Greater China Smartphone Sector 130904

Information Technology / China and Taiwan 4 September 2013
Curtain call on new iPhones: likely winners and losers

Probable new range: 5S (high-end), 5C (mid-range), 4S (low end) We forecast total production of 90m units for 2H13, with the high-end model accounting for only 38% vs. about 70% a year ago We prefer EMS players over component companies. Top pick: Hon Hai. Avoid Largan, AAC and TXC
Greater China Smartphone Sector

Positive (unchanged) Neutral Negative
How do we justify our view?
See important disclosures, including any required research certifications, beginning on page 49

4 September 2013
Contents
New iPhones: we prefer the EMS companies to the component suppliers .................................3 Wow factor likely to be limited for new iPhones ....................................................................3 Market expectations are low .................................................................................................... 4 A change in focus in the product mix to the mid-range .......................................................... 4 EMS companies should do better; components makers likely to suffer ..................................5 What we recommend ................................................................................................................5 Appendix I: Pan-Asia Apple iPhone 5S/5C supply chain ............................................................ 7 Appendix II: whats new in iOS 7 ................................................................................................ 9 New features and a new look ................................................................................................... 9 Appendix III: fingerprint scanner .............................................................................................. 11 A closer look at the technology ............................................................................................... 11 Appendix IV: comparison of likely specs of 5S with those of other handsets ........................... 12 Appendix V: comparison of likely specs of 5C with those of other handsets ............................ 13 Company Section Hon Hai Precision Industry .................................................................................................... 14 Largan Precision .................................................................................................................... 22 AAC Technologies .................................................................................................................. 30 TXC Corp ................................................................................................................................ 38 Pegatron Corp ........................................................................................................................ 42
Information Technology / China and Taiwan 4 September 2013
Curtain call on new iPhones: likely winners and losers

Probable new range: 5S (high-end), 5C (mid-range), 4S (low end) We forecast total production of 90m units for 2H13, with the high-end model accounting for only 38% vs. about 70% a year ago We prefer EMS players over component companies. Top pick: Hon Hai. Avoid Largan, AAC and TXC

Positive (unchanged) Neutral Negative
Kylie Huang
(886) 2 8758 6248 kylie.huang@daiwacm-cathay.com.tw
Jason Chen
(886) 2 8758 6251 jason.chen@daiwacm-cathay.com.tw
Whats new
Markets expectations low enough. Although we think the market sees limited spec upgrades for the new iPhones, we believe the markets expectations on the iPhone volumes are too low. We forecast the total iPhone production volume to be 90m for 2H13, higher than the markets expectation of 80-85m. Our research indicates that yieldrate issues with the fingerprint and display driver-ICs of the 5S, which are of concern to the market, were resolved recently. iPhone mix shifting focus to the mid-range. As the high-end smartphone segment is becoming saturated, we view the 5C as a clear indication that Apple is changing its focus to the mid-range segment. We forecast mid-range/legacy products to account for 62% of total iPhones for 2H13, up from 31% for 2H12. Electronic manufacturing services (EMS) players should do better than components suppliers. We expect the components firms to face increased pricing pressure, especially after the initial sell-in, due to the unfavourable product-mix change and the limited spec upgrades. Meanwhile, we believe the EMS firms which are volume players should enjoy scale benefits from the production-volume growth and possibly fast ramp-ups in yield rates due to the limited productdesign changes.
What we recommend
On 10 September, Apple is widely expected to unveil new iPhones. We outline our expectations for the new products and production volumes, and assess the implications for the Greater China supply chain. This report marks a transfer of coverage.
Whats the impact
companies when it comes to the forthcoming iPhones. For Hon Hai Precision Industry (Hon Hai), we reaffirm our Buy (1) rating given the 2H13 volume growth that we see from iPhones and overdone market concerns about new competition. We also like Pegatron Corp (Pegatron) for its expanding iPhone exposure. Among the components players, we downgrade both Largan Precision (Largan) and AAC Technologies (AAC) to Underperform (4) from Buy (1) due to rising margin risks on the back of the product-mix change. We downgrade TXC Corp (TXC) to Hold (3) from Buy (1) due to pricing pressure but see limited downside due to its undemanding valuation. The key risk to our sector view would be weaker-than-expected volumes for the new i-devices.
How we differ
New iPhones: wow factor likely to be limited. We expect Apple to announce two new handsets: a high-end flagship model (the 5S), and a new mid-range model (the 5C). We believe the 5S will be physically similar to the 5 but will have small upgrades to the battery, CPU and camera. The inclusion for the first time of a fingerprint scanner is likely to provide the only wow factor. As for the 5C, we expect lower specs than for the 5, with a plastic, coloured casing and lower memory. We think prices for the 5C will range from USD429-479 (USD49-99 with a contract), and that Apple will keep the 4S, as the low-end model offered free by operators with a contract.
We are more positive on the iPhone production volume than the market for 2H13, but more concerned about pricing pressure on the components firms due to Apples product-mix change and limited spec upgrades to new products.
Key stock calls

New Hon Hai Precision Industry (2317 TT) Rating Buy Target 98.00 19.5% Upside Largan Precision (3008 TT) Rating Underperform Target 920.00 12.4% Downside
Source: Daiwa forecasts.
Prev. Buy 105.00
Within the Greater China Smartphone Sector, we prefer the EMS
Buy 1,250.00

4 September 2013
Sector stocks: key indicators

EPS (local curr.) Company Name AAC Technologies Hon Hai Precision Industry Largan Precision Pegatron Corp TXC Corp
Source: Daiwa forecasts Note: prices as of close on 3 September 2013
Stock code 2018 HK 2317 TT 3008 TT 4938 TT 3042 TT
Share Price 82.00 45.50 40.50
Rating New Buy Buy Hold Prev. Buy Buy Buy Buy Buy
Target price (local curr.) New 33.50 98.00 920.00 62.00 41.00 Prev. 105.00 62.00 % chg (6.7%) 0.0% New 1.840 8.177 65.796 4.487 3.115 44.50 (24.7%) 1,250.00 (26.4%) 57.00 (28.1%)
FY1 Prev. 1.988 8.759 64.826 4.487 % chg (7.4%) (6.6%) 1.5% 0.0% New 2.046 9.204 71.547 5.962 3.589
FY2 Prev. 9.868 5.962 % chg (6.7%) 0.0% 2.489 (17.8%) 80.150 (10.7%) 4.769 (24.7%)
36.50 Underperform 1,050.00 Underperform
4.062 (23.3%)
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4 September 2013
Apple iPhone product profile expectations in 2H13

Category Model High-end iPhone 5S Mid-range iPhone 5C Low-end iPhone 4S
New iPhones: we prefer the EMS companies to the component suppliers

Wow factor likely to be limited for new iPhones
We expect two new iPhones this year
Apple will hold a media event on 10 September, and is likely to unveil its new phones. We expect two new products a high-end flagship model, the 5S, and a midrange model, the 5C. We expect prices for the 5S to start at USD649 (USD199 with a contract) and for the 5C to range from USD429-479 (USD49-99 with a contract). We also believe Apple will keep the 4S in its line-up as a low-end model, free with a contract. We expect the 5S and 5C to have TD versions for the China market.
Specs comparison iPhone 5 vs. iPhone 5S and iPhone 5C
Model iPhone 5S iPhone 5C iPhone 5
Photo
Price (contract price) Price (unlock price)
USD199 (16GB) USD649 (16GB)
USD49-99 (8GB) USD429-479 (8GB)
USD0 (16GB) USD399 (16GB)
Source: Company, Daiwa forecasts
The 5S: fingerprint scanner may offer the only wow factor, but value addition capped by lack of NFC
Our market research suggests the 5S will be little different in appearance to the 5 (as was the case with the 4S and the 4), with small upgrades to the CPU, memory, battery, and camera, and the inclusion of a fingerprint scanner, which may be the only exceptional feature. We expect the fingerprint scanner to be used instead of passwords and the need to log in for some applications, and maybe to enhance security when one purchases items in the App Store. We believe this new feature would enhance the user experience but do not see it as a killer feature to attract consumers. In our view, the best use of a fingerprint scanner would be to enhance security, and provide privacy protection in an e-wallet environment. Meanwhile, our market research suggests there will be no NFC feature (which can turn the smartphone into an e-wallet) in the 5S. However, we do not see NFC as a technology whose time has come. While a good idea conceptually, the reality is that there is no international industry standard. The lack of an agreed standard is not just a global issue. There are no standards at a country level (or even at a city level), because of vested interests of the phone makers, credit-card issuers, mobile-service providers, and other related parties. Each party wants to take the lead, handle transactions, keep client data, and collect fees. Another limitation is that equipping smartphones with an NFC chip is not all that is required two-way communication is needed for NFC to work. On the retail side, all shops and outlets would have to install scanners. This leads to the question of who would subsidise the hardware costs for retail stores (many of which may be mom-and-pop shops, rather than chain stores).
Photo
Launch date Price (Contract price) Price (unlock price) Cellular Dimensions Weight Casing Colour Fingerprint scanner Embedded OS Display diagonal Display resolution PPI CPU ROM capacity RAM capacity Wireless LAN Camera resolution Flash Camcorder Secondary camera
Sep-13 Sep-13 Sep-12 USD199 (16GB) USD49-99 (8GB) USD199 (16GB) USD649 (16GB) USD429-479 (8GB) USD649 (16GB) LTE/ 3G 3G LTE/ 3G TD-LTE TD-SCDMA TD-SCDMA 123.8 x 58.6 x 7.6 mm 123.8 x 58.6 x 8.2 mm 123.8 x 58.6 x 7.6 mm 112 g (3.95 oz) 125g(4.41 oz) 112 g (3.95 oz) Aluminium Plastic Aluminium Black/white/gold 6 colours Black/white Yes No No iOS 7 iOS 7 iOS 6 4.0" (Retina) 4.0"(Retina) 4.0"(Retina) 1136 x 640 pixels 1136 x 640 pixels 1136 x 640 pixels 326 ppi 326 ppi 326 ppi Apple A7 dual-core Apple A6 dual-core Apple A6 dual-core 16/32/64/128GB 8/16GB 16/32/64GB 2GB 1GB 1GB 802.11 a/b/g/n 802.11 a/b/g/n 802.11 a/b/g/n 8 MP, f/2.0 8MP, f/2.4 8MP, f/2.4 (Dual-LED flash) (Single-LED flash) (Single-LED flash) 1080p@30fps 1080p@30fps 1080p@30fps 1.2MP 1.2MP 1.2MP
iPhone 5C and iPhone 4S

Based on our market research, we expect the mid-range 5C to be a lower-specification version of the 5, with a plastic, coloured casing and less memory. We think Apple will no longer offer the 5, replacing it with the 5C. -3-
Source: Company, Daiwa estimates Note: We highlight the likely spec upgrades in dark blue and spec downgrades in light blue

4 September 2013
The iPhone 5C should be a little thicker than the 5 due to the change in the casing material, but the other features such as the camera specs, display resolution, and acoustic design should remain the same. We expect prices for the 5C to range from USD429-479, targeting the mid-range smartphone segment. Our research also indicates that Apple will keep making the 4S, as a low-end model that is free with a contract.
Global smartphone shipment forecasts by segment

(m units) 1,500 60%
1,000
40%
500
20%
Market expectations are low

Although we expect limited spec upgrades in the new iPhones, we believe market expectations of iPhone production volume in 2H13 are low. The market appears to be worried that production yield-rate issues for the 5S will affect production volume this year. Our research suggests that production bottlenecks on the 5S possible yield-rate issues with the fingerprint IC and display-driver IC were resolved recently. We now expect mass production of the iPhone 5S to start in September, and forecast total iPhone production volume of 90m for 2H13, a 36% HoH rise compared with the 26% HoH increase for 2H12, and higher than the markets recently cut expectation of 80-85m.
iPhone total production volume forecasts by quarter
(m units) 60 50 40 30 20 10 0 3Q12 4Q12 1Q13 2Q13 3Q13E 4Q13E
Source: Daiwa forecasts Note: This chart represents Daiwas iPhone production forecasts, which should be slightly different from the iPhone sales figures announced by Apple
0 2012 Low-end (LHS) Low-end YOY (RHS) Total YoY (RHS) 2013E 2014E Mid-range (LHS) Mid-range YoY (RHS)
0% 2015E High-end (LHS) High-end YoY (RHS)
Source: IDC, Daiwa forecasts Note: We define low-end smartphones as those that cost less than USD200, mid-range as those costing USD200-500 and those costing more than USD500 as high-end
Global smartphone shipment forecasts by segment mix

100% 80% 60% 40% 20% 0% 2012 Low-end (<USD 200)
Source: IDC, Daiwa forecasts
2013E
2014E
2015E High-end (>USD 500)
Mid-range (USD200-500)
iPhone: production-volume forecasts by model

(m units) iPhone 4 & 4S iPhone 5 iPhone 5C iPhone 5S Total 1Q13 15.5 20.0 35.5 2Q13 12.0 18.5 30.5 3Q13E 10.0 8.5 10.0 5.0 33.5 4Q13E 7.5 20.0 29.0 56.5 2013E 45.0 47.0 30.0 34.0 156.0
Source: Daiwa forecasts Note: This table represents Daiwas iPhone production forecasts, which will be slightly different from Apples iPhone sales figures
iPhone: production volume forecast by model mix

100%
Flagship Model
A change in focus in the product mix to the mid-range

IDC forecasts a high-end smartphone shipments (those retailing at more than USD500) CAGR of 3.9% for 2013-15 compared with a CAGR of 19.4% for all smartphones over the same period. As Apple has to face the challenge of the high-end smartphone segment becoming saturated, we view its forthcoming iPhone 5C as a clear indication of the companys strategy shift to a more mid-range focus. We forecast its midrange/legacy phones to account for 62% of total iPhones for 2H13 compared with 31% for 2H12. -4-
80% 60% 40% 20% 0%
Flagship Model
Mid-range/ legacy models
Mid-range/ legacy models
2H12 iPhone 3GS iPhone 4&4S iPhone 5
2H13E iPhone 5C iPhone 5S
Source: Daiwa forecasts Note: This chart represents Daiwas iPhone production forecasts, which will be slightly different from Apples iPhone sales figures

4 September 2013
EMS companies should do better; components makers likely to suffer

We consider Apples change in iPhone strategy ie, moving from purely high-end iPhones to focus more on a mid-range one and the implications on the supply chain. The EMS companies that focus on volume and delivering on the overall yield rate should benefit from the change in product mix, due to scale benefits from the volume growth and because they expect a fast ramp-up in the yield rate (because the design of the mid-range iPhone is not that different from the original design). However, we think the components makers could be adversely affected by the introduction of the new midrange phone. Based on our estimates, the bill of material (BOM) cost for the iPhone 5C might be only 10-15% lower than that of the iPhone 5, but the retail price could be 25-35% lower than the iPhone 5, which implies to us that Apple might carry a lower margin for the iPhone 5C and it could, in turn, put more pressure on its component vendors. In addition, the market widely expects the components specs for the iPhone 5C to be the same as those for the iPhone 5, which should give Apple even more room to squeeze its vendors. We also see less pricing bargaining power for the vendors involved in making the iPhone 5S, due to the limited specs upgrades. We think this will be especially true for Apples main components suppliers, Largan and AAC (which usually enjoy better pricing power on new product launches, on the back of spec upgrades and better yield-rate delivery compared with Apples second-tier suppliers), given Apples decision to introduce a mid-range product with limited component spec improvements.
Apple: Daiwas forecasts for the iPhone 5C
Unit: USD Retail price Factory ASP BOM cost Other cost Total COGS Gross profit Gross margin (%)
Source: Daiwa forecasts
Component ASP product life cycle

100% 95% 90% 85% 80% 75%
9 (Month)
Component ASP Cycle

Source: Daiwa forecasts Notes: x-axis is the month that a new product is launched, and y-axis is. the original ASP and how it declines over time
What we recommend
Prefer EMS companies to the components makers
In terms of the forthcoming iPhones, we are confident about the production-volume growth outlooks for 2H13 for both the EMS companies and the components makers, but we are concerned about the pricing pressure that the component makers are likely to face due to the change in Apples product mix. We believe Apples iPhone product-mix shift to a more mid-range focus could benefit the EMS vendors, but result in margin risk for the components vendors. Within the Greater China Smartphone Sector, Hon Hai is our top pick as we see its earnings-growth momentum resuming in 2H13, driven by the launch of the next wave of i-devices and because we think the markets concerns about new competition are overdone. We suggest investors avoid the leading components companies, Largan and AAC, due to rising margin risks on the back of the change in iPhone mix. Following are our ratings and valuations for the Greater China iPhone supply chain stocks that we cover. Hon Hai (2317 TT, TWD82.00, Buy [1], TP: TWD98) We reiterate our Buy (1) rating on Hon Hai and believe the company will be the major beneficiary of the new idevices. Our six-month target price is TWD98, based on a one-year forward PER of 11x (its past-three-year average). We forecast Hon Hai to regain its revenuegrowth momentum in 2H13, as we expect the company to become the sole supplier for both the iPhone 5S and the next iPad, and that it will secure 25-30% of the mid-range iPhone orders. Moreover, we foresee margin -5-
iPhone 5 649 550 240 60 300 250 45%
iPhone 5C 429-479 370-410 210 50 260 110-150 30-37%

4 September 2013
expansion for Hon Hai given its cost savings from relocating its production plants inland within China, increasing vertical integration and automation, as well as the product-mix change of its major client, Apple. The main risk to our rating would be slower-thanexpected margin expansion. Largan (3008 TT, TWD1,050.00, Underperform [4], TP: TWD920) We are downgrading our rating on Largan to Underperform (4) from Buy (1). We like Largan for its quality management and leading industry position, but we foresee pricing pressure in 4Q13 and think its current valuation of 16x 2013E PER is unattractive compared with its past-three-year average of 14x. For 2H13, we expect its earnings-growth momentum to slow from 4Q13 given the change in the iPhone product mix and limited contribution from new clients, after a stellar 3Q13 on the back of new product launches and the effects of the peak season. Our new six-month target price is TWD920, based on a one-year rollingforward PER of 14x. The major risk to our negative view would be better-than-expected orders from new clients. AAC (2018 HK, HKD36.50, Underperform [4], TP: HKD33.50) We are downgrading our rating on AAC to Underperform (4) from Buy (1). Our new six-month target price is HKD33.50, based on a one-year forward PER of 14x (in line with its past-three-year average). We are concerned about the saturation that we see in the high-end smartphone market and consider the stocks current valuation, at a one-year forward PER of 15.4x, unjustified. Furthermore, we believe AAC could be negatively affected by its major clients product-mix change, with limited spec upgrades resulting in more severe pricing pressure. Overall, we expect AACs earnings growth to decelerate to a double-digit percentage YoY in the following 2-3 years from 70% for 2012. A better-than-expected margin would be the major upside risk to our negative view.
TXC (3042 TT, TWD40.50, Hold [3], TP: TWD41) We are downgrading our rating on TXC to Hold (3) from Buy (1). We believe the worst of unfavourable currency fluctuations are now over for TXC and forecast 15% HoH revenue growth for 2H13. However, we expect TXC to experience pricing pressure in 2H13, on the back of its major clients product-mix change. As such, we are more cautious than the market on the companys margin expansion for 2013 and forecast a mild recovery in the operating margin to 11.5-12.0% for 2H13 (from 9.5-10% for 1H13). We believe TXC could regain its revenue-growth momentum in 2014, given the start of revenue contributions from new clients and its solid i-device orders. Our new six-month target price is TWD41, now based on a one-year forward PER of 12.5x (in line with its past-three-year average). The main upside risk to our view would be faster-thanexpected margin recovery, while the main downside risk would be further sharp Yen depreciation.
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Appendix I: Pan-Asia Apple iPhone 5S/5C supply chain

