MStar Semiconductor (3697.TW / 3697 TT)

Transcription

1 Asia Pacific/Taiwan Equity Research Semiconductor Devices / OVERWEIGHT Rating OUTPERFORM* [V] Price (16 Nov 11, NT$) Target price (NT$) ¹ Chg to TP (%) 27.4 Market cap. (NT$ mn) 93,696 Enterprise value (NT$ mn) 68,485 Number of shares (mn) Free float (%) week price range *Stock ratings are relative to the relevant country benchmark. ¹Target price is for 12 months. [V] = Stock considered volatile (see Disclosure Appendix). Share price performance Price (LHS) Research Analysts Randy Abrams, CFA randy.abrams@creditsuisse.com Kevin Chen kevin.chen@creditsuisse.com Rebased Rel (RHS) Dec10 Apr11 Aug The price relative chart measures performance against the TAIWAN SE WEIGHTED INDEX which closed at on 16/11/11 On 16/11/11 the spot exchange rate was NT$30.22/US$1 Performance Over 1M 3M 12M Absolute (%) Relative (%) (3697.TW / 3697 TT) INITIATION Handsets and settops improve the picture Initiate with an OUTPERFORM. We initiate coverage on MStar with an OUTPERFORM rating and a target price of NT$223, based on 15x our 2012E EPS of NT$14.85, in line with its peer group. MStar combines a stable, profitable and marketleading display business with potential growth drivers from handsets and settops, which we expect to drive its doubledigit sales growth in 2012/13. Display consolidation improves stability. MStar has consolidated its market share at 6 for monitor and TV controller ICs. The business is maturing into singledigit unit growth, offset by moderating price erosion due to content additions from Smart TV and 3DTV, and higher refresh rates. We expect display to steady gross margins in the low 4 range and operating margins near 2. Handsets and settops provide a growth option. The contribution of handsets and settops to MStar s sales has risen from 5% to 15% in 2011, and we expect it to reach 5 by In handsets, the company has grown its share among Asian brands from 2% to 7% and we model a 14% share by 2015, including its 15% emerging market share in smartphones. The company will have its 40nm 1 GHz HSPA+ / WCDMA and TDHSPA sampling in 1Q12. For settops, the company has grown share from 5% to 1 and we model a 25% share by Valuation remains reasonable. We estimate 2012 revenue and EPS of NT$41.9 bn and NT$14.85, above the street s estimates of NT$40.9 bn and NT$14.26, respectively. MStar trades at 12x our 2012E EPS, versus the peer group average of 15x and MediaTek s 21x. Our target price of NT$223 is based on 15x EPS (in line with peers) and supported by Credit Suisse HOLT valuation, which suggests an even higher valuation of NT$238, based on our assumptions for sales, EBITDA and investments. Key risks are revenue concentration on display, inventory cycle and pricing pressure. Financial and valuation metrics Year 12/10A 12/11E 12/12E 12/13E Revenue (NT$ mn) 33, , , ,988.7 EBITDA (NT$ mn) 8, , , ,017.0 EBIT (NT$ mn) 6, , , ,735.8 Net income (NT$ mn) 6, , , ,327.2 EPS (CS adj.) (NT$) Change from previous EPS (%) n.a. Consensus EPS (NT$) n.a EPS growth (%) P/E (x) Dividend yield (%) EV/EBITDA (x) P/B (x) ROE (%) Net debt/equity (%) net cash net cash net cash net cash Source: Company data, Thomson Reuters, Credit Suisse estimates DISCLOSURE APPENDIX CONTAINS ANALYST CERTIFICATIONS AND THE STATUS OF NONUS ANALYSTS. U.S. Disclosure: Credit Suisse 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.

