Tech ( ), Tianqi Laser ( ), He Laser ( ), Golden Laser

( ), and Delphi Laser ( ). At the low end of the market there are

thousands of laser equipment makers which lack core technology.

Exhibit 118. Market share breakdown in 2016 Exhibit 119. Top players’ GPM comparison

Source: Ofweek, HSBC Qianhai Securities Source: Bloomberg, HSBC Qianhai Securities

Low-power laser: new design of consumer electronics and new downstream industries

Han’s Laser’s low-power equipment segment can be separated into IT, display panel, EV

battery and others.

IT

Han’s Laser’s key clients in IT industries are smartphone makers and their component

suppliers. The main applications include laser labelling, drilling, cutting, and welding. Typical

applications for smartphone exteriors include logo labelling, laser drilling, home key cutting,

camera lens cutting, screen cutting, and LDS laser direct molding. Typical applications for

smartphones include PCB/FPC laser cutting, labelling, middle frame drilling, welding, cutting,

battery labelling, and conductive glass laser etching.

Apple is the single big client, accounting for 35% of total revenue or 55% of low-power laser

equipment segment in 2017. New material, new appearance, utilization enhancement, better quality

and environmental protection are the key reasons for smartphone makers to adopt laser processing.

For instance, the latest iPhone X model includes several innovations, including an AMOLED full

screen, double-side 2.5 glass + stainless steel middle frame, wireless charging, 3D face sensing,

stereo effect, and waterproofing, which have driven demand for laser equipment.

Consumer electronics is another growth factor. For instance, using FPC design helps make devices

smaller (laser cutting is needed for FPC manufacturing). Other processes such as

picosecond/femtosecond lasers, small structure welding on middle metal frame, laser cleaning

process to remove metal frame PVD coating, and waterproof testing equipment, will also drive the

demand for laser equipment. In addition, with the increasing adoption of 2.5/3D glasses + metal

middle frame in the 5G era, we see a potential market for laser equipment in the Android camp.

Trumpf30%

Han's Laser8%

IPG6%

Coherent (including

Rofin)13%

Jenoptik6%

Cymer7%

Prima Industrie4%

Bystronic3%

Others23%

30.0%

35.0%

40.0%

45.0%

50.0%

55.0%

60.0%

2010 2011 2012 2013 2014 2015 2016 2017

Trumpf Han's Laser Coherent IPG


September 2018

64

Display panels

Display panels are China’s fourth largest import by value after integrated circuits, oil and iron

ore. Domestic substitute demand has been accelerating in recent years. Panel makers led by

BOE began to increase their investment scale, and China’s TFT-LCD and AMOLED panel

production capacity gradually increased. According to WitsView estimates, China officially

surpassed South Korea to become the largest supply area for large-size panels in 2017, and

the supply rate in mainland China will move toward 50% by 2020. According to our estimates,

investment in panel production lines will exceed RMB400bn in the next two years.

Most of the laser equipment for new OLED lines in China is imported from South Korea and

Japan. The penetration rate of domestically produced equipment is very low. In order to reduce

costs, we expect the localization rate will gradually increase. Han’s Laser’s OLED equipment

includes laser stripping equipment (LLO), flexible cutting machine, and laser repair equipment.

The four production lines planned by BOE are currently being tested exclusively by Han’s Laser,

and the management aims to start shipments in 2018.

Exhibit 120. Large-size LCD panel capacity distribution by region

Exhibit 121. BOE LCD+AMOLED capacity area expansion

Source: WitsView, HSBC Qianhai Securities Source: IHS, HSBC Qianhai Securities

EV battery

According to the Ministry of Industry and Information Technology’s (MIIT) “Technology

Roadmap for Energy Saving and New Energy Vehicles,” by 2025, new energy vehicles will

account for more than 20% of total vehicle sales units. This will clearly drive the demand for EV

batteries. MIIT said the total capacity of the battery industry will exceed 100Gwh by 2020, a

34% CAGR from 2017, implying that over RMB50bn of equipment investment is needed in the

next three years. To improve the safety, reliability and lifespan of batteries, laser welding

technology is becoming an industrial trend in battery production.

By setting up new energy business unit/subsidiaries, and external acquisitions, Han’s Laser is

now able to produce equipment for the entire battery manufacturing process (cathode, anode,

coating, laser welding, testing, injection, and packaging). Key clients include CATL, Guoxuan

High-tech ( ), Lishen Battery ( ), China Aviation Lithium Battery ( ) and EVE

Battery ( ). Given the scale of downstream capacity expansion plans, we expect the

growth of the EV battery segment to remain robust.

PCB: benefits from production capacity relocation to China

The global value of the PCB industry’s output is now USD60bn, accounting for more than a

quarter of the total output value of the electronic components industry. Due to China’s huge

domestic market, and the advantages of lower labour costs and better industrial support, more

global PCB production capacity has shifted to China since 2000. In 2006, mainland China

surpassed Japan to become the largest PCB manufacturer in the world.

0.0%

10.0%

20.0%

30.0%

40.0%

50.0%

60.0%

70.0%

80.0%

90.0%

100.0%

2015 2016 2017e 2018e 2019e 2020e

Korea Taiwan China Japan US

0%

5%

10%

15%

20%

25%

30%

35%

40%

45%

50%

0

10

20

30

40

50

60

2012 2013 2014 2015 2016 2017e 2018e 2019e

BOE Capacity Yoy

(milliom m2)

65


September 2018

Exhibit 122. Global PCB market Exhibit 123. PCB production output by region

Source: Prismark, HSBC Qianhai Securities Source: Prismark, HSBC Qianhai Securities

Han’s Laser has a full spectrum of PCB equipment, covering the entire manufacturing process,

including exposure, mechanical/laser drilling, mechanical/laser molding, electrical

measurement, and automatic optic inspection (AOI) testing. It is the first-tier supplier of local

leading PCB producers such as SCC ( ), Suntak ( ), and Kinwong ( ).

Meanwhile, the company is gaining recognition from foreign PCB producers such as WUS (

), Tripod-tech ( ), and Zhen Ding Tech ( ).

Over the past 10 years, Han’s Laser PCB segment has registered a 20% revenue CAGR,

higher than the industry average. We believe the PCB segment will continue to outperform,

driven by production capacity expansion of local PCB producers. For example, SCC aims to

increase capacity to 1.64m sqm by end of 2018, up from 1.30m sqm in 2017.

High-power laser – a blue sky market

The high-power laser system market is emerging as an enhancement to traditional punching

machines and resistance welding equipment. It is already being used in the automobile,

aerospace and military industries, and other industrial applications. According to chyxx.com (

), the traditional punching equipment market is worth about RMB20-30bn and traditional

resistance welding equipment over RMB60bn. Although laser processing has various

advantages, such as high accuracy/flexibility, short processing time and less processing

consumables, it still at the early stage of development.

In 2017, nearly 90% of Han’s Laser high-power laser system revenue was generated from

cutting equipment, and the rest from welding equipment. Downstream clients include SAIC,

FAW, Yutong and Kinglong Bus from the automobile industry, and Xingguan ( ),

Zhongnong Boyuan ( ), XCMG ( ) from agricultural machinery, and AVIC (

) from aerospace. Looking ahead, we expect the company’s high-power segment to remain

high growth based on the improving affordability of downstream clients and low penetration rate,

particularly for local automobile OEMs.

The automobile industry is one of the largest markets for high-power laser welding equipment.

According to chyxx.com ( ), China’s auto manufacturing equipment market is now worth

over RMB150bn, of which welding equipment accounts for about 25%, so the addressable

market for laser welding in the automobile industry alone is nearly RMB40bn. As the first mover,

Trumpf is the market leader in the automobile industry, and while Han’s Laser is making

progress the contribution to revenue is still minimal. In 2016, the company delivered laser

welding integrated solutions for Audi, BMW and Mercedes Benz.

Besides heavy industry, high-power laser processing is starting to be used in consumer

electronics such as the metal frame of smartphones. The metal material utilization rate of

traditional CNC punching is about 80%, and it is about 95% for high-power laser processing.

Han’s Laser has shipped a few samples to Apple for testing, and we expect this high-power

project with Apple to materialise in 2019.

-20%

-15%

-10%

-5%

0%

5%

10%

15%

20%

25%

30%

0

10

20

30

40

50

60

70

2008 2009 2010 2011 2012 2013 2014 2015 2016

Global PCB market size Yoy

(USDbn)

0.0%

10.0%

20.0%

30.0%

40.0%

50.0%

60.0%

70.0%

80.0%

90.0%

100.0%

2008 2009 2010 2011 2012 2013 2014 2015 2016

China Japan Asia ex. China and Japan North America Europe


September 2018

66

Vertical integration to improve margin

Given the importance of the laser source, in-house supply capability is critical for competiveness

and margin improvement. In order to minimise the impact from IPG, the dominant fiber laser

source supplier, Trumpf acquired SPI’s laser source business segment in 2008. Other

equipment makers like Jenoptik and Coherent have also entered the fiber laser source market.

Han’s Laser has been putting great emphasis on laser source development. According to

management, 50% of low-power fiber laser source is now made in-house, and high-power fiber

laser source in-house supply will materialise in 2018. In 2016, Han’s Laser acquired Coractive

High-Tech, a special fiber producer in Canada. The special fiber is a core component for

producing fiber laser source. Recently, the company completed an RMB230m convertible bond

issuance, of which RMB150m will be invested in high-power laser cutting and welding system

projects. This suggests that the company is committed to closing the technology gap with IPG.

Entering the semiconductor industry by acquisition

In 2016, Han’s Laser acquired an 80% stake in Fortrend Engineering, a leading supplier of

solutions of bulk wafer transfer, standard mechanical interface (SMIF), ultra-cleaning

automation, and wafer surface heat treatment in IC fabrication. Fortrend was established in the

US in 1979, and has two manufacturing facilities in Xinzhu, Taiwan and Shenyang, China. Its

client portfolio includes TSMC, Intel, UMC, Applied Materials, Micron and Tower. It provides

wafer transport, wafer cure oven systems, and wafer sorter systems.

Fortrend recorded sales of nearly RMB200m in 2017, according to management. Han’s Laser

aims to cross-sell its laser equipment and automation solution to Fortrend’s existing clients. We

expect Han’s Laser to gain market share by gaining new customers such as SMIC and JCET.


Earnings forecasts

We forecast a 36% net profit CAGR during 2018-20e, driven by a 32% revenue CAGR, margin

expansion through vertical integration, as well as operating leverage.

We believe laser equipment will continue to be Han’s Laser’s revenue driver, with a 32%

revenue CAGR (high-power equipment 45% CAGR, low-power equipment 27% CAGR). We

expect PCB equipment to have a 30% revenue CAGR and semiconductor equipment to achieve

a 70% revenue CAGR in 2018-20e, albeit from a low base. As a result, we expect laser

equipment will account for 77% of total revenue in 2020e, down from 81% in 2017.

We expect the gross margin of high-power equipment will improve from 26% in 2017 to 30% in

2020e thanks to vertical integration for the laser source business. As the gross margin of high-power

is still lower than other segments, the overall gross margin will fall slightly from 41.3% in 2017 to

40.1% in 2020e as the high-power segment expands. We expect the SG&A to revenue ratio to

decline over time as the company is promoting automation in its manufacturing facilities.