Pan-Asia Apple iPhone 5S/5C supply chain
Part Semiconductor Processor 4G modem Wifi module WIFI, Bluetooth, GPS Nand Flash Mobile DRAM Ticker 005930 KS QCOM US 6981 JP 6762 JP BRCM US 6502 JP 000660 KS 005930 KS 000660 KS MU US DLG GR 009150 KS 4062 JP 6753 JP Not listed 034220 KS 6988 JP 4005 JP 6723 JP 011070 KS 6753 JP 3008 TT 3406 TT 3406 TT 3008 TT Private 6770 JP 6767 JP OVT US 6758 JP 6981 JP 009150 KS 6976 JP 6762 JP 6981 JP 6762 JP TQNT US AVGO US 6752 JP 6981 JP 6807 JP 6981 JP MOLX US 6752 JP 6806 JP 2392 TT 6290 TT 3501 TT Manufacturer Samsung Electronics Qualcomm Murata TDK Broadcom Toshiba SK Hynix Samsung SK Hynix Micron (Elpida) Dialog Semiconductor SEMCO Ibiden Sharp Japan Display LGD Nitto Denko Sumitomo Chemi Renesas LG Innotek Sharp Largan Genius Genius Largan Kantatsu ALPS Mitsumi Omni vision SONY Murata SEMCO Taiyo Yuden TDK Murata TDK Triquint Avago Panasonic Murata Japan Aviation Murata Molex Panasonic Hirose Cheng Uei Longwell Wellshin iPhone 5S allocation 100% 100% 70% 30% 100% 65% 35% 20% 40% 40% 100% 50% 50% 20-25% 40% 35-40% 40% 60% 100% 50% 50% 85-90% 10-15% 40-50% 30-40% 10-20% 60% 40% 100% 100% 40-45% 20-30% 10-20% 0-5% 10-15% 20-30% 15-20% 15-20% 20-30% 100% 35% 20% 10% 20% 15% 70% 15% 15% iPhone 5C allocation 100% 100% 70% 30% 100% 65% 35% 20% 40% 40% 100% 50% 50% 20-25% 40% 35-40% 40% 60% 100% 50% 50% 60-70% 30-40% 40-50% 30-40% 10-20% 60% 40% 100% 100% 40-45% 20-30% 10-20% 0-5% 10-15% 20-30% 15-20% 15-20% 20-30% 100% 35% 20% 10% 20% 15% 70% 15% 15%
PWM IC AP substrate Display Incell TFT
Polarizer Display driver IC Component 8MP camera module 8MP camera lens 1.3MP camera lens
VCM for lens module 1.3 MP CMOS sensor 8MP CMOS sensor MLCC
Duplexer
Antenna switch module Connector
Connector, cable and charger
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Part Component (Contd) Crystal Power inductor
Ticker 3042 TT 6779 JP 6762 JP 6976 JP Not listed 6801 JP 6594 JP 4062 JP 2313 TT 011070 KS 3037 TT 7240 JP 5802 JP 4958 TT MFLX US 5803 JP 051370 KS 6269 TT 2018 HK 002241 CH Private TQNT US SWKS US AVGO US 2317 TT 2354 TT JBL US 2317 TT JBL US HIP SP Private SYNA US INVN US 6762 JP Private 006400 KS 051910 KS 6121 TT 3211 TT 2317 TT 4938 TT
Manufacturer TXC NDK TDK Taiyo Yuden Cymtec (Taiwan) Toko Nidec Ibiden Compeq LG Innotek Unimicron NOK Sumitomo ZD Tech M-flex Fujikura Interflex Flexium AAC Goertek Knowles Triquint Skyworks Avago Hon Hai Foxconn Tech Jabil Hon Hai Jabil Hi-P AuthenTec Snaptics Invensense TDK/ATL Tianjin Lishen Samsung SDI LG Chemical Simplo Dynapack Hon Hai Pagatron
iPhone 5S allocation 40% 40% 30% 30% 30% 10% 100% 40% 15-25% 10-20% 10-15% 15-20% 15-20% 10-15% 10-15% 10-15% 10% 5-10% 50% 35-40% 10-15% 25-50% 25% 25-50% 40% 40% 20% n.a. n.a. n.a. 100% 100% 100% 20-25% 20-25% 20-25% 20-25% 50-60% 40-50% 100% 0%
iPhone 5C allocation 40% 40% 30% 30% 30% 10% 100% 40% 15-25% 10-20% 10-15% 15-20% 15-20% 10-15% 10-15% 10-15% 10% 5-10% 50% 35-40% 10-15% 25-50% 25% 25-50% n.a. n.a. n.a. 30-40% 30-40% 20-30% n.a. n.a. 100% 20-25% 20-25% 20-25% 20-25% 50-60% 40-50% 25-30% 70-75%
Vibration HDI PCB
Flexible PCB
Acoustic
PA
Metal casing
Plastic casing
Fingerprint sensor Fingerprint scanner (module) Gyro sensor Battery cell
Battery packaging Assembling

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iOS 6 (LHS) vs. iOS 7 (RHS): icon comparison
Appendix II: whats new in iOS 7

New features and a new look
Arguably the most sweeping redesign of the iOS since it was launched in 2007, iOS 7 is expected to be released in mid-September. We believe the new iPhones will come pre-installed with the new OS, and some older iPhone models will be able to upgrade to it. Judging from the beta versions now in testing, we expect key upgrades in the new OS to include: 1) a new, more modern design, 2) new features such as AirDrop, Control Center, and enhanced multitasking, and 3) new features specifically designed for business users.
Visual overhaul
With Apples hardware design head Jonathan Ive now tasked with overseeing Human Interfaces in the companys software, too, the icons and home screen in iOS 7 have an all-new look. Bars, buttons and shadows under icons and text on the home screen have been removed, though the underlying mode of interacting with the software is unchanged. We think the strippeddown, refined design of iOS 7 will impress users.
iOS 6 (RHS) vs. iOS 7 (LHS): home screen comparison
Source: Company, Daiwa
iOS 6 (RHS) vs. iOS 7 (LHS):UI comparison
New features
Apple has added many new features, but we think AirDrop and Control Center are among the most impressive additions. Others, such as updates to Siri and the Photos app, along with iTunes Radio, may not be eye-catching enough, in our view. -9-

4 September 2013
1) AirDrop With supported iDevices, this feature allows iOS users to share pictures, videos and other items from any app and save them in a convenient, secure way using WiFi and Bluetooth. One of the selling points is that no prior set-up is required. 2) Control Center The new Control Center in iOS 7 gives users a way to access commonly-used features with a simple swipe gesture. The five (non-customisable) rows in the beta software include mode setting (Airplane, Wi-Fi, Bluetooth, Do Not Disturb mode and Rotation Lock), brightness control, multimedia controls with a soundvolume bar, shortcuts for AirDrop and AirPlay, and quick access to the LED flashlight, timer, calculator, and camera. 3) Multitasking Given improved battery management, multitasking allows users to switch between different apps in the background, almost instantly, without draining resources. Similar to HTCs Sense Task switcher, screenshots of previously opened apps are displayed and applications can be closed with a simple swipe gesture. Among the other new features are an image editor incorporated into the Photos app, clearer, more natural-sounding female or male voices in Siri, and the new iTunes Radio service.
New features in iOS 7: AirDrop (LHS), Control Center (middle) and Multitasking (RHS)
New features for business

iOS 7 incorporates several upgrades designed to cater to business users, such as per-app virtual private network (VPN) connections, enterprise single sign on (SSO), and new mobile device management (MDM) configuration options. Overall, iOS 7 appears to offer enhanced security management functions.
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AuthenTec: acquired by Apple in 2012

Apple acquired AuthenTec, a developer of fingerprint sensor technology, for USD356m in cash (USD8 a share) on 27 July 2012. AuthenTec has long provided security solutions for global handset makers including Samsung, Nokia, Motorola and LG. On 8 May 2012, it announced that it had developed its first smart sensor specifically tailored for secure NFC mobile commerce. AuthenTecs fingerprint technology is a type of capacitance-based sensor incorporating capacitive and RF technologies in its biometric chips to capture the fingerprint image. We expect Apple to incorporate the fingerprint sensor under a durable, sapphire-covered, convex-shaped home button in the 5S, and to use it to provide secure authentication for various transactions without requiring the user to enter a password.
Cross-section of AuthenTec's fingerprint sensor
Appendix III: fingerprint scanner

A closer look at the technology
A fingerprint sensor is an electronic device widely used for personal identification and verification, since it can capture the loops, arches and spirals that make every fingerprint unique. Such a system would be useful on mobile devices, as the security of mobile data is a growing concern among many users. There are several fingerprint sensor technologies, but the most commonly used today are optical-based sensors and capacitance-based sensors.
Optical-based sensors
Similar to digital cameras and camcorders, opticalbased fingerprint sensors detect fingerprints by illuminating the surface of the finger. A charge-coupled device (CCD) system is used in the scanner to generate electrical signals in response to a fingerprint, from which a digital image is generated. This is a relatively low-cost solution, but the systems accuracy can be affected by dirt and the hardware is prone to damage.
Capacitance-based sensors
Capacitance-based sensors, on the other hand, contain small capacitive plates in which integrated circuits detect very low electrical charges sent from the users finger. By sensing the difference in the voltage output of a finger's ridges and valleys, the sensor forms the image of the fingerprint.
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Appendix IV: comparison of likely specs of 5S with those of other handsets

iPhone 5S vs. flagship models from global tier-one brands
Model iPhone 5S Samsung Galaxy S4 Nokia Lumia 1020 Motorola Moto X Sony Xperia ZL LG G2 HTC One BlackBerry Q10
Photo
Release date Sep-13 Current unlocked price USD649/749/849 Dimensions 123.8 x 58.6 x 7.6 mm Weight: 112 g (3.95 oz) Embedded OS iOS 7 Display diagonal 4.0" (Retina) Display resolution 1136 x 640 pixels PPI 326 ppi Fingerprint scanner Yes CPU Apple A7 Dual-core CPU Clock ROM capacity: RAM capacity Wireless LAN GPS Camera resolution Aperture Autofocus (AF) Flash Camcorder Secondary camera Battery capacity Loudspeaker 1.6GHz 16/32/64/128GB 2GB 802.11 a/b/g/n Yes 8MP f/2.0 Yes (dual-LED flash) 1080p@30fps 1.2MP Li-Po 1600mAh Yes
Apr-13 Jul-13 13-Aug Mar-13 3Q13 Mar-13 Apr-13 USD619.99 USD759.50 TBD $549.99 TBD USD649.99 (32GB) USD579.99 136.6 x 69.8 x 7.9 mm 130.4 x 71.4 x 10.4 mm 129.3 x 65.3 x 10.4 mm 131.6 x 69.3 x 9.8 mm 138.5 x 70.9 x 8.9 mm 137.4 x 68.2 x 9.3 mm 119.6 x 66.8 x 10.4 mm 130 g (4.59 oz) 158 g (5.57 oz) 130 g (4.59 oz) 151 g (5.33 oz) 143 g (5.04 oz) 143 g (5.04 oz) 139 g (4.90 oz) Android 4.2.2 MS Windows Phone 8 Android 4.2.2 Android 4.1.2 Android 4.2.2 Android 4.1.2 BlackBerry 10 OS 5.0" Super AMOLED 4.5" AMOLED 4.7" AMOLED 5.0'' 5.2'' IPS 4.7" Super LCD3 3.1" Super AMOLED 1080 x 1920 pixels 768 x 1280 pixels 720 x 1280 pixels 1080 x 1920 pixels 1080 x 1920 pixels 1080 x 1920 pixels 720 x 720 pixels 441 ppi 332 ppi 312 ppi 441 ppi 424 ppi 469 ppi 328 ppi No No No No No No No Cortex-A15 & A7 Quad- Qualcomm MSM8960 Qualcomm MSM8960 Qualcomm MDM9215M Qualcomm MSM8974 Qualcomm APQ8064T Snapdragon S4 Dualcore Snapdragon Dual-core Pro Snapdragon Dual- / APQ8064 Quad-core Snapdragon 800 Quad- Snapdragon 600 Quadcore core core core 1.6 & 1.2 GHz 1.5 GHz 1.7 GHz 1.5 GHz 2.26 GHz 1.7 GHz 1.5 GHz 16/32/64GB 32GB 16/32GB 16GB 32GB 16/32/64GB 16GB 2GB 2GB 2GB 2GB 2GB 2GB 2GB 802.11 a/b/g/n 802.11 a/b/g/n 802.11 a/b/g/n 802.11 a/b/g/n 802.11 a/b/g/n/ac 802.11 a/ac/b/g/n 802.11 a/b/g/n Yes Yes Yes Yes Yes Yes Yes 13MP 41MP 10MP 13MP 13MP 4MP 8MP f/2.2 n.a. n.a. f/2.2 f/2.4 f/2.0 n.a. Yes Yes Yes Yes Yes Yes Yes (Single-LED flash) Xenon & LED flash (Single-LED flash) (Single-LED flash) (Single-LED flash) (Single-LED flash) (Single-LED flash) 1080p@30fps 1080p@30fps 1080p@30fps 1080p@30fps 1080p@30fps 1080p@30fps 1080p@30fps 2MP 1.2MP 2MP 2MP 2.1MP 2.1MP 2MP Li-Ion 2600 mAh Li-Ion 2000 mAh Li-Ion 2200 mAh Li-Ion 2370 mAh Li-Po 3000 mAh Li-Po 2300 mAh Li-Ion 2100 mAh Yes Yes Yes Yes Yes Yes Yes
Source: Companies, Daiwa Note: specs for the iPhone 5S are likely rather than confirmed
iPhone 5S vs. flagship models from China brands

Model iPhone 5S Lenovo K900 ZTE GrandS Huawei Ascend D2 Huawei Ascend P2 Oppo Find 5 Nubia Z5 vivo Xplay
Photo
Release date Current unlocked price Dimensions Weight: Embedded OS Display diagonal Display resolution PPI Fingerprint scanner CPU CPU Clock ROM capacity: RAM capacity Wireless LAN GPS Camera resolution Aperture Autofocus (AF) Flash Camcorder Secondary camera Battery capacity Loudspeaker
Sep-13 USD649/749/849 123.8 x 58.6 x 7.6 mm 112 g (3.95 oz) iOS 7 4.0" (Retina) 1136 x 640 pixels 326 ppi Yes Apple A7 Dual-core 1.6GHz 16/32/64/128GB 2GB 802.11 a/b/g/n Yes 8MP f/2.0 Yes (dual-LED flash) 1080p@30fps 1.2MP Li-Po 1600mAh Yes
Apr-13 Mar-13 CNY2580 (16GB) CNY2600 157 x 78 x 6.9 mm 142 x 70 x 6.9mm 162 g (5.71 oz) 110 g (3.88 oz) Android 4.2 Android 4.1 5.5" IPS 5.0" IPS 1080*1920 pixels 1080*1920 pixels 401 ppi 441 ppi No No Intel Atom Z2580 Dual-core Qcom APQ8064 Quad-core 2.0GHz 1.5GHz 16/32 GB 16GB 2GB 2GB 802.11 a/b/g/n 802.11 a/b/g/n Yes Yes 13MP 13MP f/1.8 n.a. Yes Yes dual-LED LED flash 1080p@30fps 1080p@30fps 2MP 2MP Li-Po 2500 mAh Li-Ion 1780 mAh Yes Yes
Mar-13 CNY2750 140 x 71 x 9.4 mm 170 g (6.00 oz) Android 4.1 5.0" IPS 1080*1920 pixels 441 ppi No Haisi K3V2 Quad-core 1.5GHz 32GB 2GB 802.11 a/b/g/n Yes 13MP n.a. Yes LED flash 1080p@30fps 1.3MP Li-Ion 3000 mAh Yes
Apr-13 CNY2999 136.2 x 66.7 x 8.4 mm 122 g (4.30 oz) Android 4.1.2 4.7" IPS 720 x 1280 pixels 312 ppi No Haisi K3V2 Quad-core 1.5GHz 16GB 1GB 802.11 a/b/g/n Yes 13MP n.a. Yes LED flash 1080p@30fps 1.3MP Li-Ion 2420 mAh Yes
Feb-13 CNY2998 141.8 x 68.8 x 8.9 mm 165 g (5.82 oz) Android 4.1 5.0" IPS 1080*1920 pixels 441 ppi No Qualcomm APQ8064 Snapdragon 1.5GHz 16GB 2GB 802.11 a/b/g/n Yes 13MP f/2.2 Yes LED flash 1080p@30fps 1.9MP Li-Ion 2500 mAh Yes
2013 2013 CNY2788 CNY2998 138 x 68.8 x 7.6mm 153.8 x 79.9 x 8mm 126 g (4.44 oz) 187 g (6.60 oz) Android 4.2 Android 4.2 5.0" OGS 5.0" IPS 1080*1920 pixels 1080*1920 pixels 441 ppi 386 ppi No No Qualcomm APQ8064 Qualcomm APQ8064 Snapdragon Snapdragon 1.5GHz 1.6GHz 16GB 16GB 2GB 2GB 802.11 b/g/n 802.12 b/g/n Yes Yes 13MP 13MP f/2.2 f/2.2 Yes Yes LED flash LED flash 1080p@30fps 1080p@30fps 2MP 5MP 2300mAh 3400mAh Yes Yes
Source: Companies, Daiwa Note: specs for the iPhone 5S are likely rather than confirmed
- 12 -

4 September 2013
Appendix V: comparison of likely specs of 5C with those of other handsets

iPhone 5C vs. mid-range models from global tier-one brands
Model iPhone 5C Samsun Galaxy S4 mini Nokia Lumia 925 Motorola DROID Mini Sony Xperia ZR LG Optimus L9 II HTC Desire 600 dual sim
Photo
Release date Current unlocked price Dimensions Weight Embedded OS Display diagonal Display resolution PPI CPU: CPU clock: ROM capacity RAM capacity Wireless LAN GPS: Camera resolution Aperture Autofocus (AF) Flash Camcorder Secondary camera Battery capacity Loudspeaker
Sep-13 USD429-479 (8GB) 123.8 x 58.6 x 8.2 mm 125 g (4.41 oz) iOS 7 4.0"(Retina) 1136 x 640 pixels 326 ppi Apple A6 Dual-core 1.3GHz 8/16GB 1GB 802.11 a/b/g/n Yes 8MP f/2.4 Yes (Single-LED flash) 1080p@30fps 1.2MP Li-Ion 1600 mAh Yes
Jul-13 USD429.99 124.6 x 61.3 x 8.9 mm 107 g (3.77 oz) Android 4.0.4 4.8" Super AMOLED 720 x 1280 pixels 306 ppi Exynos 4412 Quad-core 1.4 GHz 8GB 1.5GB 802.11 a/b/g/n Yes 8MP n.a. Yes (Single-LED flash) 1080p@30fps 1.9MP Li-Ion 1900 mAh Yes
Jul-13 USD490.00 (16GB) 129 x 70.6 x 8.5 mm 139 g (4.90 oz) MS Windows Phone 8 4.5" AMOLED 768 x 1280 pixels 332 ppi Qualcomm MSM8960 Snapdragon Dual-core 1.5 GHz 16/32GB 1GB 802.11 a/b/g/n Yes 8MP f/2.0 Yes (Dual-LED flash) 1080p@30fps 1.3MP Li-Ion 2000 mAh Yes
13-Aug TBD 121.3 x 61.3 x 8.9 mm 130 g (4.59 oz) Android 4.2 4.3" 720 x 1280 pixels 342 ppi Qualcomm Snapdragon S4Pro Dual-core 1.7 GHz 16GB 2GB 802.11 a/b/g/n Yes 10MP n.a. Yes (Single-LED flash)
Jun-13 USD479.99 131.3 x 67.3 x 10.5 mm 138 g (4.87 oz) Android 4.1 4.55" 720 x 1280 pixels 323 ppi Qualcomm Snapdragon APQ8064 Quad-core 1.5 GHz 8GB 2GB 802.11 a/b/g/n/ac Yes 13.1 MP n.a. Yes (Single-LED flash) 1080p@30fps VGA Li-ion 2300 mAh Yes
1080p@30fps
2MP Li-Ion 2000 mAh Yes
3Q13 TBD TBD TBD Android OS, v4.1 4.7" True HD-IPS 720 x 1280 pixels 312 ppi Qualcomm 8230 Snapdragon 400 Dualcore 1.4 GHz 8GB 1GB 802.11 b/g/n Yes 8MP n.a. Yes (Single-LED flash) 1080p@30fps 1.3MP Li-Ion 2150 mAh Yes
Jun-13 USD449.99 134.8 x 67 x 9.3 mm 130 g (4.59 oz) Android 4.1.2 4.5" Super LCD2 540 x 960 pixels 245 ppi Qualcomm MSM8625Q Snapdragon 200 Quadcore 1.2 GHz 8GB 1GB 802.11 b/g/n Yes 8 MP f/2.0 Yes (Single-LED flash) 720p@24fps 1.6MP Li-Ion 1860 mAh Yes
Source: Companies, Daiwa Note: specs for the iPhone 5C are likely rather than confirmed
iPhone 5C vs. mid-range models from China brands

