Enterprise software market

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Equity Research | Tech, Media & Telecom

Enterprise software market

Blooming enterprise mobile internet

Software industry a government development focus: 12th Five-Year Plan proposes to target software and IT service revenue at RMB4,000b by 2015E, which represented an average annual growth rate of 24.5%. China is to build 10 software companies with RMB10b+. This year, China's State of Council issued suggestions to improve information consumption to expand domestic demand, which is to promote internet-related products including enterprise information application. China enterprise mobile internet a next growth driver: With rapid increase in mobile internet user penetration especially with recent 4G adaption, robust growth in retail mobile internet benefits social networking and entertainment. China enterprise mobile internet market is emerging and becomes a next major industry growth driver, in our view. We believe sharp increase in e-commerce effort is reviving traditional enterprise resources planning (ERP) and is hatching newer forms mobile ERP and industry solutions.

Software companies are penetrating into mobile ERP market: We see traditional software companies and internet giant to penetrate into mobile enterprise application market. Companies such as Kingdee (0268 HK) with strong ties with SMEs builds its own cloud platform and provides SaaS service to subscribers. On the other hand, other software developers such as Chinasoft (0354 HK) co-operate with internet giants. Aliyun exclusively uses Chinasoft middleware and builds an integrated cloud model covering IaaS, PaaS and SaaS in China. We are positive on software industry and suggest accumulations. We attribute stock price and potentially earnings weakness in 2013E to slow-down in corporate IT spending on weak economy as well as changing country leadership concern. From 2014E onwards, we are expecting gradual recovery of corporate IT spending both in form of traditional ERP together with increasing adaption of mobile ERP and mobile industry solutions. We are positive on the sector and suggest buy or accumulate on individual companies.

Initiation Our rating Target price 2014E P/E@TP

Kingdee (0268 HK) Buy HK$2.70 (+38%) 26.8x

Chinasoft (0354 HK) Accumulate HK$2.28 (+16%) 19.9x Sinosoft (1297 HK) Accumulate HK$1.83 (+17%) 11.8x

Kevin Mak,

CFA

Analyst

+852 35191299

[email protected]

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Content

Executive summary ... 3

Market opportunities in enterprise mobile internet universe ... 4

Government to promote software industry and information consumption in China ... 4

Development in retail mobile internet is fast on the back on rising penetration ... 5

Significant competition in retail mobile internet through games and ads ... 6

Enterprise mobile internet market is to be claimed ... 7

Enterprise mobile internet market heading into high growth stage ... 8

Notion of "Third Platform Era": Big data, cloud computing, mobility and social networks ... 8

China enterprise mobile internet to experience 65% annual growth in next 3-4 years ... 8

Enterprise mobile internet for sales opportunities and corporate management ... 9

Spending on internet security to emerge in longer-term ... 10

Penetration angles into enterprise mobile internet market in corporate mangament ... 11

Software developers eye on cloud-based enterprise solution esp for SMEs ... 11

Cooperative development form - a case between Aliyun and Chinasoft ... 12

Rating and valuation summary ... 13

Ratings and risk factors ... 13

Absolute valuation summary by discounted cash flow ... 13

Relative valuation summary base on peers ... 13

Summary of financials ... 14

P&L and balance sheet items forecast summary ... 14

Financial ratios ... 15

Revenue breakdown and margin, income exposure and customer concentration ... 16

Company initiation ... 17

Kingdee International - Buy ... 17

Chinasoft - Accumulate ... 24

Sinosoft - Accumulate ... 31

Appendix ... 38

Development of VPN market in China ... 38

A survey on corporate VPN consumption behavior in China ... 39

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Executive summary

Market opportunities in enterprise mobile internet universe. As part of 12th Five-year plan and government initiative to promote information consumption, we see opportunities in internet especially software market. With higher smartphone penetration in China, we expect enterprise mobile internet market to emerge after increasingly difficult retail consumption market. Until 2012A, mobile internet popularity among SMEs in China remained very low with current focus on simple communication.

Enterprise mobile internet market heading into high growth stage. IDC identified “Third Platform Era” that started in 2005. It is featured by big data, cloud computing, mobility and social network. According to iiMedia, China enterprise mobile internet market is to experience 65% CAGR in 3-4 years towards 2016E. In principle, enterprise utilizes tools to raise income and to reduce cost for profit maximization purpose. As such, mobile search and apps, e-commerce platform and mobile ERP market are expected to be key growth drivers, to be shortly followed by mobile internet security market.

Various penetration angles into enterprise mobile internet market. We see traditional software companies and internet giant to penetrate into mobile enterprise application market. Companies such as Kingdee (0268 HK) with strong ties with SMEs builds its own cloud platform and provides SaaS service to subscribers. On the other hand, other software developers such as Chinasoft (0354 HK) co-operate with internet giants. Aliyun exclusively uses Chinasoft middleware and builds an integrated cloud model covering IaaS, PaaS and SaaS in China.

Company initiation. We initiate coverage on Kingdee International (0268 HK), Chinasoft International (0354 HK) and Sinosoft (1297 HK) based on discount cash flow model with valuation time point at end of 2014E. Below is a quick relative valuation matrix.

 Kingdee International (0268 HK, Buy, TP HK$2.70)

 Chinasoft International (0354 HK, Accumulate, TP HK$2.28)

 Sinosoft (1297 HK, Accumulate, TP HK$1.83)

Table 1. Quick valuation matrix at current price and target price as of 2014E

Kingdee (0268 HK) Chinasoft (0354 HK) Sinosoft (1297 HK) @ Current price P/E 19.5x 17.1x 10.1x P/B 2.09x 1.14x 1.70x P/S 2.03x 0.63x 4.06x EV/EBITDA 8.2x 9.9x 3.6x @ Target price P/E 26.8x 19.9x 11.8x P/B 2.87x 1.33x 1.99x P/S 2.79x 0.73x 4.7x EV/EBITDA 10.8x 11.1x 4.6x

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Market opportunities in enterprise mobile internet universe

Software industry is part of 12th Five-Year Plan focus. Earlier last year, China's Ministry of Industry and Information Technology (MIIT) released its Software and Information Technology Services Industry Development Plans for the 12th Five-Year Plan Period. In particular, software and IT service revenue is targeted to reach RMB4,000b by 2015E, which represented an average annual growth rate of 24.5%. Under the plan, software revenue was estimated at around 40% of segment. By 2015E, intention is to build 10 software companies with RMB10b+ annual revenue, of which 3 to 5 mega companies are to earn trillions of revenue.

Table 2. 12th Five-Year Plan period (2011-2015) software industry focus Focuses

Infrastructure software Information technology consulting services Industrial software and industry solutions, Digital content processing

Embedded software Service outsourcing

Data security software and services Services for emerging information technologies Information systems integration services Integrated circuitry design

Source: Orient Securities, MIIT

Government to promote information consumption in China. This year, China's State of Council issued suggestions to improve information consumption to expand domestic demand. China seeks to boost public-sector and household spending on information consumption by more than 20% annually through 2015. Information consumption is about Internet-related products as well as enterprise application of information. In 2012, according to the document, information consumption volume was up 29% YoY and reached 1.72 trillion, driving almost RMB1 trillion worth of output for related industries. Table 3 shows government five primary missions and six supporting policies to promote information consumption.

Table 3. Government to promote information consumption

Five primary missions

Speeding up the evolution of information infrastructure Intensifying the supply power of information products Fostering the demand of information consumption Improving the level of public service

Strengthening the consumption environment Six supporting policies

Revolution of an administrative approval system Increasing financial policies

Improving the environment of corporate finance Perfecting the telecom services

Reinforcing related laws and regulations

Statistical monitoring of information consumption Source: Orient Securities, MIIT

Software industry is part of 12th Five-Year Plan focus with software and IT service to expand at 24.5% a year by 2015E Chinese government is to promote information consumption to expand domestic demand

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5 / 41 Rising penetration on rapid mobile internet user growth. China mobile

internet users increased by 53% CAGR from 2007A to 2012A to 420m, according to iResearch. By Q2 this year, the number increased to 500m thanks to continuous breakthrough in handset technology and network. While CAGR in the next 4 years would be slowed to 14%, penetration rate (mobile internet users / total population) is to further increase to 50.7% by 2016E from 31.4% at 2012A. That said, penetration improvement is enabling retail mobile internet and eventually enterprise mobile internet, in our view.

Illustration 1. Significant increase in moible internet user penetration

Source: Orient Securities, iResearch

Development in retail mobile internet is fast. At initial growing stage of mobile internet, retail / consumption-end mobile development is way ahead of enterprise mobile solution, in our view. Illustration 2 shows applications popularity among mobile internet users. As of 2012A, retail sub-segment was increasingly popular among mobile internet users. Instant chat, web-search, online music and micro-blogging were among the most popular applications among mobile internet users. In retail space, competition was increasing challenging especially for app developers.