Exhibit 124. Forecast of revenues from Apple

RMBm 2016 2017 2018e 2019e 2020e CAGR 18-20e

Labelling equipment 650 1,500 1,000 1,200 1,200 10% Welding equipment 300 1,500 1,000 1,500 1,500 22% Cutting equipment 300 500 500 800 800 26% Automation solution 350 500 500 500 500 0% High-power equipment 100 1500 1500 287% Total 1,600 4,000 3,100 5,500 5,500 33%


67


September 2018

Exhibit 125. Revenue and profit forecast by segment

RMBm 2014 2015 2016 2017 2018e 2019e 2020e CAGR 18-20e

Revenue Laser equipment 3,769 3,847 5,149 9,319 10,099 14,951 17,660 32% Low-power equipment 2,915 2,917 3,690 7,245 7,303 9,946 11,779 27% High-power equipment 854 929 1,459 2,074 2,796 5,005 5,881 45% PCB equipment 589 707 890 1,210 1,816 2,360 3,068 30% LED Equipment 618 343 482 540 594 654 719 10% Semiconductor 400 720 1,152 70% Laser printing equipment 212 158 102 Others 378 533 336 490 305 320 336 5% Total 5,566 5,587 6,959 11,560 13,214 19,005 22,935 32% Gross profit Laser equipment 1,553 1,438 2,006 3,870 3,895 5,877 7,065 35% Low-power equipment 1,285 1,173 1,577 3,333 3,140 4,476 5,300 30% High-power equipment 268 265 429 539 755 1,401 1,764 53% PCB equipment 229 257 335 460 654 873 1,135 32% LED Equipment 146 95 152 184 203 223 245 10% Semiconductor 200 360 576 70% Laser printing equipment 38 14 4 Others 239 311 164 257 152 160 168 5% Total 2,204 2,115 2,661 4,771 5,104 7,493 9,189 34% Gross margin Laser equipment 41.2% 37.4% 39.0% 41.5% 38.6% 39.3% 40.0% Low-power equipment 44.1% 40.2% 42.7% 46.0% 43.0% 45.0% 45.0% High-power equipment 31.4% 28.5% 29.4% 26.0% 27.0% 28.0% 30.0% PCB equipment 38.8% 36.3% 37.6% 38.0% 36.0% 37.0% 37.0% LED Equipment 23.6% 27.8% 31.5% 34.1% 34.1% 34.1% 34.1% Semiconductor 50.0% 50.0% 50.0% Laser printing equipment 17.8% 8.9% 3.6% Others 63.3% 58.4% 48.9% 52.5% 50.0% 50.0% 50.0% Total 39.6% 37.9% 38.2% 41.3% 38.6% 39.4% 40.1%



We think low-power laser equipment revenue from Apple and high-power laser equipment

revenue growth are the two critical swing factors for earnings. Our earnings sensitivity analysis

for 2018e shows that for every RMB500m difference in low-power laser equipment revenue

from Apple, earnings would change by 4.9%; for every 10% difference in high-power laser

equipment revenue growth, earnings would change by 0.4%, on our estimates.

Exhibit 126. Sensitivity analysis for 2018e earnings

______ Low-power laser equipment revenue from Apple (RMBm) _______ 2,000 2,500 3,000 3,500 4,000

High-power laser equipment revenue growth

16% 1,762 1,849 1,936 2,024 2,111 26% 1,769 1,857 1,944 2,031 2,118 36% 1,777 1,864 1,951 2,038 2,125 46% 1,784 1,871 1,958 2,045 2,133 56% 1,791 1,878 1,966 2,053 2,140



Han’s Laser had net cash of RMB151m at the end of 2017. The company’s operating cash flow

has largely met its capex needs over the past few years. We expect the company’s free cash

flow to increase from RMB984m in 2017 to RMB2.8bn in 2020e, driven by strong earnings

growth and flat capex. Han’s Laser is building a new production facility which it is describing as

its “Global laser smart manufacturing base” in Shenzhen’s Baoan district. Capex planned is

RMB2bn and the project is scheduled to be completed in 2019. After completion, Han’s Laser’s

production capacity will increase by 200% to meet its capacity needs before 2022. On dividend

policy, Han’s Laser maintained its cash dividend at RMB0.20/share over 2011-17, and we

believe there is upside potential, in line with the growth in free cash flow.


September 2018

68


RMBm 2013 2014 2015 2016 2017 2018e 2019e 2020e

Cash and equivalents 797 1,018 696 846 2,325 5,111 5,730 7,959 Net receivables 1,638 1,924 2,086 2,754 4,084 4,706 6,769 8,169 Inventory/stocks 1,619 1,442 1,697 1,845 2,290 2,666 3,785 4,519 Other current assets 53 271 117 122 194 213 234 258 Total Current assets 4,107 4,656 4,596 5,567 8,894 12,697 16,518 20,905 Net PP&E/Fixed assets 1,267 1,268 1,305 1,543 1,371 2,120 2,819 3,004 Net intangibles 188 189 193 814 752 810 874 944 Total investments 724 628 816 1,453 1,672 1,672 1,672 1,672 Other long-term assets 352 455 672 993 1,415 1,497 1,455 1,398 Total non-current asset 2,531 2,540 2,987 4,803 5,209 6,098 6,819 7,018 Total assets 6,638 7,196 7,582 10,370 14,103 18,795 23,337 27,923 Accounts payable 1,275 1,476 1,738 2,825 3,785 4,444 6,308 7,532 Short-term debt and current portion of long-term debt

1,026 978 299 1,282 1,833 1,833 1,833 1,833

Other current liabilities 156 207 219 294 545 545 545 545 Current liabilities 2,457 2,660 2,256 4,401 6,163 6,822 8,686 9,910 Long-term debt 187 80 246 193 341 2,641 2,841 3,041 Other long-term liabilities/creditors

105 136 169 227 315 315 315 315

Total long-term liabilities 292 216 415 421 656 2,956 3,156 3,356 Total liabilities 2,749 2,876 2,670 4,821 6,819 9,778 11,842 13,267 Common stock 1,052 1,056 1,063 1,067 1,067 1,067 1,067 1,067 Treasury stock - - - - - - - - Reserve 2,536 3,069 3,677 4,239 5,914 7,648 10,126 13,287 Other common equity (9) - - - - - - - Total common equity 3,579 4,125 4,740 5,306 6,981 8,715 11,193 14,354 Minority interest 309 195 172 242 302 302 302 302 Total equity 3,888 4,320 4,912 5,548 7,284 9,017 11,495 14,657 Total liabilities and equity 6,638 7,196 7,582 10,370 14,103 18,795 23,337 27,923


69


September 2018


RMBm 2013 2014 2015 2016 2017 2018e 2019e 2020e

Net income 549 708 747 754 1,665 1,947 2,770 3,577 Minority interest and impairment add-back

41 53 57 88 156 150 150 150


119 131 131 149 169 190 244 261

Investment Loss (223) (45) (39) (23) 17 (207) (50) (50) (Increase)/decrease in working capital :

76 48 (301) (195) (221) (339) (1,317) (910)


101 63 (55) 23 187 187 187 187


663 958 539 796 1,974 1,928 1,984 3,215

Capital expenditure (189) (263) (315) (709) (989) (900) (900) (400) (Acquisitions)/divestitures 254 2 1 1 6 - - - Investments (27) 53 (38) (358) (16) (100) (100) (100) Other investment cash flow items

13 (136) 174 (260) 40 - - -

Cash flow from investing 50 (344) (178) (1,326) (960) (1,000) (1,000) (500) Dividends paid (301) (287) (263) (271) (292) (292) (416) (537) Share repurchase/issue 42 34 43 60 5 - - - Increase/(decrease) in debt

(140) (123) (498) 906 896 2,300 200 200


8 (119) 149 (214) (146) (150) (150) (150)

Cash flow from financing (391) (494) (570) 481 464 1,858 (366) (487) Effect of foreign exchange rate changes

(7) (14) 13 12 (33) - - -

Total cash flow 316 107 (197) (36) 1,444 2,786 619 2,229 Free cash flow 473 695 223 88 984 1,028 1,084 2,815


Valuation

We apply a 12m forward PE to value Han’s Laser. We project a net profit CAGR of 29% over

2017-20e, in line with the 32% CAGR during 2008-17. We think it is reasonable to apply a mid-

cycle valuation of 22x for the stock, which translates into our target price of RMB50.59, implying

18% upside. With the growing diversification of the customer base and a solid earnings growth

outlook, we believe our target multiple valuation and Buy rating are justified.

Downside risks

Apple’s innovation progress is slower than expected. In general, smartphone innovation in

new design and new processing technology will generate demand for laser equipment. If

Apple’s innovation progress is slower than expected, it may cut its laser equipment orders from

Han’s Laser.

Laser source import substitution progress is slower than expected. Han’s Laser aims to

start high-power laser source in-house supply from 2018. If there is any delay, margin

improvement may be hard to achieve.

Regulatory changes in component sourcing policy. Han’s Laser focuses on late-stage

assembly and relies on external sourcing of various components such as fiber laser source.

Failure to secure those key component presents a downside risk to Han’s Laser’s sales.


September 2018

70

Exhibit 129. Historical 12m forward PE Exhibit 130. Historical 12m forward PB


0.0

10.0

20.0

30.0

40.0

50.0

60.0

2010

/1

2010

/7

2011

/1

2011

/7

2012

/1

2012

/7

2013

/1

2013

/7

2014

/1

2014

/7

2015

/1

2015

/7

2016

/1

2016

/7

2017

/1

2017

/7

2018

/1

2018

/7

+1 STD

Mean

-1 STD

0.0

1.0

2.0

3.0

4.0

5.0

6.0

7.0

8.0

9.0

20

10

/1

20

10

/7

20

11

/1

20

11

/7

20

12

/1

20

12

/7

20

13

/1

20

13

/7

20

14

/1

20

14

/7

20

15

/1

20

15

/7

20

16

/1

20

16

/7

20

17

/1

20

17

/7

20

18

/1

20

18

/7

+1 STD

Mean

-1 STD

71


September 2018


Year to 12/2017a 12/2018e 12/2019e 12/2020e


Revenue 11,560 13,214 19,005 22,935

EBITDA 2,045 2,160 3,368 4,313


Operating profit/EBIT 1,876 1,969 3,124 4,052

Net interest -222 -131 -152 -153

PBT 1,786 2,295 3,242 4,169

HSBC Qianhai PBT 1,786 2,295 3,242 4,169

Taxation -76 -298 -421 -542

Net profit 1,665 1,947 2,770 3,577

HSBC Qianhai net profit 1,665 1,947 2,770 3,577


Cash flow from operations 1,974 1,928 1,984 3,215

Capex -989 -900 -900 -400

Cash flow from investment -960 -1,000 -1,000 -500

Dividends -213 -292 -416 -537

Change in net debt -780 -486 -419 -2,029

FCF equity 538 491 577 2,308


Intangible fixed assets 752 810 874 944


Current assets 8,894 12,697 16,518 20,905

Cash & others 2,325 5,111 5,730 7,959

Total assets 14,103 18,795 23,337 27,923


Gross debt 2,174 4,474 4,674 4,874

Net debt -151 -637 -1,056 -3,085




Year to 12/2017a 12/2018e 12/2019e 12/2020e

Y-o-y % change

Revenue 66.1 14.3 43.8 20.7

EBITDA 152.1 5.6 56.0 28.1

Operating profit 183.4 5.0 58.6 29.7

PBT 106.0 28.5 41.3 28.6

HSBC Qianhai EPS 119.7 16.9 42.3 29.1

Ratios (%)

Revenue/IC (x) 2.3 2.2 2.5 2.5

ROIC 35.9 28.7 35.6 38.2

ROE 27.1 24.8 27.8 28.0

ROA 15.7 12.8 14.0 14.7

EBITDA margin 17.7 16.3 17.7 18.8

Operating profit margin 16.2 14.9 16.4 17.7


Net debt/equity -2.1 -7.1 -9.2 -21.0

Net debt/EBITDA (x) -0.1 -0.3 -0.3 -0.7

CF from operations/net debt


EPS Rep (diluted) 1.56 1.82 2.60 3.35


DPS 0.20 0.27 0.39 0.50

Book value 6.54 8.17 10.49 13.45

Valuation data

Year to 12/2017a 12/2018e 12/2019e 12/2020e

EV/sales 3.8 3.3 2.3 1.8

EV/EBITDA 21.4 20.1 12.7 9.5

EV/IC 8.0 6.5 4.9 4.1

PE* 27.4 23.4 16.5 12.8

PB 6.5 5.2 4.1 3.2

FCF yield (%) 1.2 1.1 1.3 5.2

Dividend yield (%) 0.5 0.6 0.9 1.2


Issuer information


Target price (CNY) 50.59 Sector Electronic Equipment




ESG metrics




CO2 reduction policy Yes Female board members (%) 30

Social Indicators Board members Independence (%) 40





Price relative


12.00

22.00

32.00

42.00

52.00

62.00

12.00

22.00

32.00

42.00

52.00

62.00

2016 2017 2018

Hans Laser Technology Ind Rel to CSI 300 Index

Financials & valuation: Hans Laser Technology Ind Buy


September 2018

72

The pioneer of China’s semiconductor industry

Tongfu Microelectronics was founded in 1997 and listed in 2007. The company, headquartered

in Jiangsu, Nantong, engages in the IC packaging and testing business. By revenue, the

company is ranked seventh among global OSATs and third in China. Tongfu has advanced

packaging platforms, including Bumping, WLCSP, FC, BGA and SiP; traditional packaging

platforms include QFN, QFP, and DIP, as well as automotive electronics, and MEMS packaging

solutions. It also provides wafer testing and system final testing services.