Model iPhone 5C Xiaomi 2S ZTE U5 (Grand Memo) Huawei Mate Huawei Ascend P6 Oppo R819T Vivo X1St
Photo
Release date Current unlocked price Dimensions Weight Embedded OS Display diagonal Display resolution PPI CPU: CPU clock: ROM capacity RAM capacity Wireless LAN GPS: Camera resolution Aperture Autofocus (AF) Flash Camcorder Secondary camera Battery capacity Loudspeaker
Sep-13 USD429-479 (8GB) 123.8 x 58.6 x 8.2 mm 125 g (4.41 oz) iOS 7 4.0"(Retina) 1136 x 640 pixels 326 ppi Apple A6 Dual-core 1.3GHz 8/16GB 1GB 802.11 a/b/g/n Yes 8MP f/2.4 Yes (Single-LED flash) 1080p@30fps 1.2MP Li-Ion 1600 mAh Yes
Apr-13 Mar-13 CNY 2088 (32GB) CNY2120 126 x 62 x 10.2 mm 159.9 x 82.4 x 8.5mm 145 g (5.11 oz) 189g (6.65 oz) Android 4.1 Android 4.1.2 4.3" IPS 5.7" IPS 720*1280 pixels 720*1280 pixels 342 ppi 258 ppi Qcom APQ8064 Pro Quad- Nvidia Tegra3 Quad-core core 1.7GHz 1.5GHz 16/32GB 16GB 2GB 2GB 802.11 a/b/g/n 802.11 a/b/g/n Yes Yes 8MP 13MP f/2.0 n.a. Yes Yes (Single-LED flash) (Single-LED flash) 1080p@30fps 1080p@30fps 2MP 1MP Li-Ion 2000 mAh Li-ion 3200 mAh Yes Yes
Mar-13 CNY2400 163.5 x 85.7 x 9.9 mm 198 g (6.98 oz) Android 4.1 6.1"IPS 720*1280 pixels 241 ppi Haisi K3V2 Quad-core 1.5GHz 8GB 2GB 802.11 a/b/g/n Yes 8MP n.a. Yes (Single-LED flash) 1080p@30fps 1MP Li-Ion 4050 mAh Yes
Jun-13 CNY2400 132.7 x 65.5 x 6.2 mm 120g (4.23 oz) Android 4.2 4.7" IPS 720*1280 pixels 312 ppi Haisi K3V2E Quad-core 1.5GHz 8GB 2GB 802.11 a/b/g/n Yes 8MP f/2.0 Yes (Single-LED flash) 1080p@30fps 5MP Li-Po 2000 mAh Yes
3Q13 CNY2298 136.5 x 68 x 7.3mm 110 g (3.88 oz) Android 4.2 4.7" IPS 720 x 1280 pixels 312 ppi MediaTek MT6589 Quadcore 1.2 GHz 16GB 1GB 802.11 b/g/n Yes 8MP f/2.0 Yes (Single-LED flash) 1080p 2MP 2000 mAh Yes
Aug-13 CNY2498 136.3 x 68.3 x 6.55mm 143g (5.03 oz) Android 4.2 4.7" IPS 720*1280 pixels 312 ppi MediaTek MT6589 Quadcore 1.2 GHz 16GB 1GB 802.11 a/b/g/n Yes 8MP f/2.2 Yes (Single-LED flash) n.a. 1.3MP 2000mAh Yes
Source: Companies, Daiwa Note: Specs for the iPhone 5C are likely rather than confirmed
- 13 -
Information Technology / Taiwan 2317 TT
Information Technology / Taiwan 4 September 2013

Hon Hai Precision Industry
Hon Hai Precision Industry

2317 TT
Target (TWD): 105.00 98.00 Upside: 19.5% 3 Sep price (TWD): 82.00
Strong earnings growth in 2H13; margin expansion on the way

As Apples major EMS partner, Hon Hai is well positioned to enjoy shipment growth when the new i-devices are launched Market concerns about competition appear overdone. We forecast Hon Hai to account for 75-80% of iPhone/iPad orders Reaffirm Buy (1) rating; we expect secular earnings growth in 2H13 to be a near-term share-price catalyst
1 2 3 4 5
Buy (unchanged) Outperform Hold Underperform Sell
Kylie Huang
unlikely to add a new iPhone assembler until 2H14, if it does at all. We expect Hon Hai to remain Apples major EMS partner, and assume a 75-80% order allocation for the iPhone/iPad in 2014. Margin expansion on the way. Thanks to cost savings from the relocation of Hon Hais production to inland China, more stable ASP environment, and the favourable trend that we see from its major clients move to the mid-range iPhone focus, we expect Hon Hais operating margin to expand from 2.8% for 2012 to 2.9%/3.1% for 2013/14, respectively.
What we recommend
How we differ
We are more positive than the market on the firms order allocation for new iPhones and its margin expansion.
Forecast revisions (%)
Year to 31 Dec Revenue change Net profit change Core EPS (FD) change
13E (3.1) (6.6) (6.6)
14E (1.9) (6.7) (6.7)
15E (0.7) (2.7) (2.7)
What's new
We like Hon Hai and regard market concerns about competition as overdone. This report marks the transfer of analyst coverage.
What's the impact
Share price performance

(TWD)
100 91 83 74 65
(%)
105 96 88 79 70
We see strong earnings growth in 2H13. We assume Hon Hai will be the sole assembly company for both the iPhone 5S and next iPad, and that it is likely to secure 25-30% of the mid-range iPhone 5C orders. Thanks to its better product mix and increasing operating leverage, we forecast its earnings to grow by 90% HoH for 2H13. The robust 2H13 should enable Hon Hai to post modest earnings growth on a YoY basis for 2013, despite a tough year for its main customer Apple. Concerns about competition seem overdone. We think Hon Hais competitive cost structure, quick time to mass production and superior execution capability are hard to duplicate, and that Apple is
Sep-12
Dec-12
Mar-13
Jun-13
Sep-13
Hon Hai P (LHS) Relative to TWSE Index (RHS)
Following our transfer of coverage, we lower our 2013-15E EPS by 3-7%. We reaffirm our Buy (1) rating and lower our six-month target price to TWD98 (from TWD105), based on a one-year forward PER of 11x (12x 2013E previously), the stocks pastthree-year average. Its strong 2H13E earnings growth should act as a share-price catalyst and be a positive for active investors. We would also advise long-term investors to gradually accumulate the shares as we think they are underpriced given the markets overly pessimistic view on Hon Hais position in the Apple supply chain. Risk would be slowerthan-expected margin expansion.
12-month range Market cap (USDbn) 3m avg daily turnover (USDm) Shares outstanding (m) Major shareholder
70.00-97.50 32.56 86.63 11,836 Terry Kuo (12.5%)
Financial summary (TWD)

Year to 31 Dec 13E 14E 15E Revenue (m) 3,825,580 4,202,250 4,617,520 Operating profit (m) 109,029 130,270 145,452 Net profit (m) 96,782 108,936 123,965 Core EPS (fully-diluted) 8.177 9.204 10.474 EPS change (%) 1.7 12.6 13.8 Daiwa vs Cons. EPS (%) 5.9 10.3 18.6 PER (x) 10.0 8.9 7.8 Dividend yield (%) 2.5 2.8 3.2 DPS 2.0 2.3 2.6 PBR (x) 1.3 1.2 1.1 EV/EBITDA (x) 4.9 3.9 3.1 ROE (%) 14.1 14.2 14.4
Source: FactSet, Daiwa forecasts

4 September 2013
1 2 3 4 5

Growth outlook Valuation Earnings revisions
Growth outlook
After disappointing 1H13 results due to inventory adjusments by Hon Hais main client, we expect the companys revenue growth momentum to resume in late-3Q13 on the back of the launch of new i-devices. We expect Hon Hai to be the sole assembler for both the iPhone 5S and the next iPad, while it should also secure 25-30% of orders for the mid-range iPhone. As a result, we expect the companys top line to rise by 24.4% HoH for 2H13E and 9.8% YoY for 2014E. On back of the companys increasing operating leverage, we forecast Hon Hais earnings to grow by 90% HoH for 2H13 and 12.6 % YoY in 2014.
Hon Hai: sales growth, EPS growth and ROE trend

16.0% 15.5% 15.0% 14.5% 14.0% 13.5% 13.0% 2011 ROE (LHS) 2012 2013E 2014E Sales growth (RHS) 5% 0% -5% 2015E EPS growth (RHS) 20% 15% 10%
Valuation
Following our transfer of coverage, we are cutting our 2013/2014/2015 EPS forecasts by 7%/7%/3% to TWD8.2/TWD9.2/TWD10.5, respectively. We set our new six-month target price at TWD98 (from TWD105), now based on a one-year forward PER of 11x, the stocks past-three-year average. We believe a PER methodology is the most appropriate way to evaluate downstream tech firms such as Hon Hai. We acknowledge that there are flaws with a PER methodology, such as a lack of insight into the long-term business outlook, a mismatch between earnings/cash flow, etc. But we think it is a more straightforward, intuitive and arguably more accurate way to predict a tech companys earnings power, at least in the near term.
Hon Hai: one-year forward PER bands

(TWD) 180 160 140 120 100 80 60 40 20 0 Jan-03 Jul-03 Jan-04 Jul-04 Jan-05 Jul-05 Jan-06 Jul-06 Jan-07 Jul-07 Jan-08 Jul-08 Jan-09 Jul-09 Jan-10 Jul-10 Jan-11 Jul-11 Jan-12 Jul-12 May-13 Jan-13 Jul-13 20x Aug-13
Hon Hai
Source: TEJ, Daiwa forecasts
5x
10x
15x
Earnings revisions
According to the Bloomberg consensus, analysts have been gradually revising down Hon Hais 2013-14 EPS forecasts since late 1Q13, given the rising concerns about competition. Although we are cutting our 2013-15 earnings forecasts by 3-7%, we believe the market has been too pessimistic; our 2014 EPS forecast is still 10.3% higher than that of the consensus. We expect Hon Hais margin expansion (gross and operating) to continue in 2014 on the back of Apples product mix change, production relocation and increasing operating leverage.
Hon Hai: Bloomberg 2013-14E EPS forecast revisions (TWD)

14 12 10 8 6 4 2 0 Aug-12 Aug-11 Aug-10 Nov-10 Nov-11 Nov-12 Feb-11 Feb-12 May-11 May-12 Feb-13
2013E EPS
Source: Bloomberg
2014E EPS
- 15 -

4 September 2013
Financial summary
Key assumptions
Year to 31 Dec Consumer related sales growth PC and networking related sales growth (YoY%) iPhone shipment (mn units) iPad shipment (mn units) 2008 31.1 9.4 13.7 0.0 2009 5.3 (7.2) 25.1 0.0 2010 11.6 44.8 47.2 14.3 2011 11.5 (5.4) 80.5 40.0 2012 18.0 (19.5) 119.7 60.1 2013E 20.5 (1.8) 117.0 55.0 2014E 15.1 (0.5) 136.0 63.5 2015E 17.7 1.6 156.4 74.3
Profit and loss (TWDm)

Year to 31 Dec PC/NB/networking Revenues Consumer electronics Revenues Other Revenue Total Revenue Other income COGS SG&A Other op.expenses Operating profit Net-interest inc./(exp.) Assoc/forex/extraord./others Pre-tax profit Tax Min. int./pref. div./others Net profit (reported) Net profit (adjusted) EPS (reported)(TWD) EPS (adjusted)(TWD) EPS (adjusted fully-diluted)(TWD) DPS (TWD) EBIT EBITDA 2008 2009 2010 2011 2012 2013E 2014E 2015E 1,041,906 1,009,676 1,521,104 1,531,057 1,322,734 1,271,751 1,218,867 1,227,539 357,896 376,979 420,625 468,801 553,134 666,626 767,103 903,255 550,680 572,527 1,055,476 1,452,823 2,029,527 1,887,203 2,216,280 2,486,726 1,950,481 1,959,182 2,997,205 3,452,681 3,905,395 3,825,580 4,202,250 4,617,520 0 0 0 0 0 0 0 0 (1,782,377) (1,772,629) (2,753,003) (3,186,299) (3,575,766) (3,573,092) (3,918,598) (4,308,146) (73,837) (76,982) (119,265) (142,691) (175,552) (93,249) (99,698) (106,549) (23,660) (26,082) (38,791) (40,847) (45,627) (50,211) (53,684) (57,373) 70,607 83,489 86,146 82,845 108,450 109,029 130,270 145,452 (1,964) (435) 492 2,721 3,752 1,967 3,880 5,509 3,951 4,977 4,839 16,970 6,177 13,806 3,936 4,396 72,594 88,031 91,477 102,536 118,379 124,802 138,086 155,357 (15,904) (11,651) (16,005) (20,602) (26,592) (27,956) (29,274) (31,538) (1,557) (695) 1,682 (344) 2,975 (64) 125 145 55,133 75,685 77,155 81,591 94,762 96,782 108,936 123,965 55,133 75,685 77,155 81,591 94,762 96,782 108,936 123,965 4.869 6.539 6.632 6.967 8.039 8.177 9.204 10.474 4.869 6.539 6.632 6.967 8.039 8.177 9.204 10.474 4.869 6.539 6.632 6.967 8.039 8.177 9.204 10.474 0.720 1.482 0.830 1.369 1.506 2.044 2.301 2.618 70,607 83,489 86,146 82,845 108,450 109,029 130,270 145,452 103,343 121,888 127,276 134,301 176,334 174,025 203,720 226,935
Cash flow (TWDm)

Year to 31 Dec Profit before tax Depreciation and amortisation Tax paid Change in working capital Other operational CF items Cash flow from operations Capex Net (acquisitions)/disposals Other investing CF items Cash flow from investing Change in debt Net share issues/(repurchases) Dividends paid Other financing CF items Cash flow from financing Forex effect/others Change in cash Free cash flow
2008 72,594 32,736 (15,904) (19,401) (3,524) 66,501 (79,568) 30,767 (14,433) (63,234) (4,398) 0 (18,872) (25,785) (49,055) 0 (45,789) (13,067)
2009 88,031 38,399 (11,651) (17,186) (3,694) 93,899 (13,618) (17,095) (7,186) (37,899) 20,152 0 (8,156) 11,160 23,155 0 79,155 80,281
2010 91,477 41,131 (16,005) (37,014) (1,552) 78,038 (74,394) (52,600) (4,517) (131,511) 166,043 0 (17,158) (19,259) 129,626 0 76,153 3,644
2011 102,536 51,456 (20,602) (64,472) (3,067) 65,852 (128,885) 64,657 (15,164) (79,392) 73,134 0 (9,661) 25,309 88,782 0 75,242 (63,033)
2012 118,379 67,883 (26,592) 90,647 1,016 251,333 (93,086) (12,350) (15,290) (120,727) 71,362 0 (16,034) (10,028) 45,300 0 175,906 158,247
2013E 124,802 64,996 (27,956) 18,945 (2,843) 177,945 (71,536) (14,990) (954) (87,480) 25,182 0 (17,754) 0 7,428 0 97,892 106,408
2014E 138,086 73,451 (29,274) (12,636) (1,232) 168,394 (68,046) (13,990) (973) (83,009) 26,441 0 (24,196) 0 2,245 0 87,630 100,348
2015E 155,357 81,483 (31,538) (13,256) (1,619) 190,427 (64,732) (12,990) (993) (78,715) 27,763 0 (27,234) 0 529 0 112,241 125,695
- 16 -

4 September 2013
Financial summary continued

Balance sheet (TWDm)
As at 31 Dec Cash & short-term investment Inventory Accounts receivable Other current assets Total current assets Fixed assets Goodwill & intangibles Other non-current assets Total assets Short-term debt Accounts payable Other current liabilities Total current liabilities Long-term debt Other non-current liabilities Total liabilities Share capital Reserves/R.E./others Shareholders' equity Minority interests Total equity & liabilities EV Net debt/(cash) BVPS (TWD) 2008 99,988 166,725 267,349 24,688 558,749 253,931 0 65,940 878,621 77,582 266,104 78,403 422,089 50,628 44,737 517,454 74,146 287,021 361,167 0 878,621 998,763 28,222 31.343 2009 179,143 180,980 307,606 31,846 699,574 234,618 0 87,753 1,021,945 86,245 300,530 88,462 475,236 62,649 44,205 582,090 85,789 354,066 439,855 0 1,021,945 940,292 (30,249) 37.905 2010 255,296 259,384 409,819 40,049 964,548 272,150 0 143,835 1,380,532 230,455 427,153 113,644 771,252 87,955 40,732 899,939 96,612 383,980 480,593 0 1,380,532 1,033,655 63,114 41.162 2011 330,538 380,522 476,050 96,558 1,283,668 355,373 0 91,270 1,730,311 271,512 548,494 171,710 991,716 115,979 44,785 1,152,480 106,891 470,941 577,832 0 1,730,311 1,027,494 56,953 49.176 2012 506,445 349,883 633,049 53,582 1,542,957 390,298 0 111,148 2,044,404 355,790 638,371 255,863 1,250,024 105,688 42,159 1,397,871 118,359 528,174 646,532 0 2,044,404 925,575 (44,966) 54.625 2013E 604,337 357,309 524,052 69,556 1,555,254 396,838 0 129,871 2,081,963 363,415 636,304 191,279 1,190,998 121,138 44,267 1,356,402 118,359 607,202 725,561 0 2,081,963 850,757 (119,784) 61.302 2014E 691,967 391,860 575,651 76,405 1,735,882 391,433 0 146,192 2,273,507 381,585 697,833 210,113 1,289,530 127,195 46,480 1,463,205 118,359 691,943 810,302 0 2,273,507 787,355 (183,186) 68.462 2015E 804,208 430,815 632,537 83,955 1,951,514 374,683 0 161,938 2,488,136 400,665 767,204 230,876 1,398,745 133,555 48,804 1,581,103 118,359 788,674 907,032 0 2,488,136 700,553 (269,988) 76.634
Key ratios (%)

Year to 31 Dec Sales (YoY) EBITDA (YoY) Operating profit (YoY) Net profit (YoY) Core EPS (fully-diluted) (YoY) Gross-profit margin EBITDA margin Operating-profit margin Net profit margin ROAE ROAA ROCE ROIC Net debt to equity Effective tax rate Accounts receivable (days) Current ratio (x) Net interest cover (x) Net dividend payout Free cash flow yield
2008 14.6 (13.6) (24.5) (29.0) (30.5) 8.6 5.3 3.6 2.8 15.5 6.3 14.5 15.2 7.8 21.9 49.1 1.3 36.0 14.8 n.a.
2009 0.4 17.9 18.2 37.3 34.3 9.5 6.2 4.3 3.9 18.9 8.0 15.5 18.1 net cash 13.2 53.6 1.5 191.7 22.7 8.3
2010 53.0 4.4 3.2 1.9 1.4 8.1 4.2 2.9 2.6 16.8 6.4 12.4 14.9 13.1 17.5 43.7 1.3 n.a. 12.5 0.4
2011 15.2 5.5 (3.8) 5.8 5.1 7.7 3.9 2.4 2.4 15.4 5.2 9.4 11.2 9.9 20.1 46.8 1.3 n.a. 19.7 n.a.
2012 13.1 31.3 30.9 16.1 15.4 8.4 4.5 2.8 2.4 15.5 5.0 10.5 13.6 net cash 22.5 51.8 1.2 n.a. 18.7 16.3
2013E (2.0) (1.3) 0.5 2.1 1.7 6.6 4.5 2.9 2.5 14.1 4.7 9.4 14.0 net cash 22.4 55.2 1.3 n.a. 25.0 11.0
2014E 9.8 17.1 19.5 12.6 12.6 6.8 4.8 3.1 2.6 14.2 5.0 10.3 16.7 net cash 21.2 47.8 1.3 n.a. 25.0 10.3
2015E 9.9 11.4 11.7 13.8 13.8 6.7 4.9 3.2 2.7 14.4 5.2 10.5 18.3 net cash 20.3 47.8 1.4 n.a. 25.0 13.0
Company profile
Established in 1974, Hon Hai Precision Industry (Hon Hai) started out making plastic products, connector products and cable assemblies. It is now the largest electronics manufacturing service (EMS) provider globally in terms of design, manufacturing, global logistics and after-market service.
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4 September 2013
growth in 2H13, with around 90% HoH growth in EPS, to TWD 5.4 for 2H13E from TWD2.8 in 1H13.
Hon Hai: revenue and earnings
(TWDbn) (TWDbn) 40.0 35.0 30.0 25.0 20.0 15.0 10.0 5.0 3Q12 4Q12 1Q13 2Q13 3Q13E 4Q13E Revenue (LHS)
We see strong earnings growth in 2H13, margin expansion on the way

We believe Hon Hai has been overly punished by the markets concerns on competition. We believe Hon Hais position in the Apple supply chain is secure and expect strong margin recovery soon.
1,400 1,200 1,000 800 600 400 200 0 Earnings (RHS)
More i-devices to come in 2014

We expect Apple to release the next version of the iPad mini in mid-1Q14 and that Hon Hai is likely to be a major supplier, with an order allocation of 50-60%, based on our forecasts. In addition to the new iPad mini, we expect Apple to release a new flagship iPhone with a larger screen in mid-2014, and that Hon Hai is likely to remain the sole supplier. Based on our analysis of the supply chain, we forecast total iPhone and iPad shipments to increase from 156m and 73m for 2013 to 180m and 84m in 2014, respectively. We forecast Hon Hai to account for 7580% of both iPhone and iPad production in 2014.
Likely to be a major beneficiary of the new i-devices

Resume strong earnings growth in 2H13.
Apple will host a media event on 10 September, at which we expect it to unveil its new phones, likely the high-end flagship model, the iPhone 5S, and a midrange phone, the iPhone 5C. Hon Hai, as Apples major EMS partner on the iPhone, should be a major beneficiary of the new products, in our view. For the iPhones, our supply chain market research indicates that Hon Hai is likely to be the sole assembler for the iPhone 5S and that it will secure 25-30% of the iPhone 5C order allocation. We do not expect the company to lose all its iPhone 5C business to its competitors like the market does. Regarding the legacy phone, the iPhone 4S, we believe Apple will keep it as its low-end model, at a USD0 price tag (ie free) when bought from a mobile-phone operator with a contract, and that Hon Hai will remain the main assembler. In total, we expect Hon Hais iPhone shipments to reach 65-70m in 2H13E, representing 20% HoH growth. In addition to the iPhone, we expect Hon Hai to start mass production of the next iPad in September, 2013. Driven by the likely launches of Apples new i-devices, along with the forthcoming peak season, we expect Hon Hai to regain its revenue-growth momentum from late-3Q13. We forecast its revenue to grow QoQ by 9%/18% for 3Q13/4Q13, respectively. Benefiting from its increasing economies of scale and operating leverage, Hon Hai should deliver strong earnings
Margin expansion is on the way

