OPTIMAS GLOAL ALPHA FUND · smartphones market while hina smartphone makers likely continue to...

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OPTIMAS GLOBAL ALPHA FUND

Newsletter, November 2019

From network to handsets: the next phase of 5G development cycle kicks off Ever since the fifth generation of cellular network technology (5G) started commercial use in South Korea in

December 2018, followed by China in November 2019, it has received much attention from the global invest-

ment community. There are two key drivers for the 5G deployment, i.e. 5G base station and 5G smartphone

device. The following content will primary focus on 5G smartphone as it has been the key focus for invest-

ment professionals in 2H19, and will likely continue into 2020.

We believe 2020 will be a tipping point for the migration of 5G cellular technology, with major smartphone

makers releasing various 5G handsets, and the speed of adoption will dictate industry’s revenue prospects.

Figure 1: 5G Smartphone shipment forecast (vs. 4G)

Source: IDC, Optimas research Source: IDC, Optimas research

Difference between 5G vs 4G Simply speaking, a 5G smartphone could be 10x as fast as a 4G device in data transmission speed. The supe-

riority in data transmission speed is a revolutionary design change in various components, including system-

on-a-chip (SoC), foundry processes, radio frequency (FR) antennas, power amplifier (PA), materials, packages

(e.g. System-in-Packaging (SiP) and Antenna-in-Packaging (AiP)).

Figure 3: Teardown comparison of 5G smartphone BOM (vs. 4G)

Source: Tech Insight

Fund AUM*

US$390 million

Portfolio Manager

Thomas Wong

Strategy

Pan Asia Equity

Long/Short

Inception

August 2016

Liquidity

Quarterly

30 days notice

Minimum

US$1 million

Management Fee

2%

Incentive Fee

20%

Administrator

Northern Trust

Auditor

Ernst & Young

Legal Counsel

Deacons (Hong Kong)

Campbells (Cayman)

Prime Brokers

Credit Suisse

Goldman Sachs

JP Morgan

Morgan Stanley

Note*: AUM is rounded to the nearest

integer

Figure 2: 5G penetration in smartphone (vs 4G)

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From the teardown comparison of 5G vs 4G smartphones, one can see that the Bill-of-Material (BOM) cost has increased by USD 70 (c.17%)

for a 5G smartphone, and the incremental component costs are mainly derived from (1) baseband (USD 32 or 45-50% higher vs 4G if com-

bined Application Process + Baseband ); (2) RF component (USD 15 or 45-50% higher) and (3) substrates (USD 13 or 100% higher).

We are seeing technology upgrades and hardware design changes in the following areas:

Application Processor (AP)/Baseband: 5G application processor and baseband tend to have bigger die sizes than existing 4G smartphones

and this required a more leading-edge technology in semiconductor for a better performance; this would apply to either SoC (including

baseband) or dual-chip solutions (AP + baseband). The total revenue from foundries of global 5G smartphone is estimated to be at least

USD 8bn in 2020.

Figure 4: Existing SoC solution for 5G smartphone

Source: Mediatek, Qualcomm, Credit Suisse research, Citi research, KGI research.

RF component: For both sub-6 and mmWave technology, RF components for 5G smartphone need to manage higher frequency, and an

increase in frequencies means more antenna support is required, i.e. there will be more components integrated into radio frequency front-

end (RFFE). The total value of RF component (including antenna) of global 5G smartphone is estimated to be USD 3.2bn in 2020.

Figure 5: Key changes in 5G antenna and frontend RF module

Source: Credit Suisse research, Citi research, Macquarie research.

Figure 6: Comparison of key component in 5G smartphone (vs. 4G)

Source: Skyworks, Citi research, Macquarie research.

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Substrate/printed circuits board (PCB): Each RF antenna module embedded in a smartphone is assembled on a substrate with multiple

components such as RF IC, switch, transceiver, power management and passive components. For 5G smartphone, especially for

mmWave, low-loss materials are required for antennas, mainboards and substrates. In order to achieve requirements for transmitting

high-frequency data and supporting multi-channels under limited space, 5G smartphone antennas require high-frequency and low loss.

That said, materials for mainboard HDI, substrate-like PCB (SLP), FPCB, and IC substrates would likely experience major changes vs 4G

smartphones. The total revenue for substrate/PCB segment is estimated to be at least USD 2bn in 2020.

Figure 7: Mainboard of Huawei 20 Pro vs. Huawei Mate 20x 5G

Source: iFixit, Industrial Technology Research Institute

What’s the demand of 5G smartphones in 2020?

One of the key debates since mid-2019 is the end demand when the new 5G handsets are launched in 2020. Bulls believe a faster adop-

tion/penetration rate than 4G, while others continue to remain cautious on weaker than expected 5G demand due to affordability.

Forecasts have been generally quite wide, ranging from 200mn to 280mn, for 2020 5G shipment numbers.

Figure 8: Recent 5G smartphone models

Source: GSMArena.com, Google.

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There are two main frequencies for 5G handsets: Sub-6 GHz 5G is cheaper and easier to roll out, but mmWave ultimately delivers better

performance (likely at a higher cost). Apple, which expected to roll out 5G iPhone model in 2H20, is likely to dominate 5G mmWave

smartphones market while China smartphone makers likely continue to focus on sub-6GHz in 2020. We do not see huge differences

amongst the forecast of 5G iPhone shipment, but there is a vast discrepancy for China smartphones OEM’s figures.

In order to reach the 250mn+ global 5G handset volume, China will likely need to contribute 100mn+ units. This is not an easy target,

given the lack of 5G-specific applications/use case, and consumers are unlikely to pay a high premium for 5G handsets over what they

paid for their previous 4G handsets. To get over 100mn units in China in 2020, we will need (1) Rmb3,000 price range phones to be

launched aggressively in early 2020; and (2) Rmb2,000 phones to become available across various brands in 2H20.

