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Samsung Electronics

(005930 KS)

Pay attention to potential returns on invested

capital

Investment points

I. Increased visibility on foundry capex to drive up valuation: For 2021, we forecast Samsung Electronics’ (SEC) foundry capex at W9.2tr or higher, which we estimate will translate into a roughly W40tr boost to the company’s value.

II. Lower DRAM investments to support structural earnings growth: We believe SEC’s conservative DRAM investments will help keep DRAM prices steady, leading to sequential earnings growth and the opening of a structural growth phase.

III. NAND market share expansion to boost earnings: We expect SEC’s NAND capex to far exceed the market average. We believe SEC will continue to execute massive capex and enjoy a dominant earnings share in the NAND market.

Earnings outlook

For 2Q20, we forecast SEC to post revenue of W48.1tr (-14.3% YoY, -13.1% QoQ) and operating profit of W5.9tr (-10.4% YoY, -8.3% QoQ). By business division, we expect: 1) operating profit of W5.2tr for semiconductor; 2) an operating loss of W0.6tr for display; 3) operating profit of W1.2tr for IT & mobile communications (IM); and 4) operating profit of W0.3tr for consumer electronics (CE).

We estimate foundry capacity will expand 43,000 wpm in 2020 and 53,000 wpm in 2021. With a utilization rate at the 90% level, we expect such capacity expansion to lead to revenue growth. For 2020, we forecast system LSI and foundry to see revenue of W17.3tr (+17.3% YoY) and an OP margin of 10.4%. For 2021, we forecast the division to deliver revenue of W21.3tr (+23.3% YoY) and an OP margin of 13.4%, as foundry supplies to Qualcomm (QCOM US/CP: US$78.09) and Nvidia (NVDA US/CP: US$352.22) should gather traction.

Initiate coverage with Buy rating and target price of W68,000

We initiate our coverage on SEC with a Buy rating and SOTP-based target price of W68,000. In deriving our target price, we applied a 2020F EV/EBITDA of 5.3x for semiconductors, 4.0x for display, 10.7x for IM, and 5.5x for CE. We believe the broader multiple of roughly 6.0x is highly reasonable, as it represents a premium of just 10.3% to the average 2020F EV/EBITDA of pure memory names Micron (MU US/CP: US$45.12) and SK Hynix (000660 KS/Buy/TP: W110,000/CP: W82,700).

FY (12) 12/17 12/18 12/19 12/20F 12/21F 12/22F Revenue (Wbn) 239,575 243,771 230,401 218,366 255,586 299,150 OP (Wbn) 53,645 58,887 27,769 30,807 45,409 53,642 OP Margin (%) 22.4 24.2 12.1 14.1 17.8 17.9 NP (Wbn) 41,345 43,891 21,505 23,903 34,545 40,186 EPS (W) 5,421 6,024 3,166 3,519 5,086 5,916 ROE (%) 21.0 19.6 8.7 9.1 12.2 13.1 P/E (x) 9.4 6.4 17.6 13.8 9.5 8.2 P/B (x) 1.8 1.1 1.5 1.2 1.1 1.0 Dividend Yield (%) 1.7 3.7 2.5 3.3 3.7 3.7

Note: All figures are based on consolidated K-IFRS; NP refers to net profit attributable to controlling interests Source: Company data, Mirae Asset Daewoo Research estimates

Technology Initiation Report May 13, 2020 (Initiate)

Buy

Target Price(12M, W)

68,000

Share Price (05/13/20, W)

48,550

Expected Return

40%

OP (20F, Wbn) 30,807 Consensus OP (20F, Wbn) 32,813 EPS Growth (20F, %) 11.2 Market EPS Growth (20F, %) 28.5

P/E (20F, x) 13.8 Market P/E (20F, x) 13.0 KOSPI 1,940.42 Market Cap (Wbn) 289,833 Shares Outstanding (mn) 6,793 Free Float (%) 74.8 Foreign Ownership (%) 55.0 Beta (12M) 0.98 52-Week Low 41,200 52-Week High 62,400 (%) 1M 6M 12M Absolute 0.5 -7.5 13.8 Relative -5.4 1.2 22.0

Mirae Asset Daewoo Co., Ltd. [Semiconductors] Young-gun Kim +822-3774-1448 younggun.kim.a@miraeasset.com Yumi Cha +822-3774-1770 yumi_cha@miraeasset.com 60 80 100 120 140 160 5.19 9.19 1.20 5.20

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C O N T E N T S

I. Investment points 4

Point I: Increased visibility on foundry capex to drive up valuation 4

Point II: Lower DRAM investments Structural earnings growth 14

Point III: NAND market share expansion to boost earnings 19

II. Outlook and earnings forecasts by division 25

Key assumptions for IT product demand forecasts 25

[Semiconductors] NAND outlook 43

[Semiconductors] DRAM outlook 57

[Semiconductors] System LSI and foundry outlook 72

Display outlook 77

IM outlook 79

III. Valuation 80

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Table 1. SEC: Quarterly and annual earnings (Wbn, %) 1Q19 2Q19 3Q19 4Q19 1Q20P 2Q20F 3Q20F 4Q20F 2019 2020F 2021F US$/W 1,125 1,167 1,194 1,176 1,193 1,213 1,190 1,160 1,160 1,099 1,150 Revenue 52,386 56,127 62,003 59,885 55,330 48,098 55,955 58,982 230,401 218,366 255,586 YoY -13.5 -4.0 -5.3 1.0 5.6 -14.3 -9.8 -1.5 -5.5 -5.2 17.0 QoQ -11.6 7.1 10.5 -3.4 -7.6 -13.1 16.3 5.4 Semiconductors 14,472 16,088 17,587 16,792 17,640 18,556 19,422 20,742 64,939 76,361 98,026 Memory 11,469 12,300 13,263 13,184 13,140 14,591 15,103 16,251 50,216 59,085 76,731 System LSI and foundry 3,004 3,788 4,324 3,608 4,500 3,965 4,319 4,491 14,723 17,276 21,295

Display 6,124 7,622 9,262 8,046 6,590 5,902 7,402 7,578 31,054 27,472 29,765 Large-sized LCD 1,530 1,670 1,500 1,100 1,100 1,000 1,014 784 5,800 3,897 1,660 Small/mid-sized LCD 4,594 5,952 7,762 6,946 5,490 4,903 6,388 6,794 25,254 23,575 28,105 IM 27,200 25,860 29,254 24,951 26,000 19,424 24,151 25,170 107,266 94,745 100,617 MC 25,915 24,272 28,096 24,049 24,950 18,532 23,303 24,339 102,332 91,123 97,332 IT 1,285 1,588 1,159 902 1,050 893 848 831 4,934 3,621 3,285 CE 10,041 11,068 10,935 12,713 10,300 8,741 9,228 9,265 44,756 37,534 43,463 VD 5,836 5,998 6,257 8,088 5,650 4,567 5,179 5,338 26,178 20,734 27,011 Harman 2,195 2,518 2,631 2,733 2,100 2,310 2,541 2,795 10,077 9,746 10,843 Gross profit 19,639 20,182 22,010 21,330 20,520 19,239 22,942 24,773 83,161 87,474 115,014 YoY -31.5 -25.8 -27.3 -15.5 4.5 -4.7 4.2 16.1 -25.3 5.2 31.5 QoQ -22.2 2.8 9.1 -3.1 -3.8 -6.2 19.2 8.0 Gross margin 37.5 36.0 35.5 35.6 37.1 40.0 41.0 42.0 36.1 40.1 45.0 Operating profit 6,233 6,597 7,778 7,160 6,450 5,914 8,966 9,478 27,769 30,807 45,409 YoY -60.2 -55.6 -55.7 -33.7 3.5 -10.4 15.3 32.4 -52.8 10.9 47.4 QoQ -42.3 5.8 17.9 -7.9 -9.9 -8.3 51.6 5.7 Semiconductors 4,122 3,398 3,049 3,447 3,990 5,194 5,670 6,161 14,016 21,015 32,655 Memory 3,836 3,158 2,625 3,166 3,319 4,790 5,169 5,656 12,785 18,935 29,810 System LSI and foundry 287 240 424 281 389 403 501 505 1,232 1,798 2,845

Display -561 748 1,174 220 -290 -646 886 1,054 1,581 1,005 3,108 Large-sized LCD -375 -158 -316 -518 -356 -311 -142 -166 -1,366 -975 -823 Small/mid-sized LCD -186 906 1,490 738 66 -335 1,028 1,220 2,948 1,979 3,930 IM 2,274 1,561 2,917 2,520 2,650 1,174 2,106 2,069 9,273 8,000 9,585 MC 2,030 1,228 2,731 2,385 2,440 1,103 2,039 2,003 8,374 7,584 9,292 IT 244 334 185 135 210 71 68 66 898 416 292 CE 541 712 548 805 450 293 463 300 2,606 1,506 2,449 VD 428 433 394 652 362 85 341 182 1,907 970 1,955 Harman 8 92 99 123 -190 69 76 84 322 39 325 OP margin 11.9 11.8 12.5 12.0 11.7 12.3 16.0 16.1 12.1 14.1 17.8 Semiconductors 28.5 21.1 17.3 20.5 22.6 28.0 29.2 29.7 21.6 27.5 33.3 Memory 33.4 25.7 19.8 24.0 25.3 32.8 34.2 34.8 25.5 32.0 38.8 System LSI and foundry 9.5 6.3 9.8 7.8 8.6 10.2 11.6 11.2 8.4 10.4 13.4

