We assume coverage of AAC with an UW rating and a Jun-16 PT of HK$42 (12x
2016 EPS). We recommend investors take profit as we believe management's
positive 2016 tone is already priced in and we are conservative on margin
improvement, primarily due to risks of haptics oversupply and a lack of visibility
in RF growth, and expect 2017 growth to decelerate to single digits. Our 2016/17
EPS estimates are 2%/10% below BBG consensus. AAC's share price correlates
with market expectations for its share allocation from Apple on major products.
We believe the stock could trade down to the low-40s in 1H16 given iPhone 6S
weakness and haptics share loss, and would recommend investors revisit below
HK$40 or if we see better haptic content growth.
Haptics: tougher comps in 2H16; limited growth in 2017: We see heightened
competition in haptics and over-supply risks starting from 2016, given: 1) very
slim likelihood for dual-haptics in iPhone 7; 2) the Android camp's hesitation to
adopt haptics widely in 2016; and 3) rising competition with new vendors such
as Alps. With competitors' improving yields and Apple's push for supplier
diversification, AAC's haptics share is likely to drop to ~40% in 2017E (vs
~70% in 3Q15). Hence, we see decelerating growth from 2H16 for AAC and
expect Street estimates for ASP/margins to trend down.
Strong acoustics upgrade cycle in 2016 already priced in: AAC has
benefited from the upcoming acoustics upgrade cycle with both Apple and
Chinese brands. Of note, Chinese brands are adopting more speakerbox and the
SPBX mix is likely to hit 40%+ in 2016E, up from 25% in 2015. We model in
~12%/ 6% YoY growth for AAC's acoustics in 2016/17.
More cautious on margin improvement & metal casing initiatives: We
largely agree with management's revenue guidance and model 17%/8% revenue
growth in 2016/17E. However, we are less confident on margin improvement
and expect a slight margin decline in 2016, with downside from haptics/RF to
more than offset upside on acoustics. Of note, we are cautious about metal
casing initiatives and see potential margin downside.
New products: optics traction appears to be slow: AAC's optics push has
gained minimal early traction, but we see challenges in scaling up this business.
Tunable RF is a promising area but it looks like far away from mass adoption.
AAC's continued investments in new businesses are encouraging, but the next
driver of structural growth appears unclear to us now.
Investment negatives
#1: Heightened competition in Apple haptics, oversupply
likely from 2016
We see heightened competition in haptics and potential overcapacity risks from 2016
onwards. We believe AAC's haptics allocation within Apple iPhone is likely to
decline to ~40% levels in 4Q16/2017 (vs ~70% with iPhone 6S in 3Q15) and we see
nearly zero growth on haptics for AAC in 2017 within Apple due to new competitors
coming in.
Rising competition from NIDEC/Jinlong and emerging vendor Alps
NIDEC is a close rival with nearly the same haptics capacity as AAC (with 40-45
production lines). Despite still lower yields than AAC, NIDEC is improving
manufacturing efficiency and is likely to grab ~40% haptics shares in CY2016.
Jinlong is upgrading its existing production lines and started supplying haptics for
iPhone 6S (4.7 inch model) with very competitive prices (30-40% lower than AAC/
NIDEC). Alps is another emerging competitor and is likely to become a minor
haptics supplier from 4Q16/2017.
Weakening bargaining power with Apple taking back patent ownership
Meanwhile, Apple is trying multiple sourcing for its key components to diversify
supply chain risks. We acknowledge that the new haptics on iPhone 6S is designed
by Apple and thus supplier switching should be easier compared to the last
generation on iPhone 6, in which AAC largely controlled the design and patent
Oversupply risk exist in 2016, given nearly zero likelihood of dual-haptics on
iPhone 7 and slow penetration to Android brands
Further, we believe mass adoption of advanced haptics by the Android camp has not
materialized and Apple is likely to remain the major consumer for haptics in the next
two years. With very slim visibility of dual-haptics per iPhone 7 (thus little
likelihood with 7S in 2017 as well), we see worsening demand & supply dynamics
for AAC, as its competitors are aggressively expanding capacity, and rising
oversupply risks (Table 2), which weighs on AAC's revenue growth and margins.
Alps Electric (OW, covered by Masashi Itaya) is also likely to come in as a key
vendor for haptics within the Apple supply chain in 2017, after contributing small
volumes in 2H16. With four vendors in play (AAC, Nidec, Alps and Jinlong), we
believe that overcapacity is quite likely to emerge within the haptics supply chain for
Apple from 4Q16 onwards.