Moreover, total demand in China for Rmb3,000+ Android phones in 2018 was only 65mn units. Assuming no dramatic shift in price elas-

ticity, telco carriers will have to increase their handset subsidies, or the handset brands will have to price in a larger discount, which in

turn will put margin pressure on the component makers. One alleviating angle is that SoC makers (e.g. MediaTek and Qualcomm) will

likely have solutions for mid-end segment smartphones into 2H20, which should help to lower the price points.

Which 5G subsectors likely to benefit (or not)?

1) SoC/Foundries

We believe foundries with the most leading edge technology will likely enjoy the greatest benefit in the upcoming 5G cycle given the

unique industry competitive landscape. There will be incremental revenue from 5G SoC (USD 7 per die) as the die size becomes larger

(e.g. 100mm2 vs 80mm2 for a 4G SoC). Also, major SoC makers could benefit from less intensive pricing competition when compared to

4G cycle. However, while we expect SoC makers to charge initial price premiums in 1Q20 given the scarcity in supply, pricing will likely

come down gradually, in order to gain market share in the mid-end smartphone segment.

2) RF components and Substrate/PCB

We believe RF components are unlikely to be replaced, or have to face cost cutting pressure, as smartphone with mmWave is expected

to have higher cost compared to the Sub-6GHz, due to more complex and integrated RF front-end design, meaning that the dollar value

of RF per 5G smartphone should be higher (e.g. 35-40% incremental vs a 4G smartphone). For substrate/PCB, there should be major

upgrades/changes for 5G smartphones vs 4G ones, despite margin pressure over time.

3) Components without major upgrades or design changes will face harder times

Those electronics components and hardware which don’t have major upgrades or design changes for 5G version will likely see significant

margin pressure, as OEMs will have to squeeze costs from them, in order to pay for the incremental component costs for the aforemen-

tioned subsectors (such as SoC, foundries, RF component and substrate/PCB).

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OPTIMAS GLOBAL ALPHA FUND PERFORMANCE SUMMARY

The Optimas Global Alpha Fund net return was +0.1% in November 2019. This brings the performance of the fund to +8.2% YTD and +43.7% since inception (with 1.6 annualized Sharpe ratio). Gross/net exposure was 172%/-12% at month end. We had good attribution from Materials/I.T. sector, while Consumer/Financials sector underperformed. Market wise, we did well in Hong Kong, while US lagged.

Several observations in November: (1) The US/China trade negotiations continued to dominate headlines, and short term market direction. The signing of the Hong Kong human rights bill further complicated the issue. (2) China PMI unexpectedly rose to 50.2 in November, above the 50 mark for the first time in seven months. More investors are starting to price in a short term bounce in economic activities due to an impending inventory restocking.

Looking forward: (1) Much attention is on the Dec 15 deadline, for the next “tranche” of tariff to go in effect. Market has priced in a “Phase One” deal hap-pening, which could include some roll-back (or at least a plan to roll back) of the Sep 15 tranche. (2) China should host the annual Central Economic Work Conference at year end, to review the current economic situation and set tone for the 2020 plan. Supportive measures to boost economy growth? (3) US market continued to break new highs, on a rather subdued round of earnings. Would be interesting to see how far this multiple expansion can go (and how it deflates). As always, we keep our focus on earnings trajectory of individual companies and seeking alpha ideas during market volatilities.

Top 10 Positions

AIA GROUP LTD

CHINA LIFE INSURANCE CO-H

CHINA PETROLEUM & CHEMICAL-H

GALAXY ENTERTAINMENT GROUP L

HENGAN INTL GROUP CO LTD

VITASOY INTL HOLDINGS LTD

PETROCHINA CO LTD-H

NETEASE INC-ADR

TAIWAN SEMICONDUCTOR MANUFAC

CHINA OILFIELD SERVICES-H

Return (Last 12 Months) 9.6%

Volatility (Last 12 Months) 4.2%

Maximum Drawdown (Last 12 Months) -0.9%

Sharpe Ratio (Last 12 Months) 1.7

Avg. Net Exposure (Last 12 Months) 2%

Avg.Gross Exposure (Last 12 Months) 158%

Return (Since Inception) 43.7%

Return (Annual CAGR Since Inception) 11.5%

Sharpe Ratio (Since Inception) 1.6

Avg. Net Exposure (Since Inception) 9%

Avg. Gross Exposure (Since Inception) 164%

Source: Optimas Capital, as of Nov 30, 2019.

Note: Top 10 positions based on gross exposure (in alphabetical order), could be long or short positions.

Note: Fund returns are rounded to 1 decimal place

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LEGAL NOTICE

This report is intended exclusively for the person to whom it was given by Optimas Capital Limited and does not constitute an offer to

sell or a solicitation to buy any securities or an offer of any investment advisory services. The statistics presented are based on estimates

and assumptions which may be materially incorrect. No representation is made as to their accuracy. Past performance is not indicative of

future results.

References to market or composite indices, benchmarks, or other measures of relative market performance (indices) over a specified

period of time are provided for the intended recipient’s information only and do not imply that a portfolio will achieve similar returns,

volatilities or other results.

This document is intended only for professional investors as defined under the relevant laws of Hong Kong and is not intended for the

public in Hong Kong. The contents of this document have not been reviewed by any regulatory authority in Hong Kong. No action has

been taken in Hong Kong to permit the distribution of this document. This document is distributed on a confidential basis and may not

be reproduced in any form or transmitted to any person other than the person to who it is addressed.

In the course of discrepancies between the Chinese and English newsletter, please refer to the English version.

Thank you for your continued support and interest in our fund. Please contact us with any questions or to request additional

information at [email protected]

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