Current price not factoring in the significant slowdown

Dr. Peng continues to see pressure in its core broadband business withbroadband access revenue down 6% and its net adds slowing to ~100k in2Q17, the lowest rate in the past 4-5 years. Meanwhile, gross margin andARPU continue to decline and the business had to cut its opex by 10% in orderto deliver a more respectable 3% decline in net profit. Capex slowed sharply in1H17 and while this is a prudent move, future growth might also slow. Withthe shares trading on 33x FY17 EPS, this slower future growth does not seemto be factored in; retaining Sell.

Quarterly data show a deteriorating trend

2Q17 revenue declined 5% while gross profit fell 17%, a deterioration vs. thetrends seen in 1Q17. The company cut its 2Q sales and marketing expense by23% and management expense by 18% in order to deliver a flat profit but thisclearly had an impact on customer acquisition with net adds reducing to 100kin the quarter (vs. an average of 700k in the past 2 years). With Dr. Peng’sbroadband ARPU at RMB42/m, still significantly higher than China Mobile atRMB35/m, and given limited bundling offerings to differentiate its offerings,we think Dr. Peng’s business model continues to be challenged. Capex diddecline to RMB1.2bn in 1H17 from an average of RMB1.9bn in the previousfour halves, but the pace of its network rollout also slowed, adding only 2mhouseholds in coverage in the half.

Earnings changes

We have reduced our earnings forecasts in line with the lower-than-expected1H17 results. We have removed the equity raising, which increased the EPS.

Valuation and risks

We value Dr. Peng based on the mid-point of our peer-based valuation andDCF. Risks relate to market share, tax rate, regulation, and margins.