The company is the first domestic packaging and testing company to achieve back-end

processes for the mass production of 12-inch 28nm mobile phone processors, including

Bumping, Circuit Probing, Flip Chip, and Final Test. Its products are widely used in high-end

processors (CPU, GPU), memory, mobile terminals, the Internet of Things, power modules, and

automotive electronics.

Exhibit 131. Tongfu’s corporate development

Year Events

1997 Nantong Fujitsu was founded. Huada and Fujitsu take 60% and 40% respectively. 2007 Nantong Fujitsu was listed on A-share market. 2009 Became the first domestic company providing BGA packaging; obtained LQFP and Bumping technology from Fujitsu;

became the supplier of Toshiba. 2010 Set up the first wafer-level bumping production line. Completed additional A-share public offering. Became the supplier

of Texas Instruments. 2011 Developed high-density bumping technology and applied it to high-end chips such as CPU and GPU. Established

cooperation with Teramikros (formerly Casio Micro) on WLP advanced packaging technology. 2012 Obtained Cu Pillar bumping technology from Fujitsu, which is critical for advanced tech node IC packaging 2014 Achieved strategic cooperation with a well-known domestic design company; became the supplier of MediaTek. 2015 Completed private placement and acquired 85% stake of two AMD packaging fabs in Suzhou and Penang 2016 Sutong and Hefei fabs were put into operation; renamed as “Tongfu Micro”; became the supplier of Huawei,

Spreadtrum, ZTE, Samsung, Broadcom, Socionext. 2017 Invested in Xiamen fab; signed a strategic cooperation agreement with Infineon 2018 Fujitsu sold its stake to Huada, National Big Fund, and local industry fund. Signed a strategic cooperation agreement

with Loongon; Became the supplier of domestic DRAM manufacturer Hefei Ruili


Tongfu began life as a joint venture between Nantong Huada and Fujitsu (China). Through

acquisitions and co-development with Japanese companies, Tongfu gradually mastered industry-

leading packaging technologies. The company has become the qualified packaging and testing

supplier for domestic and foreign semiconductor companies such as Broadcom, MediaTek,

Tongfu Microelectronics

(002156 CH)

A top 3 OSAT supplier with a high-quality customer base

Benefiting from the robust growth of AMD, MediaTek and Bitmain

Initiate with Buy rating and 12m target price of RMB12.05

73


September 2018

STMicroelectronics, Texas Instruments, Toshiba, Fuji Electric, Huawei, HiSilicon, and Spreadtrum.

Five of the world’s top 10 fabless IC design houses are clients of the company.

Exhibit 132. Tongfu’s client portfolio Exhibit 133. Revenue breakdown by client

Europe, US Japan, Korea, Taiwan

Mainland China

AMD MediaTek Spreadtrum Texas Instruments Realtek RDA Infineon Fujitsu Leadcore STMicro Renesas Silan Micro NXP Ricoh Hisilicon freescale Toshiba Goodix On Semi Rohm Semi Nationz Tech Micronas Niko-sem BCD Semi Fairchild Semi Spansion


As a part of the global semiconductor supply chain, the growth profile of Tongfu is highly correlated

with the global semiconductor market. After suffering due to the global financial crisis in 2008 and

2009, the global semiconductor market recorded a strong recovery in 2010. Between 2012 and

2015, Tongfu’s growth was driven by product mix enhancement and improving the client base. The

revenue contribution from high-margin advanced packaging platforms has now reached 60-70%. In

2016 and 2017, in order to cope with the rapid development of the domestic semiconductor industry,

the company expanded the scale of its business through acquisitions and capex.

Exhibit 134. Tongfu historical revenue trend

Exhibit 135. Tongfu historical net profit trend


The company has facilities in Nantong Sutong Technology Industrial Park, Anhui Hefei and

Xiamen Haicang district, and has built new fabs at Sutong, Hefei and Xiamen. In April 2016,

with the support of the national “Big Fund”, Tongfu acquired an 85% stake in AMD’s Suzhou

and Penang fabs (AMD still holds 15%) for USD370.6m. The deal was completed in two stages.

First, Tongfu and the Big Fund provided 22.5% and 62.5% of the amount in cash, respectively.

In the second stage, completed in December 2017, Tongfu acquired the Big Fund’s 62.5%

stake through a private placement. As a result, 85% of profits from Suzhou and Penang fabs will

absorbed by Tongfu from January 2018.

AMD45%

MediaTek10%

STMicroelectronics6%

Texas Instruments

4%

Infineon4%

Others31%

-20%

0%

20%

40%

60%

80%

100%

120%

-

1,000

2,000

3,000

4,000

5,000

6,000

7,000

20072008200920102011201220132014201520162017

(RMBm)

-100%

-50%

0%

50%

100%

150%

-

20

40

60

80

100

120

140

160

180

200

2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017

(RMBm)


September 2018

74

AMD’s Suzhou and Penang fabs have leading-edge advanced flip-chip packaging and testing

technology. The main products are used in high-end applications such as computers, servers,

high-end game consoles, and cloud computing centres. The transaction means that Tongfu has

obtained mass production technology and know-how about advanced packaging. Meanwhile,

the two fabs will continue to serve as the primary packaging and testing supplier for AMD and

transition to the OSAT business model.

According to company guidance, AMD allocates over 80% of its IC packaging and testing

orders to the Suzhou and Penang fabs. The two fabs now actively respond to AMD orders and

have developed 7nm wafer node technology, launched a number of new products, and acquired

many high-profile new customers. In 2017, the two fabs’ revenue grew by 24% y-o-y.

The two new fabs at Sutong and Hefei went into operation in September 2016 and utilization

rates are ramping up. At the Sutong fab, which is an additional production base for high-end

products, the number of clients has increased from 13 in early 2017 to 29, and the production

output has increase from a daily average of 200,000 units in early 2017 to 1.2m units.

The Hefei fab is focused on supporting the local IC industry. The number of clients has

increased from 11 in early 2017 to 33 and output has increased from a daily average of 3m

units in early 2017 to 11m units. Over 2017-19 the Heifei fab will build a world leading LCD

driver packaging and testing production line to support local panel makers, such as BOE. The

fab has also been selected as a supplier of Heifei Ruili, the strategic partner of GigaDevice, to

co-develop packaging and testing technology for high-end DRAM products.

In June 2017, Tongfu signed a strategic cooperation agreement with the Xiamen Haicang

government to build an advanced packaging and testing fab in Xiamen. Tongfu invested

RMB30m, giving it a 10% stake. At the time of break-even, Tongfu will acquire the remaining

stake from the government at the original invested price.

Top client AMD has positive momentum

AMD, the US multinational, is Tongfu’s largest client and accounted for 45% of the company’s

revenue in 2017. AMD wasn’t very competitive for several years but is regaining ground on its

two much larger competitors, Intel and Nvidia. Based on newly-developed Zen and Vega micro-

architecture, the company had great success in launching the Ryzen family of CPUs and

Radeon GPUs. The revenue of its computing and graphics segment surged 54% in 2017.

Enterprise, embedded, and semi-custom segment revenue grew 3%, driven by the new family

of high-performance EPYC processor platforms for the datacentre.

Looking ahead, AMD hopes to build on this momentum with the next wave of premium

products. In the PC market, the company expects more than 60 new Ryzen processor-based

OEM commercial and consumer systems to launch throughout 2018. In the graphics market, the

company aims to expand the Radeon “Vega”-architecture based line-up into high-end

notebooks, and start sampling the first 7nm node GPU for machine learning later in 2018.

In the datacentre segment, the company will continue to work closely with major cloud vendors

and OEMs to ramp their first-generation EPYC processor-based systems, while also completing

Exhibit 136. Six fabs and packaging platforms

Chongchuan Suzhou Penang Sutong Hefei Xiamen (10% ownership)

Bumping 8/12'' solder/copper FCBGAs FCBGAs BGAs, LGAs, FCCSP ICs (High Density) WLCSP WLCSP FCLGAs FCLGAs FCBGA, FCCSOP Memory Copper Pillar BGAs, LGAs, FCCSP FCPGAs FCPGAs QFN Test services Gold bumping QFNs, QFPs, ICs Coreless BGAs Coreless BGAs Test services Power Packaging Test services Bumping Test services Test services


75


September 2018

development milestones on the next-generation “Zen 2” architecture-based server platforms.

AMD aims to achieve double-digit market share in the USD16bn datacentre market in the

coming years, up from 1% in 2017.

Exhibit 137. AMD is gaining market share Exhibit 138. AMD revenue trend

3Q16 4Q16 1Q17 2Q17 3Q17 4Q17

AMD PC CPU 9.1% 9.9% 11.4% 11.1% 10.9% 12.0%

GPU supplier 4Q17 2017 1Q18

AMD 27.2% 29.5% 33.7% Nvidia 72.8% 70.5% 66.3%

Source: Mercury Research, Jon Peddie Research Source: Company data, Bloomberg consensus estimates

MediaTek, Tongfu’s second largest client, accounted for about 10% of revenue in 2017. The

Taiwanese company has been losing market share to Qualcomm and Spreadtrum in the past

year due to a slowdown in product upgrades. The company is now back on a growth track and

revenue grew 21.8% y-o-y to USD2bn in 2Q18. This was driven by the adoption of its AI

capable mobile SoCs, such as Helio P60 chip, by a number of China-based smartphone

vendors, including Xiaomi, Oppo and Vivo.

MediaTek announced that it has joined China Mobile’s ‘5G Device Forerunner Initiative’

program to jointly develop 5G terminal devices and 5G chipsets. As one of the first chip makers

participating in the program, MediaTek announced its first 5G baseband chipset, Helio M70, will

be ready in 2019. In addition to its core smartphone business, MediaTek has been shifting more

of its business to chips for IoT, game consoles and ASICs, which account for about one third of

the company’s total revenue. The company has sold IoT chips to new customers such as

Amazon, Google and Chinese internet companies. Automotive electronics will be the next target

in terms of MediaTek’s long-term business growth.

