China Internet and Software：All eyes on cloud and Internet finance

Please refer to page 36 for important disclosures and analyst certification, or on our website www.macquarie.com/research/disclosures. CHINA/HONG KONG Inside Cross-country comparison indicates upside in China adoption 2 Sales and implementation towards specialization 3 Comparison across ERP brands 4 Industry overview 6 Yonyou - More than just ERP 9 Kingdee - More competition in mobile office 28 Analyst(s) Hillman Chan, CFA +852 3922 3716 hillman.chan@macquarie.com Wendy Huang, CFA +852 3922 3378 wendy.huang@macquarie.com Jake Lynch +852 3922 3583 jake.lynch@macquarie.com Julia Pan +852 3922 4211 julia.pan@macquarie.com Joe Yu +852 3922 1160 joe.yu@macquarie.com 29 April 2016 Macquarie Capital Limited China Internet and Software All eyes on cloud and Internet finance Upside in China’s ERP and cloud adoption Spending on software accounted for merely 5% of total IT spending in 2015 in China, according to IDC, in contrast to the more developed US IT market where software, hardware and services each accounted for roughly one-third of the IT spending. In addition, China is behind the US in cloud adoption among small-and-medium sized enterprises. As China’s corporates are growing into a more mature stage and cloud becoming the de facto standard for software delivery, closely on the heels of the US, we expect further upside to ERP and cloud adoption in China. Sales and implementation towards specialization Shifting sales and implementation to third-party specialists is the trend in the China ERP market, in line with the more sophisticated models of SAP and Oracle in the developed markets. Yonyou adopted indirect sales for its ERP products for medium-sized enterprises, i.e., U8, in 2015 and looks to gradually rely more on external specialists for its high-end products such as NC. Kingdee is moving in the same direction. These transitions are positive to margin expansion at the Chinese ERP players. Internet finance still in early stage After obtaining the payment business licence, Yonyou is engaged mostly in POS acquiring (processing of debit and credit card payments) and P2P financing. Yonyou is also developing its Internet payment solutions for enterprises i.e. Chanjet Payment acting as a gateway between enterprises and the financial institutions, offering a one-stop service platform to ERP customers. We see the merits of Internet payment solutions from ERP providers but the adoption by enterprises is still in the early stage. On the other hand, Kingdee has not got a payment licence yet. Initiate with OP on Yonyou and reiterate OP on Kingdee Yonyou. We are initiating coverage with an Outperform and a SOTP-based TP of Rmb29, with 50% upside to the current share price, on the back of 9% revenue and 26% earnings CAGRs in 2015-18E supported by fast-growing cloud and Internet finance. We expect revenue contribution from these two initiatives to grow from 3% in FY15 to 18% in FY18E. We value Yonyou’s ERP at 40x FY17E P/E, in line with A-share software peers and its historical median, and value enterprise Internet/cloud and Internet finance at 9x FY17E P/S, in line with peers. Kingdee. Its mobile office Cloud Hub will face more intense competition from Ding Ding and the emerging Enterprise Weixin with strong social networking and upcoming third-party enterprise apps, in our view. We reduce our cloud revenue growth forecast from 80% to 70% for FY16 but maintain 50% for FY17-18, and thus trim FY16-18E revenue by 1%, earnings by 3%, and TP from HK$3.55 to HK$3.40. We transfer coverage from Jake Lynch to Hillman Chan. Reiterate Outperform. Macquarie Research China Internet and Software 29 April 2016 2 Cross-country comparison indicates upside in China adoption Spending on software accounted for merely 5% of total IT spending in 2015 in China, whereas hardware investments made up 83% and services the rest, according to IDC. This is in contrast to the more developed US IT market, where software, hardware and services each accounted for roughly one-third of the 2015 IT spending. As China’s economic and business developments are progressively maturing, we expect software as a percentage of IT spending will gradually reach the level of developed countries. Fig 1 China’s software (5%) as % of IT spending well below the US (29%) in 2015 Fig 2 Cloud as % of software-only revenue (2015 vs 2013) Source: IDC, Macquarie Research, April 2016 Source: company data, Macquarie Research, April 2016 According to an IDC survey, the cloud adoption among the emerging market SMEs is higher, which we believe is due partly to the web-based methodology as emerging country customers responding to an online survey tend to be less representative of the population. Yet, China is still behind the US in cloud adoption, but we expect further upside to this and an increase in cloud content per enterprise, as the cloud is becoming the de facto standard for software delivery in China, closely on the heels of the US. Fig