Due to the cost savings it has made from relocating its production in-land within China over the past year or so, more stable ASP environment, along with what we see as the favourable trend of its major client expanding its product mix to include mid-range phones, we expect Hon Hais operating margin to continue its upward trend for 2013/14. We forecast Hon Hais operating margin to expand from 2.8% for 2012 to 2.9%/3.1% in 2013/14, respectively.
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4 September 2013
Hon Hai: operating margin and net profit margin

3.4% 3.2% 3.0% 2.8% 2.6% 2.4% 2.2% 2.0% 2010 2011 Operating Margin
Major clients product mix change could help its margin

As Apple is facing the challenge of the high-end smartphone segment becoming saturated, we think Apples forthcoming iphone 5C is a clear indication of its strategy change to more mid-range options. We estimate that Apples mid-range/legacy models could account for 62% of total iPhones in 2H13 compared with 31% in 2H12. We believe this should benefit Hon Hai in terms of its operating margin, on the back of increasing economies of scale and vertical integration (more in-house components) for its legacy model, and a lower production-yield loss rate for the mid-range model, as this model is likely to have limited changes to the product design.
iPhone: production forecasts by model
(m units) iPhone 4 & 4S iPhone 5 iPhone 5C iPhone 5S Total 1Q13 15.5 20.0 35.5 2Q13 12.0 18.5 30.5 3Q13E 10.0 8.5 10.0 5.0 33.5 4Q13E 7.5 20.0 29.0 56.5 2013E 45.0 47.0 30.0 34.0 156.0
2012
2013E
2014E Net Profit Margin
2015E
A more stable ASP environment

In general, a declining ASP should now be the norm in the EMS industry, but for Hon Hai, we have been seeing a more stable ASP environment since 2012. Our market research shows Hon Hai was even able to raise its ASP (or its manufacturing value added (MVA), as it is called in the assembly business) for its major client, Apple, for the iPhone and iPad in 2Q12. We do not expect this price hike to continue but see this as evidence that Hon Hai has been getting more bargaining power when it comes to pricing. Our recent market research also indicates that the ASP pressure should ease in the coming quarters.
Source: Daiwa forecasts Note: This table represents Daiwas iPhone production forecasts, which will be slightly different to Apples iPhone sales figures
iPhone: production forecast by model mix

100% 80% 60% 40% 20% 0% 2H12 iPhone 3GS iPhone 4&4S iPhone 5 2H13E iPhone 5C iPhone 5S
Mid-range/ legacy models Mid-range/ legacy models Flagship Model
The benefits from moving inland should gradually kick in

Hon Hai started to switch production sites in 4Q08, from the south coast of china, where labour costs are high, to inland China, where labour costs are lower. After year of efforts, Hon Hai has almost completed its relocation. The company has gradually ramped up its capacity in the Zhengzhou and Chengdu industrial parks (two major inland China production sites for the iPhone and iPad, respectively) since 2011. According to our estimates, Hon Hais inland China production sites should account for about 50% of its total production output in 2013E, from about 30% in late 2012 and less than 20% in 2011. We expect the trend to continue and estimate that inland production output could reach 70% in 2014E. Although Hon Hai will still face rising labour-cost issues inland, our market research shows that the current inland China labour cost is about 30% lower than on the coast, which should give Hon Hai a further competitive cost edge and the potential for margin expansion, in our view. In addition to the lower labour costs, Hon Hai will receive tax incentives from the local governments (Zhengzhou and Chengdu). We forecast Hon Hais tax rate to fall gradually to 20% for 2015, from 23% in 2012.
Flagship Model
Source: Daiwa forecasts Note: This table represents Daiwas iPhone production forecasts, which will be slightly different to Apples iPhone sales figures
Market concerns on competition appear overdone

We believe the market is worrying that Apple might further diversify its assembly outsourcing orders and add new vendors into the supply chain. We think these concerns are overdone. We think Hon Hais winning formula is a combination of its competitive cost structure on the back of its larger economies of scale and strong vertical integration, its time to get to mass production, and superior execution capability, all of which would be difficult for newcomers to duplicate in the short term and should secure Hon Hais position in the Apple supply chain. According to our market
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4 September 2013
research, we believe Apple is unlikely to add new iPhone assembly companies until 2H14 or later, if at all. Even if there are newcomers to the supply chain in 2H14, we believe they will start with small orders (highly unlikely to be profitable due to the lack of scale) and, thus, the impact on Hon Hai is likely to be limited for the next 2-3 years.
Hon Hai: vertically integrated components
Hon Hai's Ticker holding Main products Not-listed 100% Touch panels Not-listed 100% Camera lenses Handset design & assembly, enclosure, keypad, FIH Mobile 2038 HK 68% connector Zhen Ding Tech 4958 TT 41% Flexible PCB Fitipower Integrated Tech 4961 TT 36% Power management IC and display driver IC Foxconn Tech 2354 TT 30% Casing G-Tech 3149 TT 28% Cover glass Pan International 2328 TT 27% Component EMS Foxsemicon Integrated Equipment modules and components for 3413 TT 20% Tech semiconductor and TFT-LCD Sputtering system and vacuum-coating system UVAT Tech 3580 TT 17% equipments Advanced SMD LEDs for mobile phones and other related 3437 TT 14% OptoelectronicTech applications Ways Tech 3508 TT 13% Plastic surface decorating related products CyberTan Tech 3062 TT 11% Broadband and wireless networking products Simplo Tech 6121 TT 8% Battery-pack Innolux 3481 TT 4% LCD Solytech 1471 TT 3% Power supply-related products Related Cheng Uei 2392 TT Connectors, cable assemblies, and power packs Company Company Name GIS Wcube Co., Ltd
Source: Companies, TEJ
Hon Hai: one-year forward PER bands

(TWD) 180 160 140 120 100 80 60 40 20 0 Jan-03 Jul-03 Jan-04 Jul-04 Jan-05 Jul-05 Jan-06 Jul-06 Jan-07 Jul-07 Jan-08 Jul-08 Jan-09 Jul-09 Jan-10 Jul-10 Jan-11 Jul-11 Jan-12 Jul-12
Apr-13
250.0% 200.0% 150.0% 100.0% 50.0% 0.0% (50.0)%
Jul-09 Jul-10 Jul-11 Oct-09 Oct-10 Oct-11 Jul-12 Jan-09 Jan-10 Jan-11 Jan-12 Oct-12 Jan-13 Apr-09 Apr-10 Apr-11 Apr-12 Apr-13
Hon Hai
5x
10x
15x
Hon Hai: one-year forward PBR bands

(TWD) 180 160 140 120 100 80 60 40 20 0 Jan-03 Jul-03 Jan-04 Jul-04 Jan-05 Jul-05 Jan-06 Jul-06 Jan-07 Jul-07 Jan-08 Jul-08 Jan-09 Jul-09 Jan-10 Jul-10 Jan-11 Jul-11 Jan-12 Jul-12 Jan-13 Jul-13 Hon Hai
1x
2x
3x
Hon Hai: share price vs. operating profit

(TWD) 120 100 150.0% 100.0% 50.0% 0.0% (50.0)%
Valuation and target price

Reiterate our Buy (1) rating
Following our transfer of coverage, we are lowering our 2013/2014/2015 EPS forecasts to TWD8.2/TWD9.2/ TWD10.5, respectively. We believe margin expansion will drive Hon Hais EPS growth over 2013-15. We set our new six-month target price at TWD98, which is now based on a one-year forward PER of 11x (2013E PER of 12x previously), which is in line with the stocks past-three-year trading average.
80 60 40 20 0
Jul-09
Jul-10
Jul-11
Oct-09
Oct-10
Oct-11
Jul-12
Jan-10
Jan-11
Jan-12
Oct-12
Share price (LHS)

Source: TEJ, Company
OP YoY (RHS)
Catalysts/risks
We expect the major share-price catalysts to be: 1) solid revenue growth from 3Q13, and 2) margin expansion from 3Q13. The key risks to our target price would include: 1) the weaker-than-expected sell-through of new iPhones, 2) the Taiwan Dollar appreciating against the US Dollar by more than we expect, and 3) a higher-than-expected increase in labour/raw material costs.
Hon Hai: share price vs. net profit

(TWD) 120 100 80 60 40 20 0
Share price (LHS)

NP YoY (RHS)
- 20 -
Jan-13
Jan-09
Apr-09
Apr-10
Apr-11
Apr-12
Jan-13 Jul-13 20x 4x

4 September 2013
EMS/ODM companies: valuations

Company Regional peers Hon Hai* Pegatron* Quanta* Compal* Wistron* Global peers Flectronics Jabil Circuit BYD Elec. Average Ticker 2317 TT 4938 TT 2382 TT 2324 TT 3231 TT FLEX US JBL US 0285 HK Price (lc) Target 3 Sept-13 Price (LC) 82.00 45.50 64.10 20.10 30.50 8.98 22.82 3.7 98.0 62.0 68.0 18.0 28.0 n.a. n.a. n.a. Daiwa Rating Buy Buy Outperform Hold Hold Not rated Not rated Not rated PER (x) EPS growth (%) ROE(%) PBR (x) Mkt cap EPS (local currency) (USDm) 2013E 2014E 2015E 2013E 2014E 2015E 2013E 2014E 2015E 2013E 2014E 2015E 2013E 2014E 2015E 32,562 3,498 8,282 2,978 2,386 5,497 4,625 1,075 8.2 4.5 5.3 1.7 3.5 0.8 2.2 0.3 9.2 6.0 6.6 1.9 3.6 1.0 2.7 0.4 10.5 7.1 6.9 2.1 3.8 1.2 2.9 0.5 10.0 10.1 12.1 11.7 8.8 10.7 10.2 11.6 10.6 8.9 7.6 9.7 10.7 8.4 8.8 8.5 9.1 9.0 7.8 6.4 9.2 9.6 8.1 7.4 8.0 7.9 8.1 1.7 68.3 -11.4 18.4 14.4 1.7 -96.9 -72.5 12.6 32.9 24.2 9.5 5.1 21.5 19.7 26.9 13.8 19.5 5.2 11.5 3.3 18.7 6.1 15.5 14.1 10.1 16.9 6.7 11.8 21.2 19.8 6.8 14.2 12.4 20.7 6.8 11.5 20.5 21.3 7.9 14.4 13.8 20.2 7.3 11.2 n.a. 18.6 8.3 1.3 1.0 2.1 0.7 1.0 2.4 2.1 0.8 1.4 1.2 0.9 1.9 0.7 0.9 1.8 1.8 0.7 1.2 1.1 0.9 1.8 0.7 0.9 1.5 1.5 0.7 1.1
Source: Bloomberg, *Daiwa forecasts
Hon Hai: quarterly P& L statement

(TWDm) Net sales COGS Gross profit Operating costs Operating profit Pretax profit Net profit Net EPS (TWD) Operating Ratios Gross margin Operating margin Pre-tax margin Net margin YoY (%) Net revenue Gross profit Operating income Pretax income Net income QoQ (%) Net revenue Gross profit Operating income Pretax income Net income 1Q 1,001,286 934,760 66,526 51,301 15,225 19,381 14,924 1.27 2012 2Q 891,917 821,218 70,700 49,181 21,519 17,146 12,610 1.07 3Q 4Q 874,442 1,137,750 791,003 1,028,786 83,439 108,964 53,474 67,223 29,965 41,742 34,438 47,415 30,256 36,973 2.57 3.14 1Q 809,012 763,099 45,913 32,006 13,907 22,597 16,353 1.38 2013E 2Q 3QE 973,132 895,617 843,685 905,692 51,933 67,440 33,330 36,150 18,603 31,290 25,544 31,390 16,978 26,038 1.43 2.20 4QE 1,147,819 1,060,616 87,202 41,973 45,229 45,271 37,415 3.16 2011 3,452,681 3,186,299 266,382 183,537 82,845 102,536 81,591 6.97 2012 3,905,395 3,575,766 329,629 221,179 108,450 118,379 94,762 8.04 2013E 3,825,580 3,573,092 252,488 143,459 109,029 124,802 96,782 8.18 2014E 4,202,250 3,918,598 283,652 153,382 130,270 138,086 108,936 9.20
6.6% 1.5% 1.9% 1.5%
7.9% 2.4% 1.9% 1.4%
9.5% 3.4% 3.9% 3.5%
9.6% 3.7% 4.2% 3.2%
5.7%1 1.7% 2.8% 2.0%
5.8%1 2.1% 2.9% 1.9%
6.9%1 3.2% 3.2% 2.7%
7.6%1 3.9% 3.9% 3.3%
7.7% 2.4% 3.0% 2.4%
8.4% 2.8% 3.0% 2.4%
6.6%1 2.9% 3.3% 2.5%
6.8%1 3.1% 3.3% 2.6%
37% 26% 20% 14% 4%
13% 24% 36% -18% -3%
1% 37% 58% 49% 58%
6% 14% 18% 14% 6%
-19% -31% -9% 17% 10%
0% -27% -14% 49% 35%
11% -19% 4% -9% -14%
1% -20% 8% -5% 1%
15% 9% -4% 12% 6%
13% 24% 31% 15% 16%
-2% -23% 1% 5% 2%
10% 12% 20% 11% 13%
-7% -30% -57% -53% -57%
-11% 6% 41% -12% -16%
-2% 18% 39% 101% 140%
30% 31% 39% 38% 22%
-29% -58% -67% -52% -56%
11% 13% 34% 13% 4%
9% 30% 68% 23% 53%
18% 29% 45% 44% 44%
Source: Company, Daiwa forecasts Note: 1 All listed companies in Taiwan have been required to adopt IFRS since 2013, and one major difference between IFRS and ROC GAAP is the reclassification of some items, such as warranties and provisions from operating expenses to COGS, thus the gross margins since 2013 cannot be directly compared with past numbers.
- 21 -

Largan Precision
Largan Precision
3008 TT
Target (TWD): 1,250.00 920.00 Downside: 12.4% 3 Sep price (TWD): 1,050.00
Rising margin risk

1
Change in iPhone mix should mean rise in pricing pressure for Largan, with no change in specs for mid-range/legacy models Markets expectations on SEC orders could be overly optimistic: we expect contribution from SEC to remain limited in 2014 We see the risk of a margin disappointment for 4Q13. Valuation unattractive: down to Underperform
2 3 4 5
Buy Outperform Hold Underperform (from Buy) Sell
that SECs current vendors have sufficient lens supply, there is uncertainty about potential orders from SEC for Largan in 2014.
Kylie Huang
change in the iPhone product mix and uncertain SEC orders.
What's new
We are turning cautious on Largans prospects due to rising margin risks from the change in its main clients product mix. This report marks the transfer of analyst coverage.
What's the impact
Not immune to change. We expect Apple to shift the focus of its iPhones from solely the high-end segment to the mid-range segment. We expect this to result in greater pricing pressure on Largan, as the mid-range/legacy iPhones will not have upgraded camera lenses. Last piece may still be missing. The market has been optimistic about Largan winning orders from Samsung Electronics (SEC). Investors expect Largan to be a key 8MP/13MP lens vendor for SEC in 2H13 and for SEC to become one of its top-three clients in 2014. We believe there has been a delay in the qualification process, and so expect Largans shipments for SEC in 4Q13 to be small. Given this, and
Strong 3Q13 still likely, but 4Q13 could disappoint. We forecast 20% QoQ revenue growth for Largan for 3Q13, driven by the peak season and new-product launches. However, we expect pricing pressure to emerge in 4Q13 following the initial sell-in of new products and forecast its gross margin to fall to 45.4% for 4Q13, below the Bloomberg-consensus forecast of 47-48%. We are cutting our 2014-15 EPS forecasts by 11-14% to factor in the rising margin risk.
What we recommend

13E 0.3 1.5 1.5
14E (6.0) (10.7) (10.7)
15E (7.0) (14.0) (14.0)

(TWD)
1,150 988 825 663 500
(%)
165 144 123 101 80
Sep-12
Dec-12
Mar-13
Jun-13
Sep-13
Largan (LHS) Relative to TWSE Index (RHS)
We like Largan for its quality management and leading industry position, but the current 2013E PER of 16x looks unattractive to us. We downgrade the stock to Underperform (4) from Buy (1) and lower our sixmonth target price to TWD920 (from TWD1,250 [one-year-forward PER of 16x]), now based on a one-year forward PER of 14x, in line with its past-three-year average. The major risk to our call would be better-thanexpected orders from new clients.
How we differ
12-month range 592.00-1,120.00 Market cap (USDbn) 4.72 3m avg daily turnover (USDm) 55.62 Shares outstanding (m) 134 Cathay Life Insurance Co., Ltd. (5.2%) Major shareholder

Year to 31 Dec Revenue (m) Operating profit (m) Net profit (m) Core EPS (fully-diluted) EPS change (%) Daiwa vs Cons. EPS (%) PER (x) Dividend yield (%) DPS PBR (x) EV/EBITDA (x) ROE (%) 13E 26,650 10,074 8,826 65.796 58.2 (2.5) 16.0 3.1 32.9 4.8 11.0 33.8 14E 30,805 11,552 9,597 71.547 8.7 (7.7) 14.7 3.4 35.8 4.1 9.1 30.2 15E 35,500 13,171 10,877 81.083 13.3 (4.9) 12.9 3.9 40.5 3.5 7.7 29.1
We are more concerned than the market about margin risk due to the

4 September 2013
1 2 3 4 5

Growth outlook
Largan has had a strong 2013 so far. This follows a tough 2012 on the back of a disappointing gross margin and reduced revenue growth, driven by weakness in end demand and a low utilisation rate. Although we expect revenue-growth momentum to remain strong for 2H13, we believe the companys earnings growth will decelerate significantly, to a double-digit YoY percentage for the coming year (3Q13-2Q14), driven by margin pressure from an unfavourable change in the iPhone model mix and limited contributions from new clients. We believe consensus expectations for SEC orders for 2014 are too optimistic and expect an insignificant revenue contribution from SEC in 2014.
Largan: sales, EPS, and ROE

40% 60% 50% 30% 40% 20% 30% 20% 10% 10% 0% 2011 2012 ROE (LHS)
2013E 2014E Sales growth (RHS)
0% 2015E EPS growth (RHS)
Valuation
Our six-month target price is based on a 14x one-year forward PER, in line with the stocks past-three-year average. Considering the decelerating earnings growth we expect, we view the risk-reward profile unattractive at the current level, a 2013E PER of 16x. We believe PER is the most appropriate way to evaluate downstream tech companies such as Largan. We recognise the flaws in the methodology, such as a lack of insight into the long-term business outlook, and a mismatch between earnings and cash flow. However, we think it is a more straightforward, intuitive, and accurate way to predict a tech companys earnings power, at least over the near term.
Largan: one-year forward PER bands

(TWD) 1,200 1,000 800 600 400 200 0 Mar-02 Sep-02 Mar-03 Sep-03 Mar-04 Sep-04 Mar-05 Sep-05 Mar-06 Sep-06 Mar-07 Sep-07 Mar-08 Sep-08 Mar-09 Sep-09 Mar-10 Sep-10 Mar-11 Sep-11 Mar-12 Sep-12 Mar-13 Largan
6x
12x
18x
24x
Earnings revisions
The 2013-14 Bloomberg-consensus earnings forecasts have been raised gradually since late 4Q12, driven by the markets anticipation of the announcement of the addition of a new client, the expectation of shipment volume growth from new iPhones, and the companys strong margin in 1H13. Our 2014 EPS forecast is 8% below that of the consensus, which we expect to be cut on the back of rising margin pressure.
Largan: consensus 2013-14 EPS-forecast revisions (TWD)

90 80 70 60 50 40 30 20 10 0 Feb-11 Feb-12 May-11 May-12 Feb-13 May-13 Aug-10 Aug-11 Aug-12 Aug-13 Nov-10 Nov-11 Nov-12
2013E EPS
Source: Bloomberg
2014E EPS
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4 September 2013
Financial summary
Key assumptions
Year to 31 Dec Mobile phone lens shipment (K units) Blended ASP of handset lens (USD) Gross margin of VCM assembly (%) 2008 200,491 1.01 0.0 2009 173,300 1.12 5.0 2010 215,100 1.21 7.3 2011 286,554 1.33 6.8 2012 344,730 1.34 5.3 2013E 478,434 1.44 6.0 2014E 563,891 1.44 6.0 2015E 663,559 1.43 5.8