Exhibit 139. MediaTek shipment trend Exhibit 140. MediaTek revenue trend

Source: Company data, HSBC estimates Source: Company data, Bloomberg consensus estimates

-40.0%

-30.0%

-20.0%

-10.0%

0.0%

10.0%

20.0%

30.0%

40.0%

-

1,000

2,000

3,000

4,000

5,000

6,000

7,000

8,000

9,000

2012 2013 2014 2015 2016 2017 2018e2019e2020e

Revenue Yoy

(USDm)

-40%

-30%

-20%

-10%

0%

10%

20%

30%

40%

50%

60%

-

20

40

60

80

100

120

140

Smartphone chip shipment Yoy

(m units)

-20.0%

-10.0%

0.0%

10.0%

20.0%

30.0%

40.0%

50.0%

60.0%

70.0%

-

50,000

100,000

150,000

200,000

250,000

300,000

350,000

2012 2013 2014 2015 2016 2017 2018e2019e2020e

Revenue Yoy

(TWDm)


September 2018

76

Well positioned in the automotive IC market

According to IC Insights, the global automotive IC market in 2017 totalled USD27.2bn, accounting for

7.5% of the total IC market. IC Insights forecasts the automotive IC market to grow to USD43.6bn in

2021, which a 12.5% CAGR for 2017-21, the highest among the six major end-use applications.

Automotive IC’s are traditionally wire-bond packages. Due to the increasing complexity and

higher performance requirements of automotive applications, the packaging industry is moving

towards high performance advanced flip chip, fan-out and SiP packages for automotive

infotainment, GPS, and radar applications.

Tongfu is well positioned in the fastest growing automotive IC market. Among the top 10 automotive

IC vendors worldwide, seven of them are Tongfu’s existing clients. Moreover, the company has a

strategic cooperation agreement with Infineon to help enhance Tongfu’s manufacturing capabilities

and productivity by sharing Germen industry 4.0 experience and acknowledge.

According to the agreement, the cooperation between two parties will be carried out in stage.

Infineon will evaluate the current manufacturing capability of Tongfu in terms of equipment

productivity, production cycle, on-time delivery and quality, and propose a manufacturing

improvement plan. As part of the cooperation, Infineon also assisted Tongfu in setting up a 4.0

intelligent manufacturing demonstration production line at the Hefei fab in 2017.

Exhibit 141. 2017 Automotive IC vendor market share

Exhibit 142. IC market growth by end-use application (2017-2021e CAGR)

Ranking Company Market share

1 NXP 12.5% 2 Infineon 10.8% 3 Renesas 10.0% 4 Texas Instruments 8.0% 5 STMicro 7.1% 6 Bosch 5.5% 7 ON Semi 4.8% 8 Rohm Semi 2.7% 9 Toshiba 2.7% 10 ADI 2.6%

Source: Strategy Analytics Source: IC Insights

New revenue stream from cryptocurrency mining

Cryptocurrency mining, or cryptomining, is a process in which transactions for various forms of

cryptocurrency are verified and added to the blockchain digital ledger. Also known as cryptocoin

mining, altcoin mining, or Bitcoin mining (for the most popular form of cryptocurrency, Bitcoin),

cryptocurrency mining activity has increased rapidly in the last few years.

Cryptocurrency mining was originally designed to be something everyone could do with their

home computer. Those days are long gone. Today, whether you’re mining Bitcoin, Litecoin,

DASH, or a host of other cryptocurrencies, the most effective way to do so is with a piece of

hardware known as an ASIC miner. Application specific integrated circuits, or ASICs, are chips

that are designed with a singular purpose, ranging from audio processing to managing a

cellphone call. In the case of cryptocurrency mining, these chips are built into specifically-

designed motherboards and power supplies, constructed into a single unit.

Frost and Sullivan forecasts the ASIC-based hardware market will reach RMB28.6bn in 2020

from RMB2.6bn in 2016, implying an 82% CAGR. According to the prospectus of Canaan

4.6%

5.2%

5.4%

6.1%

6.8%

8.1%

12.5%

0.0% 2.0% 4.0% 6.0% 8.0% 10.0% 12.0% 14.0%

Comm

Gov/Mil

Computer

Total Ics

Consumer

Industial

Automotive

77


September 2018

Creative, which produces blockchain servers and designs ASIC microprocessor solutions,

Chinese producers dominate the ASIC miner market. Bitmain takes nearly 70% market share,

followed by Canaan Creative 20%, Ebang 4%, and Pangolin 2%. About 1.5m mining units were

shipped in 2017, so we estimate that over 200m ASIC chips were shipped (assuming each

miner carries 150 ASIC chips on average). We expect Tongfu, as the main packaging and

testing supplier of Bitmain ASIC processor, to benefit from this new market.

Exhibit 143. Mainstream Bitcoin miners Exhibit 144. Blockchain hardware market size

Ant miner S9i Avalon miner A841

Producer Bitmain Canaan Creative Processor 189 units of BM1387

16nm ASIC chips 104 units of A3210

16nm ASIC chips Rated calculation power

13.5Hash/s 13Hash/s

Rated power 1320W/h 1290W/h Price RMB4500 RMB7600

Source: Company data, HSBC Qianhai Securities Source: Frost & Sullivan

Introducing new clients to improve utilization

Tongfu’s margin has been dragged down by the low utilization rate of the two new fabs at

Sutong and Hefei. Introducing clients to a new fab usually takes 1.5-2 years as it takes time to

complete IC packaging platform verification. The fabs started operating in September 2016.

According to the company guidance, the two fabs lost nearly RMB100m on a net basis in 2017

but gross profit turned positive (RMB2-3m) in 1Q18. The company expects the two fabs to break

even by the end of 2018, which should drive margin improvement.

Another positive is that AMD orders now account for about 80% of the capacity of the Suzhou

and Penang fabs. Given the strong demand from AMD and the introduction of new clients in the

coming quarters, the company guided an RMB2.4bn capex in 2018 to increase capacity.

Broadcom and IDT’s products are mass produced at the Penang fab, and ZTE’s new product

has started mass production at Suzhou. Samsung has completed the verification process, while

Socionext, UMC and Higon have entered the verification stage. Pango ( ), Loongson

( ), and Brigates ( ) have entered the sample trial production stage.


Earnings forecast

We forecast a 44% net profit CAGR during 2018-20e, driven by an 18% revenue CAGR, margin

expansion through vertical integration, as well as operating leverage.

We expect the Suzhou and Penang fabs to have a 20% revenue CAGR during 2018-20e thanks

to strong demand from AMD and the introduction of new clients. We also expect the other three

fabs – Chongchuan, Sutong and Hefei – to have revenue CAGRs of 15%, 27% and 27% in this

period, driven by rising demand from automotive electronics and cryptocurrency mining, as well

as new clients.

2.6 7.3

14.6

24.0 28.6

0.8

1.4

2.9

5.6

6.9

0.0

5.0

10.0

15.0

20.0

25.0

30.0

35.0

40.0

2016 2017 2018e 2019e 2020e

Non-ASIC based blockchain hareware

ASIC-based blockchain hareware

(RMBbn)


September 2018

78

We expect the gross margin to improve from 14.5% in 2017 to 19.0% in 2020e, driven by

capacity utilization improvement in the new fabs. We expect the SG&A to revenue ratio to

decline over time thanks to efficiency enhancements.

Exhibit 145. Revenue and gross profit forecast

RMBm 2016 2017 2018e 2019e 2020e CAGR 18-20e

Chongchuan 2,825 3,265 3,852 4,430 5,095 15% Suzhou and Penang 1,740 2,955 3,546 4,256 5,107 20% Sutong 2 147 400 520 650 27% Hefei 25 153 400 520 650 27% Total 4,592 6,519 8,199 9,726 11,501 18% Gross profit 826 943 1,394 1,751 2,185 Gross profit margin 18.0% 14.5% 17.0% 18.0% 19.0%



We think the two AMD fabs’ revenue growth and Chongchuan fab revenue growth are the two

critical swing factors for earnings. Our earnings sensitivity analysis for 2018e suggests that for

every 5% difference in the AMD fabs’ revenue growth, earnings would change by 1.0%; for

every 5% difference in Chongchuan fab revenue growth, earnings would change by 2.3%.

Exhibit 146. Sensitivity analysis for 2018e earnings (RMBm)

___________________ AMD fabs’ revenue growth ____________________

Chongchuan fab revenue growth

10% 15% 20% 25% 30% 8% 285 288 291 294 297

13% 293 296 299 302 305 18% 300 303 306 309 312 23% 308 311 314 317 320 28% 315 318 321 324 327



Tongfu had net debt of RMB997m as at 2017, with a healthy net gearing level of 16.8%. It has

consistently generated positive operating cash flow, but free cash flow has been negative since

2014 due to the capex on new fabs.

The company guided for RMB2.4bn capex in 2018 for capacity expansion. Hence, we expect the

company’s free cash flow to stay negative and the net gearing ratio to increase in 2018. Beyond

that, with an improving margin and ROE, we expect the company’s free cash flow to turn positive

and net gearing ratio to decrease gradually. As the company is still in an expansion cycle with

more capital committed to new fabs, we expect the company to pay a dividend after 2019.

79


September 2018


RMBm 2013 2014 2015 2016 2017 2018e 2019e 2020e

Cash and equivalents 765 561 1,438 1,603 1,704 1,692 2,335 3,516 Net receivables 356 422 522 1,291 1,626 2,045 2,426 2,868 Inventory/stocks 250 274 318 782 975 1,190 1,395 1,629 Other current assets 29 72 661 266 132 132 132 132 Total Current assets 1,400 1,329 2,939 3,942 4,437 5,059 6,288 8,146 Net PP&E/Fixed assets 1,874 2,318 2,715 5,027 5,665 6,913 7,211 7,038 Net intangibles 72 95 125 285 267 307 314 322 Total investments 32 28 39 38 69 69 69 69 Other long-term assets 309 185 695 1,911 1,708 1,488 1,282 1,056 Total non-current asset 2,287 2,626 3,573 7,262 7,709 8,778 8,877 8,485 Total assets 3,686 3,955 6,512 11,203 12,146 13,838 15,165 16,632 Accounts payable 527 568 562 1,788 1,748 2,133 2,500 2,920 Short-term debt and current portion of long-term debt

513 591 983 1,468 1,928 1,928 1,928 1,928

Other current liabilities 16 17 15 59 53 53 53 53 Current liabilities 1,057 1,175 1,560 3,316 3,730 4,115 4,482 4,902 Long-term debt 120 152 476 301 772 1,772 2,272 2,772 Other long-term liabilities/creditors

253 263 736 1,445 1,387 1,387 1,387 1,387

Total long-term liabilities 373 416 1,212 1,746 2,158 3,158 3,658 4,158 Total liabilities 1,430 1,591 2,772 5,061 5,888 7,273 8,140 9,060 Common stock 650 650 748 973 1,154 1,154 1,154 1,154 Treasury stock Reserve 1,606 1,714 2,992 2,925 4,765 5,072 5,533 6,079 Other common equity 0 0 1 20 0 - - - Total common equity 2,256 2,364 3,740 3,918 5,919 6,225 6,686 7,232 Minority interest - - - 2,223 339 339 339 339 Total equity 2,256 2,364 3,740 6,142 6,258 6,564 7,025 7,571 Total liabilities and equity 3,686 3,955 6,512 11,203 12,146 13,838 15,165 16,632



September 2018

80


RMBm 2013 2014 2015 2016 2017 2018e 2019e 2020e

Net income 61 121 147 181 122 306 461 638 Minority interest and impairment add-back

11 16 14 100 69 39 54 70


251 292 355 655 893 1,181 1,237 1,212

Investment Loss 3 3 (14) 1 (2) - - - (Increase)/decrease in working capital :

(66) (52) (312) (156) (212) (249) (219) (257)


50 36 41 4 140 140 140 140


309 415 231 785 1,010 1,418 1,673 1,803

Capital expenditure (119) (664) (1,251) (1,561) (1,657) (2,400) (1,500) (1,000) (Acquisitions)/divestitures 2 0 1 0 33 - - - Investments 15 1 4 6 (30) - - - Other investment cash flow items

(37) 5 (679) (1,909) 4 - - -

Cash flow from investing (139) (657) (1,925) (3,464) (1,650) (2,400) (1,500) (1,000) Dividends paid (52) (47) (68) (89) (92) - - (92) Share repurchase/issue - - 1,253 1,809 - - - - Increase/(decrease) in debt

(62) 110 968 147 912 1,000 500 500


(6) (10) 312 1,011 (30) (30) (30) (30)

Cash flow from financing (120) 53 2,464 2,878 790 970 470 378 Effect of foreign exchange rate changes

(13) 1 15 (4) (37) - - -

Total cash flow 38 (189) 786 194 113 (11) 643 1,181 Free cash flow 190 (249) (1,020) (777) (647) (982) 173 803


Valuation

We apply a 12m forward PE to value Tongfu. As earnings were cyclical up to 2015 the

company’s shares have historically traded in a quite wide multiple range, with a mid-cycle

forward PE of 60x and one-standard deviation of 33x. But since the acquisition of AMD’s

packaging and testing fabs in 2016, we believe Tongfu’s revenue and earnings growth profile

and has structurally changed and become less volatile and more predictable.

