China smart devices - Nomura

52 Pages·2014·1.71 MB·English

China smart devices

EQUITY: TECHNOLOGY
The next mega trend for 2014 and beyond?
Global MarketsResearch

21 May 2014
LTE, Smart Homes, 3D Vision, EV, IT nationalism,

Smart TVs, 4G smartphones and more…
Anchor themes
Despite the macro slowdown and
Industry view: hardware + service to stimulate industry upgrade
saturation in major technology
We believe “hardware + service” has become an important business model to
product lines, we think innovation
drive the development of China’s IT hardware sector. In the past two years,
and policy supports are
the popularity of WeChat and mobile gaming has accelerated adoption of 3G
incubating a new round of
smartphones in China. Since 2013, IPTV services such as LeTV have started
growth, potentially benefiting
to reshape China’s TV industry. Looking ahead, we believe:
players well positioned in various
 Mobile video services will stimulate growth of 4G smartphones TMT sub-sectors.

 TV game deregulation will become a new driver for Smart TVs in China
Nomura vs consensus
 Air pollution may boost demand for EV and green home appliances
We analyse China's TMT industry
 E-commerce will create new opportunities in O2O logistics from the perspective of a broad
scope throughout the vertical &
 Smart home hardware is ready to incubate service and reshape the industry
horizontal axis, and across sub-
 Concerns on IT security will benefit players in nationally strategic areas like sectors.
semiconductor and enterprise equipment
 3D vision may help machines to better understand the real world and Research analysts

innovate the way people use e-commerce and auto driving.
China Technology
Regulatory policies still matter
Leping Huang, PhD - NIHK
As well as the above, government policy will play an important role in guiding
[email protected]
the development of China technology and telecoms. In 2014, we think: [phone]
 Information consumption is an important driver of 4G development David Hao - NIHK
[email protected]
 ‘Beautiful China’ and a new EV subsidy programme will drive EV adoption
[phone]
 Government funding and committee established to address the rising
importance of national security for information, network equipment and IC

How to invest?
We believe that some Chinese IT vendors (eg. Lenovo/Xiaomi in
PC/Smartphones, Huawei/ZTE in telecom equipment, BYD in EVs and
Haier/Gree in home appliances) are well positioned to transform their existing
market share into profit if they can capture the growth opportunities that we
explore in this report.

Fig. 1: Summary of relevant stocks listed in HK/China market
Themes Relevant stocks in HK/China market
ZTE (763 HK, top Buy), Huawei (unlisted), CCS (552 HK, Buy), Comba (2342 HK, Buy),
4G Capex
Trigiant (1300 HK, NR)
Digital China (861 HK, Reduce), Haier (1169 HK, NR), Gree (000651 CH, NR),
O2O (online-to-offline)
Midea (000651 CH, NR)
Skyworth (751 HK, top Buy), TCLM (1070 HK, NR), LeTV (300104 CH, NR), Haier, Gree,
Smart TV & Smart Homes
Midea
Electric Vehicle BYD (1211 HK, top Buy), Tianneng (819 HK, Buy), Chaowei (951 HK, NR)
3D Vision & Smart Drive Sunny Optical (2382 HK, top Buy), Truly (732 HK, NR)
Lenovo (992 HK, Neutral), ZTE, SMIC (981 HK), Digital China, Kingdee (268 HK, NR),
IT & Network Security
ChinaCache (CCIH US), 21Vianet (VNET US)
Lenovo, ZTE, Huawei, TCLC (2342 HK, Neutral), Coolpad (2369 HK, Neutral), BYDE (285 HK,
Smartphone Value Chain
Buy), Sunny Optical, Truly, Xiaomi (unlisted), AAC (2018 HK, Buy), O-Film (002456 CH, NR)
Source: Nomura research

See Appendix A-1 for analyst certification, important disclosures and the status of non-US analysts.
Nomura | China smart devices 21 May 2014

Contents

3 “Hardware + services” stimulate industry upgrades

4 Mobile video stimulates the growth of 4G smartphones

5 TV game deregulation to become second driver for Smart TVs

5 Air pollution drives EV adoption and green home appliances

6 E-commerce drives online-to-offline (O2O) logistics

7 Smart Homes: hardware is ready to incubate services

8 3D vision in e-commerce and driving

9 Regulatory changes in China

9 Which are the largest IT hardware companies in China?

11 How to invest?

12 Our top picks

13 What are the structural trends ahead?

13 How big will 4G and export markets be in 2014?

18 Smart Homes: a bigger market than smartphones?

24 Smart TVs: service market starts to take off

27 Information security and IT nationalism

31 Electric Vehicle: How do you have a beautiful China without some

green cars?

