27 September 2017 Telecom Asia-Pac Telecoms Telecommunications Telecommunications Industry Update Asia Australasia Japan Industry Asia-Pac Telecoms Date 27 September 2017 Deutsche Bank Markets Research Five paths lead up At what point will investors need to care The tech sell-o of the last week is, in our view, a wake-up call to investors that a broader universe exists beyond momentum stocks. Asia-Pacic ex Japan telcos have lagged the market by 29% over the last three years - with almost all of that occurring in the last 12M, We believe there are ve potential avenues to drive telecom stocks back up:1) Further tech stock weakness, leading to rotation into telecoms,2) A bond to high-yield-equity switch when ination becomes apparent,3) An awareness that sector prot is trending up ahead, and capex down, delivering sector FCF CAGR that we estimate at 19% in 2016-&39;19, 4) Growing belief that new services, that IoT, cloud and other services drive protability, and 5)2017&39;s high M&A continues and drives consolidation. We believe each of these is a likely factor to drive the sector ahead. Top picks: China Mobile, SoftBank, Telstra, HKT Trust, Idea Cellular, CITIC Telecom. The sector is as out-of-favour as we can recall since perhaps 2005, but with some value investors starting to nibble. I&39;ve been reading small cap legend, Joel Tillinghast&39;s, book Big Money Thinks Small (it is a good read). He makes a very apt point for telecom investors today, suggesting humans pay for excitement in life and investing, and conversely earn shadow income through patience, boredom, worry, courage, pain, loneliness, being a nerd, and looking like an idiot - each, especially the last, describes being overweight telecoms recently - and we believe investors could start to collect this shadow income as some or, all of the Valuation and risks We value the telecoms on DCF, and the holdcos on SOTP. Our WACCs are typically based on local 10-year bonds, with risk premiums of 4.5-5.5%, and terminal growth rates of 0-2%. Key downside risks include:1) Interest rates rebounding, cutting sector value,2) Competition deteriorating, and 3) Risk of spectrum pricing rising on competitive or regulatory change. Peter Milliken, CFA Research Analyst +852-22036190 Craig Wong-Pan Research Analyst +61-2-8258-284 8James Wang Research Analyst +852-22036145 Srinivas Rao, CFA Research Analyst +65-64234114 Dan Kong Research Analyst +82-2-3168911 Top picks Telstra Corporation (TLS.AX),AUD3.48Buy China Mobile (0941.HK),HKD80.25Buy CITIC Telecom (1883.HK),HKD2.28Buy HK Telecom Trust (6823.HK),HKD9.55Buy Idea Cellular Limited (IDEA.BO),INR76.00Buy SoftBank (9984.T),9,035Buy SK Telecom (017670.KS),KRW257,000.00 Buy Source: Deutsche Bank Deutsche Bank AG/Hong Kong Deutsche Bank does and seeks to do business with companies covered in its research reports. Thus, investors should be aware that the rm may have a conict of interest that could aect the objectivity of this report. Investors should consider this report as only a single factor in making their investment decision. DISCLOSURES AND ANALYST CERTIFICATIONS ARE LOCATED IN APPENDIX 1. MCI (P)083/04/2017. Distributed on:27/09/201713:21:07 GMT 0bed7b6cf11c 27 September 2017 Telecom Asia-Pac Telecoms Rotation from tech to telcos Long only funds seem heavily underweight telecoms, and hedge funds, we believe, are commonly using the sector as a funding short. As such, any good news, or simply on a rotation away from tech, can create a buying squeeze in telcos. With the Chinese internet market cap becoming double that of its telecom sector, there would appear room for a sustained sector rally should repositioning be signicant. HK, Korean and Taiwanese telecoms could also benet from an intra-market skew from tech to defensives, and telcos allow TMT weights to be maintained at lower risk..We believe the underperformance of telecoms is extreme, as is the general lack of interest in the sector - at a time when our risk- on proxy appears to