#2: Haptics adoption in Android camp going slow
In contrast to AAC management's positive tone, we are more cautious on haptics
adoption in the Android camp and expect the total addressable market of haptics
from Android brands to remain small, at only 4%/ 8% of Apple in dollar terms,
in 2016/17.
Haptics on Android subject to force-touch adoption at the UI level
We believe the Android camp's mass adoption of advanced haptics is likely to come
along with force touch functions (similar to 3D Touch with iPhone 6S/ 6S+). Despite
no major hardware technology hurdle in the display/touch control supply chain, OS-
level native support and deep hardware/software integration are required to promote
force touch. Thus, we believe early traction of advanced haptics (with ASP of
US$1.5-2.0+) is likely to come out in 2H16, when the force-touch supply chain
becomes more mature, and is likely limited to very few high-end models only.
The key variable remains Google's support of haptics and force touch functionality
for Android (earliest being Android 7.0 in end 2016). With a lukewarm reception for
the 3D Touch feature in Apple iPhone 6S so far, we see limited motivation for
Google to integrate force touch into Android in a hurry.
Haptics on Android likely come in with small volume in 2016/17
Our checks show that Samsung is not likely to enable force touch/ haptics functions
in a sizeable volume. Even it were to do so, key components including haptics are
likely local sourced in Korea.
Chinese brands such as Huawei might be more aggressive in pushing new features as
a marketing tactic, but recent feedback to force touch on its Mate S model has not
been encouraging.
Most in the Android camp are unlikely to adopt a high-end haptic element (ASP $6-
8) like Apple does, and are likely to settle for lower cost parts (ASP $1.5-2.0), given
the cost benefit is still unclear. As a result, we believe the benefit to AAC from
Android camp adoption in 2016 is likely to be minimal.
#3: Margin downside risk from non-acoustics
We expect downside from haptics/ RF mechanics to more than offset upside from
acoustics and thus model in 60bps/ 50bps YoY decline for GM in 2016/17 (vs YoY
margin improvement by the Street).
Haptics: With heightened competition in haptics, we expect some downside to
both ASP and margins. We expect AAC's haptics GM to trend down slightly
YoY in 2016/17 (vs Street expectations of flat YoY or slight improvement).
RF components: Given deteriorating product mix (increasing mix from metal
casing) as well as rising competition from GoerTek/Sunway, we expect GM on
RF to decline to sub-35% levels (vs 40%+ now).
Of note, different from acoustics in which AAC enjoys a high-level of automation,
metal casing is a highly customized component and the upfront fixed cost (equipment
depreciation, molding, etc.) is high.
In particular, three-layer design (Plastics + Metal + Plastic) and die-casing metal frame
are more welcomed by Chinese brands than uni-body design in the mid-low end,
putting a low barrier to entry. As such, we see execution risks and margins downside if
AAC adds capacity aggressively and fails to achieve certain scale per model.
#4: Lack of large customers in RF components remains risk
AAC's RF mechanical solution is well positioned for emerging small brands with
very lean R&D resources. AAC has actually secured quite good margins from these
new customers (media/ internet players entering the hardware space) who normally
are generous on component procurement. However, in collaborating with small
brands, AAC has to bear the risks of high volatility & low visibility of future orders.
Scaling up RF components remains a challenge as it is unappealing to large
customers
To grow its RF business meaningfully and sustainably in the longer term, AAC
needs to break into large customers (such as Huawei/ Samsung, and even Apple) as it
has done on acoustics/haptics. However, we believe AAC's bargaining power &
value-add on antenna design is relatively unappealing to larger brands. Big brands
like Huawei have in-house RF/ antenna design capacity and give relatively less value
to AAC's one-stop RF solution, since they want to retain flexibility in designing
casings and RF/antenna components on their own.
As we have seen with custom-made components (such as plastic/metal casings), the
hit-rate with smaller brands is usually quite low for component makers due to high
volatility and low predictability on the success of particular models. As a result, we
remain concerned that this could become a high volatility revenue stream from 2017
onwards for AAC, unless it breaks into large customers.
#5: Stock already factoring in 20% growth in 2016
After the company's strong guidance in its 3QFY15 earnings conference, we believe
the current stock price has already factored in ~20% YoY revenue growth in 2016.