36 3D vision and smart drive

41 Links to our recent reports

42 Stocks fall into the themes

43 China Technology industry forecast summary

44 Industry value chain charts

49 Appendix A-1

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Nomura | China smart devices 21 May 2014

“Hardware + services” stimulate industry
upgrades
We believe “hardware + service” has become an important business model to drive the
development of China’s IT hardware sector. As highlighted in our 2013 report, China
smart devices - What will be the next mega trend?, the innovation in consumer
electronics has shifted from smartphone to TV in 2013.
We expect this shift will continue in 2014 and expect new innovation to come from home
appliances (Smart Home), automobiles (new energy vehicles and smart drives) and e-
commerce (3D shopping). In addition, we see the rising importance of regulation such as
information security and air pollution control, which will accelerate the growth of
enterprise equipment and new energy vehicles, in our view.

Fig. 2: Service innovation in China drives hardware upgrades

2010~
WeChat + =
2013~
LeTV
+ =
2013~
+ =
Made in China
2014~
+ =
2014~
+ =
Source: Nomura research

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Mobile video stimulates the growth of 4G smartphones
In the past two years, the popularity of WeChat and mobile gaming has accelerated the
use of 3G smartphones in China. As illustrated in the charts below, WeChat MAU
reached 396mn subscribers (32% mobile subscriber penetration rate) at end-1Q14, vs.
461mn 3G subscribers (37% penetration rate) at end-1Q14, showing growth clearly
outpacing that of overall 3G services. In our opinion, the growth of WeChat’s subscriber
base and the upgrade in WeChat services are important drivers for China’s 3G
smartphone growth. For example, new features in the WeChat platform include areas
such as acoustics, maps/GPS, cameras as well as touch panels and Near Field
Communication (NFC).
Looking forward, the key question is what will be the killer applications for 4G services in
China. We believe mobile video services such as iQiYi and Youku may become
important drivers to stimulate 4G migration.
Looking at the mobile market in China, according to iResearch, mobile video daily
average users (DAU) reached 6.22mn in Dec 2013, increasing 148% y-y from 2.51mn in
Dec 2012. At the same time, the monthly total mobile video viewing time increased to
119mn hours in December 2013, up 298% y-y from same period in 2012 (30mn hours).
Thus, we think the explosive growth in demand for traffic-heavy mobile services such as
video will ultimately fuel the demand for faster smartphones and a faster network from both
consumers and operators for reasons such as better user experience and cost savings.

Fig. 3: WeChat subscriber growth has outpaced 3G Fig. 4: Explosive growth in mobile video DAU and viewing
subscriber growth in China time in China

(mn subs) (mn users) DAU (LHS) (mn hours)
500 WeChat MAU (RHS) 40% 7 Hours/month (RHS) 140
3G Sub.(LHS)
35% 6 120
400 WeChat Penetration (RHS)
30% 5 100
3G Penetration (RHS)
25% 4 80
300
20% 3 60
200 15% 2 40
10% 1 20
100
5% 0 0
2 2 2 2 2 3 3 3 3 3 3 3 3 3 3 3 3
1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1
0 1Q12 3Q12 1Q13 3Q13 1Q14 0% Aug- Sep- Oct- Nov- Dec- Jan- Feb- Mar- Apr- May- Jun- Jul- Aug- Sep- Oct- Nov- Dec-
Source: Company disclosure, Nomura research Source: iResearch, Nomura research

At the same time, even IM services such as WeChat are evolving, introducing more
services (eg. location sharing, GPS, video calls, etc) that will not only increase data
consumption, but also require the network speed and latency to be faster.