2 Focus charts and table Figure 1: MStar s growth driven by productline expansion Figure 2: MStar s current product mix Sales (NT$mn) 50,000 40,000 30,000 20,000 10, F 2012F 2013F LCD Digital TV LCD Monitor Other (GPS, RFID) Handsets STB Other (GPS, RFID) 3% STB 4% LCD TV 69% Handse ts 12% LCD Monitor 12% Figure 3: MStar s smartphone ramp up starts from 2012E Units (mn) Smartphones % of sales 30 9 Source: Company data Figure 4: 3G will quickly be the driver of handset sales Units (mn) 3G % of sales Q10 2Q10 3Q10 4Q10 1Q11 2Q11 3Q11 4Q11E 1Q12E 2Q12E 3Q12E 4Q12E 1Q13E 2Q13E 3Q13E 4Q13E 1Q14E 2Q14E 3Q14E 4Q14E 1Q15E 2Q15E 3Q15E 4Q15E Mstar Feature Phone Mstar Smartphones Smartphone % of handset sales 75% 6 45% 3 15% 50 75% % % 1Q10 2Q10 3Q10 4Q10 1Q11 2Q11 3Q11 4Q11E 1Q12E 2Q12E 3Q12E 4Q12E 1Q13E 2Q13E 3Q13E 4Q13E 1Q14E 2Q14E 3Q14E 4Q14E 1Q15E 2Q15E 3Q15E 4Q15E 2.5G units WCDMA units TDSCDMA units 3G % of handset sales Figure 5: MStar s margins have remained stable Sales (NT$mn) Margin (%) 10,000 5 Figure 6: Settops could approach 15% of sales Sales (NT$mn) Handsets % of sales 60, , ,000 75% 6,000 4, ,000 30,000 20, % 3 2, ,000 15% 1Q09 2Q09 3Q09 4Q09 1Q10 2Q10 3Q10 4Q10 1Q11 2Q11 3Q11 4Q11E F 2012F 2013F 2014F 2015F Sales GM % Op Margin % MStar sales MStar settop sales MStar % of sales Figure 7: MStar summary of CS 3Q/4Q11 and estimates 3Q11 4Q11 1Q (NT$ mn) Actual CS(old) Street Guidance CS CS(old) Street Guidance CS Street CS Street CS Street CS Street Net sales $9,327 $9,339 $9,185 NT$8.8 $9,590 $9,467 $9,332 NT$9.3$9.9bn $9,089 $8,905 $35,474 $35,455 $41,880 $40,929 $47,989 $47,367 Chg 11.7% 11.8% % 1.4% 1.6% 3% to +3% 5.2% 4.6% 5.6% 4.7% 18.1% 15.4% 14.6% 15.7% GM (%) 42.1% 41.3% 4042% 41.9% 41.2% 4042% 41.8% 41.9% 41.6% 41.5% Op. M (%) 18.3% 18.8% 18.8% 1519% 18.6% 19.4% 18.2% 1519% 17.5% % 18.5% 19.4% % 19.2% Net income 1,618 1,628 1,621 1,731 1,699 1,619 1,554 1,558 6,291 6,180 7,853 7,506 9,327 8,652 EPS (NT$) $3.06 $4.39 $3.12 $3.27 $4.58 $3.09 $2.94 $2.96 $11.89 $11.99 $14.85 $14.26 $17.64 $16.92, Bloomberg consensus (3697.TW / 3697 TT) 2

3 Handsets and settops improve the picture MStar is a Taiwanbased fabless semiconductor company that came into being in 2002 when the display and RFID divisions split off from System General Technology (now part of Fairchild), an analog design house. The company s initial competencies were an analog to digital converter and a silicon technology for displays, which the company later used to break in and eventually dominate the TV and monitor controller IC markets. The company is now expanding, using its competencies in integration, analog to digital control and multimedia processing to enter into handset baseband, GPS, settop and RFID markets. Display business provides the base MStar s product mix in 2011 is still dominated by display with about 7 LCD TV controllers and 12% monitor controllers. In monitors, MStar retains its stable 6 share by shipping to all the top monitor manufacturers, including Samsung, LG, ACO, Philips, ViewSonic, Dell, Lenovo and HP. We model sales slightly down in the next few years as singledigit unit growth is more than offset by about 1 annual price erosion. In TVs, MStar is also consolidating its market share, accounting for 6 of the 200 mnunit DTV market. The chipset landscape has consolidated as smaller standalone suppliers have struggled to maintain their development cost and a competitive cost structure with larger or Asiabased fabless companies coming closer to OEMs. For MStar, we project market share in DTV controllers remaining close to 6 but dropping from a peak of 75% of sales in 2009 to 45% of sales by 2015 as newer product categories grow faster. Revenue should hold stable near 2011 levels in the next few years as modest unit growth offsets price erosion. Handsets and settops open up new opportunities MStar has seen a good volume ramp up this year in handsets, growing its volumes from 10 mn units in 2010 to 50 mn units in Even with this success, MStar still has a <1 share of emerging market platforms, allowing much more room for potential unit upside. Blended pricing could expand, as MStar is starting to sample its smartphone platforms with two 40nm 3.75G basebands (one with HSPA+ / WCDMA, another with TD SCDMA/TDHSPA) with integrated 1 GHz. We model a ramp up to 9 mn smartphone units in 2012 (out of 90 mn) and 24 mn in 2013 (out of 123 mn). A 14% share of the Asian chipset market should