Illustration 2. Applications popularity among mobile internet users

Source: Orient Securities, CNNIC 50 420 713 0.0% 15.0% 30.0% 45.0% 60.0% 0 100 200 300 400 500 600 700 800

2007A 2008A 2009A 2010A 2011A 2012A 2013E 2014E 2015E 2016E Internet user (LHS m) Mobile internet user (LHS m) Mobile internet user / total population

53% CAGR 07A-12A 14% CAGR 12A-16E Penetration 31.4% Penetration 50.7% 83.9% 69.4% 50.9% 48.2% 43.3% 42.0% 33.2% 32.0% 29.1% 13.2% 13.2% 12.9% 5.9% 4.6% 0.0% 20.0% 40.0% 60.0% 80.0% 100.0%

Mobile instant chat tool Mobile search Mobile online music Mobile microblogging Moible online web literature

Mobile social network website Mobile game

Mobile network video Mobile e-mail Mobile online shopping Mobile online payment Mobile e-banking

Mobile online travel booking

Mobile online group purchase

2011A

2012A

We believe substantial increase in mobile internet users that pushes penetration rate to 50.7% by 2016E is the key to facilitate wider use of mobile internet

At initial stage of mobile internet development with lower penetration rate, retail space of mobile internet is developing faster than other sub-segments, in our view

Instant chat, web-search, online music and micro-blogging were among the most popular applications among mobile internet users, which are more related to retail area

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6 / 41 Significant competition in retail mobile internet universe. According to

iiMedia Research, as of Q3 2013A, in China 16.8% app developers is making profit. Of 61.3% loss-making developer, 35.6% are making significant losses. For instance, although mobile game segment was growing especially fast in Q2 this year at 126% YoY growth to RMB2.76b, considerable income portion went to channels. As of 1H 2013A, 87% initial listing of apps was still on mobile app store, which was dominated by 3rd party platform notably Tencent. In addition to considerable channel costs, average app life was short with significant degree of competition. As for retail mobile market, revenue and profit growth for app developer could be increasingly difficult.

Table 4. Profitability of app developers in China as of Q3 2013A

Profitability %

Making profit 16.8%

Expect to make profit 9.2%

Break-even 10.3%

Making loss 25.7%

Making significant loss 35.6%

Sub-total 61.3%

Others 2.4%

Illustration 3. User preference of app store / platform (user may choose multiple)

Table 5. Frequency of app update (related to lifespan)

Update frequency %

No updates for 6 months+ 15.0%

Updated once in 6 months 13.0%

Sub-total (partial active) 27.4%

Updated once in 1 month 27.6%

Sub-total (active) 57.6%

Source: Orient Securities, iiMedia Research

56.6% 37.4% 28.1% 25.7% 12.3% 7.7% 0.0% 10.0% 20.0% 30.0% 40.0% 50.0% 60.0% 70.0%

Tencent UC Browser 360 91 wireless d.cn 155.cn

Facing significant competition, 61.3% app developers were making losses while 16.8% were actually making profit under fast developing retail mobile internet market

As of 1H 2013A, 87% initial listing of apps was on mobile app store. It was dominated by 3rd party platform notably Tencent (high channel costs)

Average app life was short with 15% inactive and 27% partial active apps in the internet universe (short lifespan in general)

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7 / 41 Enterprise mobile internet market is to be claimed. CNNIC adapted

small-to-mid enterprise definition under "Regulations on the Classification Standards for Small and Medium-sized Enterprises" released by MIIT (工业和信息化部), the National Bureau of Statistics (国家统计局), NDRC (发展改革委) and the Ministry of Finance (财政部) in 2011 and conducted a survey about their internet usage. In the survey, CNNIC identified 71.0% fixed broadband and 6.4% fixed line penetration among SME in China as of 2012A. Nevertheless, partly due to network and handset limitations in the past, mobile internet penetration was only 10.4%. Table 6 shows SME internet connectivity in China as of 2012A. Enterprise mobile internet market in terms of both hardware and software for SMEs in China is to be developed following fast development of retail segment, in our view.

Table 6. Small-to-mid enterprise internet connectivity in China

Penetration (2012A)

Fixed line (dail-up / ISDN / GPRS, etc) 6.4%

Fixed broadband (Fiber optic / ADSL / intranet, etc) 71.0%

Mobile internet (3G) 10.4%

Source: Orient Securities, CNNIC

Current usage by SME was mainly communication and information-based. In the same survey by CNNIC, results show that SME in China currently utilize internet access to perform basic functions such as “send / receive emails”, demonstrate “product / service info”, “publish news / events” and “online banking”. Table 7 shows a summary of popular applications by SME with respect to internet usage. As mobile internet applications emerge, enterprise stance on internet and mobile internet as tools should be simple: it is to either increase channel sales or to reduce cost for profit maximization purpose. We believe there is rich opportunity in enterprise mobile internet market. According to iiMedia, China enterprise mobile internet market is to experience 65% CAGR in 3-4 years towards 2016E. Market outlook of enterprise mobile internet is discussed in the next section.

Table 7. Popularity of various appliacations with respect to internet usage

Category Application Popularity

Communication Send / receive emails 84.7%

Information Product / service info 68.1%

Acquire info from gov 43.6% Publish news / events 60.7%

Business service Provide customer service 53.3%

Online banking 71.1%

Internal support Online recruitment 42.3%

Online training 20.1% Interaction with gov 35.4% Source: Orient Securities, CNNIC

Current SME utilization of mobile internet is low in China at 10.4% as of 2012A

Communication and information-based display are current main functions with respect to internet usage by enterprises

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Market growth outlook

“Third Platform Era": Big data, cloud computing, mobility & social network. IDC predicts that by 2020, 40% industry revenue and 98% of industry growth is driven by 3rd platform technologies with focus at big data, cloud computing, mobility and social network. Since 2005, especially with introduction of iPhone in 2007, mobile internet growth emerged at retail end. IDC and Appcelerator survey showed that, on the other hand, R&D effort on enterprise end rose to 42.7% by Q2 2013A from 29.3% in Q4 2010A.

Illustration 4. IDC “Third Platform Era” 2005-2020

Source: Adapted from IDC Predictions 2013

China enterprise mobile internet to experience 65% CAGR in 3-4 years. According to iiMedia, enterprise mobile internet market was expected to grow fast since 2012A/2013E. Between 2012A and 2016E, 65% CAGR is estimated towards RMB66.6b in 2016E. Portal/search engine, e-commerce as well as mobile ERP are key drivers to the enterprise market in short-term, in our view.

Illustration 5. Enterprise mobile internet market size in China

Source: Orient Securities, iiMedia Research

7,860 12,440 21,670 38,610 66,630 58% 74% 78% 73% 0% 10% 20% 30% 40% 50% 60% 70% 80% 90% 0 10,000 20,000 30,000 40,000 50,000 60,000 70,000

2010A 2011A 2012A 2013E 2014E 2015E 2016E

China enterprise mobile internet market (RMBm) YoY

Third platform may represent 98% industry growth by 2020 By Q2 2013, R&D effort on enterprise end in mobile internet universe was 42.7%, up from 29.3% at Q4 2010

China enterprise mobile internet market is expected to grow at 65% CAGR towards RMB66.6b in 2016E

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9 / 41 Enterprise mobile internet for sales opportunities... As we have discussed in

the previous section, in principle enterprise utilizes tools to raise income and to reduce cost for profit maximization purpose. In the example of traditional internet market, with significant online traffic, search engine market and B2B e-commerce market grew fast at 62% 6-year CAGR and 32% 4-year CAGR towards 2012A respectively. As for enterprise internet market, however, due to re-distribution of traffic partly towards mobile apps and map portal, a new fight for traffic emerges again; enterprises are taking serious consideration of self-developed apps or 3rd party functional app / platform.

Table 8. Popoularity of various e-marketing channels in 2012

Marketing channels Popularity

Through search engines 53.2%

Through instant chat tool such as QQ 51.6%

Through e-commerce platform 50.0%

Through emails 44.5%

Through web-based adv display 44.3%

Through microblog 20.2%

Through blog / SNS (social network services) 17.9%

Through online advertising alliance 16.4%

Through forum / BBS (bulletin board system) 16.4%

Through network video adv 16.3%

Through group purchase activity 16.1%

Source: Orient Securities, CNNIC

…and corporate management perspective. In view of increasing travel of working group, increasing demand from customers and increasing need of real-time business decision-making, mobile enterprise application management provides necessary mobile ERP, mobile SCM, mobile CRM, mobile BI, etc. With breakthrough in network and handsets, we believe market growth could be significant for enterprise mobile internet.