Year to 31 Dec Mobile Phone Lens Revenues DSC Lens Revenues Other Revenue Total Revenue Other income COGS SG&A Other op.expenses Operating profit Net-interest inc./(exp.) Assoc/forex/extraord./others Pre-tax profit Tax Min. int./pref. div./others Net profit (reported) Net profit (adjusted) EPS (reported)(TWD) EPS (adjusted)(TWD) EPS (adjusted fully-diluted)(TWD) DPS (TWD) EBIT EBITDA 2008 6,412 507 559 7,478 0 (3,491) (412) (456) 3,119 56 163 3,338 (96) 0 3,242 3,242 24.653 24.653 24.653 9.895 3,119 3,684 2009 7,421 377 357 8,154 0 (4,580) (345) (507) 2,722 30 (109) 2,643 (157) 0 2,486 2,486 18.651 18.651 18.651 10.064 2,722 3,344 2010 11,433 555 363 12,351 0 (6,546) (374) (770) 4,661 28 (356) 4,334 (289) 0 4,044 4,044 30.150 30.150 30.150 13.500 4,661 5,398 2011 15,243 391 351 15,984 0 (9,043) (506) (963) 5,472 50 314 5,837 (638) 0 5,199 5,199 38.755 38.755 38.755 17.000 5,472 6,372 2012 19,190 415 468 20,072 0 (11,710) (530) (1,034) 6,798 84 (71) 6,811 (1,234) 0 5,578 5,578 41.581 41.581 41.581 20.000 6,798 8,005 2013E 25,823 453 373 26,650 0 (14,284) (777) (1,515) 10,074 113 447 10,634 (1,808) 0 8,826 8,826 65.796 65.796 65.796 32.898 10,074 11,508 2014E 30,007 470 328 30,805 0 (16,696) (866) (1,690) 11,552 145 7 11,704 (2,107) 0 9,597 9,597 71.547 71.547 71.547 35.773 11,552 13,389 2015E 34,785 465 251 35,500 0 (19,383) (999) (1,948) 13,171 184 7 13,362 (2,485) 0 10,877 10,877 81.083 81.083 81.083 40.542 13,171 15,255
Cash flow (TWDm)

2008 3,338 565 (96) 711 (17) 4,502 (1,420) (39) (16) (1,475) 94 0 (1,232) (200) (1,338) 0 1,688 3,081
2009 2,643 622 (157) (466) 14 2,656 (1,057) (20) (26) (1,103) (120) 0 (1,301) 591 (831) 0 723 1,599
2010 4,334 737 (289) (539) 21 4,263 (1,066) (1) (21) (1,088) 142 0 (1,341) (23) (1,223) 0 1,952 3,197
2011 5,837 900 (638) 1,202 18 7,318 (3,149) (2) (23) (3,173) 319 0 (1,811) 37 (1,456) 0 2,690 4,169
2012 6,811 1,208 (1,234) (783) (2) 6,000 (2,865) (101) (19) (2,985) (356) 0 (2,280) (43) (2,679) 0 336 3,136
2013E 10,634 1,434 (1,808) (937) (7) 9,317 (3,500) (10) 75 (3,435) 10 0 (2,683) 0 (2,673) 0 3,208 5,817
2014E 11,704 1,837 (2,107) (921) (7) 10,506 (2,150) (10) 0 (2,160) (52) 0 (4,413) 0 (4,465) 0 3,881 8,356
2015E 13,362 2,084 (2,485) (468) (7) 12,485 (2,150) (10) 0 (2,160) 0 0 (4,799) 0 (4,799) 0 5,527 10,335
- 24 -

4 September 2013

As at 31 Dec Cash & short-term investment Inventory Accounts receivable Other current assets Total current assets Fixed assets Goodwill & intangibles Other non-current assets Total assets Short-term debt Accounts payable Other current liabilities Total current liabilities Long-term debt Other non-current liabilities Total liabilities Share capital Reserves/R.E./others Shareholders' equity Minority interests Total equity & liabilities EV Net debt/(cash) BVPS (TWD) 2008 5,904 625 1,494 234 8,257 5,018 0 365 13,640 111 273 1,278 1,662 0 47 1,709 1,301 10,629 11,931 0 13,640 135,054 (5,793) 89.902 2009 6,627 622 2,377 199 9,825 5,453 0 397 15,675 16 410 1,521 1,948 0 21 1,969 1,341 12,365 13,706 0 15,675 134,237 (6,610) 102.178 2010 8,579 902 3,182 153 12,815 5,795 0 386 18,996 112 560 1,871 2,543 0 67 2,610 1,341 15,045 16,386 0 18,996 132,381 (8,467) 122.156 2011 11,268 1,461 3,510 234 16,473 8,057 0 379 24,909 444 1,358 3,243 5,045 0 54 5,099 1,341 18,469 19,810 0 24,909 130,023 (10,824) 147.685 2012 11,604 2,532 6,581 255 20,973 9,731 0 485 31,188 93 3,555 4,426 8,075 0 49 8,124 1,341 21,723 23,064 0 31,188 129,336 (11,511) 171.943 2013E 14,813 3,089 8,737 333 26,972 11,796 0 427 39,195 100 3,914 5,922 9,936 0 52 9,988 1,341 27,866 29,207 0 39,195 126,134 (14,713) 217.738 2014E 18,694 4,174 10,128 362 33,358 12,109 0 444 45,912 100 4,574 6,846 11,520 0 0 11,520 1,341 33,050 34,392 0 45,912 122,253 (18,594) 256.387 2015E 24,221 4,846 11,671 394 41,132 12,175 0 461 53,769 100 5,310 7,889 13,299 0 0 13,299 1,341 39,128 40,470 0 53,769 116,726 (24,121) 301.697
Key ratios (%)

2008 27.1 6.2 6.9 26.2 24.2 53.3 49.3 41.7 43.4 29.4 26.1 28.1 50.2 net cash 2.9 79.9 5.0 n.a. 40.1 2.2
2009 9.0 (9.2) (12.7) (23.3) (24.3) 43.8 41.0 33.4 30.5 19.4 17.0 21.1 38.7 net cash 6.0 86.6 5.0 n.a. 54.0 1.1
2010 51.5 61.4 71.3 62.7 61.7 47.0 43.7 37.7 32.7 26.9 23.3 30.8 57.9 net cash 6.7 82.1 5.0 n.a. 44.8 2.3
2011 29.4 18.0 17.4 28.5 28.5 43.4 39.9 34.2 32.5 28.7 23.7 29.8 57.7 net cash 10.9 76.4 3.3 n.a. 43.9 3.0
2012 25.6 25.6 24.2 7.3 7.3 41.7 39.9 33.9 27.8 26.0 19.9 31.3 54.2 net cash 18.1 91.7 2.6 n.a. 48.1 2.2
2013E 32.8 43.8 48.2 58.2 58.2 46.4 43.2 37.8 33.1 33.8 25.1 38.4 64.2 net cash 17.0 104.9 2.7 n.a. 50.0 4.1
2014E 15.6 16.3 14.7 8.7 8.7 45.8 43.5 37.5 31.2 30.2 22.6 36.2 62.5 net cash 18.0 111.8 2.9 n.a. 50.0 5.9
2015E 15.2 13.9 14.0 13.3 13.3 45.4 43.0 37.1 30.6 29.1 21.8 35.1 66.7 net cash 18.6 112.1 3.1 n.a. 50.0 7.3
Company profile
In Asia ex-Japan, Largan Precision (Largan) is the leading lens manufacturer for mobile handsets. Nokia, Motorola, Sony Ericsson, Apple, HTC and RIM are the companys major customers. It currently has around a 28% share of the global handset lens market.
- 25 -

4 September 2013
iPhone: production forecast by model mix

100% 80%
Flagship Model Flagship Model
Rising margin risk

We like Largan for its quality management and leading industry position. However, we worry it might encounter gross-margin pressure due to Apples changes to the iPhone mix and the limited contribution from its possible new client Samsung.
60% 40% 20% 0%
Mid-Range/ Legacy Models
Source: Daiwa forecasts Note: This chart represents Daiwas iPhone production forecasts, which are slightly different from the iPhone sales figures reported by Apple
Not immune to changes in Apples iPhone mix

Apple is Largans largest customer, accounting for about 50% of its total revenue, based on our estimates. As Apple is facing the challenge of the high-end smartphone segment becoming saturated, we expect it to release two new iPhones in September 2013 the iPhone 5C and its high-end flagship model, the iPhone 5S. We think the iPhone 5C would mark a clear indication of a change in Apples strategy, ie, moving from purely high-end phones to a focus on mid-range ones. We forecast the mid-range/legacy products to account for 62% of total iPhones in 2H13, double from 31% in 2H12. Our market research of the supply chain indicates that the iPhone 5C will use the same lens module as the legacy model (the iPhone 5), which should bring more pricing pressure for Largan this year due to no specs upgrades (to lens modules), in our view. In addition, we estimate Largans share of orders for the iPhone 5C and legacy products would be 60-70% for 2H13. For the iPhone 5S, the new high-end model, we expect small upgrades in the lens module, with the aperture ratio increasing from f/2.4 to f/2.0. We believe Largan will remain the major supplier of this module, with an allocation of 85-90% and a 10-20% ASP premium.
Too much hype about the new client

Last piece should remain missing
Over the past six months, the market has been optimistic about Largan finding the final missing piece in its client base ie, new-order wins from SEC. The market seems to be expecting Largan to become a key 8MP/13MP lens vendor for SECs mid-range to highend smartphones and may be thinking that SEC could become one of Largans top-three clients in 2014. We hold different view on this. According to our market research, Largan has sent out lens-module samples for SECs S4 and Note 3 smartphones. However, the process may have been delayed, and Largans lens modules do not yet appear to have been qualified for either model. Considering the life cycles of these products (the S4 was launched nearly six months ago while the Note 3 is due to be launched in early September), we think it is unlikely that Largan will become a major lens vendor for either model this year. We therefore expect SECs revenue contribution to Largan to be limited for 4Q13, with only small volume shipments for the S4 or Note 3. In addition, our market research shows there should be sufficient high-end lens module capacity among the Korea lens-module makers (SECs current vendors) from 4Q13, which could lead to further uncertainty about SECs orders to Largan into 2014.
Rising risks from aggressive capacity expansion

Our market research also indicates that Largan has been aggressively expanding its capacity for 2H13, which is supported by Largans capex rising in 1H13 (up 85% YoY). We forecast Largans capacity to - 26 -

4 September 2013
increase by 20-30% HoH for 2H13, and estimate that over 30% of the new capacity is likely to be allocated to SEC. But, we now see rising risks from this aggressive capacity expansion due to uncertainty over the SEC orders. If there are further delays or if SEC cancels orders, Largan might have to cut prices to win orders to fill its capacity, which in turn could result in further margin pressure in 2014.
Largan: capex trend
(TWDm) 3,000 2,500 2,000 1,500 1,000 500 0 2008 2009 2010 2011 Capex 2012 1H12 1H13
Valuation and recommendation

Good company, but risk/reward not attractive
We like Largan for its solid management team, superior execution, and its leading industry position. However, we believe the market has priced in most of the positives. Largans share price has rallied by about 50% since April 2013, driven by the markets optimism about the new client (SEC), its strong 2Q13 results, and the expectation of strong revenue-growth momentum in 2H13. The stock is trading at a 16x 2013E PER, at the high end of its past-three-year trading range of 10-20x and at a premium to its past-three-year average of 14x. We view the current risk/reward profile as unattractive and believe it leaves little room for any disappointment. Although we think the near-term revenue-growth momentum remains intact, we see potential downside risks due to margin pressure and a decelerating revenue-growth outlook from 4Q13. Following the transfer of analyst coverage, we are raising our 2013 EPS forecast to TWD65.8 and cutting our 2014/2015 EPS forecasts to TWD71.6/TWD81.1, respectively. We set our new six-month target price at TWD920, which is now based on a 14x one-year forward PER, in line with the stocks past-three-year average.
Source: Company
3Q13 outlook looks intact but 4Q13 could disappoint

We forecast Largan to deliver strong 3Q13 revenue growth on a ramp-up in shipments of new products for the peak season. We estimate Largan to deliver 20% QoQ revenue growth for 3Q13, with an EPS of TWD17.4 (up 15% QoQ, 101% YoY). However, we expect more pricing pressure in 4Q13 after the initial sell-in period. Despite greater economies of scale, we forecast Largans gross margin to decline to 47.5% in 3Q13 and 45.4% in 4Q13, lower than the Bloombergconsensus forecast of 47-48%. For the coming year (3Q13-2Q14), we forecast Largans earnings growth to be only 11.5% YoY, significantly lower than growth of 78% YoY a year ago (3Q12-2Q13), given the likely unfavourable product mix change for Apple, limited spec upgrades in the new models, and a likely delay in orders from SEC.
Catalysts and risks

Downside risk would come from: 1) disappointing margin delivery and earnings growth from 4Q13, and 2) further delays or cancellation in orders from SEC. We would turn more positive on Largan if we were to see: 1) better-than-expected orders from new clients, or 2) stronger-than-expected sell-through of the iPhone 5S, leading to what we would see as a favourable shift in Largans product mix.
- 27 -

4 September 2013
Largan: share price vs. operating profit

(TWD) 1,200 1,000 800 600 400 200 0
Jul-09 Jul-10 Jul-11 Apr-09 Apr-10 Apr-11 Apr-12 Jul-12 Oct-09 Oct-10 Oct-11 Jan-09 Jan-10 Jan-11 Jan-12 Oct-12 Jan-13 Apr-13
Largan: one-year forward PER bands

200% 150% 100% 50% 0% (50)% (100)%
Share price (LHS)

OP YoY (RHS)
6x
12x
18x
24x
Largan: share price vs. net profit

(TWD) 1,200 1,000 800 600 400 200 0
Jul-09 Jul-10 Jul-11 Apr-09 Apr-10 Apr-11 Apr-12 Jul-12 Oct-09 Oct-10 Oct-11 Jan-09 Jan-10 Jan-11 Jan-12 Oct-12 Jan-13 Apr-13
Largan: one-year forward PBR bands

250% 200% 150% 100% 50% 0% -50% -100%
Share price (LHS)

NP YoY (RHS)
2x
4x
6x
8x
- 28 -

4 September 2013
Handset component companies: valuations

Company Regional peers Largan* AAC Technologies* TXC* Sunny Optical* Catcher Foxconn Tech Genius Optical Merry Silitech Ichia ChengUei Flexium interconnect Career Technology Zhen Ding Tech BYD Elec. Average BBG code Share price (lc) 3-Sept-2013 3008 TT 2018 HK 3042 TT 2382 HK 2474 TT 2354 TT 3406 TT 2439 TT 3311 TT 2402 TT 2392 TT 6269 TT 6153 TT 4958 TT 0285 HK 1,050.00 36.50 40.50 9.04 148.50 77.10 173.00 76.70 43.95 16.20 61.90 117.00 31.95 78.90 3.70 Target price Daiwa Rating Mkt. cap EPS (local currency) PER (x) EPS growth (%) ROE (%) PBR (x) (USDm) 2013E 2014E 2015E 2013E 2014E 2015E 2013E 2014E 2015E 2013E 2014E 2015E 2013E 2014E 2015E 4,728 65.8 5,780 1.8 420 3.1 1,166 0.6 3,742 17.8 3,382 6.2 579 8.95 453 4.751 277 3.6 181 1.3 1,026 4.8 789 9.9 348 2.4 1,956 6.8 1,075 0.3 71.5 2.0 3.6 0.8 15.2 6.6 10.8 5.51 3.8 1.8 5.3 11.5 3.0 7.8 0.4 81.1 2.3 4.2 1.0 16.8 7.1 n.a. 5.9 4.5 n.a. 4.4 13.5 3.2 9.3 0.5 16.0 15.7 13.0 14.7 8.4 12.5 19.3 16.1 12.0 12.2 12.9 11.8 13.4 11.6 11.6 13.4 14.7 14.1 11.3 11.0 9.7 11.6 16.0 13.9 11.5 9.1 11.7 10.1 10.7 10.1 9.1 11.7 12.9 12.4 9.7 8.6 8.8 10.9 n.a. 13.0 9.7 n.a. 14.2 8.7 10.1 8.5 7.9 10.4 58.2 8.7 13.3 28.2 11.2 13.7 -19.4 15.2 15.9 45.4 34.1 26.8 46.6 -14.2 10.5 -0.9 7.5 6.6 -2.1 20.7 n.a. 86.8 16.0 7.1 -20.1 4.5 18.4 241.3 33.4 n.a. 64.2 10.5 -17.6 10.7 16.7 16.8 -18.2 24.5 6.6 21.7 14.2 19.4 -72.5 26.9 15.5 33.8 33.3 12.0 22.3 20.2 12.5 6.0 17.5 9.9 4.9 8.7 29.0 10.1 23.4 6.8 30.2 30.0 13.1 25.3 15.5 12.4 12.5 18.6 10.7 4.9 10.4 27.3 12.3 22.6 7.9 29.1 28.3 14.2 26.4 15.3 11.7 n.a. 18.8 12.7 n.a. 8.8 25.1 11.7 22.4 8.3 4.8 4.7 1.5 3.1 1.6 1.4 4.8 2.7 1.2 0.8 1.3 3.1 1.3 2.3 0.8 2.4 4.1 3.9 1.4 2.5 1.4 1.2 2.4 2.5 1.3 n.a. 1.3 2.4 1.2 1.9 0.7 2.0 3.5 3.2 1.3 2.0 1.3 1.2 n.a. 2.4 1.2 n.a. 1.2 1.9 1.1 1.7 0.7 1.7
920.0 Underperform 33.50 Underperform 41.0 Hold 11.60 Buy n.a. Not rated n.a. Not rated n.a. Not rated n.a. Not rated n.a. Not rated n.a. Not rated n.a. Not rated n.a. Not rated n.a. Not rated n.a. Not rated n.a. Not rated
Largan: quarterly P&L statement

(TWDm) Net sales COGS Gross profit Operating costs Operating profit Pre-tax profit Net profit Net EPS (TWD) Operating ratios Gross margin Operating margin Pre-tax margin Net margin YoY (%) Net revenue Gross profit Operating income Pre-tax income Net income QoQ (%) Net revenue Gross profit Operating income Pre-tax income Net income 1Q 3,640 2,238 1,402 291 1,110 1,025 882 6.58 38.5% 30.5% 28.2% 24.2% 4% -6% -4% -18% -26% -9% -12% -13% -21% -24% 2012 2Q 3,338 2,096 1,242 315 927 1,054 665 4.96 37.2% 27.8% 31.6% 19.9% -18% -32% -37% -24% -39% -8% -11% -17% 3% -25% 3Q 4,512 2,676 1,836 361 1,475 1,413 1,160 8.65 40.7% 32.7% 31.3% 25.7% 3% -9% -6% -25% -34% 35% 48% 59% 34% 74% 4Q 8,583 4,700 3,882 597 3,286 3,319 2,869 21.39 45.2% 38.3% 38.7% 33.4% 114% 144% 158% 156% 147% 90% 111% 123% 135% 147% 1Q 5,103 2,967 2,136 460 1,676 2,013 1,849 13.79 41.9% 32.8% 39.4% 36.2% 40% 52% 51% 96% 110% -41% -45% -49% -39% -36% 2013E 2Q 5,858 2,902 2,956 486 2,470 2,673 2,035 15.17 50.5% 42.2% 45.6% 34.7% 76% 138% 167% 154% 206% 15% 38% 47% 33% 10% 3QE 7,046 3,698 3,347 585 2,762 2,782 2,337 17.42 47.5% 39.2% 39.5% 33.2% 56% 82% 87% 97% 101% 20% 13% 12% 4% 15% 4QE 8,643 4,717 3,926 761 3,165 3,165 2,604 19.42 45.4% 36.6% 36.6% 30.1% 1% 1% -4% -5% -9% 23% 17% 15% 14% 11% 2011 15,984 9,043 6,941 1,468 5,472 5,837 5,199 38.76 43.4% 34.2% 36.5% 32.5% 29% 20% 17% 35% 29% 2012 20,072 11,710 8,362 1,564 6,798 6,811 5,578 41.58 41.7% 33.9% 33.9% 27.8% 26% 20% 24% 17% 7% 2013E 26,650 14,284 12,366 2,292 10,074 10,634 8,826 65.80 46.4% 37.8% 39.9% 33.1% 33% 48% 48% 56% 58% 2014E 30,805 16,696 14,109 2,557 11,552 11,704 9,597 71.55 45.8% 37.5% 38.0% 31.2% 16% 14% 15% 10% 9%
- 29 -
Information Technology / China 2018 HK
Information Technology / China 4 September 2013

AAC Technologies
AAC Technologies
2018 HK
Target (HKD): 44.50 33.50 Downside: 8.2% 3 Sep price (HKD): 36.50
Not immune to the unfavourable product mix shift

AAC could come under more pricing pressure due to Apples product mix shifting to focus more on mid-range iPhones Limited upside for high-end/uncertainty of tapping into midrange phones could lead to decelerating earnings growth Premium valuation looks unjustified; downgrade to Underperform
1 2 3 4 5
Kylie Huang
Eric Chen
(852) 2773 8702 eric.chen@hk.daiwacm.com
potential for AAC in the high-end smartphone segment, which we see as saturated with slower volume growth and limited room for further soundquality enhancements. AACs intention to win orders in the mid-tolow-end segment could be a long-term positive if it can deliver solid profitability in this pricingcompetitive segment. However, we believe AAC could see its margins decline during this transition period. Valuation premium looks unjustified. Driven by the increasingly unfavourable industry trend, AACs EPS growth rate should decelerate to around 12% YoY for 3Q13E-2Q14E, compared with 6070% for 3Q12-2Q13, on our forecasts.
What we recommend
AAC due to the increasingly unfavourable product mix for smartphones overall.
13E (1.1) (7.4) (7.4)
14E (6.3) (17.8) (17.8)
15E (4.6) (17.3) (17.3)