Fig. 5: Illustration of WeChat’s roadmap

Ver. 3.0
Ver. 4.0 Ver. 5.0
Ver. 1.0 Ver. 2.0 Location
Video call, Game,
Test Voice based
photo payment,
message message social
sharing O2O
network
Touch Screen
Smartphone Acoustics Map & GPS Camera Quad-core
NFC
Acoustics
Camera
Source: Nomura research

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Nomura | China smart devices 21 May 2014

TV game deregulation to become second driver for Smart TVs
We have noticed a boom in the launch of TV game consoles since the beginning of
2014. Products include Huawei’s game console launched during MWC with Perfect
World, ZTE’s FunBox launched with The9 cities in March 2014, Microsoft’s Chinese
version of XBox jointly developed with BesTV (600637 CH, NR), and TCL’s T2 launched
together with Gameloft in April 2014.
We believe this boom is triggered by two things. First, the Chinese government reversed
its 14-year ban on dedicated-purpose game consoles (eg, Xbox, Nintendo Wii, PS4),
which was in place since 2000. Second, it is driven by the availability of Android-based
games and software platforms which greatly lower the incremental cost to develop
games for multiple platforms (eg, smartphones, TVs and PCs). Although there are still
some regulatory restrictions such as the pre-approval requirement for game titles, we
think this will become a new driver of Smart TV sales, and benefit TV vendors like TCL
Multimedia and Skyworth in terms of recurring contents revenue.

Fig. 6: XBox in China Fig. 7: TCL T2

Source: Nomura research

Source: Nomura research

Air pollution drives EV adoption and green home appliances
Pollution has become a serious problem in China along with industrialisation in major
cities. The government’s latest view on environment protection is to find the quickest and
easiest way to effectively reduce levels of pollution, and all eyes are on vehicle licensing
controls and promotion of pure/hybrid EVs.
Fine particulate matter (PM 2.5) refers to tiny particles in the air that are two and a half
microns or less in width, which can travel deep into the respiratory tract to the lungs.
Long-term exposure can lead to health conditions including asthma and heart disease.
Major sources of PM 2.5 in China’s cities, particularly Beijing, include cooking, industrial
pollution, vehicles and dust; among these, vehicles are the largest source, contributing
40-50% of the PM 2.5 in the air.

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Nomura | China smart devices 21 May 2014

Fig. 8: Example of polluted air in Beijing due to PM2.5 Fig. 9: Beijing’s PM2.5 index trends
Beijing's CCTV building peeking through the haze (14 Jan) Above 50 is unhealthy; above 150 is very unhealthy
PM 2.5 Index
350
300
250
200
150
100
50
0
Source: news.cn, Nomura research

Source: Nomura research

Vehicles are the largest source of PM 2.5; the Chinese government has rolled out
numerous incentives to contain vehicle pollution, which in turn should help to accelerate
EV adoption in China, in our view.
E-commerce drives online-to-offline (O2O) logistics
According to iResearch, the online shopping market has taken off over the past six
years, with a 71% CAGR to reach CNY1.86tn in gross merchandise volume (GMV) in
2013, from CNY0.13tn in 2008. At the same time, O2O GMV took off in 2011 and grew
13x over two years from CNY13bn in 2011 to CNY183bn in 2013. From 2013 to 2016,
iResearch forecasts online shopping and O2O will grow at 38%/115% CAGRs to reach
CNY4.89tn/CNY1.83tn, respectively.
This rapid shift in consumer buying behaviour is nurturing the growth of a brand-new
logistics business to efficiently handle e-commerce-related inventory distribution and
product/service delivery. China’s e-commerce giants have taken aggressive steps to
develop their logistics platforms.
• Alibaba’s investment in Haier and Cainiao
On 9 December 2013, Alibaba (unlisted) made a CNY2.8bn strategic investment in Haier
Electronics Group. The investment focused on Goodaymart (unlisted), Haier’s logistics
subsidiary for large items. Through the investment, Haier and Alibaba aim to build a
logistics platform dedicated to e-commerce-driven home appliance purchases.
In May 2013, Cainiao was formed, led by Alibaba (e-commerce), Yintai (property/retail),
Fosun (property/retail), Shunfeng Express (Logistics) and five other companies with the
intention to build a nationwide integrated warehouse, inventory management, and
logistics centre for e-commerce. Planned investment is CNY300bn in the next 5-8 years.
• JD.com and others
In addition to Alibaba in 2013, JD.com announced a CNY3.5bn investment in a logistics
centre; Yixun.com (subsidiary of Netease, NTES US, NR) plans to build more than 10
distribution centres in China; and Suning plans CNY20bn capex to build logistics centres
in the next three years.