We forecast a 44% net profit CAGR over 2018-20e, which is slightly higher than the A-share

semiconductor sector average earnings CAGR of 37%. Therefore, we apply the A-share

semiconductor peer group’s valuation matrix to value the stock. We apply 35x forward PE to

Tongfu, in line with A-share sector average multiple. Accordingly, we derive a target price of

RMB12.05, implying 20% upside.

81


September 2018

Exhibit 149. Comparable A-share semiconductor value chain

Ticker Company Currency Price Market cap DAV _ PE (x) __ PS (x) PB (x) EPS CAGR EV/EBITDA ROE (%) Div yield (%) USDm USDm 18e 19e 18e 18e 18-20e 18e 18e 18e

A-share 002371 CH NAURA TECH CNY 53.26 3,576 99 101.9 64.3 7.2 6.8 53% 51.4 7.1 0.2 002008 CH HAN'S LASER CNY 42.77 6,677 99 21.4 16.4 3.2 5.2 30% 18.5 25.0 1.0 002156 CH TONGFU MICRO CNY 10.05 1,696 13 30.0 19.9 1.4 1.8 39% 10.6 6.2 0.9 603986 CH GIGADEVICE SEMI CNY 110.00 4,566 86 49.5 34.3 10.2 14.5 45% 46.1 30.9 0.3 600584 CH JCET CNY 15.11 3,539 31 32.9 19.9 0.9 2.3 51% 9.4 7.1 0.3 300316 CH ZHEJIANG JINGSHENG CNY 12.46 2,357 34 23.0 17.9 5.0 3.9 25% 19.6 16.6 1.2 002049 CH UNIGROUP GUOXIN CNY 43.04 3,849 133 66.7 54.4 10.6 6.9 22% 41.8 11.1 0.2 300613 CH SHANGHAI FULLHAN CNY 119.85 801 7 40.4 28.0 8.9 5.0 37% 25.9 12.3 0.2 002185 CH TIANSHUI HUATIAN CNY 5.06 1,584 15 18.0 14.4 1.3 1.8 24% 8.3 10.1 0.9 600703 CH SANAN OPTOELECTRONICS CNY 15.94 9,458 95 16.4 12.8 6.0 2.8 27% 10.4 17.5 2.2 600460 CH HANGZHOU SILAN CNY 11.35 2,179 59 61.8 47.2 4.4 5.0 28% 33.2 8.6 0.8 300672 CH GOKE MICRO CNY 51.04 840 16 76.5 38.8 11.5 0.0 54% - 7.1 0.0 300666 CH KONFOONG MATERIALS CNY 47.00 1,518 36 124.2 85.5 13.6 16.0 38% 80.7 13.0 0.0 300458 CH ALL WINNER TECH CNY 23.67 1,153 21 49.2 35.2 5.1 3.6 38% 32.0 7.1 0.0 603005 CH CHINA WAFER LEVEL CSP CNY 20.23 692 6 37.2 24.7 5.9 2.5 44% 14.7 6.6 0.0 300323 CH HC SEMITEK CNY 11.60 1,872 12 15.9 11.6 3.0 2.4 33% 11.9 16.6 0.5 47.8 32.8 6.1 5.0 37% 27.6 12.7 0.5 Share prices as at 3 Sep 2018 Source: Company data, Wind, Bloomberg

Downside risks

Market share loss with key customers: Tongfu has around 80-90% market share in AMD’s

packaging and testing business, so we see limited chance of this improving. Also, AMD has

divested its majority ownership in the Suzhou and Penang fabs. According to the acquisition

agreement, AMD guarantees that the two fabs will generate not less than USD20m profit in the

following three years, otherwise AMD will cover any shortfall. This guarantee will expire in 2019.

Although AMD still has 15% ownership, it will have more options in terms of packaging and

testing suppliers by then, leading to downside risk for sales.

Raw material and key component sourcing: Tongfu relies on external souring of raw

materials such as bonding wire, molding material and key components such as lead frame and

substrate. Any regulatory changes or natural disaster causing a supply shortage would lead to

downside risk to sales and margins. g

Longer-than-expected new customer order wins: The IC packaging and testing business

needs a long period of time for product verification. It takes about two years to introduce new

clients and even longer for automotive electronics clients due to high requirements for reliability.

Slower-than-expected progress in verification would be a downside risk for sales.



0.0

20.0

40.0

60.0

80.0

100.0

120.0

140.0

160.0

180.0

2007

/8

2008

/2

2008

/8

2009

/2

2009

/8

2010

/2

2010

/8

2011

/2

2011

/8

2012

/2

2012

/8

2013

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/8

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2014

/8

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/2

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/8

2016

/2

2016

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2017

/2

2017

/8

2018

/2

+1 STD

Mean

-1 STD

0.00

1.00

2.00

3.00

4.00

5.00

6.00

7.00

8.00

2007

/8

2008

/2

2008

/8

2009

/2

2009

/8

2010

/2

2010

/8

2011

/2

2011

/8

2012

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2012

/8

2013

/2

2013

/8

2014

/2

2014

/8

2015

/2

2015

/8

2016

/2

2016

/8

2017

/2

2017

/8

2018

/2

+1 STD

Mean

-1 STD


September 2018

82


Year to 12/2017a 12/2018e 12/2019e 12/2020e


Revenue 6,519 8,199 9,726 11,501

EBITDA 1,119 1,591 1,870 2,077

Depreciation & amortisation -893 -1,181 -1,237 -1,212

Operating profit/EBIT 226 409 633 866

Net interest -198 -137 -173 -190

PBT 178 373 561 776

HSBC Qianhai PBT 178 373 561 776

Taxation 19 -37 -56 -78

Net profit 122 306 461 638

HSBC Qianhai net profit 122 306 461 638


Cash flow from operations 1,010 1,418 1,673 1,803

Capex -1,657 -2,400 -1,500 -1,000

Cash flow from investment -1,650 -2,400 -1,500 -1,000

Dividends 0 0 0 -92

Change in net debt 831 1,011 -143 -681

FCF equity -928 -1,232 -77 553




Current assets 4,437 5,059 6,288 8,146

Cash & others 1,704 1,692 2,335 3,516

Total assets 12,146 13,838 15,165 16,632


Gross debt 2,700 3,700 4,200 4,700

Net debt 997 2,008 1,865 1,184




Year to 12/2017a 12/2018e 12/2019e 12/2020e

Y-o-y % change

Revenue 42.0 25.8 18.6 18.3

EBITDA 32.2 42.2 17.6 11.1


PBT -27.1 109.7 50.4 38.3

HSBC Qianhai EPS -31.6 104.3 50.4 38.5

Ratios (%)

Revenue/IC (x) 1.0 1.0 1.1 1.3

ROIC 4.1 5.0 6.9 9.3

ROE 2.5 5.0 7.1 9.2

ROA 3.6 3.5 4.6 5.5

EBITDA margin 17.2 19.4 19.2 18.1



Net debt/equity 15.9 30.6 26.5 15.6

Net debt/EBITDA (x) 0.9 1.3 1.0 0.6

CF from operations/net debt 101.3 70.6 89.7 152.3


EPS Rep (diluted) 0.13 0.27 0.40 0.55


DPS 0.00 0.00 0.00 0.08

Book value 5.13 5.40 5.80 6.27

Valuation data

Year to 12/2017a 12/2018e 12/2019e 12/2020e

EV/sales 1.9 1.7 1.4 1.1

EV/EBITDA 11.2 8.5 7.2 6.1

EV/IC 1.7 1.6 1.5 1.5

PE* 77.3 37.8 25.2 18.2

PB 2.0 1.9 1.7 1.6

FCF yield (%) -8.1 -10.7 -0.7 4.8

Dividend yield (%) 0.0 0.0 0.0 0.8


Issuer information


Target price (CNY) 12.05 Sector It Services




ESG metrics










Price relative


6.60

8.60

10.60

12.60

14.60

16.60

18.60

6.60

8.60

10.60

12.60

14.60

16.60

18.60

2016 2017 2018

TongFu Microelectronics Rel to CSI 300 Index

Financials & valuation: TongFu Microelectronics Buy

83


September 2018

Broadening product portfolio to drive growth

GigaDevice is a leading memory chip design company with strong exposure to microcontrollers

and non-volatile memory devices such as NOR flash and NAND flash. It is a top-five global

NOR flash supplier with 13% market share and is China’s largest NOR flash and NAND flash

supplier. The company was established in 2005 and has been involved with R&D in NOR flash

since 2007.

Over the past decade, GigaDevice’s NOR flash technology has advanced from 130nm to 45nm,

covering 1.8V, 2.5V and 3.0V. In addition, GigaDevice started to mass produce microcontroller

units (MCU) in 2013 and NAND flash in 2017. The company is also partnering with Hefei

Changxin to develop 12-inch 19nm DRAM. Key customers include Spreadtrum, RDA

Microelectronics, MediaTek, Samsung, and IC component distributors. In 2017, China’s

National IC Fund (the “Big Fund”) took an 11% stake in the company.

Apart from organic growth, GigaDevice is also looking for M&A opportunities. The company is in

the process of acquiring a 100% stake in Shanghai Silead, a leading fingerprint chip designer.

NOR flash and microcontrollers are the main products, accounting for 84% and 15% of total

revenue in 2017.

Thanks to market share gains in NOR flash and product portfolio expansion, GigaDevice

achieved a 27% revenue and 56% net profit CAGR during 2013-17. Its gross margin has also

been rising in the past few years thanks to higher NOR flash prices and better product mix.

GigaDevice (603986 CH)

Leading NOR flash and MCU supplier keeps gaining market share

NAND flash and DRAM are long-term growth drivers

Initiate with a Hold rating and a target price RMB107.19


September 2018

84

Exhibit 152. Corporate development history

Year Events

2005 Established in Beijing, mainly focused on the R&D of SRAM

2006 Low power SRAM in production

2007 Shifting the R&D focus to NOR flash

2009 The first 130nm 3.0V SPI NOR flash in mass production

2010 512K~32Mb NOR Flash in mass production

2011 The first 90nm product 3.0V SPI NOR flash in production

Starts R&D of 32-bit ARM-based MCU

2012 Starts R&D in 65nm, with annual chip sales to 590m units

2013 Mass production of 65nm NOR flash; 810m units sales

ARM Cortex 32 bit MCU is released

2014 NOR flash products enters wearable and smart home industry

2016 Listed in Shanghai Stock Exchange

2017

Proposes acquiring ISSI, a leading SRAM and DRAM supplier, but fails

China National IC Fund purchases 11% share of GigaDevice

Starts mass production of 38nm NAND Flash

Partnership with Hebei municipal government to develop 19nm DRAM

Invests 1% stake in SMIC for HKD533m

2018

Proposes acquiring 100% stake in Shanghai Silead and intends to invest in 14nm

Inferencing AI chip and 30MHz ultrasound sensor

To form JV with Rambus and THG Ventures to develop RRAM


Exhibit 153. Revenue growth trend Exhibit 154. Gross margin trend


Gaining market share

We think GigaDevice is becoming more competitive and has the potential to become a tier-one

player in NOR flash in the coming five years.