(HKD) (%)
155 136 118 99 80 47 41 36 30 25
What's new
We have turned cautious on AAC due to the increasingly unfavourable industry trend and its unattractive valuation. This report marks a transfer of analyst coverage.
What's the impact
Sep-12
Dec-12
Mar-13
Jun-13
Sep-13
AAC Tech (LHS)
Relative to HSI (RHS)
Affected by major clients product mix change. AACs largest client, Apple, looks likely to become more focused on mid-range iPhones. We forecast Apples mid-range and legacy iPhones to account for 62% of its iPhone production volume in 2H13, from 31% in 2H12. We believe this change would result in more pricing pressure on AAC, due to unlikely spec upgrades on midend/legacy models. Upside capped for high-end, uncertainty of being able to tap into mid-to-low end. We are concerned about the business
Following a transfer of coverage, to factor in the margin risks, we cut our 2013-15E EPS by 7-18% and downgrade AAC to Underperform (4) (from Buy [1]). Our new six-month target price of HKD33.50, based on a 14x one-year forward (ie, 3Q13E2Q14E) PER, is in line with the stocks past-3-year average (formerly HKD44.50 on a 16x PER). A betterthan-expected margin would be the main risk to our view.
How we differ
12-month range 25.85-46.40 Market cap (USDbn) 5.78 3m avg daily turnover (USDm) 27.75 Shares outstanding (m) 1,228 Chun Yuan Wu Ingrid (21.4%) Major shareholder
Financial summary (CNY)

Year to 31 Dec Revenue (m) Operating profit (m) Net profit (m) Core EPS (fully-diluted) EPS change (%) Daiwa vs Cons. EPS (%) PER (x) Dividend yield (%) DPS PBR (x) EV/EBITDA (x) ROE (%) 13E 8,385 2,453 2,260 1.840 28.2 (2.6) 15.7 2.6 0.736 4.7 14.3 33.3 14E 9,675 2,815 2,512 2.046 11.2 (7.0) 14.1 2.8 0.818 3.9 12.4 30.0 15E 11,025 3,197 2,858 2.327 13.7 (5.8) 12.4 3.2 0.931 3.2 10.8 28.3
We are more concerned than the market about margin pressure on

4 September 2013
1 2 3 4 5

Growth outlook
We expect AACs revenue and earnings growth to decelerate from 3Q13 onwards, driven by: 1) Apples product mix shift to mid-range smartphones, 2) limited possibilities for product spec upgrades for AACs clients, and 3) a slowdown in demand for high-end smartphones. We forecast AACs rate of annual EPS growth to decelerate to 11% YoY for 2014 and 14% YoY for 2015 from the 70% YoY growth the company posted for 2012.
AAC: sales growth, EPS growth and ROE trend

35% 30% 25% 20% 15% 10% 5% 0% 2011 ROE (LHS)
80% 70% 60% 50% 40% 30% 20% 10% 0% 2012 2013E Sales growth (RHS) 2014E 2015E EPS growth (RHS)
Valuation
We have a new six-month target price for AAC of HKD33.50, based on a one-year forward PER of 14x, in line with the stocks past-3-year average (formerly HKD44.50 on a 16x PER). AAC trades at a 15.4x oneyear forward PER, which we view as unattractive based on its past-3-year average, and we see the risk of a derating due to the lukewarm near-term earningsgrowth outlook. We believe the PER methodology is more appropriate to evaluate downstream tech companies like AAC. While we recognise flaws with this methodology, such as a lack of insight into the longterm business outlook, a mismatch between earnings/cash flow, etc., we think it is a more straightforward, intuitive and arguably accurate way to predict a tech companys earnings power, at least in the near term
AAC: one-year forward PER bands

(HKD) 45 40 35 30 25 20 15 10 5 0 Sep-07 Sep-08 Sep-09 Sep-10 Sep-11 Sep-12 Mar-08 Mar-09 Mar-10 Mar-11 Mar-12 Mar-13 26x Aug-13
AAC
5x
12x
19x
Source: Bloomberg, Daiwa forecasts
Earnings revisions
Following a transfer of coverage, we are cutting our 2013/2014/2015 EPS forecasts for AAC to CNY1.84/ CNY2.05/CNY2.33, respectively, representing cuts of 7%/18%/17%, respectively. We believe the 2013-14 Bloomberg-consensus earnings forecasts for AAC have reached the peak; they have trended down since late 2Q13, due mainly to market concerns about high-end smartphone saturation. Our 2013E EPS is slightly (2.6%) lower than that of the consensus, while our 2014E EPS is around 7% lower.
AAC: consensus 2013-14 EPS forecast revisions (CNY)

2.5 2.0 1.5 1.0 0.5 0.0 Aug-11
Nov-11
Feb-12
May-12
Aug-12
Nov-12
Feb-13
May-13
2013E EPS
Source: Bloomberg
2014E EPS
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4 September 2013
Financial summary
Key assumptions
Year to 31 Dec Receiver sales growth (% YoY) Speaker box sales growth (% YoY) MEMS microphone sales growth (% 2008 28.5 0.0 0.0 2009 (38.0) 0.0 0.0 2010 39.9 0.0 0.0 2011 35.8 109.0 44.9 2012 49.0 91.4 151.5 2013E 38.6 76.4 27.8 2014E 19.0 17.7 20.6 2015E 15.3 18.8 15.2
Profit and loss (CNYm)

Year to 31 Dec Dynamic components Revenues Microphone Revenues Other Revenue Total Revenue Other income COGS SG&A Other op.expenses Operating profit Net-interest inc./(exp.) Assoc/forex/extraord./others Pre-tax profit Tax Min. int./pref. div./others Net profit (reported) Net profit (adjusted) EPS (reported)(CNY) EPS (adjusted)(CNY) EPS (adjusted fully-diluted)(CNY) DPS (CNY) EBIT EBITDA 2008 1,645 158 453 2,256 0 (1,316) (223) (123) 594 20 3 616 (26) (0) 590 590 0.481 0.481 0.481 0.096 594 727 2009 1,678 146 379 2,203 0 (1,214) (184) (159) 646 12 19 676 (67) 5 615 615 0.501 0.501 0.501 0.199 646 816 2010 2,483 366 500 3,349 0 (1,839) (237) (214) 1,060 20 20 1,099 (112) (1) 987 987 0.804 0.804 0.804 0.359 1,060 1,257 2011 3,228 459 372 4,060 0 (2,275) (290) (358) 1,136 22 (17) 1,142 (109) 3 1,036 1,036 0.844 0.844 0.844 0.360 1,136 1,395 2012 5,052 774 457 6,283 0 (3,509) (464) (462) 1,849 4 163 2,016 (259) 6 1,763 1,763 1.435 1.435 1.435 0.574 1,849 1,849 2013E 7,025 866 494 8,385 0 (4,771) (755) (406) 2,453 2 78 2,533 (279) 6 2,260 2,260 1.840 1.840 1.840 0.736 2,453 2,453 2014E 8,115 1,001 559 9,675 0 (5,534) (862) (464) 2,815 3 (2) 2,816 (310) 6 2,512 2,512 2.046 2.046 2.046 0.818 2,815 2,815 2015E 9,350 1,140 535 11,025 0 (6,339) (967) (521) 3,197 5 2 3,204 (352) 6 2,858 2,858 2.327 2.327 2.327 0.931 3,197 3,197
Cash flow (CNYm)

2008 616 133 (26) (43) (0) 680 (588) 0 120 (469) 18 0 0 12 30 0 241 212
2009 676 170 (67) 133 5 918 (245) 0 4 (241) (13) 0 (118) (77) (208) 0 469 677
2010 1,099 197 (112) (155) (1) 1,029 (576) (104) (177) (857) 283 0 (245) (211) (172) 0 (1) 172
2011 1,142 259 (109) (369) (0) 923 (1,189) (75) (100) (1,363) 421 0 (441) 100 80 0 (361) (441)
2012 2,016 0 (259) (469) 6 1,294 (927) (60) (43) (1,030) 144 0 (442) (26) (324) 0 (60) 264
2013E 2,533 0 (279) (593) 19 1,680 (900) 0 (14) (914) 31 0 (705) 0 (674) 0 92 766
2014E 2,816 0 (310) (600) 15 1,921 (855) 0 (14) (869) 32 0 (904) 0 (872) 0 180 1,052
2015E 3,204 0 (352) (558) 12 2,305 (898) 0 (14) (912) 33 0 (1,005) 0 (972) 0 421 1,393
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4 September 2013

Balance sheet (CNYm)
As at 31 Dec Cash & short-term investment Inventory Accounts receivable Other current assets Total current assets Fixed assets Goodwill & intangibles Other non-current assets Total assets Short-term debt Accounts payable Other current liabilities Total current liabilities Long-term debt Other non-current liabilities Total liabilities Share capital Reserves/R.E./others Shareholders' equity Minority interests Total equity & liabilities EV Net debt/(cash) BVPS (CNY) 2008 1,266 296 563 129 2,254 1,289 0 161 3,704 200 366 75 641 0 0 641 100 2,964 3,064 0 3,704 34,311 (1,066) 2.495 2009 1,735 230 729 38 2,733 1,364 0 157 4,254 187 482 101 770 0 0 770 100 3,384 3,484 0 4,254 33,828 (1,548) 2.836 2010 1,735 343 1,293 32 3,402 1,752 0 430 5,584 470 857 241 1,569 0 0 1,569 100 3,915 4,015 0 5,584 34,112 (1,264) 3.270 2011 1,374 559 1,488 5 3,425 2,697 0 592 6,714 891 897 216 2,004 0 0 2,004 100 4,611 4,710 0 6,714 34,893 (483) 3.836 2012 1,314 958 2,329 6 4,607 3,624 0 694 8,926 1,035 1,575 310 2,921 0 0 2,921 100 5,905 6,005 0 8,926 35,097 (279) 4.890 2013E 1,406 1,325 3,108 9 5,849 4,524 0 695 11,068 1,066 2,142 299 3,508 0 0 3,508 100 7,460 7,560 0 11,068 35,036 (340) 6.156 2014E 1,587 1,581 3,587 10 6,764 5,379 0 699 12,843 1,098 2,274 302 3,675 0 0 3,675 100 9,069 9,168 0 12,843 34,888 (489) 7.466 2015E 2,008 1,981 4,087 11 8,087 6,277 0 708 15,072 1,131 2,605 315 4,051 0 0 4,051 100 10,922 11,021 0 15,072 34,499 (877) 8.975
Key ratios (%)

2008 15.6 11.1 3.8 8.3 9.9 41.7 32.2 26.3 26.2 21.4 17.1 20.1 31.5 net cash 4.2 107.2 3.5 n.a. 20.0 0.6
2009 (2.3) 12.3 8.8 4.2 4.1 44.9 37.0 29.3 27.9 18.8 15.5 18.6 29.6 net cash 9.9 107.0 3.5 n.a. 39.8 1.9
2010 52.0 54.1 64.1 60.5 60.5 45.1 37.5 31.6 29.5 26.3 20.1 26.0 40.6 net cash 10.2 110.2 2.2 n.a. 44.7 0.5
2011 21.2 11.0 7.2 5.0 5.0 44.0 34.4 28.0 25.5 23.8 16.9 22.5 29.5 net cash 9.5 125.0 1.7 n.a. 42.7 n.a.
2012 54.8 32.5 62.8 70.1 70.1 44.2 29.4 29.4 28.1 32.9 22.5 29.3 32.4 net cash 12.8 110.9 1.6 n.a. 40.0 0.7
2013E 33.5 32.7 32.7 28.2 28.2 43.1 29.3 29.3 27.0 33.3 22.6 31.3 33.7 net cash 11.0 118.4 1.7 n.a. 40.0 2.2
2014E 15.4 14.8 14.8 11.2 11.2 42.8 29.1 29.1 26.0 30.0 21.0 29.8 31.5 net cash 11.0 126.3 1.8 n.a. 40.0 3.0
2015E 14.0 13.6 13.6 13.7 13.7 42.5 29.0 29.0 25.9 28.3 20.5 28.5 30.2 net cash 11.0 127.0 2.0 n.a. 40.0 3.9
Company profile
AAC Technologies designs and manufactures miniature acoustic components, including speakers, receivers, microphones and hands-free headsets, for use in mobile phones and other consumer handheld devices.
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4 September 2013
iPhone: production breakdown by model mix

100% 80%
Flagship Model Flagship Model
Not immune to the product mix change

We like AACs leading position in the acoustic components industry, but are concerned that it could see margin pressure due to the increasingly unfavourable industry trend towards mid to low-end smartphones.
60% 40% 20% 0%
Source: Daiwa estimates and forecasts Note: This chart represents Daiwas iPhone production forecasts, which will be slightly different from the iPhone sales figures reported by Apple
Likely to be adversely impacted by product mix change

Apple is AACs largest client, with a 45%+ revenue contribution for 2013, based on our forecasts. Facing the challenge of the high-end smartphone segment moving into the saturated stage, Apple is expected to release two new iPhones this September a mid-end iPhone 5C, and a high-end flagship model, iPhone 5S. We see the iPhone 5C as a clear indication of Apples strategy to shift its focus from being purely high-end to be more mid-range. We forecast Apples mid-range and legacy handsets to account for 62% of total iPhone production volume in 2H13, up two-fold from 31% in 2H12 (the following bar chart shows). Our supply chain research indicates that the mid-range iPhone 5C will use the same acoustic components as the legacy model, which would mean more severe pricing pressure for AAC due to the likely lack of spec upgrades.
AAC: revenue breakdown by client (2013E)
Chinese brands 17.4% Blackberry 2.3% HTC 3.1% Motorola 3.3% Nokia 11.8% Samsung 15.4%
Source: Daiwa forecasts Note: Samsung Samsung Electronics
Upside looks capped for highend; rising uncertainties from move into mid-low range phones
We are positive about AACs leading position in the acoustic components industry through its competitive technology, solid execution, and quality management team. However, we believe the company might enter a transition period due to the changing dynamics in the smartphone industry. For the high-end smartphone segment, in addition to the likelihood that sales-volume growth could slow from 2H13 onwards due to this segment moving into the saturated stage, we are concerned that the room for further upgrades to acoustic components could be limited or proceed at a slower pace. Take Apple for example. To fulfil the sound quality requirement for popular apps like Siri (personal voice assistant) and Facetime (video call), Apple added another MEMS microphone and upgraded the receiver to HD for the iPhone 5 (released in September 2012) to enhance its sound quality. However, we do not expect a similar degree of upgrades for the new forthcoming iPhone 5S. Our market research shows that the iPhone 5S may only have small upgrades to the receiver, and as such, we believe AAC may only post a single-digit rise in its ASPs for its components supplied for this new model for 2H13, compared with a 20-30% ASP increase on average for its components for the iPhone 5 last year. We also view this limited acoustic upgrade on the iPhone 5S as an indication that the sound quality is already good enough for this new high-end smartphone, and that there is no urgency for an immediate further significant improvement.
Others 1.5%
Apple 45.2%
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4 September 2013
During the 2Q13 results meeting for analysts held on 16 August, AACs management team indicated its intention to gain more shares with customers other than Apple in the mid-to-low end smartphone segment. We have two perspectives on this statement: 1) it may indicate that AAC expects its business to be adversely affected by its major clients product mix change and thats why the company is willing to move from the very profitable high-end segment to the midto-low end one, or 2) it could broaden AACs addressable market given that currently the company has limited exposure to mid-to-low end phones, and if AAC can deliver solid margins and profitability in a lower and more competitive pricing environment, this could be a long-term positive for the company. However, we believe this switch in strategy will take time to bear fruit, and expect AACs profit margins to come under more pressure during the transition period, which we expect in coming years.
The AAC stock is trading at a one-year forward PER of 15.4x, at a premium to its past-3-year average trading multiple of 14x, which we view as unjustified. We see a risk of a de-rating during the next 6-12 months given the lukewarm near-term earnings-growth outlook we see for the company. Thus, we downgrade our rating on the stock to Underperform (4) (from Buy [1]).
Catalysts and risks

We expect the major downside risks for AAC to be: 1) potentially disappointing profit margins in 2H13E, and 2) a slowdown in earnings growth for 3Q13E onwards. The key upside risk to our Underperform rating would be a better-than-expected margin delivery by the company. We could turn more positive on AAC if we saw: 1) a faster ramp-up in the earnings contribution from its non-acoustic products, or 2) faster-than-expected significant upgrades to acoustic products for high-end smartphones due to new innovative apps or functionality.
AAC: one-year forward PER bands
(HKD) 45 40 35 30 25 20 15 10 5 0 Sep-07 Sep-08 Sep-09 Sep-10 Sep-11 Sep-12 Sep-12 Mar-08 Mar-09 Mar-10 Mar-11 Mar-12 Mar-13 26x Mar-13 8x
Decelerated growth outlook

Driven by the unfavourable industry trend and AACs major clients change in its product mix, AACs gross margin could be under pressure in the coming year. For 2H13, although we expect AAC to post solid revenue growth (up 20%+ YoY) on the back of new product launches and peak seasonality, we forecast its gross margin to recover only mildly, from 42.8% for 1H13 to 43.5%, lower than the 44-45% in 2H12, despite its greater economies of scale. In all, we forecast AACs EPS growth rate to decelerate to 12% YoY in the coming year (3Q13E-2Q14E), compared with 60-70% YoY growth a year ago (3Q122Q13).
AAC
5x
12x
19x
AAC: one-year forward PBR bands

(HKD) 45 40 35 30 25 20 15 10 5 0 Mar-08 Mar-09 Mar-10 Mar-11 Sep-07 Sep-08 Sep-09 Sep-10 Sep-11 Mar-12 6x
Valuation and recommendation

Valuation looks unattractive; downgrade to Underperform
Following a transfer of coverage, we are reducing our 2013/2014/2015 EPS forecasts for AAC to CNY1.84/CNY2.05/ CNY2.33, respectively, ie, by 7%, 18% and 17% respectively. We set our new six-month target price at HKD33.50, which is based on a one-year forward (ie, 3Q13E-2Q14E) PER of 14x, in line with the stocks past-three-year average multiple.
AAC
2x
4x
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4 September 2013
AAC: share price vs. operating profit YoY change

50 40 30 20 10 0 Jan-09 Apr-09 Jul-09 Oct-09 Jan-10 Apr-10 Jul-10 Oct-10 Jan-11 Apr-11 Jul-11 Oct-11 Jan-12 Apr-12 Jul-12 Oct-12 Jan-13 Apr-13 Share price (LHS)
Source: Bloomberg, Company
(HKD)
150.0% 100.0% 50.0% 0.0% -50.0% -100.0%
OP YoY (RHS)
AAC: share price vs. net profit YoY change

50 40 30 20 10 0 Jan-09 Apr-09 Jul-09 Oct-09 Jan-10 Apr-10 Jul-10 Oct-10 Jan-11 Apr-11 Jul-11 Oct-11 Jan-12 Apr-12 Jul-12 Oct-12 Jan-13 Apr-13 Share price (LHS)
Source: Bloomberg, Company
(HKD)
250.0% 200.0% 150.0% 100.0% 50.0% 0.0% -50.0% -100.0%
NP YoY (RHS)
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4 September 2013
Valuations: handset component companies

Company Regional peers Largan* AAC Technologies* TXC* Sunny Optical* Catcher Foxconn Tech Genius Optical Merry Silitech Ichia ChengUei Flexium interconnect Career Technology Zhen Ding Technology BYD Elec. Average Ticker Price (lc) 3-Sept-13 Target price Daiwa rating Mkt cap EPS (local currency) PER (x) EPS growth (%) ROE(%) PBR (x) (USDm) 2013E 2014E 2015E 2013E 2014E 2015E 2013E 2014E 2015E 2013E 2014E 2015E 2013E 2014E 2015E 4,728 5,780 420 1,166 3,742 3,382 579 453 277 181 1,026 789 348 1,956 1,075 65.8 1.8 3.1 0.6 17.8 6.2 9.0 4.8 3.6 1.3 4.8 9.9 2.4 6.8 0.3 71.5 2.0 3.6 0.8 15.2 6.6 10.8 5.5 3.8 1.8 5.3 11.5 3.0 7.8 0.4 81.1 2.3 4.2 1.0 16.8 7.1 n.a. 5.9 4.5 n.a. 4.4 13.5 3.2 9.3 0.5 16.0 15.7 13.0 14.7 8.4 12.5 19.3 16.1 12.0 12.2 12.9 11.8 13.4 11.6 11.6 13.4 14.7 14.1 11.3 11.0 9.7 11.6 16.0 13.9 11.5 9.1 11.7 10.1 10.7 10.1 9.1 11.7 12.9 12.4 9.7 8.6 8.8 10.9 n.a. 13.0 9.7 n.a. 14.2 8.7 10.1 8.5 7.9 10.4 58.2 8.7 13.3 28.2 11.2 13.7 (19.4) 15.2 15.9 45.4 34.1 26.8 46.6 (14.2) 10.5 (0.9) 7.5 6.6 (2.1) 20.7 n.a. 86.8 16.0 7.1 (20.1) 4.5 18.4 241.3 33.4 n.a. 64.2 10.5 (17.6) 10.7 16.7 16.8 (18.2) 24.5 6.6 21.7 14.2 19.4 (72.5) 26.9 15.5 33.8 33.3 12.0 22.3 20.2 12.5 6.0 17.5 9.9 4.9 8.7 29.0 10.1 23.4 6.8 30.2 30.0 13.1 25.3 15.5 12.4 12.5 18.6 10.7 4.9 10.4 27.3 12.3 22.6 7.9 29.1 28.3 14.2 26.4 15.3 11.7 n.a. 18.8 12.7 n.a. 8.8 25.1 11.7 22.4 8.3 4.8 4.7 1.5 3.1 1.6 1.4 4.8 2.7 1.2 0.8 1.3 3.1 1.3 2.3 0.8 2.4 4.1 3.9 1.4 2.5 1.4 1.2 2.4 2.5 1.3 n.a. 1.3 2.4 1.2 1.9 0.7 2.0 3.5 3.2 1.3 2.0 1.3 1.2 n.a. 2.4 1.2 n.a. 1.2 1.9 1.1 1.7 0.7 1.7
3008 TT 1,050.00 2018 HK 36.50 3042 TT 40.50 2382 HK 9.04 2474 TT 148.50 2354 TT 77.10 3406 TT 173.00 2439 TT 76.70 3311 TT 43.95 2402 TT 16.20 2392 TT 61.90 6269 TT 117.00 6153 TT 31.95 4958 TT 78.90 0285 HK 3.70
920.00 Underperform 33.50 Underperform 41.00 Hold 11.60 Buy n.a. Not rated n.a. Not rated n.a. Not rated n.a. Not rated n.a. Not rated n.a. Not rated n.a. Not rated n.a. Not rated n.a. Not rated n.a. Not rated n.a. Not rated
AAC: quarterly P&L statement