Display -9.2 9.8 12.7 2.7 -4.4 -10.9 12.0 13.9 5.1 3.7 10.4 Large-sized LCD -24.5 -9.4 -21.1 -47.1 -32.3 -31.1 -14.0 -21.2 -23.6 -25.0 -49.6 Small/mid-sized LCD -4.1 15.2 19.2 10.6 1.2 -6.8 16.1 18.0 11.7 8.4 14.0 IM 8.4 6.0 10.0 10.1 10.2 6.0 8.7 8.2 8.6 8.4 9.5 CE 5.4 6.4 5.0 6.3 4.4 3.4 5.0 3.2 5.8 4.0 5.6 Harman 0.4 3.7 3.8 4.5 -9.0 3.0 3.0 3.0 3.2 0.4 3.0 Pretax profit 6,913 7,179 8,621 7,719 7,157 6,589 9,668 10,224 30,432 33,746 48,836 YoY -57.3 -53.4 -52.0 -33.5 3.5 -8.2 12.2 32.4 -50.2 10.5 44.2 QoQ -40.4 3.9 20.1 -10.5 -7.3 -7.9 46.7 5.7 Net profit 5,107 5,065 6,105 5,228 5,064 4,611 6,752 7,114 21,505 23,903 34,545 YoY -56.0 -53.9 -52.9 -37.2 -0.9 -8.9 10.6 36.1 -51.0 9.5 44.0 QoQ -38.7 -0.8 20.5 -14.4 -3.1 -8.9 46.4 5.4 Net margin 9.7 9.0 9.8 8.7 9.2 9.6 12.1 12.1 9.3 10.8 13.3

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I. Investment points

Point I: Increased visibility on foundry capex to drive up valuation

SEC’s 2021 foundry capex to reach at least W9.2tr (+77% YoY)

For 2021, we forecast SEC’s foundry capex at W9.2tr or higher, which we estimate will translate into a roughly W40tr boost to the company’s value (based on TSMC’s [2330 TT/CP: NT$291.50] average ROIC of 23.5% and P/E of 18x). We believe that capital recovery seems very likely in the 7nm-or-below segment, in which the company enjoys a duopoly alongside TSMC.

Technological and capital requirements form high barriers to entry

Amid massive capital investments by leading foundries and logic chipmakers, the threat of new entrants has been easing significantly. During the most recent five years, pure memory players invested an average of US$7.9bn annually, while foundry/logic firms executed average capex of US$11.6bn. SMIC (0981 HK/CP: HK$19.30), the leading Chinese foundry, spent a meager US$2bn annually.

Moreover, in 7nm-or-below processes, SEC and TSMC have held a duopoly since GlobalFoundries ceased all 7nm development in 2018. For reference, there are five foundries/integrated device manufacturers (IDMs) in the 20nm segment and around 10 in 40nm. We note that Intel (INTC US/CP: US$60.29) is scheduled to begin 10nm production shortly, and could potentially pursue a node shrink to 7nm.

Another barrier to entry is the limited availability of lithography machines, which are essential to fabrication at 7nm or below (excluding TSMC’s N7 process). ASML (ASML US/CP: US$306.25) usually ships only around 10 EUV lithography machines quarterly, and in 2Q20, only two units were shipped amid the COVID-19 outbreak. Demand for EUV lithography systems is rising due to their adoption in memory chip production, and players that fail to secure the machines will be unable to migrate to the 7nm process.

Figure 1. Annual capex trends and forecasts for global semiconductor companies

Source: Thomson Reuters, Mirae Asset Daewoo Research 0 5 10 15 20 2006 2008 2010 2012 2014 2016 2018 2020F (US$bn) Intel TSMC SK Hynix Micron SMIC

Foundry/logic 5Y avg. capex:US$11.6bn

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Figure 2. GlobalFoundries ceased 7nm development in August 2018

Source: GlobalFoundries, Mirae Asset Daewoo Research

Figure 3. Foundry players by process node

Source: WikiChip, Mirae Asset Daewoo Research

Figure 4. ASML: Lithography equipment shipments by technology

Source: ASML, Mirae Asset Daewoo Research

28 25 18 13 13 9 6 5 3 2(3) 2(3) Silterra X-FAB DB하이텍 ADI ADI Atmei Atmei Rohm Rohm Sanyo Sanyo Mitsubishi Mitsubishi ON Semiconductor ON Semiconductor Hitachi Hitachi

Cypress Cypress Cypress

Sony Sony Sony

Infenion Infenion Infenion

Sharp Sharp Sharp

Freescale Freescale Freescale

Renesas Renesas Renesas Renesas Renesas

Toshiba Toshiba Toshiba Toshiba Toshiba

Fujitsu Fujitsu Fujitsu Fujitsu Fujitsu

Texas Instrument Texas Instrument Texas Instrument Texas Instrument Texas Instrument

Panasonic Panasonic Panasonic Panasonic Panasonic Panasonic

STMicro STMicro STMicro STMicro STMicro STMicro

UMC UMC UMC UMC UMC UMC

IBM IBM IBM IBM IBM IBM IBM

SMIC SMIC SMIC SMIC SMIC SMIC SMIC SMIC

GF(AMD) GF(AMD) GF(AMD) GlobalFoundries GlobalFoundries GlobalFoundries GlobalFoundries GlobalFoundries

Intel Intel Intel Intel Intel Intel Intel Intel Intel (Intel) (Intel)

Samsung Samsung Samsung Samsung Samsung Samsung Samsung Samsung Samsung Samsung Samsung

TSMC TSMC TSMC TSMC TSMC TSMC TSMC TSMC TSMC TSMC TSMC 180nm 130nm 90nm 65nm 45nm/40nm 32nm/28nm 22nm/20nm 16nm/14nm 10nm 7nm 5nm 4 7 7 8 2 0 20 40 60 80 4Q13 2Q14 4Q14 2Q15 4Q15 2Q16 4Q16 2Q17 4Q17 2Q18 4Q18 2Q19 4Q19 (Units)

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Demand for SEC’s 7nm-or-below products to expand

Qualcomm: Mass production of 5nm modem chips to start in 2021

SEC’s foundry unit has won orders for Qualcomm’s Snapdragon X60, the world's first 5nm 5G baseband modem, with mass production scheduled to begin in 2021. We note that, beginning with the Snapdragon 865 5G platform, Qualcomm has separated its modem and application processor (AP) orders. While SEC will provide X60 modem chips built on its 5nm low-power early (LPE) process, TSMC will supply APs built on its N5 process.

Order volumes should be dictated by 5G smartphone demand. Qualcomm is looking for 450mn smartphone sales in 2021 and 750mn units in 2022, and Strategy Analytics forecasts Qualcomm’s 5G modem shipments at 150mn units. The exact die size of the X60 is not yet known, but based on the Snapdragon 845’s relatively small die size (91mm2), the production of 150mn chips annually will require capacity of 30,000 wpm (12”). If mass production progresses smoothly in 2021, Qualcomm could decide to use SEC’s 4nm LPE process to manufacture its 5G modems in 2022, in which case additional capex will be needed in 2021.

Figure 5. Snapdragon X60 modem chip to be produced on SEC’s 5nm process (2021)

Source: Qualcomm, Mirae Asset Daewoo Research

Figure 6. 5G smartphone shipment estimates

Source: Gartner, Mirae Asset Daewoo Research 70 190 400 600 950 0 20 40 60 80 0 250 500 750 1,000 2019 2020F 2021F 2022F 2023F (%) (mn units) 5G smartphone shipments 5G smartphone penetration Qualcommest.: 450mn Qualcommest.: 750mn

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Figure 7. Qualcomm: 5G baseband shipment forecasts

Source: Strategy Analytics, Mirae Asset Daewoo Research

Figure 8. Snapdragon 845 die

Source: TechInsights, Mirae Asset Daewoo Research

Figure 9. Snapdragon 845 production: 540 dies per wafer (12”)

9.5mm

6 32 113 180 248 1 6 27 63 110 0 100 200 300 400 2019 2020F 2021F 2022F 2023F (mn units) SEC Qualcomm 140 243

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Nvidia: Ampere architecture rollout in 2020

One of the key events for SEC’s foundry business this year will be the start of mass production for Nvidia’s next-generation graphics processing units (GPUs) based on the new Ampere microarchitecture. After lengthy negotiations, SEC is believed to have taken mass production orders for the new GPUs, which Nvidia is set to showcase at the GPU Technology

Conference (GTC) scheduled for May 14th. While Ampere has been rumored to be designed

for the 7nm process, actual production is expected to take place on the 8nm node. Nvidia’s GPU dies are larger than those of SEC’s existing chips. For instance, the die size of Nvidia’s TU106 GPU (Turing) is 445mm2, around five times larger than that of the

Snapdragon 845 (91mm2). The upcoming Ampere chips are believed to feature a larger die

size than existing GPUs, given their sharply increased transistor count despite the use of the 7nm process.