Illustration 6. Typical reasons for ERP implementation

Source: Internet sources

From 2013E onwards, re-distribution of online traffic gives rise to new opportunities for mobile internet marketing for enterprises

Between 2006A and 2012A, search engine market in China rose to RMB28.8b in 2012A at 62% 6-year CAGR

(Analysys International) Between 2008A and 2012A, SME B2B e-commerce market in China rose to RMB16.7b in 2012A at 4-year 32% (iResearch)

In view of increasing In view of increasing travel of working group, increasing demand from customers and increasing need of real-time business decision-making, opportunities are with mobile enterprise application

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10 / 41 Spending on internet security to emerge in longer-term. According to

research firm CNNIC, internet security spending in developed countries such as US and Europe could was 8%-10% of overall IT spending. It was in the contrary to 1%-2% in China. In another measurement, based on Research firm Gartner estimation, global public cloud service market was estimated at US$111b in 2012A, of which cloud advertising was the largest segment (48%), followed by BPaaS (28%), SaaS (14.7%), IaaS (5.5%), security services (2.8%) and PaaS (1%). While the ratio was relative low at current level in China compared to other developed countries, we believe increasing B2B activities and mobile ERP demand should gradually raise demand for internet securities for enterprises in China.

Illustration 7. Survey on internet users concern on internet security in selected countries

Source: Orient Securities, CNNIC, WIP

On a side note, Government may also spend higher amount on systems and software to monitor and regulate internet universe. Huge amount of data is to be collected, analyzed and handled especially after comments on internet from new leadership in China.

Illustration 8. Sharp increase in applications and data traffic (2012A-2016E)

Source: Adapted and modified from NQ Mobile (IDC and Cisco data)

China US Japan Sweden Portugal Poland Very concerned 2.0% 21.0% 36.0% 9.0% 14.0% 6.0% Concerned 7.7% 18.0% 52.0% 28.0% 25.0% 12.0% A little bit concerned 46.5% 49.0% 12.0% 40.0% 37.0% 40.0% Not a concern 43.4% 12.0% 1.0% 20.0% 24.0% 42.0% 0.0% 10.0% 20.0% 30.0% 40.0% 50.0% 60.0%

Currently, internet security spending was very small in China at 1%-2% as compared to overall spending in China.

Internet security concerns will be increasingly important especially to enterprises and government

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Penetration angles into mobile corporate management market

Software developers eye on cloud-based enterprise solution esp for SMEs. Illustration 9 shows China enterprise software industry and China ERP market. Noted that while it appears that market growth was strong in recent years, poor SME sub-market was not reflected. Software developers like Yonyou Software (600588 CH) and Kingdee (0268 HK) leveraged on their ERP strength to cover SaaS, mobile solution, enterprise social network, etc. Cloud-based ERP is especially attractive to SMEs due to high front-loaded costs of traditional ERP solutions, in our view. Opportunities for SME market could re-emerge with the new angle and potentially bottoming China economy.

Illustration 9. China enterprise software industry and ERP market

Source: Orient Securities, Gartner

Illustration 10. Kingdee emergence into SaaS cloud universe

Source: Adapted and modified from Kingdee

6.3 0.6 7.3 0.7 8.3 0.8 9.5 1.0 10.8 1.2 12.3 1.4 14.0 1.6

China enterprise software industry China ERP market

2010A 2011A 2012A 2013E 2014E 2015E 2016E

US$b

CAGR 12A-16E: 14%

CAGR 12A-16E: 19%

Overall China enterprise software industry and China ERP market were growing in recent years despite

underperformance of SMEs

Kingdee, like Yonyou Software, is developing its cloud platform to provide mobile internet services to enterprises especially attractive for SMEs

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12 / 41 Cooperative development form – a case between Aliyun and Chinasoft. In

addition to self-development, software developers could partner with internet giant to create integrated cloud solutions for enterprise subscribers. For instance, leveraging on huge data base and cloud computing technology, Alibaba Group provides integrated cloud service that covers IaaS (infrastructure as a service), PaaS (Platform as a service) as well as SaaS (Software as a service) under Aliyun. Illustration 11 shows a quick diagram on services provided. Chinasoft (0354 HK) signed exclusive agreement with Aliyun to provide middleware for the platform. Preliminary data migration to Aliyun is also done by Chinasoft. While application software is open for competition, with various co-operation ties software companies could partner with established platform to quickly ramp-up mobile enterprise applications to target a wider range of clients, especially SMEs in this case.

Illustration 11. Aliyun and Chinasoft joint force on integrated cloud development

Source: Orient Securities, Analysys

Source: Aliyun

Software companies could work with 3rd_{party platform to}

promote its own mobile ERP application

Chinasoft works with Aliyun to build integrated cloud platform to capture mobile internet opportunities

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Rating and valuation summary

Ratings and risks factors. We are positive on China software and IT market due to government support and industry trend especially in enterprise mobile market. In particular, we like Kingdee (0268 HK) for its rebounding profitability as well as leadership in SME ERP market. We initiate Buy rating on Kingdee. We are also positive towards Chinasoft especially with its positioning in cloud business, yet we concern short-term earning risk that may surprise the market. We initiate Accumulate rating on Chinasoft. Sinosoft is a strong regional player, yet its listing history is short and there is concern on longer-term prospects. We initiate Accumulate rating on Sinosoft.

Table 9. Rating and valuation summary

Kingdee (0268 HK) Chinasoft (0354 HK) Sinosoft (1297 HK)

Rating Buy Accumulate Accumulate

TP HK$2.70 HK$2.28 HK$1.83 Valuation at TP 2014E P/E 26.8x 19.9x 11.8 2014E P/B 2.87x 1.33x 1.99 2014E P/S 2.79x 0.73x 4.7 2014E EV/EBITDA 10.8x 11.1x 4.6

Table 10. Peers valuation table

Company name Ticker Fiscal Yr Mkt Cap

(US$m) Hist P/E (x) 1-yr fw P/E (x) 2-yr fw P/E (x) ROE(%) P/B P/S HK-listed software

Kingdess Int'l 268 HK Equity 12/2012 692.8 53.0 42.6 23.4 5.3 2.6 2.4 Chinasoft Int'l 354 HK Equity 12/2012 489.3 24.9 17.1 12.9 8.1 2.0 1.6 Sinosoft Tech 1297 HK Equity 12/2012 211.8 12.3 11.3 10.4 39.0 n.a. 4.1 Kingsoft Corp 3888 HK Equity 12/2012 3,167.7 32.6 29.6 23.3 22.3 6.5 10.7 Inspur Int'l 596 HK Equity 12/2012 188.5 5.5 n.a. 2.1 48.9 1.8 0.6 M Dream Inworld 8100 HK Equity 12/2012 32.2 n.a. n.a. n.a. n.a. n.a. 3.3 China-listed software

Neusoft Corp 600718 CH Equity 12/2012 2,533.6 32.7 27.5 21.9 9.2 3.0 2.1 Glodon Software 002410 CH Equity 12/2012 2,518.1 37.9 31.5 22.7 19.9 7.2 12.6 Yonyou Software 600588 CH Equity 12/2012 2,145.7 34.6 26.1 19.9 14.5 5.0 3.2 YGSOFT 002063 CH Equity 12/2012 1,328.1 24.6 21.2 16.2 25.4 5.5 9.4 Wonders Information 300168 CH Equity 12/2012 1,066.4 55.1 36.8 27.9 9.9 5.3 6.6 BJ eGOVA 300075 CH Equity 12/2012 761.7 57.6 36.0 27.3 8.6 4.8 14.3 BJ Thunisoft 300271 CH Equity 12/2012 653.3 40.0 31.0 24.5 11.5 4.6 7.4 Overseas-listed software

Microsoft Corp MSFT US Equity 06/2013 318,141.1 13.5 14.3 13.1 30.1 3.9 4.0 Oracle Corp ORCL US Equity 05/2013 158,599.6 15.1 12.0 11.0 25.5 3.7 4.4

SAP SAP GR Equity 12/2012 72,543.2 22.5 17.7 15.9 22.1 4.7 4.2

Salesforce CRM US Equity 01/2013 32,017.1 n.a. 158.9 107.2 (5.4) 11.0 8.5 Adobe ADBE US Equity 11/2012 27,653.8 62.1 41.1 34.4 6.7 4.1 6.6 Intuit Inc INTU US Equity 07/2013 21,364.0 28.1 20.9 18.8 34.9 9.6 5.0 NetSuite Inc N US Equity 12/2012 7,306.4 n.a. 385.2 351.9 (33.4) 35.1 18.7 Sage Group SGE LN Equity 09/2013 6,724.9 102.4 15.9 14.5 4.1 4.8 3.1 Source: Bloomberg