scale handsets to 35% of MStar s total sales by 2015, up from only 12% of sales in The settop business is on pace to almost double from NT$800 mn in 2010 to NT$1.5 bn in 2011 and we project sales to again double in 2012, modelling NT$3.4 bn in sales. MStar should have an added boost by starting shipments to the cable space at higher ASPs. We factor in settop share expanding to 25% by 2015 and reaching 15% of MStar s total sales. Solid growth and profitability outlook MStar has maintained a solid model of moderate growth from new products and good profitability with stable 4043% gross margins and about 2 operating margins. The growth model has enabled MStar to grow cash reserve to 25% of the company s market cap and FCF yield to 1315%. Due to the additional growth drivers from handsets and settops, we project a reacceleration of growth to +18% YoY in 2012 and +13% in 2013 and model EPS above the street s expectations for both the years (NT$14.85/NT$17.64 versus the street s forecasts of NT$14.26/NT$16.92 for 2012/13). Valuation remains reasonable We initiate coverage on MStar with an OUTPERFORM and a NT$223 target price, based on 15x our 2012E EPS of NT$14.85, in line with its Asian and overseas peer group. We believe MStar is an attractive investment due to its potential upside to grow handsets and settops operations, stable and profitable margin profile and cash flow and valuation support. MStar is a fabless semiconductor company initially focused on display but now expanding into handsets and settops MStar has a stable, mature and profitable TV and monitor controller business Handsets and settops grew from 5% to 15% of sales in 2011 and could combine for a 5 share by 2015 MStar could see accelerating revenue growth and stable margins Valuation is reasonable at a discount to the peer group (3697.TW / 3697 TT) 3

4 Financial summary Figure 8: MStar income statement summary Summary Income Statement 1Q11 2Q11 3Q11 4Q11E 1Q12E 2Q12E 3Q12E 4Q12E F 2011F 2012F 2013F Net Sales 8,207 8,351 9,327 9,590 9,089 10,068 11,380 11,343 27,712 33,594 35,474 41,880 47,989 Sequential Change % 11.7% 2.8% 5.2% 10.8% % Y/Y Change 2.1% 8.9% 0.9% % 20.6% % 82.6% 21.2% 5.6% 18.1% 14.6% Cost of Goods Sold 4,818 4,803 5,401 5,572 5,286 5,869 6,649 6,649 15,825 19,394 20,595 24,452 28,077 Gross Profits 3,388 3,548 3,925 4,018 3,803 4,199 4,732 4,694 11,886 14,200 14,880 17,428 19,912 Gross Margin 41.3% 42.5% 42.1% 41.9% 41.8% 41.7% 41.6% 41.4% 42.9% 42.3% 41.9% 41.6% 41.5% Operating Exp. Promotion ,824 2,170 2,413 % of Sales 4.8% 4.7% 5.6% 5.4% 5.7% 5.2% % % 5.2% 5. Operating Exp. Administrative ,088 1,517 1,621 1,891 2,044 % of Sales % 4.9% 4.8% % 4.3% 4.3% 3.9% 4.5% 4.6% 4.5% 4.3% Operating Expense R&D 1,218 1,238 1,247 1,259 1,247 1,272 1,364 1,351 4,313 4,715 4,961 5,233 5,719 % of Sales 14.8% 14.8% 13.4% 13.1% 13.7% 12.6% % 15.6% % 11.9% Total Operating Exp 1,939 2,009 2,220 2,237 2,215 2,259 2,422 2,398 6,300 7,230 8,406 9,294 10,176 Income from Operations 1,449 1,539 1,705 1,781 1,588 1,939 2,310 2,296 5,586 6,970 6,474 8,134 9,736 % of Sales 17.7% 18.4% 18.3% 18.6% 17.5% 19.3% 20.3% 20.2% 20.2% 20.7% 18.2% 19.4% 20.3% Non Operating Income (408) Pretax Income 1,547 1,664 1,740 1,882 1,689 2,040 2,410 2,397 5,177 7,158 6,832 8,537 10,139 % of Sales 18.8% 19.9% 18.7% 19.6% 18.6% 20.3% 21.2% 21.1% 18.7% 21.3% 19.3% 20.4% 21.1% Income Taxes Exp. /(Gains) Tax Rate 7.4% 9.2% % 7.9% Net Income after Extraordinaries 1,432 1,510 1,618 1,731 1,554 1,877 2,217 2,205 4,815 6,537 6,291 7,853 9,327 % of Sales 17.4% 18.1% 17.4% % 18.6% 19.5% 19.4% 17.4% 19.5% 17.7% 18.8% 19.4% Dividend to Common Share Holders 4,804 4,718 1,057 4,804 4,718 5,890 Net EPS (diluted) Share Count Figure 9: MStar balance sheet summary* NT$ mn 1Q11 2Q11 3Q11 4Q11E 1Q12E 2Q12E 3Q12E 4Q12E Cash, Cash Equivalent 25,566 26,485 24,591 26,080 27,741 28,907 25,487 27,985 13,896 25,212 26,080 27,985 30,738 Inventories 4,283 3,906 4,052 3,969 3,765 4,502 5,465 5,101 3,077 4,381 3,969 5,101 5,530 Account receivables 4,950 4,331 5,408 5,255 4,980 5,517 6,236 6,215 3,873 4,109 5,255 6,215 6,750 Other current assets Total current asset 35,422 35,278 34,785 36,057 37,201 39,717 38,082 40,193 21,631 34,307 36,057 40,193 43,986 LT investment Fixed Assets 1,976 1,960 2,095 2,155 2,211 2,276 2,354 2,431 2,211 1,966 2,155 2,431 2,769 Intangible Assets 0 1,077 1,410 1,410 1,410 1,410 1,410 1, ,410 1,410 1,410 Other Assets 1, ,414 1, Total NonCurrent