A larger die size generally implies higher foundry capacity requirements. Accordingly, SEC will need to add capacity to handle mass production. Considering that larger chips suffer from greater wafer yield losses than smaller chips, successful production of Nvidia’s new GPU will help SEC establish a strong track record in large-sized chip mass production. We forecast SEC’s foundry revenue from Nvidia at W0.8tr in 2020 and W2.5tr in 2021.

Table 2. Nvidia GPU specifications

Name GK180 GM200 GP100 GV100 TU106 GA100 GA103 GA104

Architecture Kepler Maxwell Pascal Volta Turing Ampere Ampere Ampere Transistor count 7bn 8bn 15bn 21bn 11bn 30bn+ Approx. 22bn Approx. 16bn

Process 28nm 28nm 16nm FinFET+ 12nm FFN 12nm FFN 7nm 7nm 7nm

Die size 551mm2 601mm2 610mm2 815mm2 445mm2 Huge Big Moderate

Launch date 3Q20 3Q20 2021

Source: Nvidia, Mirae Asset Daewoo Research

Figure 10. Nvidia GPU (Turing) production: 62 dies per wafer (12”)

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AMD vs. Intel rivalry in 2022 and beyond

The CPU rivalry between Intel and AMD (AMD US/CP: US$55.47) is intensifying. In recent years, AMD has gained ground with its 7nm technology, while Intel has been held back by delays to the launch of its 10mn process and poor yields. The primary foundries with which AMD does business are TSMC (7nm) and GlobalFoundries (14nm+). With Intel already planning to migrate to 7nm due to poor 10nm yields, AMD will likely have to adopt 5nm to maintain competitiveness. According to recent press releases, AMD is aiming to kick off 5nm mass production in 2021, with TSMC handling manufacturing. Meanwhile, the company is likely to gradually replace its 14nm CPUs with 7nm CPUs, but this migration should prove complicated given GlobalFoundries’ abandonment of 7nm development. As such, in 2021, we believe that AMD will decide between: 1) relying solely on TSMC for chip manufacturing; or 2) choosing to partner with SEC. We believe that both options will be beneficial to SEC. Indeed, even though the first scenario will not directly benefit the Korean giant, it should be positive to overall supply/demand dynamics given the likely increase in capacity utilization on 7nm-or-below processes.

Figure 11. Intel’s manufacturing road map: 7nm CPUs in 2021

Source: Intel, Mirae Asset Daewoo Research

Figure 12. AMD’s CPU and GPU manufacturing road map: 7nm already in place

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All in all, we think there are three major factors that will affect SEC’s foundry demand in 2021 and beyond:

1) 5nm production for Qualcomm’s 5G modems and potential orders for 4nm fabrication 2) Successful mass production of Nvidia’s new Ampere GPU

3) Whether the company can displace GlobalFoundries to become one of AMD’s two primary 7nm-or-below manufacturing foundry partners

For 45nm+ processes, leading-edge capacity utilization is already high at major foundries (including SEC); this means that ramp-ups will be required to meet additional demand. Furthermore, Qualcomm, Nvidia, and AMD—all of which are growing increasingly reliant on SEC and/or TSMC—are forecast to report above-market revenue growth in the coming years. The three companies are projected to report combined growth of 19.0% in 2020 and 20.6% in 2021, while the other PHLX Semiconductor Sector Index constituents are anticipated to display growth of 6.3% and 10.2%, respectively.

Figure 13. Global foundry utilization: Leading-edge utilization for 45nm+ is near full capacity

Source: Gartner, Mirae Asset Daewoo Research

Figure 14. PHLX Semiconductor Sector Index constituents: Revenue and growth forecasts

Source: Thomson Reuters, Mirae Asset Daewoo Research

101.0 95.8 91.5 91.0 90.2 0 30 60 90 120 0 6,000 12,000 18,000 24,000 1Q17 3Q17 1Q18 3Q18 1Q19 3Q19 1Q20F 3Q20F (%) ('000 wafers) Capacity (L) Shipments (L)

Foundry utilization (R) Leading-edge utilization (R)

-30 0 30 60 90 0 100 200 300 400 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020F 2021F (%) (US$bn)

AMD (L) Nvidia (L) Qualcomm (L)

Other PHLX (L) Qualcomm YoY (R) Nvidia YoY (R) AMD YoY (R) Other PHLX YoY (R)

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Given the strong demand prospects, we anticipate that SEC’s foundry business, which is operating at near full capacity, will need additional capacity of 40,000 wpm in 2020. Fabs that are well positioned to add capacity include the S3, S4 (Line 11 for CMOS image sensors [CIS]), and S5 (EUV line).

In 2021, we project that SEC will need additional capacity of 50,000 wpm, which translates to capex of W9.2tr (+76.3% YoY). Among the firm’s facilities, we think the new P2 fab in Pyeongtaek is best positioned to add capacity. While others (P3 in Pyeongtaek and S2 in the US) could also be considered for expansion, we believe P2 will be first in line given its existing back-end infrastructure, etc.

Table 3. SEC: Foundry wafer capacity trends and forecasts (‘000 wpm)

Group Fab Site Wafer size Products 2016 2017 2018 2019 2020F 2021F

Legacy fab

Line 4 Giheung 150mm (6") LED 55 55 55 55 55 55 Line 5 Giheung 200mm (8") CIS, smart card IC 50 50 50 50 50 50 Line 6 Giheung 200mm (8") PMIC, DDI, CIS

RF/IoT, FPS

80 80 80 80 80 80

Line 7 Giheung 200mm (8") 70 70 70 70 70 70

S1

Line 8 Giheung 200mm (8")

Logic (AP, etc.), CIS

70 70 70 70 70 70 Line 14 Giheung 300mm (12") 45 45 45 45 45 45 Line S Giheung 300mm (12") 40 40 40 40 40 40 S2 SAS Austin 300mm (12") Logic (AP, etc.) 50 50 50 50 50 50 S3 Quarter of Line

17 Hwaseong 300mm (12") 7-10nm, EUV 0 3 18 20 30 40 S4 Line 11 Hwaseong 300mm (12") CIS 0 2 11 15 23 25 V1 EUV fab Hwaseong 300mm (12") 7nm or below (planned), EUV 0 0 0 0 23 30 New fab - - 300mm (12") 7nm or below (planned), EUV 0 0 0 0 1 19

Total wafer capacity (12" equiv.) 269 274 302 314 334 379

Source: Mirae Asset Daewoo Research estimates

Figure 15. SEC: Foundry capacity trend Figure 16. SEC: Foundry capex trend

Source: Company data, Mirae Asset Daewoo Research Source: Company data, Mirae Asset Daewoo Research

6.7 5.2 9.2 -100 0 100 200 300 0 3 5 8 10 2005 2007 2009 2011 2013 2015 2017 2019 2021F (%) (Wtr)

SEC foundry capex (L) YoY (R) 0 100 200 300 400 2008 2010 2012 2014 2016 2018 2020F Total capacity

Total capacity (12" equiv.) ('000 wafers)

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High visibility on ROIC for leading-edge foundry investments

We believe visibility on the ROIC outlook for SEC’s foundry investments is improving amid: 1) rising barriers to entry; and 2) signs of structural demand growth.

Our analysis of global pure semiconductor plays shows that memory manufacturers such as Micron and SK Hynix exhibit high ROIC volatility due to the cyclical nature of the memory industry and the high sensitivity of supply/demand dynamics to capex. In contrast, semiconductor manufacturers such as Intel and TSMC have generally managed to keep their ROIC steady at around 25%, as: 1) non-memory facility investments are unlikely to cause oversupply; and 2) the oligopolistic market structure ensures a high likelihood of capital recovery.

Going forward, SEC is likely to concentrate its capex in 7nm-or-below processes, where new competition is unlikely to emerge. As mentioned earlier in this report, we project that SEC will execute foundry capex of W9.2tr in 2021 to meet growing demand. We believe that once a consensus on the scale of capex is formed, the firm’s foundry investments will be priced into shares. Assuming SEC’s foundry ROIC matches TSMC’s level (23.5%), we believe that a valuation based on TSMC’s multiple (18x P/E) will be warranted. This would add roughly W40tr (18x W2.2tr) to SEC’s market cap.