We are positive to China enterprise software industry and rate individual companies: Kingdee (Buy),

Chinasoft (Accumulate) and Sinosfot (Accumulate) Major risk factors include: 1) weaker-than-expected economy recovery especially in SME market;

2) later-than-expected or weaker-than-expected government incentive program is finalized to promote the industry;

3) slower-than-expected adaptation of mobile internet and cloud among enterprises

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Summary of financials

P&L and balance sheet items forecast summary

Table 11. P&L and balance sheet items forecast summary

2012A 2013E 2014E

268 HK 354 HK 1297 HK 268 HK 354 HK 1297 HK 268 HK 354 HK 1297 HK Turnover 1,765.5 2,768.2 226.7 1,659.4 3,281.4 271.5 1,912.7 4,505.8 310.8 EBITDA (23.1) 289.4 143.5 338.9 293.0 186.6 548.3 369.8 224.6 EBIT (262.9) 199.9 103.1 28.5 191.8 131.4 203.5 251.0 154.2 EBT (162.0) 187.7 93.9 106.6 195.7 120.0 243.0 236.8 151.4 Net profit (140.2) 133.2 76.2 87.4 137.0 96.0 199.3 165.8 121.1 Minority interest (23.7) 17.0 0.0 0.0 19.6 0.0 0.0 23.7 0.0

Investment properties fair value gain 61.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0

Listing expenses 0.0 0.0 (7.2) 0.0 0.0 (10.3) 0.0 0.0 0.0

Other one-off items 0.0 (38.3) 0.0 0.0 0.0 0.0 0.0 0.0 0.0

Adjusted net profit (201.2) 171.5 83.4 87.4 137.0 106.3 199.3 165.8 121.1

Non-current assets 2,418.8 1,026.9 97.8 2,449.9 1,367.2 109.9 2,484.3 1,381.6 127.8 (incl) Land use rights 138.8 0.0 0.0 139.2 0.0 0.0 139.5 0.0 0.0 (incl) Property, plant and equipment 791.2 132.9 7.5 795.4 137.9 8.2 799.7 143.2 8.9 (incl) Intangible assets 637.2 159.3 87.4 663.8 235.1 100.4 693.6 241.7 117.3

(incl) Goodwill 0.0 629.1 0.0 0.0 833.0 0.0 0.0 833.0 0.0

(incl) Investment properties 825.6 0.0 0.0 825.6 0.0 0.0 825.6 0.0 0.0

Current assets 1,562.5 2,415.5 317.7 1,616.1 2,735.4 732.2 1,351.5 3,294.5 824.9

(incl) Inventories 3.9 24.0 0.7 5.8 44.8 5.6 6.1 62.2 5.6

(incl) Trade and other receivables 313.5 1,039.4 200.8 325.0 1,312.6 258.0 367.5 1,757.3 295.2 (incl) Due from customers on contracts 326.3 561.4 0.0 338.7 610.9 0.0 377.5 734.6 0.0 (incl) Pledged bank deposits 5.6 0.0 63.3 0.0 0.0 64.6 0.0 0.0 64.6 (incl) Short-term bank deposits 14.5 4.5 0.0 0.0 0.0 0.0 0.0 0.0 0.0 (incl) Cash and cash equivalents 898.0 774.8 52.9 886.3 767.2 404.1 540.1 740.5 459.6

Non-current liabilities 1,432.9 36.6 14.0 1,484.2 453.9 16.8 1,066.5 412.9 21.2 (incl) Borrowings 1,363.6 19.0 0.0 1,417.7 250.0 0.0 1,000.0 200.0 0.0

Current liabilities 958.1 1,343.5 168.1 904.0 1,349.6 175.4 909.9 1,774.6 189.3 (incl) Trade and other payables 537.6 668.9 68.1 559.5 716.8 73.1 585.5 1,087.7 81.4 (incl) Due to customers on contracts 73.6 110.5 0.0 79.7 152.7 0.0 94.4 198.5 0.0 (incl) Borrowings 227.0 309.3 82.3 184.8 430.9 80.7 150.0 430.9 80.7 (Incl) Convertible loan notes 0.0 199.1 0.0 0.0 0.0 0.0 0.0 0.0 0.0 (incl) Deferred income 119.8 0.0 0.0 80.0 0.0 0.0 80.0 0.0 0.0

Total equity 1,590.3 2,062.3 233.4 1,677.7 2,299.1 649.9 1,859.5 2,488.6 742.2

- MI 11.5 134.7 0.0 11.5 154.2 0.0 11.5 177.9 0.0

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15 / 41 Financial ratios

Table 12. P&L and balance sheet items forecast summary

2012A 2013E 2014E

268 HK 354 HK 1297 HK 268 HK 354 HK 1297 HK 268 HK 354 HK 1297 HK

Growth Indicators

Total Revenue Growth Rate -13% 23% 23% -6% 19% 20% 15% 37% 14%

EBITDA Growth Rate - 9% 49% - 1% 30% 62% 26% 20%

EBIT Growth Rate - 12% 41% - -4% 27% 615% 31% 17%

Growth Rate of Profit for the Year - 20% 30% - 3% 26% 128% 21% 26%

Profitability Indicators

Gross Profit Margin 65% 33% - 72% 32% - 74% 31% -

EBITDA Margin - 10% 63% 20% 9% 69% 29% 8% 72%

EBIT Margin - 7% 45% 2% 6% 48% 11% 6% 50%

Net Profit Margin - 5% 34% 5% 4% 35% 10% 4% 39%

ROE - 6% 33% 5% 6% 15% 11% 7% 16%

ROA - 4% 18% 2% 3% 11% 5% 4% 13%

ROIC - 6% 27% 0% 5% 15% 5% 6% 15%

Return on Invested Capital ex-cash - 9% 43% 0% 6% 41% 6% 8% 41%

Solvency Indicators

Current Ratio 163% 180% 189% 179% 203% 417% 149% 186% 436%

Quick Ratio 163% 178% 189% 178% 199% 414% 148% 182% 433%

Cash to current liability 96% 58% 17% 98% 57% 19% 59% 42% 22%

EBITDA Interest Coverage Ratio - 930% 5283% 345% 635% 6608% 778% 683% 7950%

Operating Indicators

Accounts Receivable Turnover 563% 266% 113% 511% 250% 105% 520% 256% 105%

Accounts Payable Turnover 115% 277% 294% 83% 313% 294% 83% 286% 294%

Fixed Assets Turnover 0% 0% 0% 0% 0% 0% 0% 0% 0%

Total Assets Turnover 44% 80% 55% 41% 80% 32% 50% 96% 33%

Leverage Ratios

Total Debt/Total Equity 100% 26% 52% 96% 38% 35% 62% 33% 12%

Net Debt/Total Equity 42% 26% -15% 43% 38% -60% 33% 33% -60%

DuPont Analysis

Net Profit Margin - 5% 34% 5% 4% 35% 10% 4% 39%

Total Assets Turnover 44% 80% 55% 41% 80% 32% 50% 96% 33%

Total Assets/Total Equity 250% 167% 178% 242% 178% 130% 206% 188% 128%

ROE - 6% 33% 5% 6% 15% 11% 7% 16%

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16 / 41 Revenue breakdown and margin

Table 13. Revenue breakdown and margin

Revenue Segment margin

2010A 2011A 2012A 2010A 2011A 2012A

Kingdee (0268 HK)

Sales of software 812.6 1,088.0 873.6 - - -

Software implementation services 352.3 509.3 486.8 - - -

Software solution consultation & support 253.7 346.6 354.2 - - -

Sales of computers and related products 18.1 78.6 51.0 - - -

Overall turnover 1,436.6 2,022.5 1,765.5 19.2% 7.6% n.a.