GigaDevice’s NOR flash product covers 512Kb to 1Gb density and 130nm-45nm by geometry,

which is comparable to Macronix and Winbond. Its products are widely used in consumer

electronics, mobile phones, computing, IoT auto and industrial sectors. It has a large market

share in feature phones, WiFi routers, PC mainboards, notebooks, set-top boxes, USB keys,

smart TVs, surveillance cameras, graphic cards, and GPS navigation.

787 931

1,062 1,292

1,716 1

15

127

197

311

-

300

600

900

1,200

1,500

1,800

2,100

2013 2014 2015 2016 2017

Memory Microcontroller Others

(RMBm)

27% CAGR

21.9%24.9%

27.3%24.2%

37.6%40.0% 39.4%

43.1%

47.9%

21.9%

25.2%

28.7%26.7%

39.2%

0.0%

10.0%

20.0%

30.0%

40.0%

50.0%

2013 2014 2015 2016 2017

Memory Microcontroller Overall

85


September 2018

The company also recently became a supplier of 32MB NOR flash for Samsung’s Galaxy S9

camera modules, together with Winbond. The memory is used for image processing purposes.

That said, GigaDevice already a leading player in the low-density product category.

Its growth strategy is to continue to gain market share in the low-density segment (<128Mb)

while enhancing its know-how in high-density products. As Macronix and Winbond have both

expressed their intention to focus on high-density products, we expect GigaDevice will continue

to gain traction in the low-density category. In the high-density category, GigaDevice indicates

that 128MB and 256MB above products accounted for around 20% of sales in 2017.

In terms of node technology, two-thirds of its revenue was generated from 65nm in 2015, with

most of the balance coming from 90mn. In 2018, the company has assigned SMIC to produce

45nm products on a small scale and we expect sales to make a revenue contribution in 2019.

Although GigaDevice only accounted for low teens’ market share of the NOR flash market in

terms of revenue in 2017, its market share in total volume shipments is about 30%, down from

43% in 2015. This suggests its average selling price is lower than the industry average. But this

pricing discount has narrowed from 74% in 2015 to 57% in 2017, implying that GigaDevice is

moving up the value chain and gaining traction in high-density, high-quality product categories.

Exhibit 155. NOR flash volume shipment share

Exhibit 156. NOR flash ASP comparison

Source: WSTS, Company data, HSBC Qianhai Securities Source: WSTS, Company data, HSBC Qianhai Securities

We believe the fabless model provides flexibility in terms of production capacity and technology

advantages, and also enables the company to focus on IC design. As a shareholder of SMIC,

we believe GigaDevice receives strong support from SMIC in terms of capacity allocation and

technical know-how. Also, GigaDevice is able to leverage SMIC’s expertise and R&D in

advanced wafer fabrication to compete with global peers. SMIC produces 28nm IC and is in the

process of migrating to14nm. As at the end of 2017, 61% of its employees worked in the R&D

department; the company has filed 781 patents and been granted 261.

The company also has access to a low cost of equity financing to support new product R&D and

M&A. GigaDevice is trading at premium valuation to overseas peers, which means it is able to

raise capital at lower cost, which we think helps explain its proposal to acquire Shanghai Silead

and its previous unsuccessful effort to acquire ISSI in 2017.

3,959 4,253

3,461

4,923

5,710

810 1,108

1,478 1,686 1,736

20%

26%

43%

34%

30%

0%

5%

10%

15%

20%

25%

30%

35%

40%

45%

-

1,000

2,000

3,000

4,000

5,000

6,000

2013 2014 2015 2016 2017

Global NOR Flash volume GigaDevice volume

GigaDevice market share

(m)

0.97 0.84

0.72 0.77 0.99

3.62

2.90 2.80

2.31 2.30

-73%-71%

-74%-67%

-57%

-80%

-70%

-60%

-50%

-40%

-30%

-20%

-10%

0%

-

0.50

1.00

1.50

2.00

2.50

3.00

3.50

4.00

2013 2014 2015 2016 2017

GigaDevice Global average Discount

(RMB)


September 2018

86

Exhibit 157. Gross margin comparison Exhibit 158. R&D as % of total revenue comparison


MCU

Microcontroller (MCU) is a small computer on a single IC. It consists of processors (CPU),

memory and input/output peripherals (display, RF, switches, sensors) that can be used as an

embedded system. Most MCU in use today are embedded in equipment, and widely used in

automobiles, industrials, consumer electronics, and IoT. This is in contrast to microprocessors

(MPU) that are used in PCs or other applications that consist of various discrete chips.

GigaDevice started its R&D of MCU in 2011 and in 2013 launched the first 32-bit general-

purpose ARM Cortex M3 MCU, which was mainly applied in entry-level industrial and consumer

IoT markets. Industrial applications include long-range data collection, safety controls, and

environmental monitoring, while consumer applications cover smart appliances, smart meters,

and home gateways. It then launched the 32-bit ARM Cortex-M4 series MCU in 2016, targeting

fingerprint technology, wireless charging, high-performance computing, and graphic design. 32-

bit is now the prevailing standard for high-performance MCUs, accounting for roughly 40% of

the total MCU market, with the balance from 8- and 16-bit. In terms of technology node, it is in

the process of reviewing a possible migration from 55nm to 40nm.

Leveraging on its expertise in memory, a critical part of MCU, we think GigaDevice can extend

its product portfolio by entering the MCU market. MCU is a much larger market than NOR flash.

According to IC Insights, the global MCU market’s revenue was USD17.9bn in 2017, which is

almost 9x higher than that for NOR flash.

IC Insights forecasts that the MCU market, fuelled by applications in autos, IoT and industrial

controls, will reach USD20.9bn in 2020, implying a CAGR of 6.3%. The MCU market is

dominated by overseas suppliers such as NXP, Renesas and Microchip. GigaDevice’s market

share in MCU is below 3%, so we see ample room for growth.

0.0%

10.0%

20.0%

30.0%

40.0%

50.0%

60.0%

2011 2012 2013 2014 2015 2016 2017

Cypress Micrcon Macronix Winbond GigaDevice

0.0%

5.0%

10.0%

15.0%

20.0%

25.0%

30.0%

35.0%

2011 2012 2013 2014 2015 2016 2017

Cypress Micrcon Macronix Winbond GigaDevice

87


September 2018

Exhibit 159. MCU market share breakdown in 2016

Exhibit 160. Global MCU market size forecast

Source: IC Insights, HSBC Qianhai Securities Source: IC Insights, HSBC Qianhai Securities

Revenue from the MCU business has increased from RMB15m in 2014 to RMB311m in 2017, a

CAGR of 175%. In addition, due to more customization and less direct competition, the MCU

margin is higher than in its flash memory unit. GigaDevice currently has over 300 MCU products

with cumulative unit sales exceeding 200m as at May 2018, serving over 10,000 customers.

Exhibit 161. A typical wearable MCU architecture

Exhibit 162. GigaDevice MCU margin and ASP

Source: ARM Source: Company data

NAND Flash

Apart from NOR Flash, GigaDevice is ramping up NAND flash sales with a focus on the low-

density, SLC (single level cell) 2D product segment. Its applications include embedded systems

in feature phones, low-end smartphones, data cards, set-top boxes, and smart TVs. Its initial

strategy behind entering the NAND market is to complement high-density NOR flash in high-end

feature phones as the bit cost for NAND is more competitive in the 512Mb and above Flash

memory category.

The market for NAND Flash amounts to USD47bn in 2017, which is much larger than for NOR

Flash and MCU. However, due to high technical entry barriers the market is quite consolidated

with the top five vendors (Samsung, Toshiba, Western Digital, Micron and SK Hynix) accounting

for 93% market share in 2017.

NXP19%

Renesas16%

Microchip13%

Samsung12%

STMicroelectronics10%

Infineon7%

Texas Instrument

5%

Cypress4%

Others14%

-

0.1

0.2

0.3

0.4

0.5

0.6

0.7

0.8

0.9

1.0

0

5

10

15

20

25

30

2013 2014 2015 2016 2017 2018e 2019e 2020e

Market size (USD) (LHS) Units (LHS) ASP (RHS)

(bn) (USD)

Apps.

CPU

Always ON

CPUGPU

Display

Processor

Video

Processor

Interconnect

RadioFlash

MemoryROM SRAM

4.40 4.30 4.21

39.4%

43.1%47.9%

0.0%

10.0%

20.0%

30.0%

40.0%

50.0%

60.0%

2.00

2.50

3.00

3.50

4.00

4.50

5.00

2015 2016 2017

ASP Gross margin

(RMB)


September 2018

88

Exhibit 163. NAND Flash market size Exhibit 164. NAND Flash market share in

2017

Source: Company data, HSBC Qianhai Securities Source: DramExchange

Global NAND bit demand has increased from 43bn GB in 2013 to 183bn GB in 2017, a CAGR

of 62%. Rapid growth is likely to continue. Micron forecasts that NAND flash bit demand will rise

at a 40-45% CAGR over 2017-21, driven by the proliferation of cloud data centres, high

definition video, data storage, the growing transition from hard disk drive (HDD) to solid state

drive (SSD) in PCs and servers, as well as growing storage density for mobile devices.

GigaDevice is able to provide SPI (Series Peripheral Interface) 1G-8G NAND with 1.8/3.0V

voltage, and is in the process of extending this to 32GB. In terms of node technology, the

company started mass producing 38nm NAND Flash in 3Q17, and is in the process of

improving 24nm yield (over 40% yield in 3Q17). We estimate revenue from NAND flash will

reach RMB50m in 2018, accounting for 2% of its total revenue.

However, we still see a big technology gap between GigaDevice and leading NAND flash

suppliers. Their advanced 2D NAND node is generally at the 1xnm level, vs the 2x/3xnm offered

by GigaDevice. They are also able to produce advanced 3D NAND. 3D NAND uses a stacked

architecture, which means memory cells are layered vertically, in contrast to 2D NAND, which

has a single layer. 3D NAND can pack more capacity into less physical space at lower cost than

2D NAND. 3D NAND normally uses MLC (multi-level cell) and TLC (triple-level cell) as it stores

2 and 3 bits per cell compared to SLC. It is essentially a solution to solve the bottlenecks in

node shrinking under Moore’s Law.

SLC is now a niche market as it accounts for less than 5% of the total NAND market, with TLC

capturing over 50% share, with the balance going to MLC. We think GigaDevice’s major competitors

in SLC NAND include Taiwanese peers such as Macronix, Winbond, and Powerchip.

11.514.5

12.314.8

21.724.4 25.4

27.5 28.2 28.8

32.0

47.2

-20%

-10%

0%

10%

20%

30%

40%

50%

60%

0.0

5.0

10.0

15.0

20.0

25.0

30.0

35.0

40.0

45.0

50.0

2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017

NAND market size Yoy

(USDbn)

Samsung, 36%

Toshiba, 17%

Western Digital, 17%

Micron, 12%

SK Hynix, 10%

Intel, 6%Others, 1%

89


September 2018

Exhibit 165. NAND Flash bit demand growth

Exhibit 166. SLC, MLC and TLC NAND comparison

SLC MLC TLC

Bits per cell 1 2 3

Writing speed Fastest <SLC <MLC

Service life Longest Average < 1/2 of MLC

Program/erase cycle times

50-100K 3-10K 0.5-1K

Source: Micron Source: Speedguide.net

Proposed acquisition of Shanghai Silead – eyeing AI and IoT opportunities

GigaDevice wants to acquire a 100% stake in Shanghai Silead (unlisted) for RMB1,700m

(RMB255m in cash and new share issuance of RMB1,445m). The placement price is fixed at

RMB63.97/share, implying a total of 22.59m shares to be issued (8% of total outstanding

shares). The transaction is now under review and subject to approval by the regulator, the

CSRC.