Figure 17. ROIC by semiconductor manufacturer

Source: Thomson Reuters, Mirae Asset Daewoo Research

Figure 18. TSMC: 12-month-forward P/E

Source: Thomson Reuters, Mirae Asset Daewoo Research

18.0 0 6 12 18 24 1/15 10/15 7/16 4/17 1/18 10/18 7/19 4/20 (x) Avg. since 2019:18.0x -50 -25 0 25 50 1Q10 1Q11 1Q12 1Q13 1Q14 1Q15 1Q16 1Q17 1Q18 1Q19 (%)

SEC SK Hynix TSMC Micron

SMIC UMC Intel

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We believe the case of TSMC illustrates how the market reflects capex into share price. The foundry player’s 12-month-forward P/E—which gradually rose from an average of 13x in 2016 to 15x in 2017 and 16x in 2018—displayed its sharpest rise ever in 2019. Indeed, while 2020-21 earnings forecasts were left virtually unchanged last year, the stock’s valuation increased by 20%.

We believe the re-rating was driven by capex outlook upgrades rather than by earnings forecasts. While earnings projections stayed flat, market expectations for TSMC’s 2020 capex were revised upward by 30% in the second half of 2019. As a consensus formed that the firm’s investments would translate safely into earnings, upward revisions to capex projections were accompanied by market value expansion. Like TSMC, we expect SEC to see a valuation re-rating driven by a promising foundry investment outlook.

Figure 19. TSMC: Quarterly capex Figure 20. TSMC: Quarterly OP

Source: Thomson Reuters, Mirae Asset Daewoo Research Source: Thomson Reuters, Mirae Asset Daewoo Research

Figure 21. TSMC: 12-month-forward P/E Figure 22. TSMC: OP and capex consensus throughout 2019

Source: Thomson Reuters, Mirae Asset Daewoo Research Source: Thomson Reuters, Mirae Asset Daewoo Research 0.0 1.5 3.0 4.5 6.0 1Q15 1Q16 1Q17 1Q18 1Q19 1Q20F 1Q21F (US$bn) 0.0 1.5 3.0 4.5 6.0 1Q15 1Q16 1Q17 1Q18 1Q19 1Q20F 1Q21F (US$bn) 9 12 15 18 21 1/19 3/19 5/19 7/19 9/19 11/19 (US$bn) 2020F OP 2021F OP 2020F capex 16.3 20.8 12.9 14.6 15.9 18.0 10 13 16 19 22 1/16 7/16 1/17 7/17 1/18 7/18 1/19 7/19 (x)

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Point II: Lower DRAM investments Structural earnings growth

We expect SEC to remain conservative on DRAM investments, in light of the following factors:

1) The firm needs to channel resources to its foundry business. Against this backdrop, we believe that SEC is likely to remain conservative on DRAM investments to keep semiconductor capex at an appropriate level relative to EBITDA.

2) Conservative DRAM investments will help stabilize DRAM prices. DRAM industry growth is driven by price increases rather than by bit growth. When the demand outlook is subdued (as it is currently), price stability, not shipment growth, holds the key to maximizing market share gains and margins.

3) Even if SEC makes aggressive capital investments to increase its market share, well-financed rivals are likely to follow suit. We believe aggressive DRAM capex is more likely to cause DRAM price declines than to bring about the desired result.

All in all, SEC’s conservative DRAM investments should help keep DRAM prices steady, leading to sequential earnings growth and the opening of a structural growth phase. For 2020, we estimate that the firm will execute W7.2tr (-11.1% YoY) in DRAM capex (or wafer capacity additions of 40,000 wpm), and that DRAM ASP will continuously increase, driving quarterly earnings growth.

Figure 23. SEC: DRAM capex trend Figure 24. SEC: DRAM wafer capacity trends

Source: Company data, Mirae Asset Daewoo Research Source: Company data, Mirae Asset Daewoo Research

Figure 25. SEC: DRAM ASP trend Figure 26. SEC: DRAM revenue and OP forecasts

13.7 8.1 7.2 7.8 -100 0 100 200 300 0 4 8 12 16 2005 2008 2011 2014 2017 2020F (%) (Wtr) SEC DRAM capex (L)

YoY (R) -30 -15 0 15 30 1Q14 1Q15 1Q16 1Q17 1Q18 1Q19 1Q20P 1Q21F (%) 32.2 53.0 0 20 40 60 80 0 4,000 8,000 12,000 16,000 1Q16 1Q17 1Q18 1Q19 1Q20P 1Q21F (%) (Wbn) Revenue (L) OP (L) OP margin (R) 40 60 15 21 -15 14 39 30 -19 30 -100 -50 0 50 100 2014 2015 2016 2017 2018 2019 2020F 2021F Increase Decrease Avg. capacity chg. ('000 wpm)

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Rationale behind our conservative DRAM capex outlook: 1) SEC needs to make room for foundry capex

As we highlighted in our first investment point, SEC needs to significantly increase its foundry capex in 2021. However, the foundry business does not yet generate sufficient EBITDA to fund the required capex. We estimate foundry capex executed in 2017 and 2019 was equivalent to more than 150% of the EBITDA generated in each respective year. In our view, SEC needs to secure sufficient funds for investment within the semiconductor business, while also striking a balance between EBITDA and capex. We believe the semiconductor division’s overall capex has never once exceeded 70% of EBITDA since 2014. We think conservative spending on DRAM is a sensible move from this perspective. More disciplined DRAM capex would allow SEC to generate stable profits (rather than expand market share) and dedicate more resources to the foundry business. After expanding capacity through aggressive capex in the past, TSMC has now entered a virtuous cycle, in which the company is making stable profits from its facilities following the end of depreciation, which is, in turn, leaving more room for investments in advanced processes. Similarly, we believe the DRAM business can serve as a cash cow for SEC. In 2020-21, we forecast DRAM capex to be W15.0tr. We expect DRAM EBITDA to be around W52.2tr. Even after taking into account foundry capex of W14.6tr, this should still be enough to keep the semiconductor division’s overall EBITDA/capex ratio at 50.0%, in line with the level seen during the 2018 memory up cycle.

Figure 27. SEC: Foundry EBITDA and capex Figure 28. SEC: Semiconductor EBITDA and capex

Source: Company data, Mirae Asset Daewoo Research Source: Company data, Mirae Asset Daewoo Research

Figure 29. SEC: DRAM EBITDA and capex Figure 30. TSMC: EBITDA and capex

161.7 93.8 56.3 150.8 61.4 132.5 80.1 99.4 0 50 100 150 200 0 2,500 5,000 7,500 10,000 2014 2015 2016 2017 2018 2019 2020F 2021F (%) (Wbn) Foundry EBITDA Foundry capex Capex/EBITDA 68.7 54.5 47.3 55.0 38.2 68.3 50.3 50.0 0 25 50 75 100 0 20,000 40,000 60,000 80,000 2014 2015 2016 2017 2018 2019 2020F 2021F (%) (Wbn) Total semiconductor EBITDA

Total semiconductor capex Capex/EBITDA 39.2 34.5 24.3 33.8 40.0 31.3 26.6 0 15 30 45 60 0 12,000 24,000 36,000 48,000 2014 2015 2016 2017 2018 2019 2020F 2021F (%) (Wbn) DRAM EBITDA DRAM capex Capex/EBITDA 75.7 85.7 78.8 79.3 58.8 48.0 55.2 51.8 47.6 71.1 60.0 0 25 50 75 100 0 8 16 24 32 10 11 12 13 14 15 16 17 18 19 20F (%) (US$bn) TSMC capex TSMC EBITDA Capex/EBITDA

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Rationale behind our conservative DRAM capex outlook: 2) SEC needs to keep DRAM prices stable

DRAM revenue and profit growth move in line with price changes. It is safe to say that during the past decade, DRAM revenue and profits have never increased during periods of price decline. Unlike the NAND market, whether DRAM revenue and profits grow is determined by whether ASP is rising or falling (not by the price elasticity of shipments), with bit growth largely fixed.

That said, aggressive pricing strategies do work during down cycles. In 2016 and 2019, SEC was able to either expand or maintain its market share (45.3% 48.0% in 2016; 43.9% 43.7% in 2019) by employing an aggressive bit growth strategy. During these years, operating profit across the DRAM industry declined 30.7% and 66.6%, respectively, but SEC’s share of overall profits increased from 58.3% to 68.8% and from 47.9% to 52.0%, respectively. In other words, the company’s strategy of overcoming market downturns through preemptive inventory depletion has worked well.

However, the DRAM cycle is set to undergo a recovery from 2020. In this case, maintaining stable prices is likely to take priority over aggressive spending or shipments. Due to SEC’s conservative capex stance, we expect quarterly ASP to move up in 2020. The uptrend in ASP should continue through 2021, driving strong profit growth. We forecast SEC’s DRAM operating profit to grow 12.1% to W13.5tr in 2020 and 55.1% to W21.0tr in 2021.