Chinasoft (0354 HK)

Professional services business 863.9 1,215.0 1,452.8 8.5% 8.1% 8.3%

Outsourcing business 682.9 959.5 1,221.8 12.5% 11.5% 9.3%

Training 54.4 69.3 93.6 14.3% 14.1% 13.7%

Overall turnover 1,601.2 2,243.8 2,768.2 10.4% 9.7% 8.9%

Sinosoft (1297 HK)

Export tax software and related services 23.1 30.6 39.0 90.8% 77.2% 82.4%

e-Government solutions 34.0 61.6 63.1 73.6% 79.2% 88.6%

Carbon management solutions - 7.7 13.3 - 87.8% 71.8%

Information integration software 25.9 28.4 55.7 88.1% 72.2% 61.2%

System integration solutions 69.3 56.7 55.7 10.8% 2.5% 12.8%

Total revenue 152.4 184.9 226.7 50.1% 54.6% 61.2%

Source: Orient Securities

Income exposure and customer concentration

Table 14. Income exposure and customer concentration (2012A)

Kingdee (0268 HK) Chinasoft (0354 HK) Sinosoft (1297 HK) Inspur (0597 HK) Exposure to government spending

Government bodies / public sector revenue 10% 15% 65% 5%

Non-government clients revenue 90% 85% 35% 95%

Income type breakdown

ERP solutions / information integration solutions 90% 0% 25% 15%

Specialized industry solutions 0% 30% 20% 10%

Government / public sector solutions 10% 15% 30% 5%

Outsourcing 0% 45% 0% 10%

System integration 0% 0% 25% 0%

Others 0% 10% 0% 10%

Customer concentration

Largest customer sales contribution 0.7% 20.7% 29.1% 17.0%

5-largest customers sales 2.3% 35.1% 49.2% 45.6%

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17 / 41

Kingdee (0268 HK)

No.1 SME ERP solution provider in China

Equity Research | Tech, Media & Telecom

Company initiation

19 Dec 2013

Founder back to lead re-focus on EPR; achieved break-even 1H 13A: Kingdee switched its business focus from ERP to consulting service when under ex-IBM Managing Partner leadership 2011-12. With lower gross margin on income mix and sharp increase in SG&A, Kingdee recorded losses in 2012A. Founder Xu Shao Chun took charge again in 2012 and refocused on ERP business. In 2013A, Kingdee successfully cut manage operating expenses and achieved break-even.

ERP market was growing; expecting recovery in SME segment:

While China enterprise software industry and ERP market were still expanding at 10%-15% in the past 2 years, SME market was not performing, unlike large enterprises and SOEs market. With China economy bottoming out, we believe Kingdee is well positioned for SME demand recovery with its established products and sales channels. SME-focus player to penetrate into mobile cloud business:

Since 2004, Kingdee has been the leader in ERP market in China with especially strong presence in financial management and supply chain management. In 2013, IDC ranked Kingdee as having “Number 1 market share of ERP solutions to SMEs” in China for 9 consecutive years. We believe Kingdee is on the right path to develop mobile cloud business and various platforms with its SME resources.

Ride on recovery and cloud opportunities. Initiate with Buy:

Our 3-stage DCF model with 5-year projection, 10% medium-term growth rate and 2% terminal growth rate suggests a TP of HK$2.70 at Dec 2014 valuation time point. We suggest investor to ride on current recovery and long-term cloud opportunities. Initiate Buy.

Kevin Mak,

CFA

Analyst

+852 35191299

[email protected]

Buy (initiating coverage)

Target price: HK$2.70

Share price: HK$1.96

Bloomberg Ticker: 268 HK Reuters: 268.HK

RMBm (Yr-end Dec) 2011A 2012A 2013E

Revenue 2,022.5 1,765.5 1,659.4 % of growth 40.8% -12.7% -6.0% Core earnings 9.3 (201.2) 87.4 % of growth -96.2% - - Core EPS (RMB) 0.0035 -0.0799 0.0346 % of growth -96.8% - - Core P/E (x) - - 44.39 P/B (x) 2.36 2.44 2.31 Dividend Yield 2.2% 0.0% 0.0% Core ROE 0.6% - 5.2%

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18 / 41 Number 1 market share in SME ERP market in China. Kingdee was found in

1993 and listed on HK GEM board in 2001 and then main board in 2005. The company focuses on ERP solution with majority of income from sales of software licenses supplementary by implementation services and maintenance services. Since 2004, Kingdee has been the leader in ERP market in China with especially strong presence in financial management and supply chain management. In 2013, IDC ranked Kingdee as having “Number 1 market share of ERP solutions to SMEs” in China for 9 consecutive years.

Range of product and services series to fit growing SMEs in China. Back in 1995 Kingdee offers its first window-based finance management software. Under software license model, Kingdee gradually offers KIS, K/3 and EAS solutions of increasing complexity to accompany stages migration of SME customers. Illustration 1 and Table 1 show Kingdee services summary as well as revenue breakdown between 2008A and 2012A. Kingdee is also providing mobile internet versions to meet customers demand.

Illustration 1. Kingdee services summary

Table 1. Kingdee revenue

RMBm 2008A 2009A 2010A 2011A 2012A

Sales of software license 555.3 584.0 812.6 1,088.0 873.6

Kingdee KIS 89.2 96.5 132.9 157.4 130.7 Kingdee K/3 257.1 226.9 288.9 388.1 325.3 Kingdee EAS 136.3 185.3 268.9 354.3 309.5 Other software 72.6 75.3 121.8 188.2 108.0 Implementation service 198.8 235.1 352.3 509.3 486.8 Maintenance service - - 224.0 284.6 312.5 Consulting service - - 18.4 50.1 30.6 Training service - - 11.3 11.9 11.1 Others 121.2 177.8 18.1 78.6 51.0 Total revenue 875.3 996.8 1,436.6 2,022.5 1,765.5 Source: Orient Securities, Kingdee

IDC ranked Kingdee “Number 1 market share of ERP solutions to SMEs” in China for 9 consecutive years

Kingdee offers range of solutions of increasing complexity to accompany different stages of SMEs

As of 2012A, sales of software license accounted for 50% revenue, followed by implementation and maintenance services

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19 / 41 Flexible modules to serve a diversified portfolio of clients. Kingdee has

conformed to CMM4 and ISO9001 International standards and has more than 6k employees, over 100 offices and up to 2.4k partners in Asia Pacific. With flexible key modules and industry editions, Kingdee served a diversified client portfolio of 1m+. Between 2008A and 2012A, revenue contribution of the largest customer was below 2%; and largest 5 customers together contributed below 5% revenue during the 5-year period.

Table 2. Customer concentration 2008A-2012A

2008A 2009A 2010A 2011A 2012A Customer concentration

Largest customer sales contribution 1.07% 1.76% 1.09% 0.29% 0.74% 5-largest customers sales 4.09% 4.09% 3.76% 1.40% 2.25% Source: Orient Securities

Table 3. Kingdee functionl modules and industry editions

Key functional modules Finance Management Supply Chain Management Basic Manufacturing Management Advanced Manufacturing Management Other major functional modules Human Resources Management Costing Management

Industry editions

Pharmaceutical Trading Solution Real Estate Solution

Commercial Trading Solution Auto & Motorcycle Parts Solution Electronic Equipment Solution Hardware Solution

Illustration 2. Kingdee core module - finance management

Source: Kingdee

Kingdee utilized flexible functional modules to serve diversified portfolio of clients. In addition to general ERP, Kingdee also provides industry editions to fit industry specific needs

It is a demonstration of Kingdee core finance management module

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20 / 41 From license model towards cloud subscription model. Shifting from a

sales-oriented model to a delivery-sales-oriented model, Kingdee provides cloud version of its ERP solutions. In addition, Kingdee is enhancing enterprise internet services including Cloud Hub (enterprise social networking), Youshang (Online accounting SaaS platform), Kuaidi 100 (courier and logistics platform) and Kingdee Wise Note (Cloud + terminal sales-and-inventory software). While Kingdee is not the only SaaS player, we believe Kingdee could leverage on its SME expertise and exposure to penetrate into mobile internet ERP market.

Source: Kingdee

Shareholder and management background. Xu Shao Chun, Chairman and CEO, is the founder of Kingdee. He is Deputy Director of China Software Industry Association. Since Xu taking charge again of the company after resignation of ex-IBM Managing Partner, Kingdee refocused on ERP products and refined cloud business. In 1H 2013A, Kingdee recorded slight revenue fall YoY and was able to break-even since making loss in 2012A. As of Nov 2013, Xu held 31.1% shares in Kingdee. Fidelity, Capital Group as well as Franklin Templeton held 6.18%, 6.11% and 6.01% respectively.

Table 4. Shareholders

Shareholding

Chairman & CEO Xu Shao Chun 31.09%

Fidelity 6.18%

The Capital Group 6.11%

Franklin Templeton 6.01%

Public 50.61%

Total 100.00%

Kingdee penetrates into enterprise mobile internet market with the advantage of strong SME expertise and exposure

Kingdee is building a complete product line from mobile ERP to enterprise social network, SaaS platform and logistics platform that echoes “Third Platform Era” hypothesis

Chairman and CEO Xu Shao Chun turned Kingdee

profitability again in 1H 2013A after strategy disruption in 2011A-12A

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21 / 41 DCF valuation at HK$2.70. Initiate Accumulate rating. With turnaround in

2013E and greater opportunities with enterprise mobile internet development ahead, we are positive on Kingdee. For Dec 2014E, our DCF model suggests a market valuation of RMB5,336m, which translates to HK$2.70 per share. Table 5 shows DCF absolute valuation on Kingdee; Table 6 shows corresponding valuation multiples. As for P/E, Kingdee is trading at 19.5x and 14.0x P/E as for 2014E and 2015E. Initiate with Buy with 37.6% upside.

