AAC announced to introduce four strategic investors (incl. Xiaomi, Oppo) to its optics subsidiary, AAC Communication, with RMB1.15bn capital increase for 9.58% of enlarged equity. We become more positive on AAC’s optics segment given 1) two major clients (Xiaomi, Oppo) are positive on its business with more synergies in business expansion and new projects, 2) new capital for lens/HCM capacity and R&D, and 3) unlock value of AAC’s optics as an independent fundraising platform (e.g. spinoff, IPO). We lifted FY20-22E EPS by 2-10% to reflect better optics volume/margin and 5G iPhone cycle. We derive new TP of HK$45.3 using SOTP to better reflect valuation for diverse businesses. Upgrade to HOLD (from Sell) given our more positive view on AAC’s optics, but current valuation at 25x FY21E P/E is fair for earnings volatility and weak optics profitability in near term.
- Introduction of Xiaomi and Oppo as strategic investors. The four new strategic investors include Hubei Xiaomi Changjiang Industrial Fund, Oppo Guangdong Mobile Communication, Shenzhen Huiyou Haochuang Tech Investment Partnership and Nanjing Huarui Ruijun Entrepreneurship Investment Center. Mgmt. stated that new investors will not take mgmt. roles or take any board seats. The deal implies valuation of RMB 12bn for AAC’s optics biz, which is ~20% of AAC’s market cap as of 22 Jul 2020.
- Better synergy and capital for capex/R&D, but profitability remains weak in near term. We think the investment suggested AAC’s major clients (Xiaomi, Oppo) are positive on its optics development and new capital of RMB 1.1bn can be used for AAC’s working capital, which can boost capacity and R&D for HCM/lens. However, since client demand for its high-end WLG/hybrid lens remains weak in near term, we expect AAC will continue to focus on mid/low-end optics segment and it will take longer-than-expected time to meet GPM guidance of 30%/40% in 2Q20/2H20.
- Raise FY20-22E EPS by 2-10% for better optics GPM/shipment. We revised up our EPS to reflect higher lens shipment/GPM given better synergies with strategic clients as well as stronger 5G iPhone cycle. Our FY20-22E EPS are 10-23 % below consensus for more conservative GPM.
- Upgrade to HOLD to reflect stronger optics; Fair valuation at 25x FY21E P/E. We changed to use SOTP valuation to derive our TP of HK$45.3, to better reflect AAC’s business diversity and growth profile. We assign 20x FY21E P/E for its core biz and RMB 12bn valuation for its optics segment. Upside risks include better optics margin and stronger iPhone shipment.