Figure 31. Global DRAM ASP, bit, revenue, and OP growth

Source: DRAMeXchange, Mirae Asset Daewoo Research estimates

Figure 32. SEC: DRAM ASP, bit, revenue, and OP growth

-49.9 -29.8 2.3 -0.9 -20.0 -27.0 47.1 14.8 -46.7 50.4 28.6 26.6 34.1 22.8 23.7 19.9 21.0 19.0 -80 0 80 160 240 2011 2012 2013 2014 2015 2016 2017 2018 2019

(%) ASP chg. Bit growth Sales growth OP growth

2011-12 Industry-wide losses -45.8 -29.3 -6.3 -5.0 -17.5 -29.7 48.2 19.5 -49.2 -9.1 3.9 49.8 27.1 25.8 54.1 30.1 35.8 14.7 12.3 23.1 16.7 21.1 -80 0 80 160 240 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020F 2021F (%)

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Figure 33. Global DRAM: M/S by revenue

Source: DRAMeXchange, Mirae Asset Daewoo Research estimates

Figure 34. Global DRAM: M/S by OP

Source: DRAMeXchange, Mirae Asset Daewoo Research estimates

Figure 35. Global DRAM: OP trends

Note: OP growth figures for 2011 and 2012 represent chg. in the sum of profits, excluding operating losses. Source: DRAMeXchange, Mirae Asset Daewoo Research estimates

72.1 59.8 99.7 100.0 50.9 47.0 58.3 68.8 51.4 47.9 52.0 27.9 24.1 34.5 30.5 28.5 25.2 28.9 29.1 25.1 7.5 12.8 18.6 10.6 3.6 18.1 20.9 21.5 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 Nanya Powerchip ProMOS Elpida Micron SK Hynix SEC 72.1 59.8 99.7 100.0 50.9 47.0 58.3 68.8 51.4 47.9 52.0 0 25 50 75 100 -25 0 25 50 75 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 (%) (Wtr) Nanya Powerchip ProMOS Elpida Micron SK Hynix

SEC SEC OP share (R)

-30.7% -66.6% -71.9% -41.9% 33.3 36.9 42.3 40.9 36.7 39.6 45.3 48.0 45.8 43.9 43.7 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 Other Nanya Powerchip ProMOS Elpida Micron SK Hynix SEC

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Rationale behind our conservative DRAM capex outlook: 3) Competitors to follow suit

If SEC were to execute capex exceeding demand in order to expand its market share, its competitors would most likely follow suit. SK Hynix has room for an additional 20,000 wpm at its C2E fab in Wuxi, China, and is set to complete construction of its M16 fab (designed capacity of around 100,000 wpm). Micron is also likely to complete expansion of its Taichung fab in Taiwan and its Hiroshima fab in Japan by the end of the year. As such, DRAM makers are well-positioned to increase capacity swiftly if necessary. And considering that they differ very little in terms of cost competitiveness, any competition to expand capacity would likely only lead to price declines, rather than market share gains. As such, we expect SEC to focus its investments on bolstering its cost competitiveness.

Until early this year, many expected SEC to pursue aggressive DRAM capex as part of its efforts to widen its lead over rivals. During past periods of rapid growth, all DRAM makers vied for market share gains via capacity additions. But with the market now stable and controlled by a handful of players, aggressive capex would be a recipe for losses rather than market share gains. As such, we believe mega-fabs represent the best strategy, and one that is already adopted by all DRAM makers. By maintaining sufficient room in such facilities for potential lines and clean rooms, companies can expand capacity flexibly depending on market conditions, thus preventing unnecessary capex spending based on excessive projections.

Figure 36. SEC: DRAM breakdown by tech node (%) Figure 37. SK Hynix: DRAM breakdown by tech node (%)

Source: DRAMeXchange, Mirae Asset Daewoo Research Source: DRAMeXchange, Mirae Asset Daewoo Research

Figure 38. Micron: DRAM breakdown by tech node (%) Figure 39. Avg. tech node factors of major DRAM makers

15 20 25 30 35 0 25 50 75 100 1Q14 1Q15 1Q16 1Q17 1Q18 1Q19 1Q20 Average tech node factor (R)

1Znm 1Ynm 1Xnm 20nm 23nm 25nm 35nm 15 20 25 30 35 0 25 50 75 100 1Q14 1Q15 1Q16 1Q17 1Q18 1Q19 1Q20 Average tech node factor (R) 1Znm

1Ynm 1Xnm 21nm 25m 29nm 38nm 15 20 25 30 35 0 25 50 75 100 1Q14 1Q15 1Q16 1Q17 1Q18 1Q19 1Q20 Average tech node factor (R)

1Znm 1Ynm 1Xnm 20nm 25m 30nm 15 20 25 30 35 1Q14 1Q15 1Q16 1Q17 1Q18 1Q19 1Q20 (nm) SEC SK Hynix Micron

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Point III: NAND market share expansion to boost earnings

We expect SEC’s NAND capex to far exceed the market average for several reasons.

First, competitors’ poor earnings leave them with minimal financial room for investments. In 1Q20, most NAND suppliers, with the exception of SEC, recorded losses. In 2016, a pickup in NAND prices improved margins across the industry, triggering massive capacity expansions. However, the resulting oversupply drove down SEC’s NAND margins to near breakeven in 2019. We do not expect this situation to recur.

Second, massive NAND capex can stimulate demand. Unlike in the DRAM market, where growth has been driven by steady price increases, a major driver of NAND market growth has been the demand stimulated by persistent price declines (given NAND’s nature as a substitute good). In 2017, however, NAND prices climbed sharply on supply shortages, slowing the growth of NAND content in client solid-state drives (SSDs). In 2018, prices started to fall again, leading to higher sales volume and content. With the price elasticity of NAND confirmed, we expect SEC to pursue a bit growth-oriented strategy for client SSDs. As such, we expect SEC to continue to execute massive capex and enjoy a dominant earnings share in the NAND market. In 2020, we expect SEC’s NAND capex to come in at W8.8tr, equivalent to 90,000 wpm.

Figure 40. SEC: NAND capex forecasts Figure 41. SEC: NAND wafer capacity forecasts

Source: Company data, Mirae Asset Daewoo Research Source: Company data, Mirae Asset Daewoo Research

Figure 42. SEC: NAND ASP chg. Figure 43. SEC: NAND revenue and OP forecasts

Source: Mirae Asset Daewoo Research Source: Company data, Mirae Asset Daewoo Research

7.0 7.8 8.8 9.7 -100 0 100 200 300 0 4 8 12 16 2005 2008 2011 2014 2017 2020F (%) (Wtr)

SEC NAND capex (L) YoY (R) -30 -15 0 15 30 1Q14 1Q15 1Q16 1Q17 1Q18 1Q19 1Q20P 1Q21F (%) 20.5 22.4 -20 0 20 40 60 -4,000 0 4,000 8,000 12,000 1Q16 1Q17 1Q18 1Q19 1Q20P 1Q21F (%) (Wbn) Revenue (L) OP (L) OP margin (R) 90 100 18 40 41 47 11 -30 23 80 -120 -60 0 60 120 2014 2015 2016 2017 2018 2019 2020F 2021F Increase Decrease Avg. capacity chg. ('000 wpm)

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Rationale behind our aggressive NAND capex outlook: 1) Revisit previous cycle

In 1Q20, margins dipped below breakeven for all NAND makers except SEC, which recorded an OP margin at the low-20% level. The firm accounted for more than 90% of overall NAND market profits in the quarter. As SEC will likely strive to maintain its current profit share and margin levels, we believe it will continue to execute capex in line with demand growth. We believe NAND makers’ 2016-18 capex strategy is worth revisiting. NAND ASP/GB, which had declined continuously from 1Q10, picked up in 2H16 on wafer capacity shortages arising from the conversion to 3D NAND. At that time, both first-tier (including SEC) and second-tier NAND suppliers enjoyed high margins. Amid high margins and optimistic demand forecasts, NAND makers executed aggressive capex.

Although SEC’s NAND capex spending in 2017 was the largest in the industry, its 2018 capex accounted for only 30% of overall market spending. Thus, the firm displayed below-industry NAND wafer capacity growth and bit growth in 2017-18. In 2018, prices plunged due to oversupply stemming from aggressive shipments by chipmakers, driving down NAND makers’ profits to near or below break-even levels. Of note, the easing of the oversupply seen in 2019 was mainly driven not by demand growth, but by reduced supply caused by Toshiba Memory’s power outage.

As the NAND market is still not fully concentrated, we think SEC is highly likely to aggressively ramp up its NAND capex going forward, setting the stage for another game of chicken among NAND makers. We see NAND prices stabilizing from 2H20 amid a slowdown in price growth. With upside to NAND prices likely limited, we believe only players capable of reducing costs will benefit. All in all, we expect SEC to maintain its leading position in the NAND space (in terms of capex and operating profit) for some time.

