higher demand and eps, but depreciation skews the story;...

January 19, 2017

COMPANY UPDATE SMIC (0981.HK)

Sell Equity Research

Higher demand and EPS, but depreciation skews the story; Sell

What's changed

Historically, second-tier foundries have always run at lower utilization than

industry leader TSMC, but SMIC has kept utilization above 97% since 2Q15

and consistently above that of TSMC, likely due to a desire among its

customers to support the Chinese government’s efforts to strengthen the

domestic foundry industry. We expect SMIC to maintain 97% average

utilization and surpass its target of a 20% revenue CAGR in 2016-2019. We

also expect SMIC’s R&D grants to sustain and rise from US$34mn in 2015

to US$65mn and US$95mn (19% and 20% of earnings) in 2016E and 2019E

respectively, referencing the industry’s development path in Taiwan.

Implications

We have raised our assumptions for utilization and government grants,

which increases our 2016E-2018E EPS by 15%/146%/84%. However, we

note the company’s 7-year depreciation policy (vs. peers’ 5 years), which

we believe leads to SMIC’s high margins and ROE relative to peers despite

its lower revenue/net PP&E ratio. Even using 7-year depreciation, our

2017E-2018E depreciation estimates for SMIC are 37% above consensus.

As a result, even as we turn more positive on SMIC’s demand and R&D

grants outlook, we stay cautious on its returns and valuation. Additionally,

to offset the differences in depreciation policies, we change our valuation

methodology from P/B-ROE to EV/GCI-CROCI/WACC, which is based on

gross assets.

Valuation

Our 12-month target price rises to HK$8.40 from HK$7.40 (ADR to US$5.40

from US$4.70) after adjusting for December’s reverse stock split and

changing our valuation basis from P/B to EV/DACF, which is derived from

EV/GCI-CROCI/WACC and factors in SMIC’s superior growth in 2016-2019E.

Our new target price implies a NTM P/B of 1.19X (above UMC’s 0.61X and

Hua Hong’s 0.74X) and 24% downside potential; we maintain Sell.

Key risks

Higher-than-expected R&D grants and stock purchases by gov’t entities.

INVESTMENT LIST MEMBERSHIP

Asia Pacific Sell List

Coverage View: Neutral

Donald Lu, Ph.D +86(10)6627-3123 [email protected] Beijing Gao Hua Securities Company Limited Goldman Sachs does and seeks to do business with companies

covered in its research reports. As a result, investors should be aware that the firm may have a conflict of interest that could affect the objectivity of this report. Investors should consider this report as only a single factor in making their investment decision. For Reg AC certification and other important disclosures, see the Disclosure Appendix, or go to www.gs.com/research/hedge.html. Analysts employed by non-US affiliates are not registered/qualified as research analysts with FINRA in the U.S.

The Goldman Sachs Group, Inc. Global Investment Research

Growth

Returns *

Multiple

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profile measures please refer to the

disclosure section of this document.

SMIC (0981.HK)

Asia Pacific Technology Peer Group Average

Key data Current

Price (HK$) 10.88

12 month price target (HK$) 8.40

SMI Price ($) 7.05

SMI 12 month price target ($) 5.40

Market cap (HK$ mn / US$ mn) 39,931.2 / 5,148.4

Foreign ownership (%) --

12/15 12/16E 12/17E 12/18E

EPS ($) New 0.07 0.09 0.09 0.10

EPS revision (%) 0.0 15.1 145.6 84.3

EPS growth (%) 53.4 36.7 1.3 8.8

EPS (dil) ($) New 0.06 0.08 0.08 0.08

P/E (X) 15.1 15.8 15.6 14.3

P/B (X) 1.0 1.4 1.3 1.2

EV/EBITDA (X) 6.3 7.6 7.1 6.5

Dividend yield (%) 0.0 0.0 0.0 0.0

ROE (%) 7.6 9.5 8.7 8.7

CROCI (%) 4.6 8.3 8.1 8.5

Price performance chart

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Jan-16 Apr-16 Jul-16 Nov-16

SMIC (L) Hang Seng China Ent. Index (R)

Share price performance (%) 3 month 6 month 12 monthAbsolute 13.3 70.0 57.7

Rel. to Hang Seng China Ent. Index 12.4 57.7 30.9

Source: Company data, Goldman Sachs Research estimates, FactSet. Price as of 1/18/2017 close.

