Wangsu Technology:1Q17result:no let-up in earnings pressure
Coming quarters may remain tough.
Wangsu’s 1Q17 NPAT decline of 19% came in slightly below the mid-point ofguidance (0-30% decline). Revenue grew 21% YoY but it was the first quarterin the last five years where QoQ growth was negative. Gross margin declined afurther 3.8ppts QoQ, which likely reflected competitive pressures, though wenote that 1Q tends to be seasonally weak. With earnings cycling toughcomparables in the next few quarters, limited contributions from overseasbusinesses, and no let-up in competitive intensity from domestic cloudoperators, we remain cautious in the near term, though we continue to expectearnings to recover beyond FY17. Retaining Hold.
Weak trends exacerbated by continued investments in R&D.
Revenue grew 21% but declined 4% QoQ, and it was the first quarter in thelast five years where revenue declined on a quarterly basis. Gross margincontinued to decline and with AliCloud recently announcing a 35% cut to CDNprices, it is likely that margin will continue to be under pressure in the nearterm. We applaud management’s grit in sticking with its investment plans as itlikely brought in more R&D staff, which increased its opex in the quarter. Thatsaid, this exacerbated the earnings reduction in the quarter.
Not the time to give up yet.
We continue to see a promising future for Wangsu, given the strong growthoutlook for the industry, the unsustainable nature of the current competitiveenvironment, a potential to branch off into adjacent services, and the possibilityof becoming a global player with the CDNetworks acquisition. Furthermore, wedo not think that cloud providers will replace third-party CDN providers, giventhe unique nature of the network requirements of large enterprises.
Valuation and risks.
We have reduced our target price to reflect the earnings reduction and the 2-for-1 stock split that occurred on 25 April. We value Wangsu based on themid-point of our peer-based P/E valuation and DCF (WACC 7.5%, TGR 1%).
Risks relate to market share, tax rate, regulation, and margins.(Pg 6 for details)