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Nomura | China smart devices 21 May 2014

Fig. 10: Rapid growth of e-commerce (measured in GMV) Fig. 11: Comparison of online-offline cost structure in TV

(CNYtn) LeTV Skyworth
6 Online shopping (LHS) 500% S40 Coocaa 42E7DRS
O2O (LHS) Sales channel Online Online Offline
5 Online shopping y-y (RHS) 400% Model 40-inch 42-inch 42-inch
TV hardware 1 ,999 2,999 3,999
O2O y-y (RHS)
4
300% Mandatory 1-yr Subscription Fee 4 99 - -
3 Total revenue 2 ,498 2,999 3,999
200% COGS 2 ,373 2,729 2,729
2 Gross profit 1 25 270 1 ,270
100% GPM (%) 5% 9% 32%
1
Sales, Marketing and Other OPEX 1 48 222 923
0 0% Markup (%) 8% 8% 30%
08 09 10 11 12 13 4F 5F 6F Operating Profit ( 23) 48 347
0 0 0 0 0 0 1 1 1
2 2 2 2 2 2 20 20 20 % of sales ‐1% 2% 9%
Source: iResearch, Nomura research Source: Company data, Nomura estimates

Smart Homes: hardware is ready to incubate services
After PCs and smartphones, the trend towards “smart” is just beginning as people start
to experiment making everything else “smart”, in a world of M2M. Besides PCs and
smartphones, home appliances, wearable devices, and vehicles are next in line.
Smart Appliances prepared to make an impact as standalone hardware
From our visits to China’s leading home appliance vendors, all of Haier, Gree, and Midea
are making aggressive moves to adopt “smart” in their products. Although we agree with
Gree’s view that it is maybe still too early to define smart homes on a service level and
monetize from it, we do believe that on the hardware level smart home appliances are
ready to make an impact in areas of energy saving and user-friendly controls.
For example, smart air purifiers and air conditioners that constantly monitor home
environments and learn from the home owner’s daily patterns may act intelligently to
always provide a most comfortable environment for its users, especially important in
China where people would love to at least keep air quality under control in their homes.
Not yet ready on a service and eco-system level
We think it will take more time to build a mature eco-system where new services and
business models can be tried and monetized – much like in the early days when the
iPhone was launched, where it took a couple of years for the applications/service
community to become more creative and introduce killer applications.

Fig. 12: Smart home products as a % of total sales Fig. 13: Haier Air Box

Smart home Traditional products
100%
80%
60%
40%
50%
20%
30%
5% 15%
0%
FY14F FY15F FY16F FY18F
Source: Midea, Nomura research

Source: Nomura research

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Nomura | China smart devices 21 May 2014

3D vision in e-commerce and driving
3D vision and e-commerce
We believe there are large potential applications for 3D vision beyond handsets including
game consoles and gesture control applications (eg, Leap Motion). There are currently
many pilot programmes at major Internet companies worldwide, the most famous ones
being Google’s Project Tango and Amazon’s 3D smartphone. We find Ebay’s efforts to
bring 3D vision to the e-commerce space very interesting.
Ebay (EBAY US, NR) acquired PhiSix (unlisted) recently to let online shoppers virtually
"try on" jeans, dresses, shirts, and other clothing to see how they fit and look in an online
environment (shown in the figure below).
3D vision and vehicles
Auto makers and their suppliers are actively working with internet companies to make
vehicles “smarter”. We think it is a gradual process starting from enhancing external
sensors, to introducing driver-system interaction in the cockpit, to partially freeing up
drivers with intelligent driving assist functions, to ultimately freeing up drivers completely
with intelligent auto drive.
From a hardware perspective, we are observing several trends, including 1) more
sensors inside and outside of a vehicle (eg, cameras, infra-red, motion detectors, etc);
and 2) larger panels (eg, central displays are growing from ~5-inches to 7-inches+).
From a software/service perspective, we are observing the development of interactive
services (eg, OS, apps, and alternative controls including voice and gesture), by
companies such as Tencent, Google, and Apple with auto makers; in addition, we are
also observing cooperation between auto makers and third companies (eg, insurance
providers) to jointly introduce services based on big data.

