Greater China - Technology Hardware Findings after Recent China Trip: 4G/LTE the Key Risk

Revisiting our thesis after our recent trip to China –domestic demand, 4G/LTE ramp and competitionare worse than we expected, but overseas marketgrowth is an offsetting positive. XiaoMi’s share gainand impact on pricing are greater than projected.

    OW AAC and FIH; Remain UW on HTC and Sunny.

    1H14 demand slowdown (-10% YoY to April) reflects3/4G transition … due to operators’ subsidy cuts on 3Gon top of delay in purchase ahead of 4G ramp. 3G(TD-SDMA) inventory correction could be short-lived,and supply chain stays bullish on restocking in 2Q14.

    … but 4G/LTE ramp likely below expectations: CMhas lowered its TD-LTE target by ~20%, to 70m, due tosubsidy cuts coupled with limited availability of low-costsolution – implying rising inventory risks. Ex-China EMgrowth is an offsetting positive, but overall spec mightnot upgrade as fast as seen in China to mitigate pricing.

    XiaoMi impact – on pricing as well as share: XiaoMi’sdisruptive online business model threatens whiteboxplays, and eats into leading OEMs’ share (e.g.,Samsung, Lenovo, and HTC) by offering value atcompetitive price. Leading local OEMs need to leverageoverseas market to ensure scale and profitability.

    Components – a few shine, but most suffer: Cameramodule migration is ongoing, but we learn it’s unlikely tooffset pricing once drivers shift to ex-China EMs and/ornew entrants (O-Film) bring capacities onstream. Metalcasing likely emerges as the trend among local OEMsonce XiaoMi adopts the design through Mi3S from 3Q.

    Our top picks remained unchanged: Per our Jan. 20report, Smartphone supply chain 2014: Battle for asmaller pie, we see further upside in AAC despite recentrally, we think FIH/GoerTek story is under-appreciated,and we believe risks to HTC/Sunny are overlooked.