China Communication Services:Field trip highlights growth opportunity in non-telco market

What's changed

We participated in a field trip organized by China Communication Service(CCS) in Nanjing and Hangzhou with the following highlights: (1) CCSreiterated its guidance of high single digit revenue and earnings growth in2016. CCS also expects its FCF growth to surpass that of earnings near-term.

(2) CCS expects to capture more opportunities in the telco OPEX market andnoted that its revenue from China Unicom (CU) has risen while CU capex fellyoy in 1H16. CCS competes with local and mostly private companies in thetelco market and has gained share due to its credit worthiness and servicequality. Chinese telco represented 65% of total revenues at CCS in 1H16. (2)In Jiangsu, CCS is the largest telecom and software service company and isthe contractor and maintenance service provider for Nanjing Smart City, theexpress way control system, and the hospital IT system. CCS Jiangsu targets8% to 13% growth CAGR in 2016-2020. Over the years, CCS said CCSJiangsu has accumulated IP and software capability and ranks 27th amongsoftware companies in China. (3) CCS Zhejiang has gained market share atChina Mobile (CM) and CU through China Tower. CCS views cloud as agrowth opportunity and leads in carrier, public (BAT) and private cloud.

State and private (e.g., IDC) grids are a new growth focus for CCS Zhejiang.

CCS said it has recently become the only fully-licensed company in telco,grid and IDC, and aims to enter the below 35KV market. The Chinesegovernment plans to invest RMB2tn to upgrade state grid into 2020,according to CCS.

ImplicationsWe view CCS’s progress in the non-telco market as incrementally positive.

ValuationWe raise 2016-18E revenue 1%-2% on an improved outlook, but the positiveeffect in RMB is offset by RMB/HKD depreciation (HKD EPS fall 3%-4%). 12mTP drops from HK$4.5 to HK$4.4 still based on 9X NTM P/E. Stay Neutral.

Key risksUpside - share gains in grid market; downside - deteriorating telco capex.