Figure 44. Global NAND makers: OP margin trends Figure 45. SEC: NAND capex trend

Source: Company data, Thomson Reuters, Mirae Asset Daewoo Research Source: Company data, Mirae Asset Daewoo Research -80 -40 0 40 80 1Q11 1Q12 1Q13 1Q14 1Q15 1Q16 1Q17 1Q18 1Q19 (%) SEC SK Hynix Micron Intel Toshiba 7.0 7.8 8.8 9.7 -100 0 100 200 300 0 4 8 12 16 2005 2008 2011 2014 2017 2020F (%) (Wtr)

SEC NAND capex (L) YoY (R)

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Figure 46. Global NAND makers: Capex trends

Source: DRAMeXchange, Mirae Asset Daewoo Research

Figure 47. Global NAND makers: Bit growth trends

Source: DRAMeXchange, Mirae Asset Daewoo Research

Figure 48. Global NAND M/S breakdown in terms of OP

Source: Company data, Mirae Asset Daewoo Research

36.6 45.8 38.4 37.3 44.3 59.3 48.3 46.4 95.5 0% 25% 50% 75% 100% 2011 2012 2013 2014 2015 2016 2017 2018 2019 Toshiba Intel Micron SK Hynix SEC 67.5 26.6 33.4 48.1 24.7 42.7 49.9 34.6 41.6 45.4 29.0 40.3 0 20 40 60 80 2016 2017 2018 2019 2020 2021

(%) SEC Kioxia (Toshiba Memory) Western Digital Micron SK Hynix Total 30.4 0 15 30 45 60 0 8,000 16,000 24,000 32,000 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 (%) (US$mn) Intel Micron Toshiba/SanDisk SK Hynix SEC

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Rationale behind our aggressive NAND capex outlook: 2) Higher client SSD demand needed

DRAM market growth has been driven mainly by steady price increases. In contrast, a major driver of NAND market growth has been the demand stimulated by persistent price declines, given the nature of NAND (SSDs) as a substitute good for hard disk drives (HDDs). Indeed, NAND ASP/GB has been trending downward since 2007, supporting continuous bit growth.

In 2017, however, the spike in NAND prices caused by supply shortages crippled growth in SSD penetration and content in PCs. From 2012 to 2016, overall NAND market bit growth averaged 48.2%, with ASP declining 27.2% annually. In 2017, bit growth slowed to 35.7%, while ASP climbed 36.9%.

As for enterprise SSDs, bit growth improved to 63.8% in 2017 on the back of stronger demand for cloud SSDs, even though prices (ASP/GB) declined at a much slower rate of around 5%. We believe enterprise SSD bit growth was more affected by server-class SSDs— which benefited from robust server demand—than by storage-class SSDs (HDD substitute). For mobile NAND, content per device expanded 56% YoY in 2017 even though mobile NAND ASP increased 24.5% YoY. To sum up, for both enterprise SSDs and mobile NAND, the expansion of applications had a greater impact on bit growth than price changes.

For client SSDs, sales volume and content per PC increased at CAGRs of 27% and 13%, respectively, from 2012 to 2016. In 2017, these growth rates slowed to 7.6% and 3%, respectively, as ASP increased 16% YoY. In 2018, prices started to fall again, leading to higher sales volume and content. With client SSDs’ relatively high price elasticity confirmed, we expect SEC to pursue a bit growth-oriented strategy for client SSDs.

Indeed, we see limited upside to top-line growth of the PC SSD market going forward, as SSDs are already used in a significant portion of consumer PCs. Going forward, we think a major factor in the market’s growth is highly likely to be the content per unit trend.

For consumer PCs, average SSD content per unit stands at just 351GB, much lower than the average HDD content range of 1.1TB (2.5”)-2.3TB (3.5”). Going forward, we expect storage capacity of 1TB+ to become the status quo for consumer PCs. With average spending on storage capacity per PC likely to remain flattish, we forecast average SDD content per PC to expand to the level of HDD content in line with SSD price declines.

Figure 49. NAND flash: Bit, sales, and ASP growth

Source: DRAMeXchange, Mirae Asset Daewoo Research -57.0 -62.5 -32.1 -15.1 -30.7 -41.1 -18.1 -26.5 -27.6 -22.6 36.9 -23.5 -43.5 151.2 117.7 68.5 77.4 67.7 58.4 45.3 39.8 46.3 51.4 35.7 44.9 31.7 -80 0 80 160 240 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 (%)

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Figure 50. Enterprise SSDs: Bit, sales, and ASP growth

Source: Gartner, Mirae Asset Daewoo Research

Figure 51. Storage-class enterprise SSDs: Bit, sales, and ASP growth

Figure 52. Server-class enterprise SSDs: Bit, sales, and ASP growth

Source: Gartner, Mirae Asset Daewoo Research Source: Gartner, Mirae Asset Daewoo Research

Figure 53. Client SSDs: Sales volume and content per PC Figure 54. Client SSDs: Content per PC trend

Source: Gartner, Mirae Asset Daewoo Research Source: Gartner, Mirae Asset Daewoo Research 111.3 82.7 41.4 63.8 76.6 27.4 41.8 51.9 -38 -40 -6 -5 -35 -50 26 -17 62.6 30.0 32.8 37.4 15.3 12.5 10.5 10.3 -60 0 60 120 180 2014 2015 2016 2017 2018 2019 2020F 2021F

(%) Enterprise SSD bit growth Enterprise SSD ASP chg. Enterprise SSD unit growth

50 -1 11 -100 0 100 200 300 2013 2014 2015 2016 2017 2018 2019 2020F 2021F (%) PB chg. ASP/GB chg. Unit growth

70 -6 44 -100 0 100 200 300 2013 2014 2015 2016 2017 2018 2019 2020F 2021F (%) PB chg. ASP/GB chg. Unit growth

13.3 18.8 26.7 29.3 37.2 51.4 59.4 67.7 7.6 46.1 7.2 0 20 40 60 80 0 150 300 450 600 2014 2016 2018 2020E (%) (mn units) PC SSD (L) PC HDD (L)

PC SSD penetration (R) PC SSD unit growth(R)

351 10.4 14.4 12.8 3.0 5.6 14.0 28.3 15.0 0 8 16 24 32 0 150 300 450 600 2014 2016 2018 2020E (%, YoY) (GB) Mainstream PC SSD content/unit (L)

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Figure 55. Mobile storage (eMMC MLC) spot price trend

Source: TrendForce, Mirae Asset Daewoo Research

Figure 56. Mobile storage (eMMC, TLC) spot price trend

Source: TrendForce, Mirae Asset Daewoo Research

Figure 57. Smartphone NAND content per unit trend

Source: IDC, Mirae Asset Daewoo Research 56.0 0 15 30 45 60 0 50 100 150 200 2015 2016 2017 2018 2019 2020F 2021F (%) (GB)

Smartphone NAND content/unit (L) YoY growth (R) -4.3 -7.5 -5.2 -8.9 -6.4 -12.5 -5.8 3.9 6.4 15.8 4.1 1.5 1.6 1.8 -1.4 -6.9 -10.7 -16.9 -16.1 -6.6 6.2 5.6 4.8 -30 -15 0 15 30 0.00 0.15 0.30 0.45 0.60 4Q14 3Q15 2Q16 1Q17 4Q17 3Q18 2Q19 1Q20 (%) (US$/GB) eMMC MLC QoQ (R) eMMC MLC price (1GB equiv., L)

-18.1 -7.5 3.8 9.4 17.2 4.7 0.3 1.9 -1.6 -2.1 -5.2 -12.1 -22.5 -17.4 -6.0 0.5 5.1 3.0 -30 -15 0 15 30 0.00 0.10 0.20 0.30 0.40 1Q16 3Q16 1Q17 3Q17 1Q18 3Q18 1Q19 3Q19 1Q20 (%) (US$/GB) eMMC TLC QoQ (R) eMMC TLC price (1GB equiv., L)

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II. Outlook and earnings forecasts by division

Key assumptions for IT product demand forecasts

Given the pace of the COVID-19 spread and the growth of new cases by country, we expect China to be the first market to see a recovery in IT product demand, followed by the US/Europe and then India. All in all, our base-case scenario assumes an 8.3% YoY decline in global smartphone demand and a 15.8% increase in global server demand in 2020.

For smartphone shipment volume, we formulated three scenarios according to the severity of negative growth in 2Q20 and the extent of demand recovery in 2H20. Our base-case scenario has smartphone demand: 1) declining at a slower pace QoQ in 2Q20; 2) making a full-fledged QoQ recovery in 3Q20; 3) and return to the previous year’s levels in 4Q20. Under our worst-case scenario, which assumes sharper-than-expected contraction in the US and Europe in 2Q20, demand would continue to decline YoY and fail to recover to the previous year’s levels in 4Q20.

Table 4. Smartphone shipment scenario analysis (mn units, %)

1Q20F 2Q20F 3Q20F 4Q20F 2019 2020F 2021F Base case 278 272 336 372 1,372 1,258 1,403 Bear case 278 265 322 370 1,372 1,235 1,287 Worst case 278 255 305 351 1,372 1,189 1,254 YoY Base case -11.0 -18.1 -6.2 0.7 -2.2 -8.3 11.6 Bear case -11.0 -20.0 -10.0 0.0 -2.2 -10.0 4.2 Worst case -11.0 -23.0 -15.0 -5.0 -2.2 -13.3 5.5 QoQ Base case -24.9 -2.3 23.7 10.8 Bear case -24.9 -4.6 21.6 14.7 Worst case -24.9 -8.1 19.3 15.3

Source: Mirae Asset Daewoo Research

For server shipment volume, we created two scenarios based on server replacement cycle length and regional COVID-19 impact. In our analysis, we assumed ODM direct servers to be more sensitive to changes in the replacement cycle due to their high exposure to cloud infrastructure. That said, given that ODM direct servers account for just a small slice of the total pie, we believe structural growth of the server market hinges on hyperscale capex. We note that our bear-case scenario reflects the possibility of disruptions in server shipments/installations in the US and Europe.