Silead is a leading Chinese IC design company that specializes in fingerprint and touch panel IC

industry. It was ranked third in the fingerprint IC market in terms of shipments in 2017, with a

6.5% market share. It is also a top-five touch panel IC supplier worldwide with 9.5% market

share. Around 50% of its revenue is generated from O-film Tech (002456 CH, CNY 17.24, Buy).

In 2017, revenue totalled RMB448m, up 155% y-o-y, with 80% of revenue from fingerprint IC

and 20% from touch panel IC. Thanks to the strong revenue growth, net profit also turned from

a loss of RMB2.8m in 2016 to positive RMB11.4m in 2017.

GigaDevice expects the acquisition will help the company to broaden its product portfolio to

fingerprint and touch sensors. According to Sunrise Big Data, the fingerprint penetration rate in

smartphones has increased from 26% in 2015 to 61% and is expected to reach 88% in 2020. In

addition, we see an evolution in fingerprint technology from a traditional capacitive solution to

optical (in-display) and ultrasound (under glass) which will continue to drive the adoption of

fingerprint applications in the coming years.

More importantly, GigaDevice intends to leverage on Silead’s expertise in biometric sensors and

R&D platform in the areas of AI and IoT IC. In addition to the transaction cost, GigaDevice also

plans to raise RMB1,075m via a private placement, mainly to invest in R&D. The focus will be

on: 1) 14nm embedded AI Inferencing IC, to integrate voice, facial and biometric recognition

technology; 2) the 30MHz ultrasonic MEMS sensor, which is targeting in-display fingerprint

applications in smartphone and tablets; and 3) a human-machine interaction project. Given

GigaDevice’s know-how in memory and MCU, we think it can become a total solution provider in

SoC systems for AI and IoT.

In addition, Silead has also guaranteed its aggregate net profit in 2018-20 to be no less than

RMB320m. If it fails to achieve the target, the seller will proportionally return part of the shares

received, based on the difference between actual and guaranteed profit.

0

100

200

300

400

500

600

700

800

2013 2017 2021

Enterprise & Cloud SSD Client SSD

Mobile Consumer / removable

43

183

703~809(Bn Gb)

40-45% CAGR

62% CAGR


September 2018

90

Exhibit 168. Revenue breakdown of Shanghai Silead

Exhibit 169. Fingerprint industry market penetration

Source: Company data Source: Company data, Sunrise Big Data

Exhibit 170. 2017 fingerprint IC shipment market share

Exhibit 171. 2017 capacitive touch IC shipment share

Source: CCID, Company data Source: CCID, Company data

DRAM the long-term driver: the Hefei project is making progress

In October 2017, GigaDevice signed an agreement with Hefei Industrial Investment Group, a wholly

owned subsidiary of Hefei SASAC, to jointly develop a 19nm, 12-inch DRAM project. The total

investment amounts to RMB18bn. GigaDevice and the Hefei government are responsible for 20%

and 80% of the total, respectively, through either direct or indirect equity or debt financing.

The project aims to achieve more than 10% yield by end-2018. If the target is achieved

GigaDevice has an obligation to acquire all the interests of Hefei Industrial Investment Group

within five years. If the yield target is not realized, Hefei Industrial Investment Group has the

right to ask GigaDevice to acquire its outstanding interest before the end of 2019. So far

GigaDevice has not directly invested in the DRAM project, preferring financing through both

debt and equity.

Hefei Changxin is the primary entity for the DRAM project which started in 2016. So far

GigaDevice does not have ownership of the project. The designed phase 1 monthly capacity

amounts to 125,000 pieces. The company has recruited talent from leading memory companies

in Taiwan, Korea, and Japan. Phase 1 plant construction was completed in in 1Q18 and the

company has started equipment installation. There were over 1,500 employees as at April 2018,

with approximately one third from Taiwan.

34

358

63

140

87

14

1

2

0

50

100

150

200

250

300

350

400

450

500

2016 2017 1Q18

Fingerprint IC Touch IC Others

25%

43%

61%

73%

82%88%

26%

61%

70%

78%

85%91%

0%

10%

20%

30%

40%

50%

60%

70%

80%

90%

100%

2015 2016 2017 2018 2019e 2020e

Global China

Goodix35%

FPC35%

Silead7%

Synaptics4%

Egis Tec4%

Microarray3%

Others12%

Egis Tec15%

Mstar14%

Goodix13%

Silead10%

Synaptics9%

Betterlife8%

Chipone7%

Cypress5%

Others19%

91


September 2018

Hefei Changxin has accumulated an impressive array of proprietary IPs over the past two years. By

the end of 2017, the company had filed 354 patents and plans to apply for a further 1,155 in 2018.

The technology covers the supply chain, including development tools, design, masks, fabrication,

and testing.

We believe it will take time to improve the yield from 10% to 60%, the level required for mass

production. Once the 60% target is achieved, GigaDevice expects it will take another 8-12 months to

reach an 80%-plus yield. GigaDevice now expects to mass produce 8GB LPDDR4 in 3Q19.

On 17 July 2018, GigaDevice announced that its founder, Mr Zhu Yiming, had resigned as

general manager but would remain as chairman and a board member. Deputy general

manager, Mr He Wei, has taken over as general manager. At the same time, Mr Zhu was

appointed as the CEO of Changxin Storage and Hefei Ruili Integrated Circuits, which are the

two major subsidiaries under Hefei Changxin (see exhibit 173), according to report by

technews.tw. More importantly, Hefei Changxin completed the design process for 8Gb LPDDR4

DRAM on 17 July. This suggests a critical milestone has been reached, creating an incentive for

GigaDevice to ramp up its DRAM development.

Exhibit 172. Key milestones of the Hefei Changxin DRAM project


Exhibit 173. Ownership structure of Hebei DRAM project

Exhibit 174. DRAM market size

Source: Company data, Tianyancha.com Source: DramExchange, HSBC Qianhai Securities

The size of the DRAM market increased 76% y-o-y to USD72.8bn in 2017, driven by a 46%

y-o-y rise in selling price and 21% y-o-y bit growth. Propelled by growing demand from

applications in data centers such as AI, autonomous driving, and increasing memory per device

in smartphones and PCs, Micron forecasts that DRAM demand will increase from 92bn GB in

2017 to 190bn GB in 2021, a 20% CAGR over 2017-21.

China relies heavily on DRAM imports as we estimate it consumes more than a third of global DRAM

supply. In addition, DRAM supply is very concentrated with Samsung, SK Hynix and Micron

May 2016

Kicks off

DRAM project

2017 2018 2019 2020 2021

Mar 2017

Starts Phase 1

plant

construction

Jan 2018

Complete phase 1

plant construction

End 2018

Sampling 8Gb

DDR4

Jan 2018

Start equipment

installation

3Q19

To mass produce

8Gb LPDDR4

End 2019

To reach

20,000

pieces/month

2020

Start phase 2

plant construction

2021

To complete

R&D of 17nm

project

Hefei SASAC

Hefei Industrial

Investment Group

Hefei Industrial

Investment New

Strategic Partners

Hefei Changxin

Changxin Storage

Ruili Integrated Circuit

Hefei Ruijie

Jucheng

100%

99.75% 0.25%

19.9% 80.1%

100%

GigaDevice1:4

33.8 31.3

24.0 22.4

39.2

29.4 26.1

34.8

46.9 45.0

41.2

72.8

-40%

-20%

0%

20%

40%

60%

80%

100%

-

10.0

20.0

30.0

40.0

50.0

60.0

70.0

80.0

2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017

DRAM market size Yoy

(USDbn)


September 2018

92

accounting for 95%. Given the rising DRAM price, high import value, and growing demand, we

believe achieving DRAM self-supply is becoming a policy priority of the Chinese government.

Unigroup Guoxin Microelectronics is the first Chinese company able to produce DRAM, but its

products focus is on the DDR3 category. Fujian Jinhua, partners with UMC, focuses on 25 and

30nm node DRAM development. It completed plant construction and equipment installation in

July 2018 and plans to mass produce in September 2018. That said, we think GigaDevice has

the chance to be the technology leader among Chinese DRAM suppliers in 2019-20.

Exhibit 175. Market share of DRAM in 2017 Exhibit 176. DRAM bit demand forecast

Source: DramExchange Source: Micron, HSBC Qianhai Securities


Earnings forecasts

We forecast that GigaDevice will record a 37% net profit CAGR over 2017-20e, driven by 39%

revenue CAGR and stable margin. We believe NOR flash will continue to be an earnings driver

and expect the company to improve its market share from 13% in 2017 to 23% in 2020e,

especially in the mid- to low-density product category.

We expect NOR flash to account for over 82% of its total revenue by 2020e, similar to the 84%

in 2017. In addition, we expect NAND flash and MCU will achieve rapid revenue growth due to a

low base and fast customer adoption. On the margin side, we expect gross margin to decline

slightly due to potential pricing moderation on new capacity roll-out in China and competition

with global peers. We do not factor in any revenue and earnings contribution from the Hefei

DRAM project in our base case.

Samsung46%

SK Hynix28%

Micron21%

Nanya2%

Winbond1%

Powerchip1%

Others1%

0

20

40

60

80

100

120

140

160

180

200

2013 2017 2021

PC/Consumer Server Mobile Specialty

36

(bn Gb)

92

190

26% CAGR

20% CAGR

93


September 2018

Exhibit 178. Revenue and gross profit forecasts

2013 2014 2015 2016 2017 2018e 2019e 2020e 2017-20e

Revenue (RMBm) CAGR

Memory 782 829 1,062 1,292 1,716 2,350 3,478 4,744 40% NOR Flash 782 829 1,062 1,292 1,706 2,250 3,278 4,444 38% NAND Flash - - - - 10 100 200 300 211% MCU 1 15 127 197 311 451 586 703 31% Others 6 103 - - 3 2 3 3 0% Total 789 947 1,189 1,489 2,030 2,804 4,067 5,451 39% y-o-y

20% 26% 25% 36% 38% 45% 34%

Gross profit

Memory 172 232 290 313 645 870 1,252 1,708 38% MCU 1 6 50 85 149 203 264 317 29% Others - - - - 1 1 1 1 4% Total 173 239 341 398 795 1,073 1,517 2,026 37% Gross profit margin Memory 21.9% 24.9% 27.3% 24.2% 37.6% 37.0% 36.0% 36.0% MCU n/a 40.0% 39.4% 43.1% 47.9% 45.0% 45.0% 45.0% Total 21.9% 25.2% 28.7% 26.7% 39.2% 38.3% 37.3% 37.2%



We think global NOR flash shipment growth and GigaDevice’s NOR flash market share are the

two critical swing factors for earnings. Our earnings sensitivity analysis for 2018e suggests that

for every 5% difference in shipment growth, earnings would change by 3.8%; for every 2%

difference in market share, earnings would change by 10.3%.

Exhibit 179. Sensitivity analysis for 2018e earnings (RMBm)

________________ Global NOR flash shipment growth ________________ 0% 5% 10% 15% 20%

GigaDevice NOR flash market share

13% 453 470 486 503 519 15% 504 523 542 561 580 17% 555 576 598 619 641 19% 605 629 653 678 702 21% 656 683 709 736 762



GigaDevice had net cash of RMB359m as at end-2017. The company has consistently

generated positive operating cash flows since 2013 and positive free cash flow (except 2017),

thanks to its asset-light fabless model. As the company is in the process of acquiring Shanghai

Silead mainly via private placement, we think its balance sheet will remain solid in 2018-19.