We see downside to this especially if: 1) we see higher-than-expected ASP/market
share decline within Apple haptics and 2) rising competition in RF/acoustics kicks in.
In addition, we see limited structural growth drivers on a two-year horizon, after the
current cycle of haptics upgrade on iPhone 6/6S and the upcoming acoustics upgrade
on iPhone 7.
We believe 3Q/4Q15 is likely to mark the peak of EPS YoY growth in the next two
years and expect earnings growth momentum to moderate significantly from 2H16
onwards.
At this price level (implied 14-15x 2016EPS vs single digit EPS growth in 2017), we
see more downside than upside. Key downside catalysts in our view are market share
loss/ASP drop on haptics, Apple YoY iPhone shipments turning negative in the near
term and margin decline in 2016 due to mix degradation.
#6: Rise of Chinese smartphone component vendors a
medium-term threat
AAC is one of the pioneers in offering one-stop solutions to Chinese customers and
is so-far best positioned in 'acoustics + antenna + mechanical + casing' integrated
solutions. We see a prevailing trend of all-in-one total solutions across the China
smartphone supply chain now, through horizontal expansion and M&A. All-in-one
solutions such as 'antenna + connector', 'connector + acoustics', touch + fingerprint'
are emerging in China now.
We believe some of AAC's competitors are likely to further grow business among
Chinese brands and, in the medium long term, to challenge AAC's leading position
in component total solutions, given that: 1) most of them have already penetrated into
tier-1 clients, thus further customer/product penetration should be easy; and 2) most
of them are well prepared for total solution through horizontal product expansion,
which is further backed by financial flexibility with strong capital market support.
In particular, we believe AAC is likely to see rising competition from the following
companies in the near term.
GoerTek: Our checks show GoerTek is following AAC's strategy to address
Chinese brands with integrated antenna/acoustics solutions. Of note, GoerTek
may foray into the haptics market as well (for Android brands only at the current
stage).
Sunway/Speed: Sunway/Speed are two leading RF/antenna vendors in China.
Sunway plans to integrate acoustics components (speakerbox) with its antenna
products while Speed shows increasing interest in offering integrated RF products
with mechanical/casing, particularly after the acquisition of Shenzhen Xuanmei –
a coating and stamping company.
Luxshare & Merry: With additional placement funds, Merry might expand its
capacity (mostly with automated production) to gain acoustic shares from Apple.
With acoustics capability from Merry, Luxshare is better positioned to offer total
component solutions by covering connectors, antenna and acoustics.
Investment positives
#1: Acoustic upgrade in iPhone 7 and increased
speakerbox adoption by PRC brands
In 2016, we believe AAC should benefit from the upcoming acoustics upgrade cycle
in both Apple and Chinese brands. We model in ~12%/ 6% YoY growth for AAC's
acoustics in 2016/17, backed by: 1) ~20% increase of acoustics content with iPhone
7; and 2) usage of speakerbox among Chinese smartphone to increase to 40%/55% in
2016/17E (vs 25% in 2015).
Acoustics spec upgrade in both iPhone 7 and Chinese smartphones to help
acoustics ASP
Our research indicates that iPhone 7 is likely to come with upgraded acoustics
features including: 1) water/dust-proof, 2) low bass and even 3) stereo sound
powered by dual speakers, likely leading to a 20%+ increase of acoustics dollar
content with iPhone.
Chinese brands are also likely to upgrade speakerbox with water-proof features. We
expect AAC's blended ASP of acoustics to see a meaningful uplift in 2H16.
Rising speaker to speakerbox migration
AAC should benefit from the ongoing trend of speaker to speakerbox migration
among Chinese brands, for better audio performance as well as lower failure & repair
rate (with further protection against collision/water by the box or chamber on
speakerbox). We believe overall speakerbox penetration among Chinese customers is
at ~25% level now and we expect it to further increase to 40%/55% in 2016/17E.
#2: RF integrated metal casing seeing good initial traction
among smaller brands
Seeing a strong RF upcycle backed by 4G/multimode migration
With 3G to 4G migration and spec upgrades within 4G (such as mode migration,
career aggregation, etc.), we see meaningful upgrade in RF content and AAC, as one
of the integrated RF solution supplier, benefits from this trend. AAC is penetrating
into emerging brands by offering a one-stop RF solution (coupled with mechanical
structures) and charging premium for the time-to-market advantage, since RF design
has become increasingly challenging with 4G smartphones.