Assets 3,537 3,610 4,306 4,366 4,421 4,486 4,564 4,642 3,626 3,433 4,366 4,642 4,979 Total assets 38,960 38,889 39,090 40,423 41,622 44,203 42,646 44,834 25,257 37,741 40,423 44,834 48,965 Accounts payable 2,336 2,090 2,961 2,442 2,317 2,573 2,914 2,915 2,758 2,194 2,442 2,915 3,160 Other current liabilities 4,191 8,055 4,279 4,400 4,170 4,619 5,221 5,204 3,915 3,807 4,400 5,204 5,652 Total current liabilities 6,527 10,231 7,327 6,929 6,574 7,279 8,222 8,206 6,674 6,068 6,929 8,206 8,898 Other LT liabilities Total Long Term liabilities Total Liabilities 7,395 11,013 8,108 7,710 7,355 8,060 9,004 8,987 7,542 6,936 7,710 8,987 9,680 Total Equity 31,562 27,873 30,978 32,709 34,263 36,140 33,639 35,844 17,715 30,802 32,709 35,844 39,282 Total Liabilities & Equity 38,960 38,889 39,090 40,423 41,622 44,203 42,646 44,834 25,257 37,741 40,423 44,834 48,965 Figure 10: MStar operating metrics Revenue by product (NT$mn) 1Q11 2Q11 3Q11 4Q11E 1Q12E 2Q12E 3Q12E 4Q12E F 2011F 2012F 2013F Handsets ,155 1,560 1,450 1,703 2,205 2, ,151 4,254 7,962 11,476 LCD Monitor ,086 1,090 1, ,040 1,095 1,068 5,250 5,301 4,392 4,174 4,050 LCD TV 5,869 5,807 6,430 6,149 5,754 6,234 6,755 6,321 21,507 25,118 24,255 25,064 24,988 STB , ,479 3,352 6,257 Other (GPS, RFID) ,187 1,094 1,328 1,218 Total Revenue (NT$mn) ,351 9,327 9, ,068 11,380 11,343 27,712 33,595 35,474 41,880 47,989 Handset Units (mn) Handset ASPs (US$) Handset Revenue (NT$mn) ,155 1,560 1,450 1,703 2,205 2, ,151 4,254 7,962 11, G units (mn for all below) TDSCDMA units WCDMA units Feature phone units Smartphone units FX Rate (NT$/US$) Source for all the above charts: Company data, Credit Suisse estimates (3697.TW / 3697 TT) 4

5 Display business provides the base MStar is a Taiwanbased fabless semiconductor company that came into being in 2002 when the display and RFID divisions split off from System General Technology (now part of Fairchild), an analog design house. Wayne Liang, one of the four cofounders, remains the president of the company, while the other three have now assumed consulting roles in the company (Steve Yang, former CEO; Sterling Smith, former R&D leader; and Henry Yung, R&D manager). Much of the core R&D management team at MStar started at Texas Instruments. The company retains an engineering focus, with 66% of its 2,900 staff in R&D and 5% with a PhD and 75% with a Master s degree. MStar s initial core competencies were an analog to digital converter and a silicon technology for displays, which the company later used to break in and eventually dominate the TV and monitor controller IC markets. The company is now moving beyond that, using its competencies in integration, analog to digital control and multimedia processing to enter the handset baseband, GPS, settop and RFID markets. 17 November 2011 Figure 11: MStar product overview Category % of sales Description Applications Customers Competitors LCD TV 68.4% Mstar offers a complete digital TV controller integrating broadcasting, Internet, and settop functionalities. TVs Samsung, LG, Panasonic, Skyworth, Hisense, TCL Mediatek, Novatek, Realtek, STM, Sunplus, Trident, Zoran, HiSilicon LCD monitor 12.4% An SoC for monitors that performs scaling, deinterlacing, and image processing. Handset baseband 12. An integrated m obile chipset and protocol stack to process voice commands and run the handset software. Settop box 4.2% An SoC that combines demodulation and backend image processing for cable and free to air settops. LCD monitors Handsets Samsung, Dell, HP, Lenovo, Philips, ViewSonic, AOC Tianyu, Wingtech, Longcheer, Micromax, Smart, Karbonn, Zen, MStar has 66% of its 2,900 staff in R&D Realtek, STM, Pixelworks Mediatek, Spreadtrum, Qualcom m, Broadcom, Marvell, STEricsson, Intel/Infineon, Coolsand Videocon, Venera Settops Broadbase Broadcom, STM, Ali, Sunplus, Hi Silicon GPS 2. A chipset that allows navigation using the GPS and PnDs, handsets, Various ODMs GLONASS satellite networks. consumer products. RFID 1. A technology that uses radio waves to transfer data Portable 2Way Broadbase fr om an electronic tag in an object to a reader to Radios identify and track the objec t. Source: Company data MStar s product mix this year is still heavily loaded towards display with about 7 LCD TV controllers and 12% monitor controllers. Beyond that, handsets and settops have emerged in the past 18 months to drive 12% and 4% of sales, respectively, with GPS and RFIDs remaining small niche product segments. A profile of MStar s product mix shows display should remain a mature business with new product areas driving the growth. CSR/SIRF, Mediatek, Broadcom TI, Atmel, Cypress, ON Semi, Triquint, NXP, STM, Freescale Figure 12: MStar product mix weighs towards display (2011) Other (GPS, RFID) 3% STB 4% LCD TV 69% Source: Company data Handse ts 12% LCD Monitor 12% Figure 13: MStar growth driven by productline expansion Sales (NT$mn) 50,000 40,000 30,000 20,000 10, F 2012F 2013F LCD Digital TV LCD Monitor Other (GPS, RFID) Handsets STB (3697.TW / 3697 TT) 5