January 19, 2017 SMIC (0981.HK)

Goldman Sachs Global Investment Research 2

SMIC: Summary Financials

Analyst Contributors

Donald Lu, Ph.D

[email protected]

Profit model ($ mn) 12/15 12/16E 12/17E 12/18E Balance sheet ($ mn) 12/15 12/16E 12/17E 12/18E

Total revenue 2,236.4 2,910.2 3,622.1 4,339.4 Cash & equivalents 1,005.2 1,813.9 1,108.8 364.1

Cost of goods sold (1,553.8) (2,073.8) (2,639.4) (3,134.6) Accounts receivable 499.8 664.3 779.7 949.6

SG&A (255.1) (183.2) (259.3) (303.9) Inventory 387.3 513.3 625.8 736.2

R&D (237.2) (309.4) (373.1) (464.6) Other current assets 697.7 723.4 723.4 723.4

Other operating profit/(expense) 31.6 12.5 14.8 14.8 Total current assets 2,590.1 3,714.8 3,237.7 2,773.3

ESO expense -- -- -- -- Net PP&E 3,903.8 5,882.7 7,297.5 8,510.4

EBITDA 745.6 1,092.7 1,350.3 1,638.0 Net intangibles 224.3 225.1 225.1 225.1

Depreciation & amortization (523.5) (736.3) (985.2) (1,187.0) Total investments 199.0 263.2 263.2 263.2

EBIT 222.0 356.4 365.1 451.0 Other long-term assets 198.2 229.7 229.7 229.7

Interest income 5.2 9.7 12.0 6.6 Total assets 7,115.3 10,315.6 11,253.2 12,001.8

Interest expense (12.2) (18.9) (20.4) (20.4)

Income/(loss) from uncons. subs. (13.4) (12.4) 0.0 0.0 Accounts payable 1,047.8 1,208.0 1,251.9 1,251.8

Others 29.3 (10.2) 0.0 0.0 Short-term debt 113.1 156.6 156.6 156.6

Pretax profits 230.9 324.6 356.7 437.3 Other current liabilities 213.7 282.7 282.7 282.7

Income tax (8.5) (2.5) (3.0) (3.6) Total current liabilities 1,374.6 1,647.3 1,691.2 1,691.2

Minorities 31.1 52.9 26.6 (19.7) Long-term debt 1,301.9 2,752.1 2,752.1 2,752.1

Net income pre-preferred dividends 253.4 375.0 380.3 414.0 Other long-term liabilities 248.7 401.9 401.9 401.9

Preferred dividends 0.0 0.0 0.0 0.0 Total long-term liabilities 1,550.5 3,154.0 3,154.0 3,154.0

Net income (pre-exceptionals) 253.4 375.0 380.3 414.0 Total liabilities 2,925.1 4,801.3 4,845.2 4,845.1

Post-tax exceptionals 0.0 0.0 0.0 0.0

Net income 253.4 375.0 380.3 414.0 Preferred shares 0.0 0.0 0.0 0.0

Total common equity 3,729.9 4,169.0 4,549.4 4,963.4

EPS (basic, pre-except) ($) 0.07 0.09 0.09 0.10 Minority interest 460.4 1,345.2 1,858.6 2,193.3

EPS (basic, post-except) ($) 0.07 0.09 0.09 0.10

EPS (diluted, post-except) ($) 0.06 0.08 0.08 0.08 Total liabilities & equity 7,115.3 10,315.6 11,253.2 12,001.8

EPS excl. ESO expense (basic) ($) -- -- -- --

EPS excl. ESO expense (dil.) ($) -- -- -- -- BVPS ($) 0.96 0.99 1.08 1.18

DPS ($) 0.00 0.00 0.00 0.00

Dividend payout ratio (%) 0.0 0.0 0.0 0.0

Free cash flow yield (%) (13.1) (22.7) (16.0) (13.1)

Ratios 12/15 12/16E 12/17E 12/18E

Growth & margins (%) 12/15 12/16E 12/17E 12/18E CROCI (%) 4.6 8.3 8.1 8.5

Sales growth 13.5 30.1 24.5 19.8 ROE (%) 7.6 9.5 8.7 8.7

EBITDA growth 9.7 46.6 23.6 21.3 ROA (%) 3.9 4.3 3.5 3.6

EBIT growth 70.5 60.5 2.4 23.6 ROACE (%) 5.3 5.9 4.9 5.0

Net income growth 68.6 48.0 1.4 8.8 Inventory days 82.6 79.3 78.8 79.3

EPS growth 53.4 36.7 1.3 8.8 Receivables days 78.0 73.0 72.8 72.7

Gross margin 30.5 28.7 27.1 27.8 Payable days 216.4 198.5 170.1 145.8

EBITDA margin 33.3 37.5 37.3 37.7 Net debt/equity (%) 9.8 19.9 28.1 35.6

EBIT margin 9.9 12.2 10.1 10.4 Interest cover - EBIT (X) 31.6 38.9 43.6 32.8

Cash flow statement ($ mn) 12/15 12/16E 12/17E 12/18E Valuation 12/15 12/16E 12/17E 12/18E