New project wins should drive growth in 2016, metal casing key driver
Management expects RF mechanical projects to see strong customer traction in 2016,
with visibility for ~20 projects in 2016 (vs 4-5 projects in 2015). Of note, AAC's
integrated RF & metal casing structure has gained some early customer adoption by
LeTV and this business is expected to further drive revenue growth in 2016. Seeing
strong demand for metal casing, management plans to expand CNC machine capacity
to 2000 units in 2016 (vs 600 units now).
We expect AAC's RF business to further grow ~90%/ 40% in 2016/17E,
respectively, from a low base, and to account for 11%/ 14% of total sales.
However, our concern remains on the quality of this revenue growth, since most of
the customers are newcomers into the smartphone space and could lose momentum
after the initial ramp-up stage, as seen in the last few years.
Breakthrough into larger customers like Apple / Samsung/ Huawei is also difficult
since these brands have large in-house RF design teams themselves.
#3: Strong R&D pipeline (Optical, MEMS) and solid ROE/
execution
Good track record of new technology incubation
AAC's share price has been highly correlated with the progress in new product
development & feature innovation. We found three major sources of AAC's
technology incubation: 1) internal development with in-house R&D team; 2) co-
development with global tier-1 customers and 3) external M&A.
Based on AAC's track record on items 1) and 2), we believe AAC is not likely to
miss any major upgrades from Apple on haptics and acoustics in the future.
Strong R&D pipeline like optics/MEMS
Looking at AAC's M&A history, we believe optics/ MEMS are likely to be the
next drivers.
We note that AAC has started selling 5MPx front-camera lens to Chinese customers
and plans for mass production of 13MPx lens in 2016.
However, given the crowded optics market with many players (like Largan/ Genius/
Sunny Optical) fighting for share, in the near term, the further room left to AAC
might be limited to niche areas such as dual-camera/ array camera, or differentiated
products such as integrated products with VCM/ OIS, etc.
Further, with long-term investment in MEMS microphone and its effort on in-house
MEMS dies, AAC could be well positioned in the future 'Internet of Things' era
when MEMS contents are likely to see meaningful increases.
Strong ROE backed by solid execution
AAC has been able to maintain GM at 40%+ level even with rising competition from
local rivals and with continued diversification into non-acoustics. We expect AAC to
deliver ~25-29% ROE in 2016-17, one of the highest within the Apple Supply
Chain, warranted by solid execution. AAC manages to deliver good product quality
while expanding product variety and holds a good balance of manufacturing
automation and feature customization.
integrated RF solution appears to be slow, with very small revenue contribution.
Sunway is a serious competitor in RF/ antenna and has seen the trend of integrated
RF/ antenna solutions. However, it just started R&D on speaker-box and the RF/
acoustics integrated product may only come out as early as 1H16.
Global antenna vendors such as Amphenol, Molex seem not to be focusing on
integrated RF solution and we believe they are unlikely to invest aggressively in
acoustics & mechanicals given the scale & cost disadvantage and limited resource on
customer supports & product customization.
Metal casing: a high-mix low-volume business
Despite the structural trend of metal casing migration, we see a segmented market
with increasing competition in the mid-low metal casing business. We believe AAC
should focus on the mid-high market (namely 'Uni-body design (CNC + stamping)'
in the below table), thus leveraging its antenna design capability, and avoid low-end
segments, which have higher overcapacity risks and low margins.
Margin downside may emerge if AAC fails to manage capacity/ yield properly
With increasing contribution from PRC customers, AAC is entering into a high-mix
& low-volume market (related to Apple). In such environment, AAC needs to be
prudent in partnering with smartphone brands as scale per single model is the key
factor to warrant decent margins; otherwise, we see execution risk and margin
downside from metal casing business.
Actually, 30% appears to be the ceiling of gross margins among Android metal
casing vendors (vs 40%+ gross margins by AAC's RF segment in 2Q/3Q15). Even
with margin accretion from antenna design, we see margin downside to AAC's RF
business if it aggressively competes for casing orders.
Acoustics
Apple remains the largest acoustics customer to AAC, contributing 50%+ of the
latter's acoustics business. We expect AAC to remain a tier-1 acoustics supplier and
get stable share allocation (~40%) from Apple.
