1

Yum Cha 飲 茶 June 17, 2014

TALKING POINTS

CHART OF THE DAY— BANKS TO BENEFIT FROM EASIER REGULATION

Analyst: John Mulcahy, Managing Director

Consensus on China is generally agreed that banks and property developers should be avoided

as the country navigates through a challenging period in its development, with activity slowing in

certain areas and the government embarked on a major reform programme. The logic is sound,

in that key drivers of growth have been government investment in infrastructure, real estate

development and the credit to support these activities and associated consumption. But, we

believe the government will in due course act to support the property market, by removing or

relaxing some home purchase restrictions. On the banks, the key concern is that non-performing

loans (NPLs) understate the real credit risk, but we believe the growth in write-offs and transfers

should be recognized as a way of taking action on non-performing loans without moving the

needle on the NPL ratio. Between 2012 and 2013, as our table (Fig. 2) on the next page shows,

write-offs and transfers were increased substantially, e.g. ICBC [1398.HK] wrote off RMB16.5bn

in 2013 vs. RMB7.5bn in 2012, and China Minsheng’s write-offs surged to RMB11.4bn from

RMB2.3bn. In effect, the write-offs and transfers increase Minsheng’s NPL ratio to 1.57% from

0.85%. The point is that the banks are not in denial about the balance sheet risk, but have taken

actions other than increasing NPL to reflect the risk. In an effort to boost bank liquidity, the

regulators have allowed a select group of banks to reduce their reserve requirement ratio (RRR),

which will have a marginal impact on earnings. A more effective measure, as shown in the table

in Fig.1, is to relax the cap on loan-deposit ratio (LDR). We believe there is an opportunity to

accumulate banks ahead of a recovery in overall conditions.

Source: Bloomberg

INDICES Closing DoD%

Hang Seng Index 23,300.7 (0.1)

HSCEI 10,522.1 0.0

Shanghai COMP 2,086.0 0.7

Shenzhen COMP 1,086.5 0.7

Gold 1,272.1 0.0

BDIY 880.0 (2.9)

Crude Oil, WTI(US$/BBL) 106.8 (0.1)

Crude Oil, BRENT(US$/BBL) 112.9 0.4

HIBOR, 3-M 0.4 0.9

SHIBOR, 3-M 4.8 (0.0)

RMB/USD 6.2 0.2

DAILY NOTES FOR THIS WEEK

Jun 17 China May Property Prices

Jun 17 MNI June Business Indicator

Jun 18 Foreign Direct Investment YoY

Jun 22 HSBC China Manufacturing PMI

TONLY ELECTRONICS HOLDINGS [1249.HK] - Tonly is an ODM manufacturer with strong

R&D capability in audio-visual consumer electronics. A spin-off from TCL Corp, Tonly has some

marquee customers, including SONY, Panasonic, LG, and it has recently received orders from

Huawei and Alibaba. The key driver is “Over-The-Top” (OTT) set-top boxes, and we believe the

market is under-estimating the future for this business. We are monitoring the company, as we

believe it has considerable upside based on the momentum of new business, and increased

capacity will enable more rapid growth in 2014 and 2015.

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BANKING CHANGES—SOME DETAILS

China Minsheng’s successful pitch to the regulator for a relaxation in its reserve requirement ratio (RRR) will help to boost its lending capacity,

but a 0.50% cut will have a marginal impact on earnings, as net interest income would increase by 0.4% for a full year assuming net interest

margin of 2.9%

Bigger impact from an increase in loan-deposit ratio, as our sensitivity to a 1 percentage point increase shows in fig. 1 below.

A slowdown in mortgage lending will have an effect on banks (see loan breakdown in figure 4 on next page.

Fig. 2: BANK NPLs BOOSTED BY WRITE-OFFS AND TRANSFERS—ALL MAJOR BANKS AT LEAST DOUBLED WRITE-OFFS IN 2013

Fig. 3: CREDIT GROWTH SLOWER, BUT BANK LENDING STILL ROBUST YEAR-ON-YEAR

Fig 1: TABLE SHOWING IMPACT OF 1% INCREASE IN LOAN:DEPOSIT RATIO (LDR) FOR MAJOR BANKS

Banks most likely to benefit from increase in LDR include

Bank of China [3988.HK]; China Minsheng Bank [1988.HK];

Bank of Communications [3328.HK]; China Merchants Bank

[3968.HK]; and CITIC Bank [0998.HK].