Net income pre-preferred dividends 253.4 375.0 380.3 414.0

D&A add-back 523.5 736.3 985.2 1,187.0 P/E (analyst) (X) 15.1 15.8 15.6 14.3

Minorities interests add-back (31.1) (52.9) (26.6) 19.7 P/B (X) 1.0 1.4 1.3 1.2

Net (inc)/dec working capital 138.7 (130.1) (184.1) (280.4) EV/EBITDA (X) 6.3 7.6 7.1 6.5

Other operating cash flow (215.3) 73.5 0.0 0.0 EV/GCI (X) 0.4 0.5 0.5 0.5

Cash flow from operations 669.2 1,001.7 1,154.9 1,340.3 Dividend yield (%) 0.0 0.0 0.0 0.0

Capital expenditures (1,230.8) (2,653.5) (2,400.0) (2,400.0)

Acquisitions 0.0 (41.2) 0.0 0.0

Divestitures 49.2 0.0 0.0 0.0

Others 392.0 (6.3) 0.0 0.0

Cash flow from investments (789.6) (2,701.0) (2,400.0) (2,400.0)

Dividends paid (common & pref) 0.0 0.0 0.0 0.0

Inc/(dec) in debt (112.6) 1,596.2 0.0 0.0

Common stock issuance (repurchase) 517.6 6.6 0.0 0.0

Other financing cash flows 117.5 905.2 540.0 315.0

Cash flow from financing 522.5 2,508.0 540.0 315.0 Note: Last actual year may include reported and estimated data.

Total cash flow 402.2 808.7 (705.1) (744.7) Source: Company data, Goldman Sachs Research estimates.



We underestimated demand and R&D grants at SMIC

SMIC has had higher utilization than TSMC since 2Q15

Historically, second-tier foundries have always run at lower utilization than industry leader

TSMC. This is because TSMC can leverage its leading-edge technology to entice customers

to fill its capacity during periods of demand weakness. Contrary to this historical trend,

SMIC has maintained utilization above 97% since 2Q15, well above that of TSMC (Exhibit 1).

Furthermore, SMIC expects its wafer shipments to increase qoq in 1Q17, while we expect

shipments at TSMC and UMC to decline seasonally. SMIC has said its 40nm and 65nm

supply is constrained. As our channel checks indicate several customers including Hi-Silicon

are moving 40nm wafers to SMIC, we expect SMIC should continue to gain market share at

40nm (Exhibit 3). According to Digitimes, Qualcomm and Hi-Silicon have utilized 60%-70%

of SMIC’s 8” capacity. Qualcomm and Leadcore are SMIC’s 28nm customers, but we

believe SMIC’s 28nm is PolySiON and has inferior margin than its 40nm.

How did SMIC achieve this unprecedented high utilization and market share gain for a

second-tier foundry? Technology is not the answer. In 2016, the technology gap between

TSMC and SMIC has widened as TSMC enters 10nm mass production, and SMIC is still

struggling with its 28nm PolySiON (Exhibit 4). Pricing is also not the answer. We believe

SMIC has not cut its 40nm pricing in view of its steady EBITDA margin. We attribute SMIC’s

outperformance to its customers’ strong desire to source from SMIC in order to support the

government’s efforts to develop the foundry industry in China.

We now assume SMIC’s high revenue growth at high utilization is sustainable, but we note

that a risk to this assumption is competition from TSMC and UMC, which are ramping up

their China fabs. According to Digitimes, Spreadtrum is the first 40nm customer at UMC’s

fab in Xiamen. We expect TSMC to begin to manufacture 16nm wafers in Nanjing in 2018,

well ahead of SMIC. We do not yet know if the central government will count TSMC and

UMC’s China fabs as China foundry, but we believe the Xiamen and Nanjing local

governments should fully support UMC and TSMC’s China operations, respectively.

Exhibit 1: SMIC’s utilization has trended above 75% and surpassed TSMC’s in 2Q15

Comparison of utilization among TSMC, UMC, and SMIC

Source: Company data, Gao Hua Securities Research

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Exhibit 2: Foundry 40nm market is relatively flattish

40nm revenues of TSMC, UMC, and SMIC (US$ mn)

Exhibit 3: SMIC has gained significant 40nm market share

40nm market share among TSMC, UMC, and SMIC

Source: Company data


Exhibit 4: The technology gap between TSMC and SMIC is still widening Time gap when the node represented 1.4% of total revenues


