Brief TMT & Internet: Baidu: Time to Swoop In, with NAV Discount Widening Substantially and more

In this briefing:

1. Baidu: Time to Swoop In, with NAV Discount Widening Substantially
2. Pinduoduo (PDD US): Follow-On Offering Is a Smart Move for the Company, Rather than for Investors
3. Hamamatsu Photonics (6965 JP): 1Q Sales Growth Led by Medical, Semiconductor & Factory Automation
4. The War on Huawei, Its Impact on TSMC, and the Invincible Spanish Armada
5. Koolearn: Marketing Expenses Have Taken Operating Profits Down the Drain

1. Baidu: Time to Swoop In, with NAV Discount Widening Substantially

• Our stub valuation analysis reveals that Baidu Inc (ADR) (BIDU US) attractively trades at near 2 SD below its 3-yr average of NAV discount.
• Fundamentally, BIDU’s core business (Baidu Core) has grown healthily, with strong cash flows generation.
• China consumption slowdown is likely to mean modest sales growth deceleration (not a “sales falling off the cliff” scenario) for BIDU in 2019E.
• Implied in the current ADR price, the market is unjustifiably valuing Baidu Core (11.2x 2019E PE) as an “Old economy” company with little to no growth prospect, in our opinion.
• Our PT for next 3-6 mo, assuming 10% holdco discount to NAV, works out to be US$224/ADR, representing a 27% upside potential.   

2. Pinduoduo (PDD US): Follow-On Offering Is a Smart Move for the Company, Rather than for Investors

With the shares hitting all-time highs, Pinduoduo (PDD US) announced a follow-on public offering to raise net proceeds (potentially of $1.1 billion) from the sale of 37 million ADS along with the placing of 14.8 million ADS from existing shareholders (post-lockup expiry).

3. Hamamatsu Photonics (6965 JP): 1Q Sales Growth Led by Medical, Semiconductor & Factory Automation

Consolidated sales were up 4.1% year-on-year in the three months to December, supported by demand from the medical, semiconductor and factory automation sectors, to which sales were up 8.7%, 11.0% and 8.2%, respectively. Gross profit was up 4.5%, but higher S,G&A expenses resulted in a 1.8% decline in operating profit (the operating margin was, however, up from the previous quarter). Net profit was up 4.9% after a decline in extraordinary losses. It was a relatively good performance in view of the cyclical downturns in the semiconductor and factory automation markets, and medical sales growth of only 3.2% in FY Sep-18.

Management’s three-year plan calls for 4.2% growth in sales and 0.9% growth in operating profit this fiscal year, followed by acceleration in FY Sep-20 and FY Sep-21. This is predicated on investment in new production capacity, which should be largely completed over the coming year, sufficient demand to absorb that capacity, and depreciation leveling off in FY Sep-21. Sales growth was on target in 1Q while operating profit fell short, but management has a record of cutting R&D and other expenses in order to achieve profit guidance. 

At ¥3,985, the shares are selling at 29x management’s implied EPS estimate for this fiscal year (net profit guidance/ current shares outstanding), 26x next year’s estimate and 22x the estimate for FY Sep-21.

4. The War on Huawei, Its Impact on TSMC, and the Invincible Spanish Armada

Huawei is one of the largest telecom equipment companies in the world and it is also one of the top customers of Taiwan Semiconductor Manufacturing Company (TSMC) (2330 TT). There has been a war waged on Huawei by the US government administration. Most recently in January 2019, the US Justice Department announced 23 counts of indictments on Huawei related to the intellectual property theft, obstruction of justice, and fraud related to its evasion of US sanctions against Iran. The following are the major reasons why the US government has become so aggressive in targeting Huawei to prevent this company from selling its telecom equipment products in the US and in other allied countries:

• Serious concerns about Huawei’s equipment which can be used to conduct espionage
• The quest for 5G 
• Beyond 5G & Global technology leadership

HiSilicon Technologies, which is a fully owned company of Huawei, is one of the top five customers of TSMC. Of TSMC’s top five customers, both Apple and Huawei face significant headwinds which could reduce their sales growth rates. Although we do not have an exact figure of what percentage of TSMC’s sales that Apple and Huawei represent, we believe that is closer to about 25-30%. 

The current US administration is trying to slow down this excessive outsourcing of manufacturing out of the US. The US government’s war on Huawei is a reflection of the US government’s desire to slow down the progress of Huawei and China’s dominance of 5G services combined with threats of potential espionage. In the midst of all these intricate battles and concerns involving Huawei, TSMC is becoming negatively impacted as one of the main companies that produce chips for Huawei’s Hisilicon. 

5. Koolearn: Marketing Expenses Have Taken Operating Profits Down the Drain

• Koolearn updated its IPS prospectus and posted operating losses for 1H2019 (ended Nov. 2018).
• The company spent significantly on online promotion, but we believe that online promotion is not useful.
• We also believe online marketing expenditures are not a productive use of the Company’s cash, as Koolearn’s brand was already well known among consumers due to its parent company, New Oriental.