be peaking. Bond-to-equity switch The US Fed is tapping on the brakes in QE, suggesting a path to ination may be near. Other major sources of QE, the EU and Japan also appear to be picking up economically - albeit slowly. Once investors believe ination is coming, they will likely be inclined to shift from bonds to equities, for their better ability to retain real value in a rising price environment. High yield sectors, such as telecoms, should perform in such a scenario. We note that while the market&39;s real DY is near ve- year lows, the telcom sector is back at post-European Financial Crisis highs of Figure 1: Real telco DY at post EFC high, while market near post EFC low Figure 2: Telco index relative to market vs. risk-on proxy -3% -2% -1% 0% 1% 2% 3% 4% Se p-0Se p-0Se p-0Se p-1Se p-1Se p-1Se p-1Se p-1Se p-1Se p-1Se p-1APAC Telcos Less US 10 Yr Bond APAC Mkt Less US 10 Yr Bond51525 Se p- 0 8Se p- 09 Se p-Se p-Se p-Se p-Se p-Se p-Se p-Se p-APAC Ex JP TelcosJP Telcos Source:Deutsche Bank, Bloomberg Finance LPSource:Deutsche Bank, Bloomberg Finance LP Page 2Deutsche Bank AG/Hong Kong 27 September 2017 Telecom Asia-Pac Telecoms Strong FCF upswing Earnings tend to be accelerating, and capex is trending down across most of the region, leading us to estimate the sector FCF should grow by 19% CAGR in 2016-&39;19, with China having the fastest growth. We expect this to start to attract investors, as the index has closely tracked FCF growth historically. Figure 3: CF estimated to reach a peak – will the index climb 50% to prior peaks too Figure 4: APACxJp EBIT/Revenue and Capex/Revenue20 40 60 80 100 120 140 160 1802610 Se p-9Se p-9Se p-9Se p-9Se p-9Se p-0Se p-0Se p-0Se p-0Se p-0Se p-0Se p-0Se p-0Se p-0Se p-0Se p-1Se p-1Se p-1Se p-1Se p-1Se p-1Se p-1Se p-1Se p-1Se p-1Se p-2APAC Ex Jpn telco- FCF(Left)APAC Ex Jpn telco(Right) 0% 5% 10% 15% 20% 25% 30% Se p-0Se p-0Se p-1Se p-1Se p-1Se p-1Se p-1Se p-1Se p-1Se p-1Se p-1Se p-1Se p-2EBIT/RevenueCapex/Revenue Source: Deutsche Bank, Bloomberg Finance LPSource: Deutsche Bank, Bloomberg Finance LP New business lines as multiple expander Operators are beginning to believe that they have new areas of growth. IDCs, cloud, security, IPTV, big data and IoT are now tangible drivers, while content, payment, e-commerce and other areas are also becoming drivers for some operators. As this story progresses, we expect to see multiples lifted to reect some of the premium that tech companies enjoy. Currently they trade at the widest discount in 10 years to internet multiples. Figure 5: Internet premium to telcos1030 40 50 Se p- 09 Se p-Se p-Se p-Se p-Se p-Se p-Se p-Se p-InternetInternet Premium To telcos Source: Deutsche Bank, Bloomberg Finance LP Deutsche Bank AG/Hong KongPage 3 27 September 2017 Telecom Asia-Pac Telecoms M&A as a driver It has already been one of the bigger years in M&A in the sector&39;s history, with approximately USD40bn of deals announced. We believe this trend will continue. We pointed out in our FITT from July 12 M&A spike heralds value added era, how each market has potential for positive deals (e.g. nal leg of consolidation in India, SOE reform/ three network convergence in China, HKT and CITIC as potential targets; merger potential in Indonesia. Should such moves happen, the narrative will change, from new entrants as barriers to growth, to pricing power coming back in the more competitive markets. Conclusion - many reasons to be buyers We see many factors that can drive sector interest, from current extreme low levels, most notably a pick up in earnings, and particularly FCF ahead, that has historically been a strong sector driver. Many of the elements that have driven the Japanese telecoms up 2-3x in the last ve years currently exist in Asia-ex Japan to some degree, such as:1) OTT impacts washing through,2) Network roll outs being completed, leading to a FCF surge as capex stepped down,3) Eorts to grow beyond consumer connectivity bearing fruit,4) Cost control and less head-