(CNYm) Net sales COGS Gross profit Operating costs Operating profit Pre-tax profit Net profit Net EPS (CNY) Net EPS (HKD) Margins Gross margins Operating margin Pre-tax margin Net margin YoY (%) Net revenue Gross profit Operating income Pre-tax income Net income QoQ (%) Net revenues Gross profit Operating income Pre-tax income Net income 1Q 1,192 680 512 179 333 351 314 0.26 0.31 2012 2Q 1,397 783 613 178 435 451 406 0.33 0.40 3Q 1,697 950 747 231 516 524 473 0.39 0.47 4Q 1,997 1,095 901 337 565 690 569 0.46 0.57 1Q 1,905 1,090 814 281 533 587 534 0.44 0.53 2013 2Q 1,926 1,101 825 256 569 595 542 0.44 0.54 3QE 2,110 1,191 918 281 637 638 576 0.47 0.57 4QE 2,445 1,388 1,056 344 713 712 609 0.50 0.61 2011 4,060 2,275 1,784 649 1,136 1,142 1,036 0.84 1.03 2012 6,283 3,509 2,774 925 1,849 2,016 1,763 1.44 1.75 2013E 8,385 4,771 3,614 1,161 2,453 2,533 2,260 1.84 2.25 2014E 9,675 5,534 4,141 1,325 2,815 2,816 2,512 2.05 2.50
43.0% 27.9% 29.4% 26.3%
43.9% 31.1% 32.3% 29.1%
44.0% 30.4% 30.9% 27.9%
45.1% 28.3% 34.6% 28.5%
42.7% 28.0% 30.8% 28.0%
42.8% 29.5% 30.9% 28.1%
43.5% 30.2% 30.2% 27.3%
43.2% 29.2% 29.1% 24.9%
43.9% 28.0% 28.1% 25.5%
44.2% 29.4% 32.1% 28.1%
43.1% 29.3% 30.2% 27.0%
42.8% 29.1% 29.1% 26.0%
23% 22% 16% 18% 16%
53% 54% 74% 77% 71%
62% 62% 74% 82% 81%
76% 79% 87% 130% 115%
60% 59% 60% 67% 70%
38% 35% 31% 32% 33%
24% 23% 24% 22% 22%
22% 17% 26% 3% 7%
21% 18% 7% 4% 5%
55% 56% 63% 77% 70%
34% 30% 33% 26% 28%
15% 15% 15% 11% 11%
5% 2% 10% 17% 19%
17% 20% 31% 29% 29%
22% 22% 19% 16% 17%
18% 21% 10% 32% 20%
-5% -10% -6% -15% -6%
1% 1% 7% 1% 2%
10% 11% 12% 7% 6%
16% 15% 12% 12% 6%
When a report covers six or more subject companies please access important disclosures for Daiwa Capital Markets Hong Kong Limited at http://www.daiwacm.com/hk/research_disclaimer.html or contact your investment representative or Daiwa Capital Markets Hong Kong Limited at Level 26, One Pacific Place, 88 Queensway, Hong Kong.
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TXC Corp
TXC Corp
3042 TT
Market expectations too high

1
We believe TXC has come through the worst of pricing competition from Japan peers as a result of Yen depreciation Sales growth should resume in 2H13; but the market may be overlooking possible pricing pressure from a major client Valuation undemanding but we suggest investors wait for the market to cut earnings expectations. Downgrade to Hold
2 3 4 5
Buy Outperform Hold (from Buy) Underperform Sell
Kylie Huang
20% of revenue), could switch its focus to mid-range products, thus increasing pricing pressure on TXC given no upgrade in specs to midrange/legacy models. For 2H13, we forecast TXCs revenue to rise by 15% HoH with the operating margin recovering to 11.5-12.0%. 2014 should be better. Our research suggests TXC recently won new clients for high-end networking products and two new smartphonechip vendors. We expect the contribution to ramp up in 2014 and be revenue-growth drivers for TXC. It should also benefit the volume growth of i-devices in 2014 as we expect it to have a stable market share from 2H13. Overall, we expect TXC to see double-digit EPS growth for 2014 from a fall of about 20% YoY for this year. To factor in a slower margin recovery, we cut our respective 2013-14 EPS forecasts.
What we recommend
How we differ
We are more cautious than the market on TXCs 2H13 recovery story given the pricing pressure we expect.
13E (12.8) (21.4) (23.3)
14E (18.9) (22.9) (24.7)
15E n.a. n.a. n.a.
What's new
Following an unfavourable change in the product mix of a major client and the markets high earnings expectations, we have become less positive on the stock. This report marks a transfer of the coverage.
What's the impact

(TWD)
55 51 47 42 38
(%)
115 105 95 85 75
Worst should be over... TXC had weak 1H13 results, due mainly to a market-share loss and pricing competition from Japan peers (weak Yen). We do not expect sharp currency volatility to continue and believe TXC has seen the worst of the impact from the weak Yen. but market expectations too high and clients product-mix change should have an impact. The market expects TXC to have a back-loaded year, with 2H13 revenue rising by about 30% HoH and the operating margin recovering to 12.5-13.0% (2Q13: 10.2%). However, the likelihood of pricing pressure in 2H13 is being overlooked. In particular, Apple, (15-
Sep-12
Dec-12
Mar-13
Jun-13
Sep-13
TXC Corp (LHS) Relative to TWSE Index (RHS)
12-month range Market cap (USDbn) 3m avg daily turnover (USDm) Shares outstanding (m) Major shareholder
38.75-52.70 0.42 1.90 310 Matthews Int'l (8.6%)

Year to 31 Dec Revenue (m) Operating profit (m) Net profit (m) Core EPS (fully-diluted) EPS change (%) Daiwa vs Cons. EPS (%) PER (x) Dividend yield (%) DPS PBR (x) EV/EBITDA (x) ROE (%) 13E 10,015 1,082 965 3.115 (19.4) (15.3) 13.0 4.6 1.9 1.5 6.8 12.0 14E 10,975 1,262 1,112 3.589 15.2 (9.9) 11.3 5.3 2.2 1.4 5.9 13.1 15E 12,030 1,458 1,289 4.160 15.9 (13.9) 9.7 6.1 2.5 1.3 5.0 14.2
We are downgrading our rating to Hold (3) from Buy (1), and lowering our six-month target price to TWD41 (from TWD57), now based on a 12.5x one year forward PER (14x 2013E PER previously), in line with the stocks past-three-year average. Upside risk would be a faster-than-expected margin recovery, while downside risk would be further sharp Yen depreciation.

4 September 2013
1 2 3 4 5
Buy Outperform Hold (from Buy) Underperform Sell

Growth outlook
Given that the worst of the impact from Yen depreciation should be over for TXC, we expect the companys revenue to recover in 2H13. However, we believe that the consensus forecasts of about 30% HoH revenue growth and an operating margin of 12.5-13.0% is too optimistic given the strong likelihood of pricing pressure from one of its major customers. Overall, we expect 2014 to be a better year for TXC. Given the contributions from new clients and solid orders of i-devices, we forecast 2014 EPS to rise by 15.2% YoY, up from a decline of 19.4% YoY for 2013.
TXC: sales, EPS, and ROE

18% 16% 14% 12% 10% 8% 6% 4% 2% 0% 2011 ROE (LHS)
20% 15% 10% 5% 0% -5% -10% -15% -20% -25% 2012E 2013E Sales growth (RHS) 2014E 2015E EPS growth (RHS)
Valuation
We see limited downside to the current PER valuation (12x on a one-year forward basis), which we regard as undemanding, given the improved growth outlook we expect for 2014. At the same time, we see limited upside given what we see as the markets high 2013-14 expectations. Our new six-month target price of TWD41 is based on a one-year forward PER of 12.5x, in line with the stocks past-three-year average. We suggest investors revisit the stock after the market revises its expectations.
TXC: one-year forward PER bands

(TWD) 80 60 40 20 0 Jan-03 Jul-03 Jan-04 Jul-04 Jan-05 Jul-05 Jan-06 Jul-06 Jan-07 Jul-07 Jan-08 Jul-08 Jan-09 Jul-09 Jan-10 Jul-10 Jan-11 Jul-11 Jan-12 Jul-12 Jan-13 Jul-13 Aug-13
TXC
6x
10x
14x
18x
Earnings revisions
The share price has fallen by 15% YTD, underperforming the Taiex by 20%, as the consensus 2013-14 earnings forecasts have been cut gradually on the back of the companys disappointing 1H13 results and increased competition from peers. However, we are still less optimistic on its margin recovery in 2H13 given an unfavourable product-mix change by one of the companys major customers. Our 2013 EPS forecast is about 15.3% lower than that of the consensus. We expect the consensus forecasts to be cut further over the coming months given the pricing pressure that we expect.
TXC: consensus 2013-14 EPS forecast revisions (TWD)

8 7 6 5 4 3 2 1 0 Feb-12 Aug-11 Nov-11 Aug-12 May-12 Nov-12 Feb-13 May-13
2013E EPS
Source: Bloomberg
2014E EPS
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4 September 2013
Financial summary
Key assumptions
Year to 31 Dec Handset sales growth (YoY%) Consumer sales growth (YoY%) PC and networking related sales growth (YoY%) 2008 135.6 (43.7) 1.0 2009 26.1 (8.0) 2.7 2010 44.4 8.2 22.2 2011 15.9 (1.4) 23.6 2012 37.2 (1.2) (8.2) 2013E (13.5) 6.6 (8.8) 2014E 15.2 (0.9) 8.2 2015E 12.5 1.2 7.6

Year to 31 Dec Networking component Mobile component Other Revenue Total Revenue Other income COGS SG&A Other op.expenses Operating profit Net-interest inc./(exp.) Assoc/forex/extraord./others Pre-tax profit Tax Min. int./pref. div./others Net profit (reported) Net profit (adjusted) EPS (reported)(TWD) EPS (adjusted)(TWD) EPS (adjusted fully-diluted)(TWD) DPS (TWD) EBIT EBITDA 2008 1,914 1,325 4,123 7,362 0 (5,321) (596) (317) 1,127 (25) (47) 1,056 (104) 0 952 952 3.289 3.289 3.289 1.877 1,127 1,866 2009 2,051 1,671 4,005 7,728 0 (5,823) (584) (316) 1,004 (25) (10) 968 (186) 0 782 782 2.668 2.668 2.668 1.981 1,004 1,849 2010 2,481 2,413 4,757 9,651 0 (7,114) (781) (408) 1,347 (22) 0 1,325 (135) 0 1,190 1,190 3.966 3.966 3.966 2.469 1,347 2,199 2011 2,350 2,797 4,750 9,897 0 (7,497) (786) (463) 1,152 (17) 78 1,213 (163) 0 1,050 1,050 3.475 3.475 3.475 2.200 1,152 2,074 2012 2,285 3,836 4,807 10,928 0 (8,420) (828) (423) 1,258 (21) 66 1,303 (154) 0 1,149 1,149 3.863 3.863 3.863 2.291 1,258 2,136 2013E 2,384 3,320 4,311 10,015 0 (7,581) (879) (473) 1,082 (21) 36 1,096 (132) 0 965 965 3.115 3.115 3.115 1.869 1,082 1,950 2014E 2,661 3,824 4,490 10,975 0 (8,297) (920) (496) 1,262 (17) 18 1,263 (152) 0 1,112 1,112 3.589 3.589 3.589 2.153 1,262 2,226 2015E 2,933 4,303 4,794 12,030 1 (9,083) (970) (521) 1,458 (16) 22 1,464 (175) 0 1,289 1,289 4.160 4.160 4.160 2.487 1,458 2,542
Cash flow (TWDm)

2008 1,056 739 (104) (419) 0 1,271 (1,910) 0 (9) (1,919) 839 0 (480) 36 395 0 (253) (639)
2009 968 845 (186) 232 0 1,859 (499) 0 (104) (603) (193) 0 (543) 57 (680) 0 576 1,360
2010 1,325 852 (135) (125) (4) 1,914 (1,780) (131) (26) (1,937) 673 0 (581) (2) 90 0 67 133
2011 1,213 922 (163) (471) (16) 1,486 (1,519) (140) (86) (1,745) 333 0 (741) 322 (86) 0 (345) (33)
2012 1,303 878 (154) (567) (3) 1,458 (897) (3) (19) (918) 216 0 (665) 236 (212) 0 327 561
2013E 1,096 868 (132) 36 (6) 1,863 (800) (10) (5) (815) 89 0 (681) 75 (518) 0 531 1,063
2014E 1,263 964 (152) (285) (6) 1,784 (1,000) (10) (5) (1,015) 92 0 (579) 0 (487) 0 283 784
2015E 1,464 1,084 (175) (313) (8) 2,052 (1,000) (10) (5) (1,015) 94 0 (667) 0 (573) 0 465 1,052
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4 September 2013

As at 31 Dec Cash & short-term investment Inventory Accounts receivable Other current assets Total current assets Fixed assets Goodwill & intangibles Other non-current assets Total assets Short-term debt Accounts payable Other current liabilities Total current liabilities Long-term debt Other non-current liabilities Total liabilities Share capital Reserves/R.E./others Shareholders' equity Minority interests Total equity & liabilities EV Net debt/(cash) BVPS (TWD) 2008 992 902 2,262 113 4,270 4,439 0 93 8,801 832 747 448 2,027 1,136 19 3,181 2,717 2,903 5,620 0 8,801 13,521 976 19.152 2009 1,568 837 2,468 302 5,175 4,110 0 180 9,465 810 1,264 492 2,566 893 91 3,549 2,873 3,042 5,915 0 9,465 12,679 135 19.993 2010 1,635 1,128 2,788 140 5,691 5,062 0 316 11,069 729 1,310 769 2,809 1,718 19 4,545 2,972 3,552 6,523 0 11,069 13,356 812 21.738 2011 1,290 1,160 3,134 143 5,727 5,690 0 527 11,943 634 1,271 718 2,623 2,088 77 4,788 3,022 4,133 7,155 0 11,943 13,976 1,431 23.673 2012 1,618 1,477 3,482 162 6,737 5,734 0 524 12,996 1,340 1,418 688 3,446 1,526 150 5,121 3,022 4,853 7,875 0 12,996 13,792 1,248 26.055 2013E 2,148 1,516 3,191 148 7,003 5,666 0 545 13,215 1,380 1,246 631 3,257 1,571 153 4,981 3,097 5,136 8,233 0 13,215 13,348 803 26.581 2014E 2,431 1,659 3,496 162 7,749 5,702 0 566 14,017 1,421 1,364 691 3,476 1,619 156 5,251 3,097 5,669 8,766 0 14,017 13,154 609 28.302 2015E 2,891 1,817 3,832 178 8,718 5,618 0 587 14,924 1,464 1,493 758 3,715 1,667 159 5,541 3,097 6,285 9,383 0 14,924 12,784 240 30.292
Key ratios (%)

2008 17.8 5.3 (9.4) (16.5) (21.2) 27.7 25.3 15.3 12.9 17.7 11.5 16.3 17.6 17.4 9.9 111.0 2.1 45.9 57.1 n.a.
2009 5.0 (0.9) (10.9) (17.8) (18.9) 24.6 23.9 13.0 10.1 13.6 8.6 13.2 12.8 2.3 19.2 111.7 2.0 40.0 74.2 10.8
2010 24.9 18.9 34.2 52.2 48.6 26.3 22.8 14.0 12.3 19.1 11.6 16.2 18.1 12.4 10.2 99.4 2.0 60.3 62.2 1.1
2011 2.6 (5.7) (14.5) (11.8) (12.4) 24.3 21.0 11.6 10.6 15.4 9.1 12.2 12.5 20.0 13.4 109.2 2.2 69.6 63.3 n.a.
2012 10.4 3.0 9.2 9.4 11.2 23.0 19.5 11.5 10.5 15.3 9.2 12.2 12.5 15.8 11.8 110.5 2.0 58.9 59.3 4.5
2013E (8.4) (8.7) (14.0) (16.0) (19.4) 24.3 19.5 10.8 9.6 12.0 7.4 9.9 10.5 9.8 12.0 121.6 2.2 51.0 60.0 8.5
2014E 9.6 14.2 16.7 15.2 15.2 24.4 20.3 11.5 10.1 13.1 8.2 11.0 12.1 6.9 12.0 111.2 2.2 73.6 60.0 6.3
2015E 9.6 14.2 15.5 15.9 15.9 24.5 21.1 12.1 10.7 14.2 8.9 12.0 13.5 2.6 12.0 111.2 2.3 93.8 59.8 8.4
Company profile
TXC Corporation (TXC) was founded in 1983. The company designs, manufactures, and sells frequency-control crystal components.TXC has two major production sites, one in North Taiwan (Ping-Cheng) and the other in East China (NingBo). Each accounts for roughly 50% of the firms total output value, but the Taiwan company is mainly engaged in small crystal production and advanced optical modules.
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Pegatron Corp
Pegatron Corp
4938 TT
A major beneficiary of the likely mid-range iPhone

New orders from probable iPhone 5C should offset a decline in the PC business We expect an operating-margin recovery to drive up the share price Reaffirm Pegatron as our top pick in the Taiwan ODM Sector with a Buy (1) rating
1 2 3 4 5
Steven Tseng
(886) 2 8758 6252 steven.tseng@daiwacm-cathay.com.tw
Jason Chen
(886) 2 8758 6251 jason.chen@daiwacm-cathay.com.tw
this model. Meanwhile, in the PC business, we believe Pegatron is losing its share of Asusteks outsourcing business and is only seeing modest order gains from other clients. However, we expect the weakness in the PC segment to be offset by solid revenue growth in its non-PC business. Operating margin should rise in 2H13. For 2Q13, Pegatron had a lower-than-expected operating margin of 0.3-0.4%, due to: 1) a lessfavourable product mix, 2) higher initial costs/expenses for new products (we believe these were for the new mid-range iPhone), and 3) some notebook-capacity relocation. However, we expect the margin to recover in 2H13 on the back of better operating leverage and rising capacity utilisation, due to revenuegrowth momentum from a rise in shipment volumes of new i-devices.
What we recommend
than that of the Bloomberg consensus as a result of our more positive view on revenue growth and the operating margin.
13E -
14E -
15E -

(TWD)
60 54 48 41 35
(%)
130 119 108 96 85
What's new
We expect Apple to unveil two new phones on 10 September. As a major assembly firm for Apples consumer (in addition to Hon Hai), we expect Pegatron to benefit from the salesvolume growth of the new i-devices.
What's the impact
Sep-12
Dec-12
Mar-13
Jun-13
Sep-13
Pegatron (LHS) Relative to TWSE Index (RHS)
Should be a major beneficiary of the likely mid-range iPhone 5C. The mid-range 5C should be a lower-spec version of the iPhone 5, with a plastic, coloured casing and less memory. We would expect prices for the 5C to range from USD429 to USD479. We also expect Apple to continue selling the 4S as a low-end model. Our market research suggests that Pegatron began mass production of the iPhone 5C in August. The company should be the major supplier of the 5C, and we would expect it to account for 7075% of Apples order allocation for
12-month range 35.20-55.40 Market cap (USDbn) 3.50 3m avg daily turnover (USDm) 17.59 Shares outstanding (m) 2,290 Asustek Computer Inc. (19.6%) Major shareholder

Year to 31 Dec Revenue (m) Operating profit (m) Net profit (m) Core EPS (fully-diluted) EPS change (%) Daiwa vs Cons. EPS (%) PER (x) Dividend yield (%) DPS PBR (x) EV/EBITDA (x) ROE (%) 13E 14E 15E 956,897 1,178,836 1,311,838 8,292 12,780 15,946 10,276 13,654 16,320 4.487 5.962 7.126 68.3 32.9 19.5 7.0 18.2 21.9 10.1 7.6 6.4 3.5 5.9 7.9 1.6 2.7 3.6 1.0 0.9 0.9 6.2 4.1 3.0 10.1 12.4 13.8
We reiterate our Buy (1) rating for Pegatron and our six-month target price of TWD62, based on a oneyear forward PER of 12x, equivalent to the stocks past-two-year average. The key risk would be weaker-thanexpected shipment volume for the new i-devices.
How we differ
Our 2014 EPS forecast is 18% higher