Government R&D grants are recurring and increasing

SMIC has received grants from the government for its R&D in leading-edge semiconductor

technology. Since the cost of R&D has escalated with each node of Moore’s Law, the level

of government R&D grants has increased from US$34mn in 2015 to US$65mn, or 19% of

total net income, in 2016. We expect grants to reach US$95mn in 2019 as R&D intensity

increases with each node. SMIC’s next technology is 16nm, and the government’s plan

stipulates 20nm mass production by 2020. We expect the government to support SMIC

because it is the only Chinese company carrying out 16nm R&D. We note that this kind of

government support was common in Taiwan, Korea, and Japan in early days of their

respective semiconductor industry. For example, Taiwan offered substantial tax rebate for

R&D and capex until 2011 when TSMC’s revenue reached $13.8bn, well above SMIC’s

2016E revenue of $2.9bn. In fact, we believe the main risk to our Sell rating is the potential

for a large amount of R&D being granted to SMIC in 2017-2019. If the government R&D

grants surpass our current expected level by a large margin, we expect the additional part

could be reflected as upside in SMIC’s operating profit and net profit, which would make us

more constructive on the shares.

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TSMC UMC SMICTSMC vs.

SMIC

UMC vs.

SMIC

40nm 3Q09 2Q10 4Q12 12Q 9Q

28nm 4Q11 2Q14 3Q16 18Q 8Q

Over 1.4%

revenue

Technology progression



Exhibit 5: We expect government R&D grants to increase at SMIC Government R&D grants and as % of total net income at SMIC


SMIC reports higher ROE but lower PP&E efficiency than UMC

A comparison of profitability reveals an intriguing discrepancy between SMIC and UMC

(Exhibits 6 and 12). For 2016E, SMIC has a much lower revenue/net PP&E ratio than UMC,

indicating SMIC’s asset efficiency is lower than that of UMC (Exhibit 12), partially due to

UMC’s fully depreciated fab. However, SMIC reports much higher net margin and ROE than

UMC. SMIC’s superior utilization and high R&D grants discussed above explain a big part

of this discrepancy, but these effects should be reflected in EBITDA, and we note that UMC

still has a higher EBITDA margin than SMIC. We believe SMIC’s low depreciation/revenue

ratio is another major contributor to this discrepancy.

In Exhibits 7-9, we compare the depreciation/PP&E ratios for TSMC, UMC and SMIC.

SMIC’s depreciation level is clearly well below that of TSMC and UMC. We attribute this

difference to SMIC’s longer 12” equipment depreciation of 7 years than TSMC and UMC’s

5 years. The merits of 5-year vs. 7-year depreciation are debatable because the production

life of a fab is much longer than 7 years while wafer prices decline every year, but the pace

of decline decelerates over time. We do not hold a strong view on which depreciation

period is most appropriate, but do believe that we need to take into account the differences

in depreciation policies when comparing ROE and book value between SMIC and its peers.

We note SMIC’s depreciation is about 10% below its 7-year average capex (Exhibit 10) and

assume the same trend in 2017E-2019E. Our depreciation assumptions are well above

consensus.

On a free cash flow basis, SMIC’s consolidated business has accumulated a US$4bn

outflow since its IPO in 2004 (Exhibit 11). However, SMIC has said it will use pure debt to

finance growth going forward, because the gap in cash flow should narrow, and its Beijing

government JV partner should contribute an additional US$990mn in 2016E-2018E by our

estimate. However, we expect no cash dividend from SMIC in the foreseeable future as we

believe the Chinese government would not want SMIC to receive substantial government

support and pay cash dividend to foreign investors simultaneously.

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Exhibit 6: SMIC reports lower depreciation/revenue ratio and higher ROE than UMC Comparison of profitability among TSMC, UMC, and SMIC


Exhibit 7: TSMC’s average depreciation/PPE is 26% TSMC’s depreciation, PPE, and depreciation/PPE %

Exhibit 8: UMC’s average depreciation/PPE is 27% UMC’s depreciation, PPE, and depreciation/PPE %



2014 2015 2016E 2017E 2018E 2014 2015 2016E 2017E 2018E

Revenue ($ mn) EBITDA ($ mn)

TSMC 25,169 26,567 29,389 32,221 35,244 TSMC 16,296 17,118 18,649 21,154 23,117

UMC 4,620 4,562 4,587 4,967 5,311 UMC 1,674 1,773 1,827 2,054 2,223

SMIC 1,970 2,236 2,910 3,622 4,339 SMIC 680 746 1,093 1,350 1,638

GPM % Net profit ($ mn)

