Taiwan telcos：Risks to both competition and capex in 2016

Disclaimer & Disclosures This report must be read with the disclosures and the analyst certifications in the Disclosure appendix, and with the Disclaimer, which forms part of it. Issuer of report: The Hongkong and Shanghai Banking Corporation Limited View HSBC Global Research at: https://www.research.hsbc.com   Wireless new entrants have new spectrum and aggressive subscriber targets, but they need to show gains in 1H16  We look for increased price competition to pressure the big three, and derail Chunghwa’s proposed tariff hike in May  Maintain Reduce rating on all three telcos; minor changes to estimates reflecting 4Q15 results 1H16 critical to new entrants’ long-term prospects. We are entering an important time for Taiwan’s two 4G entrants, Taiwan Star and Asia Pacific Telecom (APT). They enter 2016 in much better shape relative to 2015: both have bought spectrum, while Taiwan Star has raised capital, and APT has completed its merger with Hon Hai unit Ambit. However, they are late: c40% of the market has already moved to 4G, and market share for these two has slipped. In our opinion, if these operators are to be viable, they will need to take share in 1H16: APT in particular has set a bullish target of 1.6m 4G customers by end-2016 (from 700k now, implying a much faster run-rate than in 2015), while Taiwan Star has been aggressive on price. Higher competition is the major risk to the sector. More intense competition could derail plans to raise prices in May. Intensifying price competition potentially complicates the shift in pricing planned by the big three telcos: Chunghwa stated that it aims to withdraw flat-rate data plans in May 2016, and the other telcos indicated that they will follow suit. Yet this would prove difficult if new entrants were gaining share, and Chunghwa has indicated that it will not raise rates regardless. Returns on 4G likely to be lower than 3G; we see upside risks to capex. Data usage (c10-12GB per 4G subscriber) is the highest in Asia: even if flat-rate plans are withdrawn, the bull argument of declining capex may be problematic as a result. We model 4% growth in capex at the big three telcos in 2016. We retain our Reduce ratings for all three Taiwan telcos. We make minor adjustments to our forecasts and DCF-based TPs to reflect the release of data for December 2015. We see risks to revenue from increased competition in 2016e and higher capex pressuring dividend. Earnings calls begin on 28 January. 27 January 2016 Neale Anderson* Analyst The Hongkong and Shanghai Banking Corporation Limitedneale.anderson@hsbc.com.hk +852 2996 6716 Angela Tay* Analyst The Hongkong and Shanghai Banking Corporation Limited, Singapore Branch angela.h.y.tay@hsbc.com.sg +65 6658 0612 Louis Pang* Associate The Hongkong and Shanghai Banking Corporation Limitedlouis.w.h.pang@hsbc.com.hk +852 2914 9934 *Employed by a non-US affiliate of HSBC Securities (USA) Inc, and is not registered/ qualified pursuant to FINRA regulations Taiwan telcos EQUITIES TELECOMS MEDIA & TECHNOLOGY Taiwan Summary of valuations and ratings for Taiwan telcos Ticker Company Old TP New TP % changeOld RatingNew RatingShare PriceUpside / EV / EBITDA PEDiv Yield TWD TWD TWDDownside FY 16e FY16eFY16, %2412.TW Chunghwa 81 81 0.0%ReduceReduce 101 -19.4% 9.5 20.4 4.4%3045.TW Taiwan Mobile 92 89 -3.3%ReduceReduce 99 -10.4% 11.9 19.65.1%4904.TW Far EasTone 58 58 0.0%ReduceReduce 68 -15.0% 8.6 19.1 5.5%Source: company data, HSBC estimates. Based on closing prices as of 25 January. Risks to both competition and capex in 2016 abc EQUITIES  TELECOMS MEDIA & TECHNOLOGY 27 January 2016 2 Focus on new entrants and their ability to improve market share Taiwan telcos have outperformed the index over the past 12 months (please refer to chart on page 4): stable earnings and less impact than expected from new entrants means that they – and Chunghwa in particular - have upheld their reputation as defensive stocks. However, we believe that Taiwan Star and APT move into 2016 in better shape compared to 2015: both have acquired new spectrum, while Taiwan Star has raised capital and APT completed its merger with Hon Hai unit Ambit. This could result in intensifying competition, as well as upset Chunghwa’s plans to withdraw flat-rate data tariffs in May 2016. 4Q15 results (starting 28 January) will provide clarity on how the big three view the market, while the success (or not) of new entrants in disrupting the market should become visible in the first-half.  Company guidance for 2016e: For 2015 all 3 telcos delivered low to mid-single digit top-line and bottom-line growth YoY (from a lower base) with Chunghwa’s 11% YoY growth in net profit the best of the three. Guidance for 2016 on 4Q15 earnings calls will indicate how the companies are viewing market dynami