6 Monitors now a mature and stable business Monitor controllers was one of MStar s initial success areas. The company used its lowcost integrated Tsunami product line to capture a 6 market share by 2008 from established incumbents Genesis Microchip (now acquired by STM) and Realtek. MStar was challenged and lost a suit to Genesis but later settled and signed a royaltypaying license agreement that allowed it to ship products. The business is now mature, with market share between MStar, STM, Novatek and Realtek stable and market growth tied to the mature PC monitor business. MStar retains a stable 6 share by shipping to all of the top monitor manufacturers, including Samsung, LG, ACO, Philips, ViewSonic, Dell, Lenovo and HP. We model sales slightly down the next few years as singledigit unit growth is more than offset by about 1 annual price erosion. Price reductions on similar products is greater, but a shift to higher frame rates, 3D processing and more advanced image processing supports blended pricing. The company notes it is shipping inside every 3D monitor and has shifted into higherend monitor markets requiring advanced imaging such as medical. With sales flat to down in a growing business, we expect monitors to decline from the current 12% of sales to 6% of sales by Monitor controller was MStar s first highvolume product group, but is now only about 1 of sales Figure 14: Monitor sales now flattening out Monitor units (mn) MStar share (%) % Figure 15: Monitors becoming a smaller driver of sales Sales (NT$mn) Monitor % of sales 60, , % 3 40,000 30,000 20, % 10, F 2012F 2013F 2014F 2015F F 2012F 2013F 2014F 2015F LCD monitor market MStar monitors MStar share (%) MStar sales MStar monitor sales MStar % of sales Digital TV leadership intact MStar extended its success in monitors into Digital TV, focusing on offering a high level of customisation and software support to entrench itself in OEM and ODM platforms. MStar has been increasingly integrating more, starting with a scaler and deinterlacer, then adding video decode, image processing, HDMI/DVI controllers, audio processors and support for higher frame rates and 3DTV. The DTV space continues to see new content adders that support blended pricing. MStar s TV controller ranges from US$6 to US$1415, with average pricing still in the US$78 range. The current trends involve adding 3DTV, which often requires higher MHz processor (up to 1GHz), timing controller integration, addition of connectivity and shift to higher speed frame rate conversion (120/240 Hz refresh rates). DTV is a strong product line for MStar but is now getting mature (3697.TW / 3697 TT) 6

7 Figure 16: Digital TV ICs continuing to add new functionality MPEG2 Integrated MPEG4 Integrated 3DTV Wired networking Bigger CPU up to 1GHz TCON Integration Frame rate conversion/mpeg 4 Tuner Wireless networking Source: DisplaySearch MStar has also created its branded product MStar Connected, which brings together its catalogue of chipset suites, a wide portfolio of software and rapidly growing library of content, applications and widgets: HBBTV solution: MStar is leading the development of Hybrid Broadcast Broadband TV (HbbTV), a solution that allows TVs to receive content from both the cable broadcast network and internet network. MStar acquired a team of engineers from Pleyo that had developed an HbbTV web browser based on Webkit (Apple s open source web engine) and addon widgets. MStar is now delivering solutions to the market, partnering with Toshiba for its new TL and RL series for Europe that uses MStar s motion compensation technology, DVBT2 demodulator and SoC controller with the Toshiba Places portal for videoondemand and internet services. Separately, MStar partnered with Skyworth and Shanxi Broadcast and TV Network Group to deliver ecommerce and entertainment. MStar is leading in bringing together hybrid connected TV systems, combining broadcast and internet content Figure 17: MStar is leading in bringing hybrid (HbbTV) connected TV platforms delivering broadcast and internet content to the TV display Source: HbbTV.org (3697.TW / 3697 TT) 7