Table 5. DCF valuation of Kingdee RMBm

Valuation point Dec 2014

Pre-tax cost of debt 6.13%

Marginal tax rate 18.0%

Risk free rate 1.87%

Market rate of return 13.3%

BETA coefficient 0.900

Target E/(D+E) 70.0%

Target D/(D+E) 30.0%

Cost of equity 12.1%

After-tax cost of debt 5.0%

WACC 10.0%

Sum of PV of FCFF until 2022E 2,300.0

Terminal growth rate 2.0%

PV of terminal value 3,708.8

EV 6,008.8

Cash 918.1

Non-core assets 0.0

Total debt 1,590.6

Intrinsic equity value 5,336.3

Common shares outstanding (million) 2,527.2

CNY/HKD 1.2771

TP (HK$) 2.70

Table 6. Quick valuation matrix at current price and target price

2013E 2014E 2015E

@ Current price (HK$1.96) P/E 44.4x 19.5x 14.0x P/B 2.31x 2.09x 1.85x P/S 2.34x 2.03x 1.72x EV/EBITDA 13.6x 8.2x 6.4x @ Target price (HK$2.70) P/E 61.1x 26.8x 19.3x P/B 3.18x 2.87x 2.55x P/S 3.22x 2.79x 2.37x EV/EBITDA 17.9x 10.8x 8.5x

Our DCF model suggests a target price of HK$2.70. We initiate Buy with 34.8% upside on turnaround story and enterprise mobile internet opportunities

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22 / 41 Financial summary

Income statement Cash flow statement

RMBm 2011A 2012A 2013E 2014E 2015E RMBm 2011A 2012A 2013E 2014E 2015E

Turnover 2,022.5 1,765.5 1,659.4 1,912.7 2,254.1 Total profit 153.1 (164.0) 87.4 199.3 276.5

Cost of sales (604.7) (618.5) (466.3) (487.9) (559.2) Change in working capital (104.9) (17.0) (45.1) (41.0) (7.0)

SG&A (1,484.2) (1,370.6) (1,062.0) (1,118.9) (1,316.4) Others 103.0 192.7 315.7 344.8 389.5

Research and development costs (168.7) (200.4) (248.9) (267.8) (293.0) Cash flow from operations 151.3 11.7 358.0 503.1 659.0

VAT refund 183.4 161.1 146.3 165.4 196.1

EBIT (51.7) (262.9) 28.5 203.5 281.6 Purchase of fixed assets (189.1) (244.0) (45.5) (47.7) (50.1)

Depreciation (36.5) (34.5) (41.3) (43.4) (45.6) Addition for amortization items (274.4) (317.6) (296.0) (331.6) (378.3)

Amortisation (166.6) (205.3) (269.1) (301.4) (343.9) Others (18.0) (158.2) (54.7) 0.0 26.0

EBITDA 151.5 (23.1) 338.9 548.3 671.1 Cash flow from investing activities (481.5) (719.8) (396.1) (379.3) (402.5)

Fair value gain on investment properties 135.7 61.0 0.0 0.0 0.0 Debt financing 427.5 973.1 11.9 (452.5) (250.0)

Government grants 82.4 56.9 70.0 70.0 70.0 Equity financing 0.0 0.0 0.0 0.0 0.0

Other gains-net 23.9 42.2 106.2 40.0 40.8 Dividend paid (60.3) 0.0 0.0 (17.5) (39.9)

Finance costs - net (8.9) (59.1) (98.1) (70.5) (55.2) Others (35.0) (0.5) 14.5 0.0 0.0

EBT 181.4 (162.0) 106.6 243.0 337.2 Cash flow from financing activities 332.2 972.7 26.4 (470.0) (289.9)

Income tax (28.3) (2.0) (19.2) (43.7) (60.7) Net cash flow 2.0 264.6 (11.7) (346.2) (33.3)

Total profit 153.1 (164.0) 87.4 199.3 276.5 Beginning cash 631.5 633.4 898.0 886.3 540.1

Net profit 145.0 (140.2) 87.4 199.3 276.5 Ending cash 633.4 898.0 886.3 540.1 506.8

Balance sheet Ratio analysis (%)

RMBm 2011A 2012A 2013E 2014E 2015E 2011A 2012A 2013E 2014E 2015E

Land use rights 83.7 138.8 139.2 139.5 139.8 Turnover growth rate 40.8% -12.7% -6.0% 15.3% 17.9%

Property, plant and equipment 518.1 791.2 795.4 799.7 804.2 EBITDA Growth Rate -53.0% n.a. n.a. 61.8% 22.4%

Intangible assets 587.9 637.2 663.8 693.6 727.6 EBIT Growth Rate n.a. n.a. n.a. 615.1% 38.4%

Investment properties 496.9 825.6 825.6 825.6 825.6 Growth Rate of Profit for the Year -46.6% n.a. n.a. 128.1% 38.8%

Other non-current assets 0.0 26.0 26.0 26.0 0.0

Gross Profit Margin 70.1% 65.0% 71.9% 74.5% 75.2%

Trade and other receivables 379.0 313.5 325.0 367.5 435.8 EBITDA Margin 7.5% n.a. 20.4% 28.7% 29.8%

Due from customers on contracts 292.5 326.3 338.7 377.5 418.0 EBIT Margin n.a. n.a. 1.7% 10.6% 12.5%

Cash and cash equivalents 633.4 898.0 886.3 540.1 506.8 Net Profit Margin 7.2% n.a. 5.3% 10.4% 12.3%

Other current assets 42.6 24.7 66.1 66.4 67.3 ROE 8.8% n.a. 5.2% 10.7% 13.2%

ROA 4.8% n.a. 2.1% 5.2% 7.0%

Borrowings 597.5 1,363.6 1,417.7 1,000.0 800.0 ROCE n.a. n.a. 0.3% 5.3% 7.4%

Other non-current liabilities 85.6 69.3 66.5 66.5 66.5

Total Debt/Total Equity 38% 100% 96% 62% 43%

Trade and other payables 465.6 537.6 559.5 585.5 671.0 Net Debt/Total Equity n.a. 42% 43% 33% 19%

Due to customers on contracts 64.5 73.6 79.7 94.4 111.5 Current Ratio 1.9 1.6 1.8 1.5 1.5

Borrowings 20.0 227.0 184.8 150.0 100.0 Quick Ratio 1.9 1.6 1.8 1.5 1.5

Other current liabilities 157.1 119.8 80.0 80.0 80.0 EBITDA Interest Coverage Ratio 17.1 n.a. 3.5 7.8 12.2

Total equity 1,643.6 1,590.3 1,677.7 1,859.5 2,096.2 Accounts Receivable Turnover 534% 563% 511% 520% 517%

Shareholders' equity 1,609.3 1,578.8 1,666.2 1,848.0 2,084.7 Accounts Payable Turnover 130% 115% 83% 83% 83%

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23 / 41 Historical valuation summary

Price chart (HK$)

Bloomberg trailing P/E (x) (distortion due to 11A decline and 12A loss-making)

Bloomberg trailing P/S (x) (distortion due to 11A decline and 12A loss-making) 0 1 2 3 4 5 6

Jan-11 Apr-11 Jul-11 Oct-11 Jan-12 Apr-12 Jul-12 Oct-12 Jan-13 Apr-13 Jul-13 Oct-13

(HK$) 0 10 20 30 40 50 60 70 80

B lo o m b erg t raili n g P/E (x) 0 1 2 3 4 5 6 7 8

Bloomb e rg tr a il ing P /S ( x )

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24 / 41

Chinasoft (0354 HK)

To expect from industry solutions and Aliyun

Company initiation

19 Dec 2013

Chiasoft industry solutions fit well with mobile enterprise theme: Chinasoft revenue increased to RMB2,768m in 2012A from RMB983m in 2008A, representing 29.5% CAGR for 4 years. Considerable growth was seen in both service revenue of professional service (PSG) and outsourcing service (OSG). PSG includes IT solutions for industries such as banking, insurance, manufacturing and government. Chinasoft expertise meets IDC prediction of focus shift from general ERP to industry solution in enterprise mobile internet, in our view.

Chinasoft positions well in cloud service with Ali and M&A:

Chinasoft partners with Aliyun through exclusive middleware support. Industry solutions of Chinasoft could be potentially applied smoothly on Ali integrated platform. In addition to initial cloud migration for Aliyu, Chinasoft in Nov this year acquired a US company at US$41m that raises cloud computing servicing capability and channels.