3

BANKING CHANGES—SOME DETAILS

19%

20%

8%9%

7%

8%5%

3%

3%

3%0%

4% 3%

4%3%

2%0%

ABC Personal mortgage loans

Manufacturing

Real estate

Transportation,logistics and postal

services Production and supplyof power, gas and water

4%

14%

11%

6%9%

5%4%2%3%2%

1%2%

3%

26%

7%

1%

Minsheng BankPersonal MortgageLoans

Manufacturing

Real estate

Leasing and commercialservices

Wholesale and retail

16%

15%

15%

5%10%

9%

10%

6%

2% 0%

1%

1%

3%

3%

3% 1%

ICBCPersonal Mortgageloans

Manufacturing

Transportation,storageand postal services

Wholesale and retail

Production and supplyof electricity, heating,

gas and waterReal estate

19%

24%

12%10%

8%

9%

3%

2%

2%

2%

2%

2%0%

5%

BOCPersonal MortgageLoans

Manufacturing

Commerce andservices

Transportation andlogistics

22%

16%

7%

11%

6%

6%

5%

3%

3%

5%

3%

0%1%

0%

0%

4%

1%

1%

3%

2% 1%

CCBPersonal mortgage loans

Manufacturing

Production and supply of electricpower, gas and waterTransportation, storage and postalservicesReal estate

Leasing and commercial services

- Commercial services

Water, enviornment and publicutilities managementConstruction

Wholesale and retail trade

Mining

- Exploitation of petroleum andnatural gasEducation

Telecommunications, computerservices and software - Telecommunications and otherinformation transmission servicesOthers

Personal business loans

Personal consumer loans

Credit Cards

Fig. 4: BREAKDOWN OF LENDING FOR MAJOR BANKS—CHINA MINSHENG LEAST EXPOSED TO MORTGAGE

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June 17, 2014

Tonly Electronics Holdings Limited (Tonly) is an ODM manufacturer with strong R&D capability in audio-visual consumer electronics. OTT set-top boxes will be a major growth driver in FY14, more than offsetting weakness in other video products. A deepening cooperation with TCL Corp will also broaden Tony’s product portfolio. Valuation appears to be attractive, trading at a trailing PER of 7.2x and 4.1% dividend yield for FY13.

Set-top boxes driving new growth. Tonly Electronics Holding Limited (Tonly) is an ODM manufacturer of consumer audio-visual electronics, including DVD/BD (blue-ray disc) player, home theatre system, wireless speaker, and Over-The-Top (OTT) set-top boxes. Driven by increasing demand for internet-based media content and new orders from customers including Alibaba and Huawei, growth in OTT set-top boxes is rising briskly, up 46 times for the first five months of FY14, and contributing 20% of total revenue from 0.6% in 5MFY13 (excluding revenue from other businesses). Tonly’s audio products segment, which targets a wide base of international brands (e.g. SONY, Harman), also generated strong revenue growth (+35% YoY in 5M14), helped by robust demand for wireless speakers and soundbars. These new growth drivers will more than compensate for the shrinkage in the traditional DVD/BD player market (-10% YoY in FY13; +5% YoY in 5M14).

Deepening co-operation with TCL. Tonly has an independent and strong R&D team, allowing it to address the fast-changing and competitive landscape in consumer electronics. The management indicates that the successful record has encouraged parent company TCL Corp, to make more use of Tonly’s R&D strength for new product development. In the absence of any meaningful sales exposure to TCL-branded products, we believe TCL will eventually become a key customer in future when the parent penetrates further into audio-visual electronics.

Upside on Conservative Sales Guidance. Though we have not assigned a rating on the stock, the sharp growth in OTT set-top boxes and new audio products, leads us to believe the company’s guidance of 10% top-line growth is conservative. Gross profit margin will start improving from 2Q14 after plant relocation is completed and when it reaches full capacity utilisation. In addition, the acquisition of Tonly’s key subsidiary by way of new shares issued to minorities, who are mainly key management and staff, is a positive move further aligning the interests of management and shareholders. Valuation appears attractive, trading at a trailing PER of 7.3x with a 4.1% dividend yield for FY13. Our preliminary projection indicates that if Tonly generates revenue of HK$5.5bn in FY14e (+20.9% YoY, which has a high likelihood in our opinion), net profit could be HK$162m if FY13 net profit margin (NPM%) is assumed — equating to a forward PER of 6x FY14e.