8 On demand solutions: MStar has added software to support premium software and services over its connected TVs. The company partnered with Acetrax premium service to deliver movies to rent or buy over the TV without a subscription. MStar also integrated in support for Vudu s connected TV streaming movie service and RoxioNow s library of TV and movies. Connected TV interface: MStar partnered with Thinking Screen Media to create an AppChannel with user interface and applications from thirdparty content providers. Highquality audio: MStar integrated dbxtv s audio product suite to enhance TV audio. The dbx enhancement allows for automatic volume control and compensates for deficiencies from small or incorrectly placed speakers. Gaming direct to the TV: MStar is incorporating a higherend processor and graphics engine to run gaming using the TV processor rather than a proprietary game console. MStar worked with Antix Game Service and integrated is software client on its platform to enable highquality games to run on TVs and settops. DLNA support: MStar integrated the AwoX s DLNA technology into its platform. The DLNA component gives MStar s chipset the capability to play back content available on any DLNA server on the local network and serve content to the rest of the network. Secure content: MStar has also added additional security features. The company has added Civolution s PayTV watermarking core on its chipset. The watermarking technology puts a unique mark on each video content so that illegally copied content is more easily traceable. MStar should benefit from the rise of Smart TV services, which will likely create more barriers to the TV platform and require higher performance silicon controllers and wired/wireless connectivity chipsets. DisplaySearch estimates connected TV integration has reached 3 in 2011 and 3D TV only 1. The scaleup of these features allow bundling of more capable image processing and connectivity to support pricing. Smart TV raises barriers and ASPs for the DTV controller maker by increasing valueadded software and connectivity Figure 18: Connected TV penetration steadily rising Smart T V (mn units) Smart TV penet ration (%) F 2012F 2013F 2014F 2015F ac n Ethernet % of LCD market Figure 19: 3D TV growing to 4 penetration by 2015E 3DTV shipments (mn units) Penetration (%) F 2012F 2013F 2014F 2015F Shipments 3D (%) FRC 2x/4x (%) LED (%) Source: DisplaySearch Source: DisplaySearch By enhancing its silicon and software platform, MStar has consolidated its market share. Based on our estimate for 110 mn unit shipments in 2010, we believe MStar had 6 of the DTV market share. In 2011, we estimate the company will ship mn units, maintaining its market share. The chipset landscape has consolidated as smaller standalone suppliers (Genesis, Pixelworks, Silicon Optix, Sunplus, Trident, Zoran) have struggled to maintain their development cost and a competitive cost structure with larger or Asiabased fabless companies coming closer to OEMs. We now believe that MediaTek and MStar together are approaching an 8 market share, allowing the landscape to grow into a more mature and stable phase. MStar generates about 4045% of its TV sales from Korean brands (Samsung and LG) and about 354 MStar has about 6 market share in DTV controller ICs (3697.TW / 3697 TT) 8

9 from Chinese brands (Hisense, Skyworth, TCL, Konka, Changhong) and growing share in Japanese brands including Sony and Toshiba. For MStar, we project market share in DTV controllers remaining close to 6 but dropping from a peak of 75% of sales in 2009 to 45% of sales by 2015 as newer product categories grow. Revenue should hold stable near 2011 levels in the next few years as modest unit growth offsets price erosion. Figure 20: LCD TV unit growth slowing LCD TV units (mn) MStar share (%) % Figure 21: LCD controller falling as a % of MStar s sale Sales (NT$mn) LCD TV % of sales 60, ,000 75% % 3 40,000 30,000 20, % % 10,000 15% F 2012F 2013F 2014F 2015F F 2012F 2013F 2014F 2015F LCD TV market MStar TV controllers MStar market share MStar sales MStar LCD TV sales MStar % of sales MStar s earnings are still sensitive to the DTV market. We estimate each incremental 5 mn units for the market will drive NT$0.40 potential upside for MStar s earnings, given its high market share and each 1% higher market share above our 58% base case should be an additional NT$0.31 EPS. Figure 22: MStar earnings sensitivity to DTV industry growth and market share (NT$) 2012 Sensitivity DTV market size and (YoY) DTV market size / share 6% 9% 11% 14% 16% 19% YoY $ % $13.16 $13.54 $13.92 $14.30 $14.68 $ % $13.46 $13.84 $14.23 $14.62 $15.00 $ % $13.76 $14.15 $14.54 $14.93 $15.33 $ % $14.05 $14.45 $14.85 $15.25 $15.65 $16.05 Mstar share 1. 