Fig. 14: Intelligent auto drive Fig. 15: 3D virtual clothes
The shopper scans herself to create a virtual model to try on different
virtual clothes also scanned to determine the fit and look
Source: Bing.com

Source: Nomura research

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Nomura | China smart devices 21 May 2014

Regulatory changes in China
• Information consumption drives 4G development in China
In July 2013, the State Council decided to promote “information consumption” as part of
China’s national strategy in economic transformation, and TD-LTE is one important part
to this strategy to stimulate the consumption of mobile Internet services and smartphone
hardware.
On 14 August, the State Council published “Opinions on information consumption
boosting domestic demand” (关于促进信息消费扩大内需的若干意见). The document
indicates that information consumption is a catalyst in creating domestic demand,
upgrading the service industry and promoting economic transformation.
• “Beautiful China” driving electric vehicle adoption
China’s government announced its new subsidy standard for new electric vehicles in
September 2013, which prioritized electric buses to resolve air pollution problems. We
believe the focus on buses is in line with the government’s policy “Beautiful China” (Dec
2012) and “Action Plan for Air Pollution Control” (Sep 2013) to replace conventional
vehicles with clean energy vehicles (LNG cars) and new electric vehicles to resolve the
air pollution problems.
By 2017, the government targets to: 1) reduce the concentration of inhalable particles
(IP) by >10% vs. 2012; 2) reduce the concentration of fine particles by 25%/20%/15% for
Jing-Jin-Ji (京津冀), Yangtze River Delta and Pearl River Delta regions, respectively; and
3) control the full-year average concentration of fine particles in Beijing at ~60mcg/m3.
• PRISM drives server and IC upgrades
We see a clear trend to promote the adoption of domestic equipment and components
since mid-2013 after media reports about the US surveillance program PRISM.
In November 2013, China established the National Security Committee (NSC, 国家安全
委员会) which is chaired by China President Mr. Xi Jinping. NSC’s mission includes:
• Strengthen regulatory oversight of the internet (加大依法管理网络力度),
• Accelerate the institutional establishment of an internet management system (加快完善
互联网管理领导体制),
• Secure the safety of national networks and information (确保国家网络和信息安全).
We think semiconductor and network equipment are two areas which are critical to the
whole IT infrastructure, but Chinese vendors still lag behind in terms of market share,
which may potentially turn into opportunities for Chinese players to grow.
Which are the largest IT hardware companies in China?
From a revenue perspective, Huawei is China’s largest IT vendor, backed by its No.2
position in telecom equipment sales. Haier has the second largest revenue, propelled by
its complete product portfolio in home appliances. Then Lenovo is a close third, behind
its No.1 position in PCs, then Gree with its No.1 position in Air conditioners. After Lenovo
completes the acquisition of IBM’s x86 business and Motorola, it will become the largest
IT vendor in China by revenue in 2014.
On the profit side, Huawei was the most profitable IT vendor in China in 2013, with net
profit of CNY21bn at a NPM of 8.8%, thanks to its technology leadership in the telecom
equipment space. This is followed by Gree’s 9% NPM and CNY11bn in net profit backed
by its in-sourcing of key components in air conditioners like compressors and its
vertically integrated business model.
However, if we compare Huawei/Gree with leading international consumer electronics
vendors like Samsung, Huawei/Gree’s profits are still only 13%/7% of Samsung’s
currently.

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Nomura | China smart devices 21 May 2014

Fig. 16: Comparison of revenues (2013) Fig. 17: Comparison of net profits and net margins

(CNYbn) (CNYbn) Net Profit (LHS)
300 25 Net Profit Margin (RHS) 10%
239
250 20 8%
200 180 179
15 6%
150 120 121
93 86 10 4%
100 75
5 2%
50 30
0 0 0%
Haier HiSense Gree Midea TCL Skyworth Huawei ZTE Lenovo Haier HiSense Gree Midea TCL Skyworth Huawei ZTE Lenovo
Source: Company data Source: Company data

Fig. 18: Comparison of major global TMT companies

(CNYbn) Revenue (LHS) Profit (LHS) Profit Margin (RHS)
38.0%
1,600 40%
1,370
1,400
30.3%
1,200 30%
1,051
1,000
20.5%
19.3%
800 20%
630
13.3%
600
400 10%
215 183
200 122 60 18 46 18
0 0%
China Mobile Apple Samsung Tencent Alibaba
Source: Company data, Nomura research

China has the world’s second-largest GDP, but none of the Chinese vendors are ranked
within the top-100 consumer brands currently according to InterBrand. From a top-down
perspective, if any of the Chinese IT brands can increase their global brand value, this
will help them to enjoy margin premium and margin expansion, and help them transform
their market share into profit.
We believe Lenovo/Xiaomi in PCs/Smartphones, Huawei/ZTE in telecom equipment,
BYD in electric vehicles, and Haier/Gree in home appliances are in a good position to
transform their existing market share into profit if they can capture some of the growth
opportunities we highlight within this report.

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