Further share loss to GoerTek is limited
AAC and GoerTek are the two major acoustics suppliers to Apple with a combined
share of 85-90%. AAC was losing market share to GoerTek in 2011-13, however, we
believe the share split between those two is at equilibrium now, with AAC taking
slightly more share from new models while GoerTek supplying larger proportion of
Apple's mature models.
This document is being provided for the excluAsia Pacific Equity Research
05 January 2016
Gokul Hariharan
(852) 2800-8564
gokul.hariharan@jpmorgan.com
Luxshare/ Merry alliance could be a medium threat
Luxshare has announced to invest up to Rmb800mn in Merry, which is worth
watching for AAC. With additional placement fund, Merry might expand its capacity
to gain acoustic shares from Apple. According to our checks, we believe Merry could
expand its existing acoustics capacity to Apple by 2-3x with Luxshare's investment.
Limited threat from global competitors
AAC largely holds 1/3 share of global acoustics component market and we see
limited threat from its global acoustics competitors, such as Knowles and Hosiden,
given their much lower scale and inferior cost structure.
Of note, Knowles is the clear leader in MEMS MIC with ~60% global market share,
followed by AAC with ~15% M/S. We expect AAC to retain its market share with a
stable allocation from Apple.
All-in-one total solutions
AAC is one of the pioneers in offering one-stop solution to Chinese customers and is
so-far best positioned in the 'acoustics + antenna + mechanical + casing' integrated
solutions. We see prevailing trend of all-in-one total solution, across China
smartphone supply chain now, through horizontal expansion and M&A. All-in-one
solutions like 'connector + FPC', 'connector + acoustics', 'touch + fingerprint' are
emerging in China now.
We analyze the company profiles of AAC's major domestic competitors. With our
findings below, we believe some of they have the opportunity to further grow their
business among Chinese brands and challenge AAC's leading position as a one-stop
component shop in the medium-/ long-term.
Already penetrated into tier-1 clients; further customers/ products
penetration should be easy: Most of Chinese component vendors have already
penetrated into large domestic smartphone brands and even global brands like
Apple (e.g. GoerTek/ Sunway/ Luxshare/ Jinlong). With stamps from those big
clients, they have demonstrated the design capacity and good product quality –
thus it should be easier for them to further gain shares among Chinese brands and
bundle sell affiliated/ new products.
Good enough technologies to offer all-in-1 solutions: We agree that AAC is
probably the leader with best-in-class technologies and product quality among
Chinese vendors now. However, more important than individual technology &
quality, what attracts Chinese brands is the total cost saving, simpler supply chain
management, time-to-market advantage and customer services – we believe most
of those Chinese vendors are competitive in those metrics.
Financial flexibility with capital market support: Most of those competitors
are as cash sufficient (scaled to their revenue base) as AAC. More importantly,
with supports from the local capital market, they could find a way to expand
capacity aggressively or break-into new businesses.
In particular, we believe AAC is likely to see rising competition from the following
companies in the near term.
GoerTek: Our check shows GoerTek is following AAC's strategy to address
Chinese brands with integrated antenna/ acoustics solution. Of note, GoerTek is
likely to foray into the haptics market as well (for Android brands only at current
stage).
Sunway/Speed: Sunway/Speed are two leading RF/ antenna vendors in China.
Sunway wants to integrate acoustics component (speakerbox) with its antenna
products while Speed shows increasing interest in offering integrated RF products
with mechanical/ casing, particularly after the acquisition of Shenzhen Xuanmei
– a coating and stamping company.
Luxshare & Merry: With investment from Luxshare, Merry might expand its
capacity (mostly with automated production) to gain acoustic shares from Apple.
With acoustics capability from Merry, Luxshare would be better positioned to
offer total component solutions by covering connectors, antenna and acoustics.
Company analysis
Company background
AAC Technologies, founded in 1993, is one of the leading miniature component
solutions providers, specializing in acoustics and mechanical parts. AAS is the global
No. 1 vendor in miniature acoustics, with ~35% market share globally. AAC excels
in design flexibility and complexity and has very good yield rates and short lead
times. It also enjoys a high level of automation and strong, lean production
management.
AAC manufactures dynamics components (namely speaker boxes, traditional
speakers and receivers), MEMS microphones, haptics, RF/ antenna and handsets for
world's major smartphone and tablets brands. Its major customers include Apple,
Samsung, Xiaomi, Huawei, Moto, Oppo, HTC, LeTV, etc.