Table 5. Server shipment scenario analysis (mn units, %)

1Q20F 2Q20F 3Q20F 4Q20F 2019 2020F 2021F Base case 2,980 3,131 3,165 3,262 10,827 12,538 12,704 Bear case 2,980 2,952 2,985 3,076 10,827 11,993 12,704 YoY Base case 25.1 27.2 11.6 3.7 -1.5 15.8 1.3 Bear case 25.1 19.9 5.2 -2.2 -1.5 10.8 5.9 QoQ Base case -5.3 5.1 1.1 3.1 Bear case -5.3 -0.9 1.1 3.1

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1) Smartphone shipment outlook and key assumptions

No consensus has formed among market researchers regarding the real impact of COVID-19 on IT demand. While it appears clear that smartphone shipments posted a quarterly decline in the mid-20% range in 1Q20, there are diverging views on: 1) the pace of shipment declines in 2Q20; and 2) the likelihood of a release of pent-up demand in 2H20.

The spread of COVID-19 began to accelerate around the world (beyond China) in March, and social distancing has been implemented globally since April, dampening consumer sentiment. Given the cases of China and Korea, where infections peaked two months after the first cases emerged, we project that smartphone demand will fall off a cliff during the first two months of 2Q20 before beginning to stabilize..

Our projections also assume that smartphone shipment volume will decline only 6.2% YoY and expand more than 20% QoQ, supported by the release of pent-up demand, in 3Q20. Accordingly, our base-case scenario projects full-year shipment volume to decline 8.3% YoY (or 110mn units) to 1.26bn units in 2020 and increase 11.6% YoY to 1.4bn units in 2021, matching 2019 levels.

Figure 58. Global smartphone shipment scenario (quarterly)

Source: IDC, Counterpoint, Mirae Asset Daewoo Research

Figure 59. Global smartphone shipment scenario (annual)

Source: IDC, Counterpoint, Mirae Asset Daewoo Research

-40 -20 0 20 40 0 120 240 360 480 1Q19 2Q19 3Q19 4Q19 1Q20F 2Q20F 3Q20F 4Q20F 1Q21F 2Q21F 3Q21F 4Q21F (%) (mn units) Base case (U-shaped recovery, L) Bear case (L)

Worst case (L) Base case YoY (R) Bear case YoY (R) Worst case YoY (R)

12.6 14.0 13.7 12.4 12.9 11.9 12.5 -20 -10 0 10 20 8 10 12 14 16 2016 2017 2018 2019 2020F 2021F (%) (mn units) Base case (U-shaped recovery, L) Bear case (L)

Worst case (L) Base case YoY (R) Bear case YoY (R) Worst case YoY (R)

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In formulating our base-case scenario, we approached the recovery outlook from a top-down perspective (by country/market) as the collapse in global demand has rendered distinctions among brands less relevant. Once demand recovers, we expect smartphone shipment volume to exhibit the strongest quarterly growth in recent years. We estimate that shipment volume, after falling 24-39% QoQ across the globe in 1Q20, will display a 20-25% QoQ bounce in China in 2Q20 and then start to recover in in the US/Europe from 3Q20. For India, we project shipment volume to decline around 20% QoQ in 2Q20 and begin to recover from 3Q20. Despite clear differences in marketing resources/capabilities, we believe that individual companies’ recoveries are unlikely to diverge significantly from the pace of market shipment growth. Accordingly, we assume market share levels will remain largely unchanged from the pre-COVID-19 levels.

By region, Apple (AAPL US/CP: US$313.14) holds meaningful market share in the US (44.2%, based on 2019 data), Europe (19.6%), and China (8.9%). Meanwhile, SEC has a significant presence in the US (22.7%), Europe (34.0%), and India (20.3%). Against this backdrop, we believe that SEC and Apple stand to see similar rebounds in the US and European markets (to which they both have significant exposure). However, given the exposure gaps in China and India, we expect Apple to exhibit a faster recovery in shipment volume than SEC, as China is likely to see a faster YoY recovery than India (3Q20 vs. 4Q20).

Figure 60. Smartphone shipment volume forecasts by region

Source: IDC, Counterpoint, Mirae Asset Daewoo Research

Figure 61. Smartphone market breakdown by region (2019)

Source: IDC, Mirae Asset Daewoo Research

-60 -40 -20 0 20 40 0 120 240 360 480 1Q18 2Q18 3Q18 4Q18 1Q19 2Q19 3Q19 4Q19 1Q20F 2Q20F 3Q20F 4Q20F (%) (mn units) Europe (L) US (L) India (L) China (L)

Other (L) China QoQ (R) India QoQ (R) US QoQ (R)

8.9 44.2 19.6 20.3 22.7 34.0 38.3 23.2 10.9 28.6 9.0 17.1 10.7 0.7 18.1 15.6 6.5 23.8 33.0 13.5

China India US Europe

(%) Other Vivo Oppo Xiaomi Huawei SEC Apple

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According to Counterpoint Research, SEC’s global smartphone sales volume contracted 20.8% QoQ in March 2020 (based on cumulative sell-through), worsening from a 9.9% decline one year prior. We estimate that the firm’s sales volume did not decline sharply YoY until March, when the impact of COVID-19 began to be felt in earnest.

In the US, SEC’s sales volume fell 16.4% QoQ, outperforming the overall market (-33.3% QoQ). We believe the firm fared similarly well in Europe. However, the firm’s sales volume plunged 42.2% QoQ in India, one of its key markets, faring worse compared to the same period last year (-27.2% QoQ in 1Q19) and the overall Indian market (-38.8% QoQ).

By region, Europe accounts for 23.6% (as of 2019) of SEC’s sales volume, the US 12.1%, and India 7.4% We estimate the firm’s smartphone shipment volume in Europe dropped 31.6% QoQ in 1Q20, with negative growth likely to continue in 2Q20, albeit at a slower pace (aided by the absence of the weak seasonality seen in 1Q20). We expect the firm’s shipment volume to recover QoQ in 3Q20 and achieve positive YoY growth in 4Q20. Accordingly, we estimate SEC’s annual smartphone shipment volume will reach 246mn units (-16.9% YoY) in 2020 and 271 mn units (+10.1% YoY) in 2021.

By region, the US accounts for 44.2% (as of 2019) of Apple’s sales, Europe 19.6%, and China 8.9%. We estimate that Apple’s US smartphone shipment volume declined 33.3% QoQ in 1Q20, with negative growth likely to continue in in 2Q20. However, given the likelihood of a slowdown in negative shipment growth in the US and high exposure to China, which is ahead of the pandemic curve, we project that Apple’s global smartphone shipment volume will expand 6.8%QoQ in 2Q20 and 7.0% YoY in 2020.

The resilient outlook for Apple is due to the fact that 1Q, which marked the peak of the COVID-19 outbreak, is an off-peak period for Apple in terms of shipments. Indeed, while Apple’s smartphone shipment volume declined 37.5% QoQ (sell-through basis) in 1Q20, this figure is largely in line with the average 1Q decline of 34.3% QoQ (sell-in basis) between 2017 and 2019. Even after accounting for the sell-through/sell-in difference, we believe there remains a possibility that Apple could achieve YoY shipment growth in 2020.

For reference, our base-case scenario is premised on: 1) a significant slowdown in negative QoQ growth in 2Q20; and 2) a swing to positive QoQ growth in 3Q20 onward, which should lead to flattish YoY growth in 4Q20.

However, if the decline in shipment growth is sharper than expected in 2Q20, there is a possibility of demand failing to recover to the previous year’s level in 4Q20. Under this worst-case scenario, we assume smartphone shipment volume will decline 13.3% YoY (or 180mn units) in 2020 and increase only 5.5% YoY in 2021, failing to reach the 2019 level for two consecutive years.