Tonly Electronics Holdings Limited [1249.HK]

Price Performance

Market Cap US$128m

Shares Outstanding 166m

Auditor Ernst & Young

Free Float 39.0%

52W range HK$3.80—$6.86

3M average daily T/O $0.12m

Major Shareholding TCL Corp (50.3%)

Star Force Inv (9.1%)

Source: Company, Bloomberg

Samuel Chan, CFA — Senior Analyst

(852) 3698-6391

samuelchan@chinastock.com.hk

John Mulcahy— Head of Research

(852) 3698-6889

johnmul@chinastock.com.hk

Not Rated

Close: HK$5.99 (June 16, 2014)

China Technology Sector

Set-top box—Revival

Source: Capital IQ estimates

Key Financials (HK$m) FY2012 FY2013 FY2014e FY2015e

Revenue 3,673.1 4,554.3 5,155.0 5,791.0

Change (yoy %)

Gross Profit 432.9 492.2 583.0 657.0

Gross Margin % 11.8 10.8 11.3 11.3

Net Profit 95.2 106.7 154.0 175.0

Net Margin % 2.6 2.3 3.0 3.0

EPS $0.710 $0.800 $0.930 $1.050

ROE (%) 28.5 26.7 31.7 28.6

Dividend Yield (%) n.a. 4.10 4.83 5.52

PER (x) 8.24 7.31 6.24 5.52

PBR (x) 2.67 1.83 1.76 1.43

Capex (m) (102.8) (262.0) n.a. n.a.

Free cash flow (m) 504.4 (586.8) n.a. n.a.

Net cash/(net debt) (m) 435.5 409.3 n.a. n.a.

0

5

10

15

20

25

30

3.5

4

4.5

5

5.5

6

6.5

7

(HK$ million)(HK$)

Turnover (RHS) Price (LHS)

5

Company background. Spun off by TCL Multimedia (1070.HK) in August 2013 by way of a share distribution, Tonly Electronics is a

vertically-integrated audio-visual ODM manufacturer with strong R&D capability. Most customers are international brands, including

SONY, Panasonic, LG, Toshiba, Philips, Harman, etc. Tonly recently received new orders from customers including Alibaba and

Huawei, mainly for Over-The-Top (OTT) set-top boxes. Production is mainly based in Huizhou, Guangdong Province, near other TCL

production plants.

Strong R&D capability. Tonly invests substantially in research and development (R&D), with the R&D cost:sales ratio in 2013 at

3.6%, significantly higher than the industry average. The R&D team comprises more than 600 staff.

Financials. Revenue from audio-visual products (excluding other businesses) rose 44.9% YoY to HK$1,763bn for the first five

months of FY2014. Sales of OTT set-top boxes was the key growth driver, up 4,620% YoY%, followed by audio products sales, up

35.1% YoY. Revenue from DVD/BD players rose 5.1% YoY for 5M14, although sales in the month of May declined by 14.7% YoY.

Sales from other businesses includes Advanced Broadcasting System—Satellite (ABS-s) products, other parts & components, and

R&D income. ABS-s products are satellite receivers, authorized by central government to a designated list of qualified manufacturers

and suppliers. Segment revenue decreased significantly YoY in 1Q14, mainly because orders placed for ABS-s in a tender the

company won in 2013 will be mainly fulfilled in Q2 and Q3 2014.

Key Risks. 1) Faster than expected shrinkage in DVD/BD player market is faster than expected; 2) Shorter-than-expected product

life cycle in OTT set-top box; 3) Uncertainty on GPM on OTT set-top box as software has a more important role in general; 4)

Earnings reliability due to its short listing track record.

Figure 1: Turnover by Products

Source: Company Data; *Other products include ABS-s, other parts and components, and R&D income

6

Tonly Electronics Holdings LImited

(1249 HK)

TCL Industries (HK)

50.3%

TCL Corporation (PRC)

Board of Directors

11.0%

Public

38.7%

Figure 2: Shareholding Structure

Source: Company Data

Company TickerMarket Cap

(US$m)Stake Principal Acitivities

TCL Communication Technology 2618 HK 1,464 50.0% Mobile phone (Brand)

TCL Multimedia Technology 1070 HK 470 61.4% Television (Brand)

Tonly Electronics 1249 HK 125 50.3% AV, OTT (ODM)

Proview International 334 HK 20 14.4% Pending for restructuring

Figure 3: Hong Kong Listed Subsidiaries Owned by TCL Corporation (000100 CH)

Source: HKEX

Figure 4: Preliminary Earnings Projection

Source: CGIHK Research, not contributing to consensus estimates

(in HK$m) FY14e FY13 YoY%

Revenue 5,508 4,554 20.9%

DVD/BD Players 2,060 2,126 -3.1%

Audio Products 1,950 1,703 14.5%

OTT Set-top Boxes 786 13 5830%

Other Products 711 711 0.0%

Net Profit Margin 2.9% 2.9%

Net Profit 162 134 20.8%

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Source: Capital IQ

Key Financials

Income Statement (RMBm) FY2011 FY2012 FY2013 Cash Flow Statement (RMBm) FY2011 FY2012 FY2013

