Investment Highlights
A major deal in the making: In Dec 2015, Sanmao released itsproposal to fully acquire “Zhongzhi Integrated-Circuits TechnologyCo.” (affiliated with Peking University), which is one of the mostoutstanding CPU design companies in China. Upon successfulcompletion of the deal, Sanmao will become: (i) one of the few pure ICdesign plays on the A-share market; as well as (ii) a major investmenttarget under the theme of localized production of information securitysystems.
Upon completing the takeover, Sanmao will have shareholderswith extensive backgrounds across technology, capital andresources. Zhongzhi has rights to CPUs proprietarily developed byPeking University as well as its outstanding computer R&D team. “HorocCapital” provides funding support for Sanmao which unleashes potentialfor M&As. As an entity controlled by the Gansu provincial SASAC,Sanmao receives favorable policies from the local government as wellas from local industrial park operators. Hence, the Company is wellsupported from the three perspectives of technology, capital andresources
Market size of Rmb40bn for domestically manufactured “secure”computers, CAGR of 100% over the next three years. Currently, theannual output of domestically manufactured “secure” computers standsat merely ~30,000 units, which only covers key government bodiesengaged in national security, suggesting a low penetration ratio.Following the campaign to strengthen information security, authoritieshave placed the procurement of domestically manufactured securemicroprocessors for government bodies and related agencies onto itsagenda. This initiative is expected to fuel a proliferation of the domesticmicroprocessor manufacturing industry over the next five years. Weforecast demand for domestically manufactured “secure” computers willsurge to 2.5-3.0mn units by 2025E, translating into a market size ofRmb30-40bn. Over the next three years, the industry is projected to seeCAGR of 100%.
Expected to command a 30% share of the domestic securecomputers market on the back of its notable technological edge inintegrated circuits. Compared to its three major domestic rivals,Zhongzhi’s products enjoy a number of advantages including a higherlevel of integration and frequency, physical separation of cores inmulti-core architecture and lower energy consumption, etc. Meanwhile,their superior compatibility also meets the needs of government bodieswith higher levels of security requirements. With Zhongzhi expected tobecome a leading domestic manufacturer of CPUs and PCs, it isforecast to command a 30% share of the domestic secure computersmarket.
Vast potential for expansion backed by its technology. Sanmao is expected to extend along theentire PC industry chain thanks to its core CPU technology, allowing itself to expand its product offeringsfrom microprocessors and secure computers to conventional PCs, tablets and mobile phones.Meanwhile, the technologies will also enable the Company to widen its customer base from governmentclients to commercial and individual consumers.
Risks: (i) restructuring falls short of expectations; (ii) disappointing earnings growth.
Earnings forecast, valuation and investing rating: We maintain its 2015-17E EPS forecast ofRmb-0.17/0.59/0.75. Given its notable technological edge in the domestic CPU market, Sanmao isexpected to become a leader in China’s CPU and information security fields. Taking into account thedearth of similar investment targets as well as peer valuations, we reiterate its BUY rating with a targetprice of Rmb35 (60x 2016E P/E).