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Figure 62. Apple: Smartphone shipments by region Figure 63. SEC: Smartphone shipments by region

Source: IDC, Mirae Asset Daewoo Research Source: IDC, Mirae Asset Daewoo Research

Figure 64. Huawei: Smartphone shipments by region Figure 65. Xiaomi: Smartphone shipments by region

Source: IDC, Mirae Asset Daewoo Research Source: IDC, Mirae Asset Daewoo Research

Figure 66. Annual smartphone shipment outlook

Source: IDC, Mirae Asset Daewoo Research 0 10 20 30 40 0 70 140 210 280 2015 2016 2017 2018 2019 2020F (%) (mn units) Other (L) Europe (L)

US (L) China (L)

China share (R) US share (R) Europe share (R) 0 5 10 15 20 25 30 0 100 200 300 400 2015 2016 2017 2018 2019 2020F (%) (mn units) Other (L) Europe (L)

India (L) US (L)

China (L) US share (R) India share (R) Europe share (R)

0 20 40 60 80 0 80 160 240 320 2015 2016 2017 2018 2019 2020F (%) (mn units) Other (L) Europe (L)

India (L) US (L) China (L) China share (R) Europe share (R) 0 25 50 75 100 0 35 70 105 140 2015 2016 2017 2018 2019 2020F (%) (mn units) Other (L) Europe (L)

India (L) US (L)

China (L) China share (R) India share (R) Europe share (R)

311 318 292 296 246 271 215 216 209 191 204 209 139 154 206 241 206 245 53 93 119 126 104 126 100 112 113 114 112 131 77 88 101 110 99 116 0 400 800 1,200 1,600 2016 2017 2018 2019 2020F 2021F (mn units) Other Vivo Oppo Xiaomi Huawei Apple SEC

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Table 6. Smartphone shipment volume: Key assumptions and scenarios (mn units, %) Scenario Manufacturer 1Q19 2Q19 3Q19 4Q19 1Q20F 2Q20F 3Q20F 4Q20F 2019 2020F 2021F Base case SEC 72 76 78 70 58 51 63 74 296 246 271 Apple 37 34 47 74 43 46 53 62 191 204 209 Huawei 59 59 67 56 42 46 58 60 241 206 245 Xiaomi 28 32 33 33 23 22 27 31 126 104 126 Oppo 23 30 31 31 24 25 31 32 114 112 131 Vivo 23 28 30 28 21 22 28 29 110 99 116 Other 70 73 73 79 68 60 75 84 295 286 305 Total 312 331 358 370 278 272 336 372 1,372 1,258 1,403 Bear case 312 312 331 358 370 278 265 322 370 1,372 1,235 Worst case 312 312 331 358 370 278 255 305 351 1,372 1,189 YoY (%) Base case SEC -8.1 6.5 8.3 -1.0 -19.0 -33.2 -19.3 6.0 1.2 -16.9 10.1 Apple -29.5 -18.2 -0.7 7.8 16.4 35.6 14.7 -15.6 -8.5 7.0 2.4 Huawei 50.2 8.3 28.2 -7.1 -29.6 -21.5 -12.4 7.1 16.8 -14.3 18.7 Xiaomi -0.1 -0.3 -3.2 31.1 -17.3 -30.7 -16.1 -5.8 5.5 -17.4 21.2 Oppo -6.1 0.4 4.0 4.2 3.7 -16.5 -0.7 5.3 0.9 -2.3 17.1 Vivo 24.0 4.8 2.2 9.6 -10.9 -22.3 -7.3 1.1 8.8 -9.8 17.1 Other -23.3 -14.9 -20.1 -16.1 -4.2 -17.8 2.6 7.3 -18.7 -2.8 6.7 Total -6.1 -2.9 0.8 -0.9 -11.0 -18.1 -6.2 0.7 -2.2 -8.3 11.6 Bear case -6.1 -6.1 -2.9 0.8 -0.9 -11.0 -20.0 -10.0 0.0 -2.2 -10.0 Worst case -6.1 -6.1 -2.9 0.8 -0.9 -11.0 -23.0 -15.0 -5.0 -2.2 -13.3 QoQ (%) Base case SEC 2.3 6.0 2.6 -11.1 -16.2 -12.6 23.8 16.9 Apple -46.1 -8.3 37.9 58.3 -41.8 6.8 16.6 16.6 Huawei -2.3 -0.6 13.4 -15.6 -25.9 10.8 26.4 3.2 Xiaomi 11.0 16.0 1.5 0.3 -29.9 -2.8 22.9 12.6 Oppo -21.4 28.0 5.6 -1.9 -21.8 3.1 25.5 4.1 Vivo -10.3 22.3 6.5 -6.2 -27.1 6.7 27.0 2.4 Other -24.8 3.0 0.4 7.8 -14.1 -11.6 25.3 12.8 Total -16.3 6.1 8.1 3.2 -24.9 -2.3 23.7 10.8 Bear case -16.3 -16.3 6.1 8.1 3.2 -24.9 -4.6 21.6 14.7 Worst case -16.3 -16.3 6.1 8.1 3.2 -24.9 -8.1 19.3 15.3

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2) Data center capex and server demand outlook

Server shipment volumes increased sharply from 2016, when global hyperscalers began to build data centers in earnest. The sharp increase in capex by cloud service providers in North America and Greater China—e.g., Microsoft (MSFT US/CP: US$183.63), Amazon (AMZN US/CP: US$2,449.33), and Alibaba (BABA US/CP: US$217.20)—led to robust demand for both branded servers from OEM vendors (e.g., Hewlett Packard Enterprise [HPE US/CP: US$10.04] and Dell [DELL US/CP: US$44.04]) and white box servers from ODM vendors (e.g., Taiwan-based Wiwynn [6669 TT/CP: NT$883.00], etc.). Demand for server DRAM also surged, causing DRAM prices to skyrocket 160% for a 26-month period amid tight supply.

The capacity expansion from 2016 to 2018 was followed by a lull in additions in 2019. There are many factors speculated to have had a role in the capex contraction, such as temporary data center saturation or increases in server efficiency via software optimization. However, we find it difficult to pinpoint a single reason. The decline in capex led to the first negative YoY growth in server shipment volume in nine quarters.

Server orders recovered from 2H19, supported by increasing capex. Against this backdrop, we believe that capex by hyperscalers and the purchase/replacement cycles hold the key to forecasting server demand.

Figure 67. Capex by major hyperscale operators

Source: Thomson Reuters, Mirae Asset Daewoo Research

Figure 68. Server shipment volume

Source: Industry data, Mirae Asset Daewoo Research

9.8 21.3 21.4 47.2 -0.1 8.8 12.0 -30 0 30 60 90 0 40 80 120 160 06 07 08 09 10 11 12 13 14 15 16 17 18 19 20F 21F 22F (%)

(US$bn) Baidu IBM Salesforce

Oracle Alibaba Tencent

Google Facebook Amazon

Microsoft Apple Total capex YoY (R)

21.9 62.8 -40 0 40 80 120 0.0 1.0 2.0 3.0 4.0 1Q02 3Q04 1Q07 3Q09 1Q12 3Q14 1Q17 3Q19 (%) (mn units)

ODM direct servers (L) OEM servers (L) Total servers YoY (R) OEM servers YoY (R) ODM direct servers YoY (R)

Robust server shipments

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Looking ahead, we expect memory chip demand from data centers to remain stable, in light of the following: 1) capex trends at cloud service providers suggest that the most recent memory down cycle (end-2018 to early-2019) was triggered by customers’ inventory reductions, rather than by fundamental demand contraction; 2) the server replacement cycle is arriving for hyperscalers; and 3) cloud service providers continue to possess strong growth potential and profitability. (Their interest coverage ratios have reached peak levels.) With demand from hyperscalers very likely to remain strong, we believe that the timing of server memory purchases will depend on the direction of mobile market demand. And we think supply management at DRAM makers will hasten the timing of purchases.

(1) Microsoft and Amazon (cloud service providers): Capex and capital lease trends Cloud investments at Microsoft and Amazon have shown an oscillating pattern, with company-wide capex growth and the combined growth of capex and capital leases taking turns outpacing one another.

At Microsoft, the combined growth of capex and capital leases outstripped capex growth in 4Q16-4Q17. In the subsequent four quarters (1Q18-4Q18), capex displayed faster growth than capex and capital leases combined. The growth structure reversed in 1Q19-4Q19 (with capex and capital lease growth prevailing) and again in 1Q20 (with capex growth picking up more rapidly). Amazon has exhibited a similar, albeit not as pronounced, pattern.

As some servers/network equipment used in data centers are leased assets, we can assume that new server installations took place during periods in which the combined growth of capex and capital leases was higher. Accordingly, we estimate that in 1Q20, more investments were made in infrastructure than in servers. Nevertheless, server DRAM sales have picked up recently, likely driven by stockpiling demand.

While some market watchers are fretting over the possibility of another server DRAM down cycle, we note several differences in market conditions compared to in 1Q19. Back before the onset of the last down cycle, inventory stockpiling continued for over four quarters at hyperscalers, with capital leases remaining at low levels since 1Q18. With this in mind, we do not believe that a pickup in stockpiling demand during a single quarter (1Q20) is enough to give buyers strong bargaining power.

In addition, we believe that DRAM suppliers will no longer just sit on their hands in the face of a down cycle triggered by stockpiling demand, especially given their oligopolistic market positioning.

We also note that capital leases continued to expand even during the 2019 memory down cycle (when capex growth slowed or even turned negative). Microsoft reported zero capex growth throughout the year, and Amazon posted single-digit capex growth for five quarters, from 2Q18 to 2Q19. During the same period, however, both companies reported double-digit growth in capex and capital leases combined. This suggests that investments in network equipment and servers continued despite the overall fall in investments.

Nevertheless, server DRAM demand stagnated at extremely low levels from end-2018 to early 2019. We attribute this demand weakness to buyers’ inventory management strategies aimed at increasing negotiating power, rather than to fundamental demand contraction. In other words, large channel inventories, rather than a lack of server demand, caused the down cycle.

References

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