AAC has multiple factories across China, including Changzhou (acoustics, haptics,
mainly for Apple), Shuyang (RF/ antenna, semi-automated acoustics), Suzhou
(optics), Shenzhen (MEMS), Vietnam (manual-line, mainly for SEC now).
Mr Zhengmin Pan (Founder and CEO)
Mr Zhengmin Pan is the CEO and Founder of the Company. Mr Pan is responsible
for company strategy, business planning and execution, as well as leading R&D. In
1996, he co-founded and was appointed President and CEO of American Audio
Component Inc. Mr Pan also co-founded Shenzhen Meiou Electronics Corporation in
1998 and American Audio Components (Changzhou) Co., Ltd. ('Changzhou AAC')
in 2000. Mr Pan is the spouse of Ms Chunyuan Wu, the non-executive Director and a
substantial Shareholder of the Company.
Segment and product analysis
AAC is a leading miniature component vendor…
AAC is a leading maker of miniature component for acoustic and mechanical parts
that widely used in smartphone/ tablets. With continued business diversification and
breakthrough in non-acoustics, AAC has diversified its core business from acoustics
centric to a more balance portfolio, including RF/antenna, haptics, optics, etc.
…Conquering the sweet corner of high-volume & innovation
AAC is one of the few hardware component companies that have been delivering
innovative products in large scale, backed by superior R&D design capacity, strong
product quality and well established cooperation with global tier-1 customers.
We analyze the AAC's production & customer strategies since 2014 (as shown in
Figure 18) and two key trends stand out: 1) China handset customers' moving up
value chains expands total addressable market of AAC's speaker-box/ MEMS mics
that used to adopt only by global tier-1 customers; and2) breakthroughs in non-
acoustics (Haptics/ RF, etc.) offers new business opportunities, putting more balls
into the sweet corner of high-volume & innovation.
Notably, AAC's endeavour in product diversification has paid off, with non-
acoustics businesses (such as haptics, RF/ Antenna) ramping up quickly and revenue
dependence on acoustics being lowered down to ~60% (vs 90%+ in 2013 and
before). According to our addressable market analysis, there is still room for AAC to
grow in non-acoustics space and we expect AAC's non-acoustics to further grow
~145%/25% YoY in 2015/16E, respectively.
Haptics: Spec upgrades with Apple; Android adoption not
imminent yet
AAC started offering haptics to Apple in 2014 for iPhone 6/6+. Despite some early
product hiccups on Apple Watch in 1H15, AAC retains one of the major haptics
suppliers for Apple's new iPhone 6S/6S+.
New haptics on iPhone 6S: 2-3x ASP boost on spec upgrade
What has surprised market to the upside was that the 2nd generation haptics on
iPhone 6S/6S+ came in with a much higher ASP compared to 1st gen on iPhone6/6+,
driven by new design and spec upgrades, such as compacter form-factor, stronger
resonance (with larger amplitude), swifter response and lower power consumption.
The high ASP also reflects the manufacturing difficulty with the new design and
partially compensates the low yields at early stage.
Haptics on Android: subject to OS-level support; limited to high-end models
We believe Android camp's mass adoption of advanced haptics are likely to come
along with force touch functions (similar to 3D Touch with iPhone 6S/ 6S+). Our
check shows that there is no major technology handle in the display/ touch control
supply chain, however, OS-level native support and deep hardware/ software
integration are required to promote force touch adoption. In addition, the user traction
of force touch is low with limited use scenario & user experience improvement.
We believe early traction of advanced haptics (with ASP at US$1.5+) is likely to
come out in 2H16, when force-touch supply chain becomes more mature. However,
those adoptions are likely limited to very few high-end models only.
RF/ Antenna: integrated solution embracing rising China
demand
Integrated RF solution gained good early traction
After multiple years' investment, AAC broke into RF/antenna business in 2013/14
and its product offerings include FPC, LDS, and integrated RF/antenna solutions
(namely RF on speakerbox and RF on mechanical structures).
Design of RF/antenna becomes increasingly mechanically challenging for LTE
smartphones and high level of RF/ antenna customization demands for early-stage
design in. AAC's integrated RF solutions answer handset producers' call for
modulized production process, which reduces the likelihood of incompatibility at the
assembler end, shortens time to market and relieves the R&D burden on smartphone
OEMs, particular those running with a very lean R&D team. Despite low ASP ($0.3-
0.5) for each single antenna, the cross selling opportunities on inner frame & metal
casing and embedded value with antenna design are much bigger.