Negative earnings surprise as for 2013E may pressure on share price: We are cautious towards 2013E earnings. With limited growth in government contracts, under-expectation Huawei contribution and higher ratio of operating expenses in 2013E, we do not expect net profit growth for the year, which may negatively surprise the market. Avoid 13E earning risk; Initiate Accumulate with HK$2.28 TP:

We are positive on Chinasoft for its income diversification and positioning in cloud service. For Dec 2014E, our DCF model suggests market valuation of RMB3,303m. Initiate Accumulate with 16.3% upside based on Dec 2014 valuation time point.

Kevin Mak,

CFA

Analyst

+852 35191299

[email protected]

Accumulate (initiating coverage)

Target price: HK$2.28

Share price: HK$1.96

HK$m (Yr-end Dec) 2011A 2012A 2013E

Revenue 2,243.8 2,768.2 3,281.4 % of growth 40.1% 23.4% 18.5% Core earnings 175.4 183.0 137.0 % of growth 27.2% 4.3% -25.2% Core EPS (RMB) 0.1199 0.1064 0.0740 % of growth -7.4% -11.3% -30.4% P/E (x) 20.30 19.83 20.73 P/B (x) 1.57 1.38 1.23 Dividend Yield 0.0% 0.0% 0.0% ROE 9.7% 8.9% 6.0%

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25 / 41 Products from middleware and IT solutions to IT outsourcing. Chinasoft was

incorporated in Beijing in 2000 with initial business focus in IT solutions in China with middleware platform ResourcesOne®. The company later diversified towards IT outsourcing business as well as IT consulting services in 2003 and 2010 respectively. As of 2012/2013, Huawei and Microsoft were the 2 largest clients of Chinasoft, making up RMB573m and RMB281m revenue respectively compared to RMB2,768m total turnover in 2012A. In terms of product portfolio, banking insurance and manufacturing industry IT solutions are main revenue contributors. Chinasoft was listed on GEM Board in 2003 and Main Board in 2008.

Illustration 1. Chinasoft development history

Illustration 2. Chinasoft product portfolio

Source: Adapted and modified from Chinasoft

Chinasoft provides middleware platform, general solutions and industry solutions to enterprises as big as Huawei and Microsoft

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26 / 41 Gradual increase in income and overall gross margin on product mix.

Chinasoft revenue increased from RMB983.4m in 2008A to RMB2,768.2m in 2012A, representing 29.5% CAGR for the past 4 years. With considerable growth in service revenue of professional service group (PSG) and outsourcing service group (OSG), the 2 segments accounted for 90% revenue in 2012A compared to 70% as of 2008A, which improved gross margin over the period partly due to change in product mix. Banking, insurance, manufacturing and government related income were classified mainly in PSG service, while Huawei and Microsoft were outsourcing business related.

Table 1. Revenue classification

Professional service group (PSG)

IT consulting Strategy and business consulting

Information technology consulting IT solutions Vertical application software & solution (Industry solutions) Product services (ResourcesOne® and TopLink) Outsourcing service group (OSG)

IT outsourcing Product engineering

ADM (Application development and maintenance) EAS (Enterprise application service) Infrastructure managed service

Business process outsourcing Data processing

CAD Call center Table 2. Revenue breakdown 2008A to 2012A

RMBm 2008A 2009A 2010A 2011A 2012A

Total revenue 983.4 1,104.6 1,601.2 2,243.8 2,768.2

PSG-equipment 241.1 183.7 226.8 283.9 216.8

PSG-service 378.5 430.6 637.1 931.1 1,236.0

OSG 344.7 455.5 682.9 959.5 1,221.8

Training 19.1 34.7 54.4 69.3 93.6

Overall gross margin 27.9% 30.5% 32.1% 32.5% 33.1% Source: Orient Securities

Outsourcing income from major clients Huawei and Microsoft. Chinasoft formed a 60%-40% JV with Huawei to provide IT outsourcing service to Huawei. OSG usually charges on “fee per worker time” basis while scope of work could be non-core software development and system testing. For Microsoft, Chinasoft provides global delivery capability for Microsoft outsourcing in US, EU and China. Microsoft is major shareholder of Chinasoft.

Table 3. Strategyic partnership with Huawei and Microsoft

RMBm 2008A 2009A 2010A 2011A 2012A

Huawei - 99 269 402 573

(60%-40% JV for OSG)

Microsoft 147 154 154 238 281

(Global delivery in US, EU and China) Source: Orient Securities

Chinasoft revenue increased 29.5% CAGR between 2008A and 2012A with gradual gross margin improvement

PSG services that includes middleware and IT solutions are mainly charged at fixed price for various industries such as banking, insurance,

manufacturing and government OSG services are outsourcing projects that are charged on fee per worker time basis. Major clients include Huawei and Microsoft

Chinasoft strategic partnership with Huawei and Microsoft together contributed 30% of total revenue as of 2012A

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27 / 41 Chinasoft partners with Aliyun to capture opportunities in cloud business. In

the previous section, we discussed Chinasoft penetration into enterprise mobile market by cooperating with Aliyun. By providing middleware support to Aliyun under exclusive agreement, Chinasoft enters Aliyun integrated ecosystem covering IaaS, PaaS as well as SaaS. With established platform, we believe Chinasoft could quickly ramp-up mobile enterprise applications to target a wider range of clients, especially SMEs in this case. At initial stage, Chinasoft assists Aliyun clients in cloud migration.

Recent M&A further secures Chinasoft ability in cloud service. As of Nov this year, Chinasoft acquired a US company headquartered in Texas at US$41.0m. The Target Company has launched four new capabilities over the past several years in Managed Services, Creative Services, Mobile Applications, and Cloud Services. Specifically, the Target Company’s new Cloud Services offering has already positioned itself as one of Microsoft’s leading cloud migration partners in the US. As of 2012A, the target recognized US$3.6m net profit, which represented 11.3x P/E for acquisition. We believe the M&A strengths Chinasoft ability and channels for cloud business.

Source: Orient Securities, Analysys

Shareholder and management background. Hony Capital is a member of Legend Holdings (联想控股) that specialized in private equity investment and management. As of Sep 2013, Hony Capital portfolio companies asset and revenue were RMB1,600b and RMB520b respectively. John Zhao founded Hony Capital in 2003. Chairman & CEO Chen Yuhong worked at ChinaSoft Group from 1996 to 2000 and served as a vice president. He worked for Great Wall Computers from 1991 to 1996 as a deputy general manager. Hony Capital, Chairman & CEO Dr Chen, Far East Holdings Int’l (0036 HK) and Microsoft together held 38.7% shares Oct 2013.

Table 4. Shareholders (As of Oct end 2013)

Shareholding

Hony Capital (Zhao John Huan) 18.1%

Chairman & CEO Chen Yuhong 9.2%

Far East Holdings International (0036 HK) 6.1%

Microsoft 5.3%

Others and public 61.3%

Total 100.0%

Chinasoft works with Aliyun to build integrated cloud platform to capture mobile internet opportunities

Chinasoft in Nov this year acquired a US company at US$41m that raises cloud computing servicing capability and channels

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28 / 41 DCF valuation at HK$2.28. Initiate Accumulate rating. While we are positive

on Chinasoft for its income diversification and positioning in cloud service, we are cautious towards 2013E earnings and do not rule out a negative surprise to the market. Nevertheless, for Dec 2014E, our DCF model suggests market valuation of RMB3,303m (HK$2.28 per share). Table 5 shows DCF absolute valuation; Table 6 shows corresponding valuation multiples. Initiate Accumulate with 16.3% upside based on Dec 2014 valuation time point.