TSMC 49.5% 48.7% 50.1% 51.0% 51.7% TSMC 8,708 9,834 10,451 11,507 12,949

UMC 22.7% 21.9% 20.1% 20.5% 23.0% UMC 401 424 276 314 481

SMIC 24.5% 30.5% 28.7% 27.1% 27.8% SMIC 150 253 375 380 414

EBITDA margin % Depreciation/revenue %

TSMC 64.7% 64.4% 63.5% 65.7% 65.6% TSMC 26.0% 26.0% 23.3% 25.3% 24.2%

UMC 36% 39% 40% 41% 42% UMC 29.0% 31.4% 35.7% 35.5% 33.0%

SMIC 35% 33% 38% 37% 38% SMIC 27.9% 23.4% 25.3% 27.2% 27.4%

EBIT margin % Capex/revenue %

TSMC 38.8% 38.4% 40.2% 40.3% 41.4% TSMC 37.8% 30.4% 34.6% 31.1% 28.7%

UMC 7.2% 7.5% 4.1% 5.9% 8.8% UMC 30.7% 41.2% 48.0% 29.8% 28.2%

SMIC 6.6% 9.9% 12.2% 10.1% 10.4% SMIC 33.2% 55.0% 91.2% 66.3% 55.3%

Net margin % Revenue/PP&E %

TSMC 34.6% 37.0% 35.6% 35.7% 36.7% TSMC 97.2% 102.2% 94.9% 96.3% 100.5%

UMC 8.7% 9.3% 6.0% 6.3% 9.1% UMC 87.6% 80.4% 73.0% 81.1% 90.5%

SMIC 7.6% 11.3% 12.9% 10.5% 9.5% SMIC 65.8% 57.3% 49.5% 49.6% 51.0%

ROE % Capex ($ mn)

TSMC 28.3% 28.0% 26.0% 24.9% 24.8% TSMC 9,514 8,085 10,167 10,018 10,129

UMC 5.6% 6.0% 4.0% 4.5% 6.6% UMC 1,416 1,881 2,201 1,479 1,496

SMIC 5.5% 7.6% 9.5% 8.7% 8.7% SMIC 653 1,231 2,654 2,400 2,400

Payable days Inventory days

TSMC 21.2 16.1 21.1 21.3 20.5 TSMC 60.3 54.6 37.6 37.9 36.6

UMC 20.0 18.6 21.2 21.2 21.0 UMC 49.3 55.1 62.9 62.9 62.2

SMIC 195.0 246.1 212.6 173.1 145.8 SMIC 77.6 91.0 90.3 86.5 85.7

Receivable days Working capital/sales

TSMC 52.8 35.8 49.8 47.6 48.1 TSMC 19.9% 15.2% 15.9% 15.3% 15.3%

UMC 55.9 47.1 54.1 55.2 53.7 UMC 21.5% 20.7% 23.9% 24.2% 23.4%

SMIC 84.6 81.6 83.3 78.6 79.9 SMIC -1.1% -7.2% -1.0% 4.2% 10.0%

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Exhibit 9: SMIC’s average depreciation/PPE is only 20%

SMIC’s depreciation, PPE, and depreciation/PPE %

Exhibit 10: We believe consensus is underestimating

SMIC’s depreciation SMIC’s capex, 7-year average capex, and depreciation


Source: Company data, Bloomberg, Gao Hua Securities Research

Exhibit 11: SMIC has had an accumulated free cash

outflow of US$4bn since its IPO in 2004 SMIC’s EBITDA, capex, and free cash flow (EBITDA-capex) on

a consolidated basis (excluding minority cash contribution)

Exhibit 12: SMIC’s revenue/net PP&E has deteriorated

significantly since 2013 Revenue/PP&E + intangibles for TSMC, UMC and SMIC, %



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$ m

n

EBITDA (LHS) Capex (LHS) EBITDA-Capex (RHS)

0%

20%

40%

60%

80%

100%

120%

140%

160%

2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016E 2017E 2018E

Revenue/(Net PP&E+intangibles)

TSMC UMC SMIC



We revise TP methodology to offset depreciation policy differences

For our TP calculation, we earlier used 0.78X P/B derived from NTM P/B-ROE regression for

peers, which assumed SMIC’s book value and ROE are comparable to peers’ but did not

capture the impact of its different depreciation policy. Now, we move to EV/DACF (Director’s

Cut), which is based on gross assets and is not dependent on the depreciation policy.

The Director’s Cut methodology analyses how the market values the cash invested in a

business (EV/GCI) relative to the returns (value) created from those assets (CROCI/WACC).

GCI stands for Gross Cash Invested and includes gross fixed assets and working capital.

CROCI stands for Cash Return On Cash Invested, which is operating cash flow over GCI.

The implication is that the market either expects stocks above the regression line to see

accelerated returns relative to the sector, or is overvaluing them relative to cash return and

thus these represent good selling opportunities, and vice-versa (Exhibit 14). The underlying

assumption in this framework is that a company’s ratio will converge to the sector average

over the long term as under/overvaluation is arbitraged away. Foundry and packaging

stocks have historically shown a high correlation in EV/GCI vs. CROCI/WACC (Exhibit 15).