RF on speakerbox: The integrated speakerbox/ antenna solution helps earlier
identify any potential noise between antenna and acoustics – given audio and
radio frequency are possibly interfered with each other – and thus increase the
overall yield rate.
RF with inner frame: AAC's integrated RF + inner frame (Speakerbox + LDS
antenna + inner plastic frame) has gained good customer tractions, such as
Xiaomi for Mi 4/ Mi Note and Moto for the G series.
RF with metallic frame: With increasing adoption of metal casing, the antenna
design becomes a challenge given the potential 'death grip' scenario. AAC's
integrated RF & metal casing structure aims to solve the signal issue through
early design in and has gained some early customer adoption by LeTV for
Pro/Max/ 1S models. Now the company has 600 units of CNC machines and
plans to expand the capacity to 2000 units by 2016.
Tunable RF planning for the future
AAC has been investing in tunable RF (with acquisition of WiSpry) and plans to roll
out its smart antenna solution in 2016. We believe tunable RF has a promising future
with the capability to support multiple modes/ bands with compact form-factor and
high integration. Industry leaders like Murata (6981 TT, OW) have been developing
tunable RF for a while, however, the quality so far has not reached commercial
standard given manufacturing and performance constraints. We believe the progress
on tunable RF would be an interesting point to watch, if AAC can deliver good
reliability and consistency.
Acoustics seeing spec upgrades and increasing
penetration to Chinese brands
Apple: spec upgrades with iPhone7 likely
Our checks show that iPhone 7 are likely to come with upgraded acoustics features
including 1) water/ dust-proof, 2) low bass and even 3) stereo sound powered by dual
speakers, likely leading to 20-30% increase of acoustics dollar content with iPhone.
Chinese brands are also likely to upgrade speakerbox with water-proof feature. We
expect AAC's blended ASPs of acoustics to see a meaningful uplift in 2H16.
Chinese brands: ongoing speaker to speakerbox migration
AAC started to promote its cost effective speakerbox with ASP at US$1.0-1.2 (vs
traditional speaker price of US$0.5-0.6) to Chinese brands. We note that Xiaomi/
Huawei / OPPO/ Lenovo have started to use AAC's acoustics products (speaker,
receivers, and speaker-box) on their mid-high end smartphones and AAC is likely to
further benefit from the trend of speaker to speakerbox migration. Besides better
audio performance, lower failure & repair rate is another good selling point for
speakerbox, given further protection against collision/ water by the box/ chamber.
The overall speakerbox penetration among Chinese customers is still at ~25% level
and we expect it to further increase to 40%/55% in 2016/17E.
MEMS MIC: increasing automation & dual MEMS-die sourcing to defend
margins
MEMS microphones have largely benefited from the fast smartphone volume growth
in the past, particular in the mid- and high-end. The addressable market of MEMS
microphones is likely to further expand post smartphone cycle, largely from
emerging areas such as wearable devices and smart home appliances, where we see
increasing adoption of voice intelligence (such as Google Now, Apple Siri, etc.).
GM on MEMS MIC has been trending south given the intensive competition and
nature of highly standardized products. We expect the gross margin to hinge at ~25%
level with help from increasing scale and automation. Of note, ~50% of the cost is
attributed to MEMS Die and ASIC Die, which now AAC has to outsource from other
vendors like Infineon. We might see upside to margins if AAC makes breakthrough
in development of its own MEMS Die or the dual MEMS-die sourcing kicks in.
AAC's market share in MEMS MIC was ~15% in 2014 and we expect it to largely
maintain this share in the next two to three years.
New products: optics the next leg, but with slow progress
so far
Share price largely correlated with product innovation and client penetration
We analyze AAC's share price trend in the past and found it highly correlated with
the progress with its product innovation and big client penetration.
Can we expect more innovations in the future?
We analyze AAC's history of technology incubation and identify three major
sources: 1) internal development with in-house R&D team; 2) co-development with
global tier-1 customers and 3) external M&A. Given AAC's track record on items
1) and 2), we believe AAC is not likely to miss any major upgrades from Apple on
haptics and acoustics in the future.
Looking at AAC's M&A history, it takes AAC at least 2-3 years to integrate and
incubate an acquired new technology before the commercial products come through.
