China Software Sector

ed-TH / sa- DL Investing for future growth  Expect traditional ERP business to resume revenue growth in 2H15F as the restructuring of distribution channels has concluded; expect a high single-digit growth rate in 2016  Expect cloud business to grow at a CAGR of 80%+ in the next few years, accounting for c.30% of Kingdee’s and c.15% of Yonyou’s total revenue by FY17F  Step up investments for FY15-16F to build the enterprise user base and scale for the cloud business  Maintain BUY on Kingdee for the long-term potential ; and maintain FULLY VALUED on Yonyou due to its rich valuation Expect a high single-digit growth rate for ERP business in 2016. The revenues from ERP businesses of Kingdee (268.HK, BUY) and Yonyou (600588.CH, FULLY VALUED) declined by 3-4% in 1H15. We expect them to resume growth in 2H15F as the restructuring of distribution channels from direct to indirect sales has concluded. The restructuring should lead to a lower revenue but improve the margins and overall profitability. In FY16F, we expect high single-digit revenue growth rates for the ERP businesses of Kingdee and Yonyou, due to more adoption of ERP by enterprises driven by the rapid development of e-commerce. More aggressive investments needed to capture the cloud business opportunity. We expect the cloud businesses of Kingdee and Yonyou to grow at a CAGR of 80%+ in the next few years amid more new product launches and more marketing and sales initiatives to promote cloud applications. The cloud business will be the new growth engine, which is expected to account for c.30% of Kingdee’s and c.15% of Yonyou’s total revenue by FY17F. However, we believe intensive investments will be needed to build a large user base to capture the growth opportunity in the next few years. Accordingly, we have revised down our earnings estimates to reflect the higher investment costs in FY15-16F and we expect the cloud business to break even in FY17-18F. Focusing on the long-term potential; maintain BUY on Kingdee. We are optimistic on the ERP business in the medium term and we believe the potential for cloud business is huge. The higher operating losses for growing the cloud business in the near term are justified by the future growth potential. We have revised up Kingdee’s TP to HK$4.2 from HK$3.8 by rolling forward to 30x FY17F PE (previously 30x FY16F PE), pegged to its A-share major peer Yonyou’s historical average. Maintain BUY on Kingdee. We maintain a FULLY VALUED rating on Yonyou as it now trades at a rich valuation of 40x+ FY17F PE. Our TP of Rmb14.0 for Yonyou is based on 30x FY17F PE, in line with its historical average.HSI: 19,286 ANALYST Tsz Wang TAM CFA +852 2971 1772 tw_tam@hk.dbsvickers.com Chris KO chris_ko@hk.dbsvickers.com Recommendation & valuation CompanyPrice Target Upside Recom17FMktcapPrice%PE (x) US$mKingdee Int'l(268 HK)HK$2.754.253Buy19.51,034Yony ouNetw orkTech.'A'(600588 CH)RMB 20.3914.0(31)FullyValued43.94,579 Source: Thomson Reuters, DBS Vickers DBS Group Research . Equity 22 February 2016 China / Hong Kong Industry Focus China Software Sector Refer to important disclosures at the end of this report Industry Focus China Software Sector Page 2 Traditional ERP Stable growth driven by e-commerce ERP revenues of Kingdee and Yonyou declined in 1H15 but we expect them to resume growth in 2H15F as the restructuring of distribution channel has concluded. The restructuring from direct to indirect sales led to revenue decline but improvement in operating margin. It should improve overall profitability. Going forward, we are positive on the ERP business and expect a high single-digit growth rate p.a. The rapid development of e-commerce encourages the adoption of ERP by enterprises. ERP revenue y-o-y growth % Total Rev enue* (Rmb m)1H141H15% chgKingdee (268.HK)705 676 -4.1%Yony ou (600588.CH)1,469 1,425 -3.0%Chanjet** (1588.HK)186 189 2.1%1H15 Rev enue segmenty-o-y GrowthKingdee Yony ouChanjetLarge enterprise segment4.4%-7.5%naMedium enterprise segment-8.7%3.6%naSmall enterprise segment10.4%2.8%2.1% Note: *the revenue includes software license and service **Chanjet is a subsidiary of Yonyou Source: Companies and DBS Vickers E-commerce has become increasingly important to enterprises as there are more online buyers (and sellers) with significant transaction volume. According to iResearch, 300m people in China purchase online, representing a penetration rate of 48.9%. The market for e-commerce is estimated to be Rmb10tn and is expected to grow at 20% p.a. from FY14-17F. Various marketing strategies and business models (such as O2O) have arisen for e-commerce. Enterprises need to rely more on enterprise software and cloud technology to integrate and manage their sales channel, inventory, supply chain and customer details in order to effectively deliver a good customer experience and drive business growth. The e-commerce business model will increase overall ERP