4 September 2013
1 2 3 4 5

Growth outlook
We expect Pegatron to record strong net-profit growth for both 2013 and 2014, due mainly to it being allocated new orders from Apples likely iPhone 5C and a steady improvement in its operating margin on the back of better operating leverage and rising capacity utilisation.
Pegatron: revenue and earnings growth

(TWDm) Net sales Gross profit Operating profit Pre-tax profit Net profit Net EPS (TWD)
2013E 956,897 29,492 8,292 11,973 10,276 4.49
YoY (%) 25% 35% 377% 72% 68% 68%
2014E 1,178,836 37,932 12,780 16,450 13,654 5.96
YoY (%) 23% 29% 54% 37% 33% 33%
Valuation
Our six-month target price of TWD62 is based on a PER of 12x applied to our one-year forward EPS forecast. Our PER multiple is equivalent to the stocks past-two-year average. We reiterate our Buy (1) rating as the current 2013E PER of 10.1x looks attractive to us compared with the stocks past-three-year range of 8-14.5x.
Pegatron: one-year forward PER bands

(TWD) 60 55 50 45 40 35 30 25 20 Jul10 Oct10 Jan11 Apr11 Jul11 Oct11 Jan12 Apr12 Jul12 Oct12 Jan13 Apr13 Jul13
8x
9.5x
12x
14.5x
Pegatron
Earnings revisions
The Bloomberg-consensus 2013-14 EPS forecasts have been cut recently to factor in the weak 2Q13 results and a potential delay in the new iPad mini. We believe that a recovery in the operating margin will be the major catalyst for the share price over the coming months. Our 2013 and 2014 EPS forecasts are respectively 7% and 18% higher than those of the consensus.
Pegatron: consensus 2013-14 EPS-forecast revision (TWD)

7 6 5 4 3 2 1 0 Aug-11
Source: xxx
Nov-11
Feb-12
May-12
Aug-12
Nov-12
Feb-13
May-13
Aug-13
2013E EPS
2014E EPS
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4 September 2013
Financial summary
Key assumptions
Year to 31 Dec Notebook shipment (m unit) Tablet sales revenue YoY (%) Communication revenue YoY (%) Computing revenue YoY (%) 2008 n.a. n.a. n.a. n.a. 2009 n.a. n.a. n.a. n.a. 2010 15.4 n.a. n.a. n.a. 2011 13.3 n.a. 118 3 2012 16.9 n.a. 99 23 2013E 14.8 241 22 (0) 2014E 15.4 16 54 1 2015E 15.9 31 11 6

Year to 31 Dec Communication Computing Other Revenue Total Revenue Other income COGS SG&A Other op.expenses Operating profit Net-interest inc./(exp.) Assoc/forex/extraord./others Pre-tax profit Tax Min. int./pref. div./others Net profit (reported) Net profit (adjusted) EPS (reported)(TWD) EPS (adjusted)(TWD) EPS (adjusted fully-diluted)(TWD) DPS (TWD) EBIT EBITDA 2008 n.a. n.a. n.a. n.a. n.a. n.a. n.a. n.a. n.a. n.a. n.a. n.a. n.a. n.a. n.a. n.a. n.a. n.a. n.a. n.a. n.a. n.a. 2009 n.a. n.a. n.a. n.a. n.a. n.a. n.a. n.a. n.a. n.a. n.a. n.a. n.a. n.a. n.a. n.a. n.a. n.a. n.a. n.a. n.a. n.a. 2010 57,621 294,770 83,097 435,488 0 (419,695) 0 (13,964) 1,829 (225) 5,711 7,315 (1,104) 0 6,211 6,211 2.753 2.753 2.753 0.000 1,829 7,556 2011 125,790 303,953 70,823 500,566 0 (489,112) 0 (15,739) (4,285) (603) 4,951 63 48 0 111 111 0.049 0.049 0.049 0.000 (4,285) 1,342 2012 249,704 374,977 143,379 768,059 0 (746,220) 0 (20,100) 1,739 0 5,241 6,980 (876) 0 6,104 6,104 2.665 2.665 2.665 0.000 1,739 8,063 2013E 2014E 2015E 304,607 469,218 520,040 373,562 378,362 400,198 278,727 331,256 391,601 956,897 1,178,836 1,311,838 0 0 0 (927,405) (1,140,904) (1,267,991) 0 0 0 (21,200) (25,152) (27,901) 8,292 12,780 15,946 (199) (480) (433) 3,880 4,150 4,150 11,973 16,450 19,663 (1,697) (2,797) (3,343) 0 0 0 10,276 13,654 16,320 10,276 13,654 16,320 4.487 5.962 7.126 4.487 5.962 7.126 4.487 5.962 7.126 1.599 2.692 3.577 8,292 12,780 15,946 15,313 20,699 24,792
Cash flow (TWDm)

2008 n.a. n.a. n.a. n.a. n.a. n.a. n.a. n.a. n.a. n.a. n.a. n.a. n.a. n.a. n.a. n.a. n.a. n.a.
2009 n.a. n.a. n.a. n.a. n.a. n.a. n.a. n.a. n.a. n.a. n.a. n.a. n.a. n.a. n.a. n.a. n.a. n.a.
2010 7,315 5,727 (1,104) 8,485 0 20,423 (10,729) 0 6,228 (4,501) 12,144 0 0 (14,001) (1,857) (2,625) 11,440 9,694
2011 63 5,627 48 (4,790) 0 948 (15,922) 0 980 (14,942) 3,775 0 0 9,215 12,990 1,685 681 (14,974)
2012 6,980 6,324 (876) 6,674 (6,324) 12,778 (20,261) 0 9,472 (10,789) (1,138) 0 0 9,166 8,028 (1,636) 8,381 (7,483)
2013E 11,973 7,021 (1,697) 942 0 18,239 (6,102) 0 5,226 (876) 2,956 0 (3,662) 9,166 8,460 (859) 24,964 12,137
2014E 16,450 7,919 (2,797) 942 0 22,514 (7,427) 0 5,226 (2,201) 5,321 0 (6,165) 9,166 8,322 (1,247) 27,388 15,088
2015E 19,663 8,846 (3,343) 942 (0) 26,108 (8,265) 0 5,226 (3,039) 9,223 0 (8,192) 9,166 10,197 (1,247) 32,019 17,843
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4 September 2013

As at 31 Dec Cash & short-term investment Inventory Accounts receivable Other current assets Total current assets Fixed assets Goodwill & intangibles Other non-current assets Total assets Short-term debt Accounts payable Other current liabilities Total current liabilities Long-term debt Other non-current liabilities Total liabilities Share capital Reserves/R.E./others Shareholders' equity Minority interests Total equity & liabilities EV Net debt/(cash) BVPS (TWD) 2008 n.a. n.a. n.a. n.a. n.a. n.a. n.a. n.a. n.a. n.a. n.a. n.a. n.a. n.a. n.a. n.a. n.a. n.a. n.a. n.a. n.a. n.a. n.a. n.a. 2009 n.a. n.a. n.a. n.a. n.a. n.a. n.a. n.a. n.a. n.a. n.a. n.a. n.a. n.a. n.a. n.a. n.a. n.a. n.a. n.a. n.a. n.a. n.a. n.a. 2010 23,393 31,260 39,885 2,082 96,620 27,973 0 35,497 160,090 12,144 40,615 8,925 61,684 6,991 574 69,249 22,564 68,277 90,841 0 160,090 99,951 (4,258) 40.260 2011 24,074 51,899 69,689 8,602 154,264 30,223 0 43,118 227,605 15,919 83,812 17,423 117,154 18,165 702 136,021 22,564 69,020 91,584 0 227,605 114,219 10,010 40.589 2012 34,414 79,587 105,032 23,225 242,258 32,128 0 43,394 317,780 14,781 161,151 25,022 200,954 20,026 721 221,701 22,903 73,176 96,079 0 317,780 104,602 393 41.950 2013E 57,419 81,706 108,839 11,303 259,267 38,156 0 48,182 345,605 17,737 152,220 38,327 208,285 30,039 793 239,117 22,903 83,585 106,488 0 345,605 94,567 (9,642) 46.495 2014E 84,807 100,515 134,083 11,303 330,708 45,583 0 52,913 429,204 23,058 187,263 61,900 272,222 42,055 952 315,228 22,903 91,074 113,977 0 429,204 84,515 (19,694) 49.765 2015E 116,826 111,712 149,211 11,303 389,051 53,848 0 57,686 500,585 32,282 208,123 82,168 322,573 54,671 1,237 378,481 22,903 99,201 122,104 0 500,585 74,336 (29,873) 53.314
Key ratios (%)

2008 n.a. n.a. n.a. n.a. n.a. n.a. n.a. n.a. n.a. n.a. n.a. n.a. n.a. 0.0 n.a. n.a. n.a. n.a. n.a. n.a.
2009 n.a. n.a. n.a. n.a. n.a. n.a. n.a. n.a. n.a. n.a. n.a. n.a. n.a. 0.0 n.a. n.a. n.a. n.a. n.a. n.a.
2010 n.a. n.a. n.a. n.a. n.a. 3.6 1.7 0.4 1.4 13.7 7.8 3.3 1.8 net cash 15.1 16.7 1.6 8.1 0.0 9.3
2011 14.9 (82.2) n.a. (98.2) (98.2) 2.3 0.3 n.a. 0.0 0.1 0.1 n.a. (4.6) 10.9 n.a. 39.9 1.3 n.a. 0.0 n.a.
2012 53.4 500.8 n.a. 5,399.1 5,317.6 2.8 1.0 0.2 0.8 6.5 2.2 1.4 1.5 0.4 12.6 41.5 1.2 n.a. 0.0 n.a.
2013E 24.6 89.9 376.8 68.3 68.3 3.1 1.6 0.9 1.1 10.1 3.1 5.8 7.4 net cash 14.2 40.8 1.2 41.6 35.6 11.6
2014E 23.2 35.2 54.1 32.9 32.9 3.2 1.8 1.1 1.2 12.4 3.5 7.7 11.1 net cash 17.0 37.6 1.2 26.6 45.2 14.5
2015E 11.3 19.8 24.8 19.5 19.5 3.3 1.9 1.2 1.2 13.8 3.5 8.2 14.2 net cash 17.0 39.4 1.2 36.8 50.2 17.1
Company profile
Founded in January 2008, Pegatron is a subsidiary of Asustek and an electronic and computing DMS (design and manufacturing service) company with extensive experience in product development. It also has vertically integrated capabilities. Pegatrons product line includes motherboards, desktop PCs, notebooks, smartphones, tablets, broadband, wireless systems, game consoles, networking equipment, set-top boxes, multimedia, and LCD TVs.
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4 September 2013
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4 September 2013
Daiwas Asia Pacific Research Directory

HONG KONG Hiroaki KATO Regional Research Head John HETHERINGTON (852) 2532 4121 (852) 2773 8787 hiroaki.kato@hk.daiwacm.com john.hetherington@hk.daiwacm.com pranab.sarmah@hk.daiwacm.com SOUTH KOREA Chang H LEE (82) 2 787 9177 Head of Korea Research; Strategy chlee@kr.daiwacm.com
Daiwas Regional Deputy Asia Head Pacific of Asia Pacific Research Research; Regional Directory Head of Product Management
Pranab Kumar SARMAH (852) 2848 4441 Regional Head of Research Promotion Kevin LAI (852) 2848 4926 kevin.lai@hk.daiwacm.com Deputy Head of Regional Economics; Macro Economics (Regional) Hui MIAO (852) 2848 4464 Macro Economics (China) Christie CHIEN (852) 2848 4482 Macro Economics (Taiwan) hui.miao@hk.daiwacm.com christie.chien@hk.daiwacm.com
Sung Yop CHUNG (82) 2 787 9157 sychung@kr.daiwacm.com Pan-Asia Co-head/Regional Head of Automobiles and Components; Automobiles; Shipbuilding; Steel Jun Yong BANG Tyres; Chemicals Anderson CHA Banking/Finance (82) 2 787 9168 (82) 2 787 9185 junyong.bang@kr.daiwacm.com anderson.cha@kr.daiwacm.com
Mike OH (82) 2 787 9179 mike.oh@kr.daiwacm.com Capital Goods (Construction and Machinery) Sang Hee PARK Consumer/Retail (82) 2 787 9165 sanghee.park@kr.daiwacm.com
Jonas KAN (852) 2848 4439 jonas.kan@hk.daiwacm.com Head of Hong Kong Research; Head of Hong Kong and China Property; Regional Property Coordinator; Property Developers (Hong Kong) Jeff CHUNG (852) 2773 8783 Automobiles and Components (China) jeff.chung@hk.daiwacm.com
Jae H LEE (82) 2 787 9173 jhlee@kr.daiwacm.com IT/Electronics (Tech Hardware and Memory Chips) Joshua OH (82) 2 787 9176 IT/Electronics (Handset Components) joshua.oh@kr.daiwacm.com
Grace WU (852) 2532 4383 grace.wu@hk.daiwacm.com Head of Greater China FIG; Banking (Hong Kong, China) Jerry YANG (852) 2773 8842 jerry.yang@hk.daiwacm.com Banking (Taiwan)/Diversified Financials (Taiwan and China) Leon QI (852) 2532 4381 Banking (Hong Kong, China) leon.qi@hk.daiwacm.com
Thomas Y KWON (82) 2 787 9181 yskwon@kr.daiwacm.com Pan-Asia Head of Internet & Telecommunications; Software (Korea) Internet/On-line Game SoYoung WANG Transportation/Logistics TAIWAN Mark CHANG Head of Research Steven TSENG (886) 2 8758 6245 mark.chang@daiwacm-cathay.com.tw (886) 2 8758 6252 steven.tseng@daiwacm-cathay.com.tw (82) 2 787 9133 soyoung.wang@kr.daiwacm.com
Joseph HO (852) 2848 4443 joseph.ho@hk.daiwacm.com Head of Industrials and Machineries (Hong Kong, China); Capital Goods Electronics Equipments and Machinery (Hong Kong, China) Winston CAO (852) 2848 4469 Capital Goods Machinery (China) winston.cao@hk.daiwacm.com
IT/Technology Hardware (PC Hardware) Christine WANG (886) 2 8758 6249 christine.wang@daiwacm-cathay.com.tw IT/Technology Hardware (Automation); Cement; Consumer Kylie HUANG (886) 2 8758 6248 kylie.huang@daiwacm-cathay.com.tw IT/Technology Hardware (Handsets and Components) Lynn CHENG (886) 2 8758 6253 lynn.cheng@daiwacm-cathay.com.tw IT/Electronics (Semiconductor) INDIA Punit SRIVASTAVA (91) 22 6622 1013 punit.srivastava@in.daiwacm.com Head of Research; Strategy; Banking/Finance Navin MATTA (91) 22 6622 8411 Automobiles and Components Saurabh MEHTA Capital Goods; Utilities Mihir SHAH FMCG/Consumer Deepak PODDAR Materials Nirmal RAGHAVAN Oil and Gas; Utilities (91) 22 6622 1018 nirmal.raghavan@in.daiwacm.com (91) 22 6622 1009 (91) 22 6622 1020 (91) 22 6622 1016 navin.matta@in.daiwacm.com saurabh.mehta@in.daiwacm.com mihir.shah@in.daiwacm.com deepak.poddar@in.daiwacm.com
Eric CHEN (852) 2773 8702 eric.chen@hk.daiwacm.com Pan-Asia/Regional Head of IT/Electronics; Semiconductor/IC Design (Regional) Felix LAM (852) 2532 4341 felix.lam@hk.daiwacm.com Head of Materials (Hong Kong, China); Cement and Building Materials (China, Taiwan); Property (China) Dennis IP (852) 2848 4068 dennis.ip@hk.daiwacm.com Power; Utilities; Renewables and Environment (Hong Kong/China) John CHOI (852) 2773 8730 john.choi@hk.daiwacm.com Regional Head of Small/Medium Cap; Small/Mid Cap (Regional); Head of Multi-Industries (Hong Kong, China); Internet (China) Joey CHEN Steel (China) (852) 2848 4483 joey.chen@hk.daiwacm.com
Kelvin LAU (852) 2848 4467 kelvin.lau@hk.daiwacm.com Head of Transportation (Hong Kong, China); Hong Kong and China Research Coordinator; Transportation (Regional) Jibo MA (852) 2848 4489 jibo.ma@hk.daiwacm.com Head of Custom Products Group; Custom Products Group Thomas HO Custom Products Group PHILIPPINES Rommel RODRIGO (63) 2 813 7344 rommel.rodrigo@dbpdaiwacm.com.ph ext 302 Head of Philippines Research; Strategy; Capital Goods; Materials (852) 2773 8716 thomas.ho@hk.daiwacm.com
SINGAPORE Adrian LOH (65) 6499 6548 adrian.loh@sg.daiwacm.com Head of Singapore Research, Regional Head of Oil and Gas; Oil and Gas (ASEAN and China); Capital Goods (Singapore) David LUM Property and REITs (65) 6329 2102 david.lum@sg.daiwacm.com
Ramakrishna MARUVADA (65) 6499 6543 ramakrishna.maruvada@sg.daiwacm.com Head of ASEAN & India Telecommunications; Telecommunications (ASEAN & India)
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4 September 2013
Daiwas Offices
Office / Branch / Affiliate DAIWA SECURITIES GROUP INC HEAD OFFICE Daiwa Securities Trust Company Daiwa Securities Trust and Banking (Europe) PLC (Head Office) Daiwa Europe Trustees (Ireland) Ltd Gran Tokyo North Tower, 1-9-1, Marunouchi, Chiyoda-ku, Tokyo, 100-6753 (81) 3 5555 3111 One Evertrust Plaza, Jersey City, NJ 07302, U.S.A. 5 King William Street, London EC4N 7JB, United Kingdom Level 3, Block 5, Harcourt Centre, Harcourt Road, Dublin 2, Ireland (1) 201 333 7300 (81) 3 5555 0661 (1) 201 333 7726 Address Tel Fax
(44) 207 320 8000 (44) 207 410 0129 (353) 1 603 9900 (353) 1 478 3469
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4 September 2013
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4 September 2013
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Greater China Smartphone Sector 130904

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Information Technology / China and Taiwan 4 September 2013

Curtain call on new iPhones: likely winners and losers

Greater China Smartphone Sector

How do we justify our view?

Greater China Smartphone Sector

Information Technology / China and Taiwan 4 September 2013

Curtain call on new iPhones: likely winners and losers

Greater China Smartphone Sector

How do we justify our view?

Key stock calls

Prev. Buy 105.00

Within the Greater China Smartphone Sector, we prefer the EMS

Greater China Smartphone Sector

Sector stocks: key indicators

Stock code 2018 HK 2317 TT 3008 TT 4938 TT 3042 TT

Share Price 82.00 45.50 40.50

36.50 Underperform 1,050.00 Underperform

Greater China Smartphone Sector

Apple iPhone product profile expectations in 2H13

New iPhones: we prefer the EMS companies to the component suppliers

Price (contract price) Price (unlock price)

USD199 (16GB) USD649 (16GB)

USD49-99 (8GB) USD429-479 (8GB)

USD0 (16GB) USD399 (16GB)

Source: Company, Daiwa forecasts

iPhone 5C and iPhone 4S

Greater China Smartphone Sector

Global smartphone shipment forecasts by segment

Market expectations are low

0% 2015E High-end (LHS) High-end YoY (RHS)

Global smartphone shipment forecasts by segment mix

2015E High-end (>USD 500)

iPhone: production-volume forecasts by model

iPhone: production volume forecast by model mix

A change in focus in the product mix to the mid-range

80% 60% 40% 20% 0%

Mid-range/ legacy models

Mid-range/ legacy models

2H12 iPhone 3GS iPhone 4&4S iPhone 5

2H13E iPhone 5C iPhone 5S

Greater China Smartphone Sector

EMS companies should do better; components makers likely to suffer

Component ASP product life cycle

Component ASP Cycle

iPhone 5 649 550 240 60 300 250 45%

iPhone 5C 429-479 370-410 210 50 260 110-150 30-37%

Greater China Smartphone Sector

Greater China Smartphone Sector

Appendix I: Pan-Asia Apple iPhone 5S/5C supply chain

PWM IC AP substrate Display Incell TFT

Antenna switch module Connector

Connector, cable and charger

Source: Daiwa forecasts

Greater China Smartphone Sector

Part Component (Contd) Crystal Power inductor

Vibration HDI PCB

Fingerprint sensor Fingerprint scanner (module) Gyro sensor Battery cell

Battery packaging Assembling

Greater China Smartphone Sector

iOS 6 (LHS) vs. iOS 7 (RHS): icon comparison

Appendix II: whats new in iOS 7

Source: Company, Daiwa

iOS 6 (RHS) vs. iOS 7 (LHS):UI comparison

Source: Company, Daiwa