For example, AAC started cooperation with Immersion on haptics and supplied piezo
actuators to Nokia back in 2008/09. AAC has been developing haptics technologies
ever since and eventually penetrated into Apple in 2014 with mass volume. Forward
looking, we feel optics/ lens seems to be the next fruit-bearing tree, post RF/ antenna.
Optics/ lens: looks beautiful; but surrounded by many chasers
Optics/ lens is another area AAC has been investing in since 2009/ 10. We also note
that AAC has started 5MPx front-camera to Chinese customers and plans for mass
production of 13MPx lens in 2016. However, given the optics market is crowded
with many players, the further room left to AAC might be limited to niche areas such
as dual-camera/ array camera, or differentiated products such as integrated products
with VCM/ OIS, etc.
Tunable RF: with promising future, but still far away from commercialization
Tunable RF appears to be an interesting area that AAC is focusing on and AAC plans
to roll out its smart antenna solution (namely MEMS based tunable RF) in 2016. We
believe the progress on tunable RF would be an interesting point to watch, if AAC
can deliver good reliability and consistency. Tunable RF could become a big
innovation with significant potential from cost saving and ease of design.
Financial analysis
Segment and revenue drivers
AAC's acoustics revenue (dynamic component plus MEMS component) peaked out
in 2013 because of speakerbox share loss to GoerTek. We expect acoustics to re-pick
growth momentum in 2016/17 driven by spec upgrades.
Non-acoustics segment (Haptics & RF) became revenue driver since 2014 and is
expected to further drive top-line growth in 2016/17E.
Margins and profitability
AAC has been consistently leading its acoustic peers in gross margins since 2011 and
has been able to maintain the margins at 40%, albeit with rising price competition
from its local rivals.
Margins from dynamics components have been declining from 48%+ in 2012 to
~45% in 2013/14 and further down to ~40% in 4Q14. We expect margins to
improve moderately in 2016/17 driven by spec upgrade and increasing automation.
Margins from non-acoustics business (Haptics/ RF) started to surpass dynamic
components from 4Q14 with increased scale and yields. We expect the blended
GM from non-acoustics to maintain at ~45% level in 2016/17E, well above
dynamic components.
Margins from MEMS MICs have seen headwinds given the increasing
competition. We believe the gross margin could stabilize at 20%+ and potentially
see upside if dual sourcing of MEMS-die metalizes.
Balance sheet & cash flow
We expect AAC to deliver 25-30% ROE in 2015-17E on back of resilient margins
and strong operation leverage. AAC maintains a clean balance sheet with net cash
position as well.
Operation cash flow is likely to top Rmb3.7bn in 2016E, enough to support Capex
spending (guided at Rmb2.3bn) and dividend payout (JPMe of Rmb700-800mn).
Investment Thesis, Valuation and Risks
AAC Technologies Holdings (Underweight; Price Target: HK$42.00)
Investment Thesis
AAC manufactures dynamics components (namely speaker boxes, traditional
speakers and receivers), MEMS microphones, haptics, RF/antenna and handsets for
the world's major smartphone and tablets brands. Its major customers include Apple,
Samsung, Xiaomi, Huawei, Moto, Oppo, HTC, LeTV, etc. AAC excels in design
flexibility and complexity and has very good yield rates and short lead times. It also
enjoys a high level of automation and strong, lean production management.
We assume coverage of AAC with an Underweight rating and a Jun-16 TP of HK$42
(12x 2016 EPS). We believe the share price has largely (if not overly) factored in
management's positive 2016 tone (~20% YoY top-line growth with some margin
increase). We are more conservative on margin improvement and worried about
future growth in 2017. We suggest investors take profits at current price level;
potential downside catalysts include iPhone 6s sales weakness, and share loss on
haptics.
Valuation
Our Jun-16 target price of HK$42 is based on a 12x 2016 EPS excluding one-offs.
Our target P/E multiple 12x is 0.5 standard deviations below the historical average
P/E of 13.5x, to account for the low visibility of structural growth post 2016.
Risks to Rating and Price Target
The key upside risks to our investment thesis include: 1) better-than-expected market
share on haptics, 2) faster-than-expected haptics penetration in Android, and 3) ASP
boost on acoustics.
The key downside risks to our investment thesis include: 1) slower-than-expected
spec upgrade by Chinese smartphones, 2) weaker-than-expected iPhone sales and
3) failure to maintain margins.