Our regression is built on SMIC’s peers in foundry/packaging in 2017E plus UMC/SMIC in

past troughs. We derive our target EV/DACF from the EV/GCI and CROCI/WACC we get

from the regression. To factor in SMIC’s fast growth in 2017E-2019E, we then calculate

2019E EV based on the target EV/DACF and 2019E DACF. This gives us an implied 2019E

value per share of HK$10.33, which we discount to 2017E with SMIC’s COE of 10.7% to

derive our new 12-month target price of HK$8.40. Our revised target price implies 1.19X

2017E P/B and represents 24% downside potential.

Exhibit 13: We factor in SMIC’s superior growth potential in 2017E-2019E in our valuation methodology

Our 12-month target price calculation for SMIC (value per share in HK$)

Source: Gao Hua Securities Research

Exhibit 14: We use a regression of peer CROCI/WACC vs.

EV/GCI to determine our target EV/GCI for SMIC A regression of EV/GCI and NTM CROCI/WACC of foundry

and packaging stocks in 2017E

Exhibit 15: We use historical data to cross check our

regression A regression of EV/GCI and NTM CROCI/WACC of foundry

and packaging stocks based on historical data

Note: Different shapes for different firms, different colors for different years



COE

8.40 4,546.1 1.09 0.34X 4.8x 2,008 9,705 10.33 10.7%(a) = (g) / (1 + (h))^2 (b) (c) (d) (e) (f) = (e) * (d) (g) (h)

2019 DACF (US$ mn)

Implied 2019 value per share

Implied 2017 value per share

Implied market cap ($mn)

SMIC 2017E CROCI/WACC

Target EV/GCI Implied target

EV/DACF Implied 2019 EV (US$ mn)

UMC 2009

SMIC 2009

TSMC

UMCHua Hong

ASE

SPIL

SMIC current

y = 0.4925x - 0.22

R² = 0.9734

-

0.20

0.40

0.60

0.80

1.00

1.20

1.40

- 0.50 1.00 1.50 2.00 2.50 3.00

EV

/GC

I

CROCI/WACC

y = 0.4283x - 0.0923

R² = 0.88

-

0.20

0.40

0.60

0.80

1.00

1.20

1.40

1.60

- 0.50 1.00 1.50 2.00 2.50 3.00 3.50

EV

/GC

I

CROCI/WACC



Exhibit 16: SMIC has superior sales/GCI than UMC due to

higher utilization and newer equipment Comparison of foundry sales/GCI

Exhibit 17: UMC converts slightly more sales to cash flow

than SMIC due to UMC’s superior EBITDA margin Comparison of foundry DACF/Sales



Risks include higher-than-expected government R&D subsidies and open market stock

purchases by government related entities. We note that between Nov 1 and Dec 9,

Tsinghua Unigroup acquired 298mn shares or 7.07% of total shares outstanding of SMIC at

an average of c.HK$10 per share.

Our 2016E-2018E EPS estimates are below consensus

We raise our 2016E-2018E EPS estimates by 15%/146%/84% as we increase our revenue

and R&D grant estimates and lower our depreciation estimates. We believe SMIC can

achieve its revenue CAGR target of 20% in 2016E-2019E given the strong support it receives

from the Chinese government. In 2016-2018, our revenue estimates are above consensus,

but our EPS estimates are still well below consensus because of our higher depreciation

estimates.

Exhibit 18: We adjust our 2016-18E EPS by 15%/146%/84% SMIC estimate revisions

Source: Gao Hua Securities Research

10%

15%

20%

25%

30%

35%

40%

45%

2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016E2017E2018E

Revenue/GCI

TSMC UMC SMIC Hua Hong

10%

20%

30%

40%

50%

60%

70%

2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016E2017E2018E

DACF/Revenue

TSMC UMC SMIC Hua Hong

SMIC

New Old Diff. New Old Diff. New Old Diff.

Revenue ($ mn) 2,910 2,903 0.2% 3,622 3,424 5.8% 4,339 4,003 8.4%

Gross margin (%) 28.7% 28.4% 33bps 27.1% 39.3% -1218bps 27.8% 48.1% -2032bps

Operating profit ($ mn) 356 343 4.0% 365 152 140.0% 451 220 105.3%

Operating margin (%) 12.2% 11.8% 44bps 10.1% 4.4% 564bps 10.4% 5.5% 491bps

Net profit ($ mn) 375 326 15.1% 380 155 145.6% 414 225 84.3%

Net margin (%) 12.9% 11.2% 166bps 10.5% 4.5% 598bps 9.5% 5.6% 393bps

EPS ($)-HK shares 0.078 0.067 15.1% 0.076 0.031 145.6% 0.082 0.045 84.3%

Wafer shipments (K 8" wafers) 3,971 3,839 3.4% 4,909 4,363 12.5% 5,790 5,113 13.2%