Revenue 4,099 3,673 4,554 Net Income 94 95 107

Growth yoy% 9.0% (10.4%) 24.0% Depreciation & Amort. 13 12 21

Gross Profit 388 433 492 Change in Working Capital (40) 191 26

Gross Margin % 9.5% 11.8% 10.8% Cash from Ops. 67 298 154

Selling General & Admin Exp. (241) (267) (289) Capital Expenditure (4) (103) (262)

R&D Expense (87) (142) (160) Sale of Property, Plant, and Equipment - 3 1

Others Operating Expenses 2 0 17 Cash Acquisitions - (14) -

Operating Income 62 23 61 Divestitures - - -

OP Margin % 1.5% 0.6% 1.3% Change in Other Investing Activities 481 311 153

Interest and Invest. Income (0) (0) (0) Cash from Investing 476 198 (108)

Currency Exchange Gains (Loss) 2 - 32 Debt/ Issuance / Repayment (623) (18) (272)

Other Non-Operating Inc. (Exp.) 52 61 42 Equity Issuance / Repurchase - 91 -

Income Tax Expense (16) (17) (18) Total Dividends Paid - (120) (323)

Net Income to Company 94 95 134 Others Financing Activities - 55 (41)

Net Income Margin % 2.3% 2.6% 2.9% Cash from Financing (623) 9 (637)

Minority Interest - - (27) Net Change in Cash (76) 504 (587)

Net Income to Shareholders 94 95 107

Balance Sheet (RMBm) FY2011 FY2012 FY2013 Ratios FY2011 FY2012 FY2013

ASSETS Profitability

Cash And Equivalents 493 997 410 Return on Assets % 1.4% 0.5% 1.2%

Short Term Investments - - 136 Return on Capital % 3.8% 2.3% 7.0%

Accounts Receivable 888 846 897 Return on Equity % 16.3% 18.5% 28.5%

Other Receivables 257 158 173

Inventory 261 345 460 Margin Analysis

Prepaid Exp. 47 67 27 Gross Margin % 9.5% 11.8% 10.8%

Other Current Assets 711 911 15 SG&A Margin % (7.3%) (6.3%) (6.0%)

Total Current Assets 2,658 3,333 2,119 R&D Margin % (2.1%) (3.9%) (3.5%)

Net Property, Plant & Equipment 39 146 393 Net Income Margin % 2.3% 2.6% 2.3%

Long-term Investments 0 0 0

Deferred Tax Assets, LT 68 68 73 Asset Turnover

Other Long Term Assets 16 16 40 Total Asset Turnover 3.6x 3.5x 2.7x

Total Long Term Assets 124 231 506 Fixed Asset Turnover 13.2x 10.1x 9.3x

Total Assets 2,782 3,564 2,625 Accounts Receivable Turnover 4.7x 4.6x 3.6x

Inventory Turnover 0.0x 0.0x 0.0x

LIABILITIES & EQUITY

Accounts Payable 1,094 1,565 1,179 Liquidity

Accrued Exp. 574 947 449 Current Ratio 1.2x 1.1x 1.0x

Short-term Borrowings 124 147 0 Quick Ratio 0.8x 0.6x 0.8x

Curr. Port. of LT Debt - 2 1 Avg. Days Sales Out. 65.63 86.41 69.87

Curr. Income Taxes Payable 92 94 84 Avg. Days Inventory Out. 28.22 34.22 36.14

Other Current Liabilities 245 415 358 Avg. Days Payable Out. 93.42 146.42 119.88

Total Current Liabilities 2,130 3,170 2,071 Avg. Cash Conversion Cycle 0.43 -25.80 -13.90

Long-Term Debt 14 3 4 Net Debt to Equity Net Cash Net Cash Net Cash

Total Liabilities 2,144 3,173 2,075

Common Stock - 189 189 Growth Over Prior Year

Additional Paid In Capital - 2,075 2,879 Total Revenue 9.0% (10.4%) 24.0%

Retained Earnings 544 - - Net Income (41.7%) 0.7% 12.1%

Comprehensive Inc. and Other 94 2,558 3,380 Payout Ratio % n.a. n.a. 29.7%

Minority Interest - 98 125

Total Equity 638 292 425

Total Liabilities And Equity 2,782 3,564 2,625

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BUY share price will increase by >20% within 12 months in absolute terms :

SELL share price will decrease by >20% within 12 months in absolute terms :

HOLD no clear catalyst, and downgraded from BUY pending clearer signal to reinstate BUY or further downgrade to outright SELL :