Table 5. DCF valuation of Kingdee RMBm

Valuation point Dec 2014

Pre-tax cost of debt 6.61%

Marginal tax rate 20.0%

Risk free rate 1.87%

Market rate of return 13.3%

BETA coefficient 0.800

Target E/(D+E) 80.0%

Target D/(D+E) 20.0%

Cost of equity 11.0%

After-tax cost of debt 5.3%

WACC 9.9%

Sum of PV of FCFF until 2022E 1,113.0

Terminal growth rate 2.0%

PV of terminal value 2,269.2

EV 3,382.2

Cash 740.5

Non-core assets 0.0

Total debt 820.1

Intrinsic equity value 3,302.5

Common shares outstanding (million) 1,849.8

CNY/HKD 1.2771

TP (HK$) 2.28

Table 6. Quick valuation matrix at current price and target price

2013E 2014E 2015E

@ Current price (HK$1.96) P/E 20.7x 17.1x 13.3x P/B 1.23x 1.14x 1.04x P/S 0.87x 0.63x 0.51x EV/EBITDA 12.6x 9.9x 8.1x @ Target price (HK$2.28) P/E 24.1x 19.9x 15.4x P/B 1.44x 1.33x 1.21x P/S 1.01x 0.73x 0.60x EV/EBITDA 14.2x 11.1x 9.1x

We are cautious towards 2013E earnings and do not rule out a negative surprise to the market We initiate Accumulate with TP at HK$2.28

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29 / 41 Financial summary

Income statement Cash flow statement

RMBm 2011A 2012A 2013E 2014E 2015E RMBm 2011A 2012A 2013E 2014E 2015E

Turnover 2,243.8 2,768.2 3,281.4 4,505.8 5,538.4 Total profit 121.1 150.1 156.5 189.5 244.4

Cost of sales (1,514.3) (1,852.8) (2,239.9) (3,107.7) (3,813.6) Change in working capital (156.1) (380.3) (250.5) (169.0) (210.7)

SG&A (458.0) (615.5) (733.4) (991.3) (1,218.5) Depreciation and amortisation 86.6 89.5 101.2 118.8 133.5

Research and development costs (46.0) (57.1) (65.6) (90.1) (110.8) Others 69.2 62.3 5.3 11.4 18.3

Amortisation of intangibles & prepaid lease (47.5) (43.0) (50.7) (65.7) (77.8) Cash flow from operations 120.7 (78.4) 12.5 150.6 185.5

EBIT 178.0 199.9 191.8 251.0 317.8

Purchase of fixed assets (63.1) (50.1) (55.6) (58.4) (61.3)

Depreciation (39.0) (46.6) (50.6) (53.1) (55.7) Addition for amortization items (23.2) (88.0) (126.4) (72.3) (85.5)

Amortisation (47.5) (43.0) (50.7) (65.7) (77.8) Others (28.8) 8.8 (253.8) 0.0 0.0

EBITDA 264.6 289.4 293.0 369.8 451.3 Cash flow from investing activities (115.1) (129.3) (435.9) (130.7) (146.8)

Finance costs - net (23.9) (31.1) (46.1) (54.2) (52.3) Debt financing 8.3 133.1 352.6 (50.0) (30.9)

Share of results of associates 2.6 2.0 0.0 0.0 0.0 Equity financing 306.4 101.2 59.7 0.0 0.0

Other items (32.7) (31.6) 0.0 0.0 0.0 Dividend paid 0.0 0.0 0.0 0.0 0.0

Government grants 26.6 48.5 50.0 40.0 40.0 Others (30.9) (24.1) 3.5 3.3 3.4

EBT 150.7 187.7 195.7 236.8 305.5 Cash flow from financing activities 283.8 210.2 415.7 (46.7) (27.5)

Income tax (29.6) (37.6) (39.1) (47.4) (61.1) Net cash flow 289.3 2.5 (7.7) (26.7) 11.2

Total profit 121.1 150.1 156.5 189.5 244.4 Beginning cash 484.2 773.0 774.8 767.2 740.5

Foreign exhange rate changes (0.6) (0.6) 0.0 0.0 0.0

Net profit 110.6 133.2 137.0 165.8 213.8 Ending cash 773.0 774.8 767.2 740.5 751.6

Balance sheet Ratio analysis (%)

RMBm 2011A 2012A 2013E 2014E 2015E 2011A 2012A 2013E 2014E 2015E

Property, plant and equipment 131.5 132.9 137.9 143.2 148.8 Turnover growth rate 40.1% 23.4% 18.5% 37.3% 22.9%

Intangible assets 157.2 159.3 235.1 241.7 249.4 EBITDA Growth Rate 52.2% 9.4% 1.2% 26.2% 22.0%

Goodwill 657.1 629.1 833.0 833.0 833.0 EBIT Growth Rate 63.9% 12.3% -4.0% 30.9% 26.6%

Other non-current assets 61.1 105.6 106.8 109.3 113.5 Growth Rate of Profit for the Year -375.6% 20.4% 2.8% 21.0% 29.0%

Inventories 24.4 24.0 44.8 62.2 76.3

Trade and other receivables 760.6 1,039.4 1,312.6 1,757.3 2,104.6 Gross Profit Margin 32.5% 33.1% 31.7% 31.0% 31.1%

Amounts due from customers for contract 363.7 561.4 610.9 734.6 890.5 EBITDA Margin 11.8% 10.5% 8.9% 8.2% 8.1%

Cash and cash equivalents 773.0 774.8 767.2 740.5 751.6 EBIT Margin 7.9% 7.2% 5.8% 5.6% 5.7%

Other current assets 19.0 15.9 0.0 0.0 0.0 Net Profit Margin 4.9% 4.8% 4.2% 3.7% 3.9%

ROE 6.1% 6.5% 6.0% 6.7% 7.8%

Deferred tax liabilities 24.8 17.6 19.6 23.7 30.5 ROA 3.8% 3.9% 3.3% 3.5% 4.1%

Convertible loan notes 193.8 0.0 184.4 189.2 0.0 ROCE 6.8% 6.3% 4.8% 6.2% 7.3%

Borrowings 29.6 19.0 250.0 200.0 200.0

Other non-current liabilities 5.6 0.0 0.0 0.0 0.0 Total Debt/Total Equity 22% 26% 38% 33% 29%

Amounts due to customers for contract 56.1 110.5 152.7 198.5 258.1 Net Debt/Total Equity 22% 26% 38% 33% 29%

Trade and other payables 613.1 668.9 716.8 1,087.7 1,334.8 Current Ratio 2.2 1.8 2.0 1.9 1.7

Borrowings 165.6 309.3 430.9 430.9 400.0 Quick Ratio 2.2 1.8 2.0 1.8 1.7

Convertiable loan notes 0.0 199.1 0.0 0.0 194.4 EBITDA Interest Coverage Ratio 11.1 9.3 6.4 6.8 8.6

Other current liabilities 55.2 55.7 49.2 57.4 71.2

Accounts Receivable Turnover 295% 266% 250% 256% 263%

Shareholders' equity 1,725.7 1,927.6 2,144.9 2,310.7 2,524.5 Accounts Payable Turnover 247% 277% 313% 286% 286%

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30 / 41 Historical valuation summary

Price chart (HK$)

Bloomberg trailing P/E (x)

Bloomberg trailing P/S (x) 1 1.5 2 2.5 3 3.5

(HK$) 15 20 25 30 35 40

B lo o m b erg t raili n g P/E (x) 1 1.5 2 2.5 3

Bloomb e rg tr a il ing P /S ( x )

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31 / 41

Sinosoft (1297 HK)

Awaiting catalysts to breakthrough bottleneck

Company initiation

19 Dec 2013

Overall income growth could be pressured on changing income mix: Sinosoft was founded in 1998 with product focus on “export tax software” & “e-Government solution”, contributing 60%-75% operating profit. Overall Sinosoft income was expanding at 20% a year over past 3 years, slightly above Jiangsu software market growth at 17%-19%. While the 2 major segments are expected to grow at 10%+ in short-to-medium term, restructuring of non-cores may affect overall growth. Significant local government revenue could be a concern:

As of 2012A, Sinosoft earned 84% from its home base Jiangsu. Barrier to enter other provinces is high especially in gov related universe. Between 10A & 12A, Sinosoft was deriving 65%-80% income from gov agencies. We are concerned with its reliance on regional government projects due to limited upside surprise but potential growth constraint, earnings volatility and negative surprise, in our view.

Growth and breakthrough could be from carbon mgmt solutions: Since 2011A, Sinosoft started to provide the first carbon management solution to government bodies, which could be one of the future growth drivers. It would be effectively breakthrough regional domestic bottleneck of Sinosoft potential 2014E or 2015E.

Valuation priced in short-term bottom line growth:

While central government intends to spend significantly in information consumption, we believe Sinosoft will likely follow stable income growth despites above concerns. Our DCF model suggests a target price of HK$1.83 per share. Initiate with Accumulate.

Kevin Mak,

CFA

Analyst

+852 35191299

[email protected]

Accumulate (initiating coverage)

Target price: HK$1.83

Share price: HK$1.56

HK$m (Yr-end Dec) 2011A 2012A 2013E

Revenue 184.9 226.7 271.5 % of growth 21.4% 22.6% 19.8% Core earnings 65.8 83.4 106.3 % of growth 41.3% 26.8% 27.5% Re EPS (RMB) 0.0877 0.1112 0.1063 % of growth 41.2% 26.8% -4.4% P/E (x) 15.60 12.02 12.72 P/B (x) 8.02 5.40 1.94 Dividend Yield 0.0% 0.0% 2.4% ROE 37.4% 32.7% 14.8%