ASP ($) 706 708 -0.3% 718 724 -0.8% 732 738 -0.8%

Capacity ('000 8" eq) 3,998 4,024 -0.6% 5,168 5,114 1.1% 6,070 5,908 2.7%

Utilization 99.3% 95.4% 391bps 95.0% 85.3% 966bps 95.4% 86.5% 885bps

Capex ($ mn) 2,600 2,500 4.0% 2,400 2,000 20.0% 2,400 2,000 20.0%

Depreciation ($ mn) 736 737 -0.1% 985 1,090 -9.6% 1,187 1,284 -7.6%

2016E 2017E 2018E



Exhibit 19: We expect SMIC to hit its revenue growth target, but are conservative on earnings GHe vs. consensus

Source: Bloomberg, Gao Hua Securities Research.

Exhibit 20: SMIC’s valuation looks expensive relative to peers

Valuation comparison, as of January 17, 2017

Note: All target prices have a 12-month timeframe

Source: Company data, Datastream, Gao Hua Securities Research, Goldman Sachs Global Investment Research.

Note: Prices in this report are as of January 17, 2017 market close, unless indicated

otherwise.

GH e Consensus Diff. GH e Consensus Diff. GH e Consensus Diff.

Revenue (US$ mn) 2,910 2,908 0.1% 3,622 3,538 2.4% 4,339 4,094 6.0%

Gross margin (%) 28.7% 28.8% -3bps 27.1% 28.6% -146bps 27.8% 28.6% -80bps

EBITDA (US$ mn) 1,093 1,073 1.8% 1,350 1,329 1.6% 1,638 1,590 3.0%

EBITDA margin (%) 37.5% 36.9% 65bps 37.3% 37.6% -28bps 37.7% 38.8% -109bps

Operating profit (US$ mn) 356 369 -3.3% 365 413 -11.6% 451 492 -8.4%

Operating margin (%) 12.2% 12.7% -43bps 10.1% 11.7% -159bps 10.4% 12.0% -163bps

Net profit (US$ mn) 375 374 0.3% 380 423 -10.1% 414 476 -13.1%

Net margin (%) 12.9% 12.9% 3bps 10.5% 12.0% -146bps 9.5% 11.6% -209bps

Capex (US$ mn) 2,600 2,452 6.0% 2,400 2,047 17.2% 2,400 1,969 21.9%

Depreciation (US$ mn) 736 547 34.7% 985 717 37.4% 1,187 867 37.0%

2017E 2018E 2016E

Ticker Ratings Market Target TP Market

capCash div

yieldPrice Price up/downside US$ mn 2016E 2017E 2016E 2017E 2016E 2017E 2016E 2017E 2016E

Hua Hong (HK$) 1347.HK Buy 8.26 10.50 27% 1,101 11.1 11.3 0.7 0.7 6.5% 6.1% 9.6% 10.0% 3.3%

Silergy (NT$) 6415.TW Buy 470.50 528.00 12% 1,143 28.2 18.8 5.3 4.3 23.9% 26.7% 50.3% 35.0% 1.0%

TSMC (NT$) 2330.TW Neutral 181.00 190.00 5% 148,420 13.9 12.8 3.4 3.0 25.8% 24.9% 12.4% 8.6% 3.3%

TSMC-ADR (US$) TSM Neutral 29.62 27.20 -8% 153,456 13.3 13.2 3.2 3.1 25.8% 24.9% 12.4% 8.6% 3.1%

UMC (NT$) 2303.TW Neutral 11.65 13.30 14% 4,784 16.1 14.2 0.6 0.6 4.0% 4.5% 2.1% 7.3% 5.3%

UMC-ADR(US$) UMC Neutral 1.85 2.10 14% 4,800 16.0 14.1 0.6 0.6 4.0% 4.5% 2.1% 7.3% 5.2%

SMIC (US$) SMI Sell 7.09 5.40 -24% 5,989 18.3 18.7 1.8 1.7 9.5% 8.7% 30.1% 24.5% 0.0%

SMIC-H shares (HK$) 0981.HK Sell 11.06 8.40 -24% 6,129 18.4 18.8 1.8 1.7 9.5% 8.7% 30.1% 24.5% 0.0%

Intel (US$) INTC Neutral 36.80 39.00 6% 179,474 17.7 14.3 2.8 2.6 18.6% 18.7% 6.0% 5.4% 2.8%

MediaTek (NT$) 2454.TW Neutral 213.50 248.00 16% 10,615 13.9 13.2 1.4 1.4 10.0% 10.5% 29.9% -1.6% 5.8%

Parade (NT$) 4966.TWO Neutral 308.00 329.00 7% 740 17.4 14.4 3.2 2.7 19.8% 21.0% 25.5% 23.2% 2.1%