September 2018

94


RMBm 2013 2014 2015 2016 2017 2018e 2019e 2020e

Cash and equivalents 199 262 420 872 587 551 796 1,228 Net receivables 57 116 136 129 173 230 334 448 Inventory/stocks 143 184 220 407 627 1,152 1,671 2,240 Other current assets 24 12 23 28 43 43 43 43 Total Current assets 423 574 798 1,435 1,431 1,977 2,845 3,959 Net PP&E/Fixed assets 37 35 47 76 102 216 320 411 Net intangibles 0 0 - 5 5 6 6 6 Total investments - 15 24 110 804 804 804 804 Other long-term assets 15 13 30 44 233 209 165 124 Total non-current asset 52 63 101 235 1,144 1,234 1,295 1,345 Total assets 475 636 900 1,670 2,574 3,211 4,139 5,304 Accounts payable 106 171 233 294 496 664 978 1,314 Short-term debt and current portion of long-term debt

- - - - 45 45 45 45

Other current liabilities 1 9 13 23 13 13 13 13 Current liabilities 108 180 246 316 554 722 1,036 1,372 Long-term debt - - - - 184 184 184 184 Other long-term liabilities/creditors

35 36 83 74 80 142 184 240

Total long-term liabilities 35 36 83 74 264 326 367 424 Total liabilities 143 216 329 391 817 1,048 1,404 1,796 Common stock 75 75 75 100 203 203 203 203 Treasury stock - - - - (121) (121) (121) (121) Reserve 256 345 496 1,179 1,675 2,081 2,653 3,426 Other common equity - - - - - - - - Total common equity 331 420 571 1,279 1,756 2,163 2,735 3,508 Minority interest - 0 (1) 1 1 1 1 1 Total equity 331 420 571 1,279 1,757 2,164 2,736 3,508 Total liabilities and equity 475 636 900 1,670 2,574 3,211 4,139 5,304


95


September 2018


RMBm 2013 2014 2015 2016 2017 2018e 2019e 2020e

Net income 67 98 158 176 397 542 763 1,030 Minority interest and impairment add-back

4 7 12 13 57 30 30 30


15 17 20 25 31 36 46 59

Investment Loss (2) (5) (0) (1) (54) - - - (Increase)/decrease in working capital :

13 (22) 34 (130) (258) (414) (309) (347)


3 (0) (7) 1 25 - - -


100 95 217 84 198 194 530 772

Capital expenditure (29) (18) (41) (79) (233) (150) (150) (150) (Acquisitions)/divestitures - - 0 - - - - - Investments (3) (6) (7) (83) (549) - - - Other investment cash flow items

- - 1 - - - - -

Cash flow from investing (32) (23) (47) (161) (782) (150) (150) (150) Dividends paid - (10) (15) - (53) (80) (135) (191) Share repurchase/issue - - - 535 121 - - - Increase/(decrease) in debt

- - - - 235 - - -


- - - (15) 9 - - -

Cash flow from financing - (10) (15) 521 313 (80) (135) (191) Effect of foreign exchange rate changes

(5) 1 3 9 (13) - - -

Total cash flow 64 63 158 452 (285) (36) 245 431 Free cash flow 71 77 176 5 (35) 44 380 622


Valuation

We apply 12m forward PE to value GigaDevice, with reference to its historical valuation and

earnings growth trend. We project the company will register 37% net profit CAGR in 2017-20e,

which is slightly lower than historical CAGR of 44% during 2012-17. We believe it is reasonable

to apply a historical average forward PE of 45.3x to value the stock. Accordingly, our target

price for GigaDevice is RMB107.19, implying 3% downside. We rate the stock as a Hold.

Upside risks

Design wins in high-density, high-quality NOR Flash. GigaDevice’s current NOR flash products

focus on the low-density category. If the company can win orders in the high-density segment for

auto and industrial, it could boost the revenue and margin outlook from our base case.

Higher-than-expected SLC NAND Flash revenue growth. SLC NAND Flash is a new

business for GigaDevice, so it has a limited track record for this product. However, given the low

base and its strategic partnership with SMIC, we do not exclude the possibility that GigaDevice

could become a more competitive supplier in the 2D NAND market in the coming years.

Downside risks

NOR flash pricing and margin trend. Demand and supply dynamics will affect the NOR flash

pricing outlook. Individual company capacity expansion/contraction, new applications and

competition from other memory products will cause price volatility. Our base case assumes a

flattish NOR flash price trend in 2018-20. Our sensitivity analysis indicates that a 1% change in

the NOR flash price would potentially result in a 0.6% change in 2018e net profit.

DRAM project development is slower than expected. There are various technical issues to be

solved before commercial production can begin. If the company’s Hefei Changxin DRAM project fails

to reach the development target on time as discussed above, GigaDevice is obliged to acquire all of


September 2018

96

Hefei Industrial Group’s interest in the DRAM development and may incur a significant loss on the

project.



0.0

10.0

20.0

30.0

40.0

50.0

60.0

70.0

2016

/8

2016

/9

2016

/10

2016

/11

2016

/12

2017

/1

2017

/220

17/3

2017

/4

2017

/5

2017

/6

2017

/7

2017

/8

2017

/9

2017

/10

2017

/11

2017

/12

2018

/1

2018

/220

18/3

2018

/4

2018

/5

2018

/6

2018

/7

+1 STD

-1 STD

Mean

0.00

2.00

4.00

6.00

8.00

10.00

12.00

14.00

16.00

18.00

20.00

2016

/8

2016

/9

2016

/10

2016

/11

2016

/12

2017

/1

2017

/220

17/3

2017

/4

2017

/5

2017

/6

2017

/7

2017

/8

2017

/9

2017

/10

2017

/11

2017

/12

2018

/1

2018

/220

18/3

2018

/4

2018

/5

2018

/6

2018

/7

+1 STD

-1 STD

Mean

97


September 2018


Year to 12/2017a 12/2018e 12/2019e 12/2020e


Revenue 2,030 2,804 4,067 5,451

EBITDA 434 641 905 1,224


Operating profit/EBIT 403 605 859 1,165

Net interest -27 3 3 4

PBT 449 623 877 1,184

HSBC Qianhai PBT 449 623 877 1,184

Taxation -52 -81 -114 -154

Net profit 397 542 763 1,030

HSBC Qianhai net profit 397 542 763 1,030


Cash flow from operations 198 194 530 772

Capex -233 -150 -150 -150

Cash flow from investment -782 -150 -150 -150

Dividends -80 -135 -191 -258

Change in net debt 513 36 -245 -431

FCF equity -136 -1 335 577



Tangible fixed assets 334 425 485 535

Current assets 1,431 1,977 2,845 3,959

Cash & others 587 551 796 1,228

Total assets 2,574 3,211 4,139 5,304

Operating liabilities 589 820 1,175 1,568

Gross debt 228 228 228 228

Net debt -359 -323 -568 -999


Invested capital 594 1,036 1,364 1,705


Year to 12/2017a 12/2018e 12/2019e 12/2020e

Y-o-y % change

Revenue 36.3 38.1 45.1 34.0

EBITDA 169.1 47.6 41.2 35.3


PBT 141.8 38.7 40.8 35.0

HSBC Qianhai EPS -6.6 -2.6 39.4 35.0

Ratios (%)

Revenue/IC (x) 4.6 3.4 3.4 3.6

ROIC 80.1 64.6 62.3 66.1

ROE 26.2 27.6 31.1 33.0

ROA 19.9 18.6 20.7 21.7

EBITDA margin 21.4 22.9 22.2 22.5


EBITDA/net interest (x) 15.9

Net debt/equity -20.4 -14.9 -20.8 -28.5

Net debt/EBITDA (x) -0.8 -0.5 -0.6 -0.8

CF from operations/net debt


EPS Rep (diluted) 1.98 1.93 2.69 3.63


DPS 0.39 0.67 0.94 1.27

Book value 8.67 10.67 13.49 17.31

Valuation data

Year to 12/2017a 12/2018e 12/2019e 12/2020e

EV/sales 14.8 10.7 7.3 5.4

EV/EBITDA 69.2 46.9 33.0 24.0

EV/IC 50.6 29.0 21.9 17.2

PE* 55.6 57.1 40.9 30.3

PB 12.7 10.3 8.2 6.4

FCF yield (%) -0.4 0.0 1.1 1.9

Dividend yield (%) 0.4 0.6 0.9 1.2


Issuer information


Target price (CNY) 107.19 Sector It Services

Reuters (Equity) 603986.SS Country China



ESG metrics










Price relative


0.00

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40.00

60.00

80.00

100.00

120.00

140.00

160.00

0.00

20.00

40.00

60.00

80.00

100.00

120.00

140.00

160.00

2016 2017 2018

Gigadevice Semiconductor Rel to CSI 300 Index

Financials & valuation: Gigadevice Semiconductor Hold


September 2018

98

Disclosure appendix

Analyst Certification

The following analyst(s), economist(s), or strategist(s) who is(are) primarily responsible for this report, including any analyst(s)

whose name(s) appear(s) as author of an individual section or sections of the report and any analyst(s) named as the covering

analyst(s) of a subsidiary company in a sum-of-the-parts valuation certifies(y) that the opinion(s) on the subject security(ies) or

issuer(s), any views or forecasts expressed in the section(s) of which such individual(s) is(are) named as author(s), and any other

views or forecasts expressed herein, including any views expressed on the back page of the research report, accurately reflect

their personal view(s) and that no part of their compensation was, is or will be directly or indirectly related to the specific

recommendation(s) or views contained in this research report: Frank He

Important disclosures

Equities: Stock ratings and basis for financial analysis

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99


September 2018

Rating distribution for long-term investment opportunities

As of 06 September 2018, the distribution of all independent ratings published by HSBC is as follows:

For the purposes of the distribution above the following mapping structure is used during the transition from the previous to current

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HSBC & Analyst disclosures

Disclosure checklist

Company Ticker Recent price Price date Disclosure

HANS LASER TECHNOLOGY INDUSTRY 002008.SZ 41.95 05 Sep 2018 6, 7


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and/or paid compensation to HSBC in respect of investment banking services.


and/or paid compensation to HSBC in respect of non-investment banking securities-related services.


and/or paid compensation to HSBC in respect of non-securities services.

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capital, calculated according to the SSR methodology. HSBC and its affiliates will from time to time sell to and buy from customers the securities/instruments, both equity and debt

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Buy 53% ( 26% of these provided with Investment Banking Services )

Hold 37% ( 25% of these provided with Investment Banking Services )

Sell 10% ( 13% of these provided with Investment Banking Services )


September 2018

100

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Additional disclosures

1 This report is dated as at 07 September 2018.

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Production & distribution disclosures

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101


September 2018

Disclaimer

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[1101716]

Head of Research, HSBC Qianhai Securities Steven Sun +86 755 8898 3158 [email protected]

China Equity Strategy

Analyst, Head of China Equity Strategy Research Steven Sun +86 755 8898 3158 [email protected]

Associate Kate Zhang

Consumer

Analyst, Head of A-share Food & Beverage and Pulp & Paper Research Katharine Song +86 755 8898 3142 [email protected]

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Healthcare

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Associate Jialei Fan

Industrials and Environmental Services

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Telecoms, Media & Technology

Analyst, Head of A-share Technology Hardware Research Frank He +86 755 8898 3136 [email protected]

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Analyst, A-share Media & Internet Jing Han +86 755 8898 3147 [email protected]

Analyst, A-share IT Software Jamie Ma +86 755 8898 3140 [email protected]

Associate Kevin Xing

HSBC Qianhai Research Team

Frank He* (S1700517120005)Analyst, Head of A-share Technology Hardware Research HSBC Qianhai Securities Limited +86 755 8898 3136 | [email protected]

Frank He joined HSBC Qianhai Securities Limited in 2017 as Head of A-share Technology Hardware Research, covering the semiconductor, handset supply chain, telecom equipment and auto electronics sectors. From 2010 to 2017, he served as an analyst at two leading global brokerages, responsible for research on the clean energy, infrastructure and conglomerate sectors. In 2007-10, Frank was a lead technology and Internet research analyst at a Chinese securities firm in Hong Kong. He holds a BSc in actuarial science from the University of Hong Kong.

*Employed by a non-US affiliate of HSBC Securities (USA) Inc, and is not registered/qualified pursuant to FINRA regulations.

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