Samsung Electronics (KRW) 005930.KS Neutral 1,848,000 1,880,000 2% 220,261 11.5 11.5 1.4 1.4 12.8% 12.8% 0.4% 11.4% 1.5%

Average 16.3 14.6 2.2 2.0 14.2% 14.3% 17.6% 13.7% 2.8%Median 16.0 14.1 1.8 1.7 11.4% 11.6% 12.4% 9.3% 3.0%STD 4.5 2.7 1.4 1.2 8.2% 8.4% 15.4% 10.6% 2.0%

P/E (X) P/B (X) ROE Revenue growth



Disclosure Appendix

Reg AC

I, Donald Lu, Ph.D, hereby certify that all of the views expressed in this report accurately reflect my personal views about the subject company or

companies and its or their securities. I also certify that no part of my compensation was, is or will be, directly or indirectly, related to the specific

recommendations or views expressed in this report.

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Disclosures

Coverage group(s) of stocks by primary analyst(s)

Donald Lu, Ph.D: Greater China Telecoms and Technology.

Greater China Telecoms and Technology: China Communication Services, China Mobile (HK), China Mobile (HK) (ADR), China Telecom, China

Telecom (ADR), China Unicom, China Unicom (ADS), Hua Hong Semiconductor Ltd., Mediatek, Parade Technologies Ltd., Silergy Corp., SMIC, SMIC

(ADR), Sunny Optical Technology Group, TSMC, TSMC (ADR), United Microelectronics Corp., United Microelectronics Corp. (ADR), ZTE Corp. (H).

Company-specific regulatory disclosures

The following disclosures relate to relationships between The Goldman Sachs Group, Inc. (with its affiliates, "Goldman Sachs") and companies

covered by the Global Investment Research Division of Goldman Sachs and referred to in this research.

Goldman Sachs had a non-securities services client relationship during the past 12 months with: SMIC (HK$10.88) and SMIC (ADR) ($7.05)

Goldman Sachs makes a market in the securities or derivatives thereof: SMIC (HK$10.88) and SMIC (ADR) ($7.05)

Goldman Sachs is a specialist in the relevant securities and will at any given time have an inventory position, "long" or "short," and may be on the

opposite side of orders executed on the relevant exchange: SMIC (HK$10.88) and SMIC (ADR) ($7.05)

Distribution of ratings/investment banking relationships

Goldman Sachs Investment Research global Equity coverage universe

Rating Distribution Investment Banking Relationships

Buy Hold Sell Buy Hold Sell

Global 32% 54% 14% 64% 60% 51%

As of January 1, 2017, Goldman Sachs Global Investment Research had investment ratings on 2,902 equity securities. Goldman Sachs assigns stocks

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provided investment banking services within the previous twelve months.



Price target and rating history chart(s)

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4.84.7

6.9

7.4

6,0007,0008,0009,00010,00011,00012,00013,00014,00015,00016,000

4.005.006.007.008.009.00

10.0011.0012.0013.0014.00

SMIC (0981.HK)

Goldman Sachs rating and stock price target history

Stock Price Currency : Hong Kong Dollar

Source: Goldman Sachs Investment Research for ratings and price targets; FactSet closing prices as of 12/31/2016.

The price targets show n should be considered in the context of all prior published Goldman Sachs research, which may or may not have included price targets, as w ell as developments relating to the company, its industry and financial markets.

Rating

Price target

Price target at removal

Covered by Donald Lu, Ph.D,as of Apr 19, 2016

Not covered by current analyst

Hang Seng China Ent. Index

Inde

xPr

ice

Sto

ckPr

ice Apr 19

NAF

SM A M J J A S O N D J F M A M J J A S O N D J F M A M J J A S O N D

2014 2015 2016

3.13

4.4

4.7

3,5003,7003,9004,1004,3004,5004,7004,9005,1005,3005,500

2.00

3.00

4.00

5.00

6.00

7.00

8.00

SMIC (ADR) (SMI)

Goldman Sachs rating and stock price target history

Stock Price Currency : U.S. Dollar

Source: Goldman Sachs Investment Research for ratings and price targets; FactSet closing prices as of 12/31/2016.

The price targets show n should be considered in the context of all prior published Goldman Sachs research, which may or may not have included price targets, as w ell as developments relating to the company, its industry and financial markets.

Rating

Price target

Price target at removal

Covered by Donald Lu, Ph.D,as of Apr 19, 2016

Not covered by current analyst

NASDAQ Composite

Inde

xPr

ice

Sto

ckPr

ice Apr 19

NAF

SM A M J J A S O N D J F M A M J J A S O N D J F M A M J J A S O N D

2014 2015 2016



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