59% $14.35 $14.76 $15.16 $15.57 $15.98 $ $14.65 $15.06 $15.48 $15.89 $16.30 $ % $14.95 $15.37 $15.79 $16.21 $16.63 $17.05 DTV market size: 5mn units = NT$ % MStar share = NT$0.31 (3697.TW / 3697 TT) 9

10 Handsets open up new opportunities MStar has been building its handset offering for the past few years, acquiring a series of design teams and IP blocks to assemble its solution. The company acquired several experienced design teams and IP blocks including: MStar has the assembled key IPs for its handset baseband platform Wavecom IPs, a wireless module developer with over 10 years of experience designing complete solutions for GSM; TTP Com, which had developed software protocol stacks for handsets and had a team disbanded when Motorola exited the business; and Digimoc, which was part of one of the original TDSCDMA chipset developers known as Commit which was split and sold off to MStar. MStar has pushed a differentiated strategy relative to MediaTek and Spreadtrum, looking to use its multimedia capability from its digital TV experience to offer a more advanced graphic user interface (GUI) and a more powerful Arm 9 core (versus Arm 7 for MediaTek and Spreadtrum s lowend platforms). Through this processor, the company markets KingMovie, a highquality video playback (720x480 resolution) with its proprietary video codec and a 3D mobile user interface. MStar started its initial push with feature phone platforms ranging from US$2.50 to US$4.00 to support up to 5 MP capabilities. The company is now just starting to integrate the RF transceiver with the MSW8532. Figure 23: MStar product roadmap Chipset Key Features 1H09 2H09 1H10 2H10 1H11 2H11 1H12 HSDPA Smartphone Cortex A, 800MHz1GHz, Android 2.2 MSW8675 TDSCDMA Smartphone Cortex A, 800MHz1GHz, Android 2.2 MSW8675 Smart feature phone ARM9 286MHz, BB, PMU, 5 MP, RFID, Wifi/GPS MSW8535N MSW8538H Midrange feature phone ARM9 208MHz, BB, PMU, 3MP cam MSW8535 MSW8533 MSW8533N Lowend feature phone ARM9 156MHz, BB, PMU, 2MP cam MSW8533C MSW8532 Source: Company data. The company has design wins with a number of midtier Chinese and Asian brands and design houses including K Touch, Wingtech, Longcheer, Micromax, Spice, Karbonn, Videocon, IMO, Venera, Smart and Zen. The handsets to date are feature phones running on GSM with " screens, Bluetooth and proprietary operating systems. Figure 24: MStar 2.5G feature phone design wins Micromax X550 Videocon V1531 IMO G11 Karbonn K9 Image Technology GSM GSM GSM GSM HSDPA No Yes Yes Yes Band 900/1800MHz 900/1800MHz 900/1800 MHz 900/1800 MHz Operating System Proprietary Proprietary Proprietary Proprietary Pixels 240x x x x320 Connectivity Bluetooth Bluetooth Bluetooth, FM, ATV Bluetooth Camera 2 MP 1.3 MP 1.3 MP 1.3 MHz Processor 208 MHz 208 MHz 208 MHz 208 MHz Display 3.2" 2.4" 3.2" 2.4" Source: Company data. (3697.TW / 3697 TT) 10

11 On top of its platform, the company markets its King Smart platform for mobile downloads from an applications store. MStar has partnered with China Mobile Games and Entertainment (CMGE) to run CMGE games on top of the MStar baseband platform. CMGE has 27 mn paying users per year for its mobile games. MStar also partnered with GAIA Holdings, the parent company of iasolution, which will integrate Java engine functionalities (stock monitoring, exchange, web browsing, online applications) on MStar s smart feature phone chipset platform. MStar is also assembling the connectivity building blocks. The company is an early supplier of near field communications (NFC) chipsets, a technology that allows data connections between two devices close together without pairing and at much lower power. MStar is also developing a supply agreement with Tianyu for an Android NFC smartphone to assist China UnionPay in promoting NFC mobile payments. Feature phones growing off a low base After two years of limited success in , MStar has seen a good volume ramp up in the past four quarters, growing its volume from 10 mn units in 2010 to 50 mn units in The ramp up has been steady through the year, with 7 mn in 1Q11, 10.5 mn in 2Q11, 14.5 mn in 3Q11 and has potential to reach 20 mn units in 4Q11. At this run rate, the company will still be just shy of a 1 market share of emerging market platforms. MStar is one of the first Asian vendors with an NFC connectivity chipset MStar s feature phone units have expanded from 10 mn in 2010 to 50 mn in 2011 Figure 25: MStar just starting to penetrate emerging market handsets Chipset units (mn) Asian share (%) % % % 0 1Q09 2Q09 3Q09 4Q09 1Q10 2Q10 3Q10 4Q10 1Q11 2Q11 3Q11 4Q11E 1Q12E 2Q12E 3Q12E 4Q12E Asian chipsets (Mstar/MTK/SPRD) Mstar Mstar share (%) Our base case for 2012 assumes a 7% industry share in feature phones and a 15% price erosion. We estimate each additional 1% industry share of 12 mn units will result in an additional NT$0.61 EPS and each 5% swing in pricing will have a NT$0.24 impact. (3697.TW / 3697 TT) 11

12 Figure 26: MStar earnings sensitivity to feature phone units and pricing (NT$) 2012 Sensitivity Feature Phone units and share Feat. Ph and smartphone units $15 5% 6% 7% 8% 9% 0 $12.01 $12.62 $13.23 $13.84 $ % $13.64 $14.24 $14.85 $15.46 $ % $14.77 $15.38 $15.99 $16.59 $ % $15.90 $16.51 $17.12 $17.73 $ % $17.04 $17.64 $18.25 $18.86 $ % $18.17 $18.78 $19.39 $19.99 $ % $19.30 $19.91 $20.52 $21.13 $21.74 YoY growth 1 32% 55% 78% 101% Feature phone share: +1% or 12mn units: +NT$0.61 EPS / +1% smartphone share: +NT$1.14 EPS Smartphone share Android smartphones starting in 2012 MStar now has two 40nm 3.75G smartphone basebands (one with HSPA+ / WCDMA, another with TDSCDMA/TDHSPA) with an integrated 1GHz ARM Cortex A9 sampling with customers. We expect the company to ramp up these in 2Q12 at the earliest, given it takes two quarters to develop a midend smartphone). The company will be attempting to start at 1 GHz, as MediaTek is starting to sample on its thirdgeneration Android chipset at 1 GHz in late 4Q11 and Spreadtrum will be on its secondgeneration Android chipset by the end of 1Q12. MStar s market opportunity in smartphones is largely tied to penetration of emerging markets. A look at feature phone penetration from 1996 to 2001 shows feature phones took five years to grow from 31 mn units to 216 mn units similar to smartphones taking 5 years from 2006 to 2011 to grow from 37 mn units to 234 mn units. Feature phones did have a brief dip in 2001/02 (post tech bubble, pause before colour screens/cameras). Tracing this penetration forward, we could see mn units by 2015, with a global recession being a swing factor. To better gauge the smartphone potential for the Asian chipset vendors, we look at their share penetration history in feature phones. If penetration matches feature phones, the Asian vendors would reach 100 mn shipments per quarter in 1Q15, 3 ½ years into the ramp up at a 4 industry share. Android EDGE smartphones start to sample in 1Q12 for 2H12 volume Figure 27: Emerging market FF ramp up vs smartphones (mn) 1,600 1,400 1,200 1, /06 97/07 98/08 99/09 00/10 01/11 02/12 03/13 04/14 05/15 06/16 07/17 08/18 09/19 10/20 11/21 Figure 28: Modelling slightly faster penetration for smartphones for the Asian chipset vendors Qtrly shipments (mn) Asian share (mn) Q11/1Q05 1Q12/3Q05 3Q12/1Q06 1Q13/3Q06 3Q13/1Q07 1Q14/3Q07 3Q14/1Q08 1Q15/3Q08 3Q15/1Q09 1Q16/3Q09 3Q16/1Q10 1Q17/3Q10 3Q17/1Q11 1Q18/3Q11 Emerging Mkt Handsets (Actual) Emerging Mkt Smartphones (CS) Asian Feature phone units Asian Smartphone units FF Asian share (%) Smartphone Asian share (%) As MStar will see some penetration into developed market carriers, we also show a cross section of lowcost subus$200 smartphones as MStar s potential market. In our global smartphone model, this category grows from 115 mn units in 2011 to 175 mn in 2012 and 480 mn in (3697.TW / 3697 TT) 12

13 Figure 29: SubUS$200 smartphone ramp up Smartphone market (mn) Sub $200 % of industry (mn) 1, , E 2012E 2013E 2014E 2015E 0$100 $100$200 $ $350$500 $500+ % <$200 Figure 30: Emerging market smartphone market ramp up Emerging mkt smartphones F 2012F 2013F 2014F 2015F Emerging market smartphones YoY Growth YoY Growth Small feature phone business means smartphones can have an impact quickly MStar was a much later entrant to feature phones than Spreadtrum and MediaTek were; so it has much smaller legacy handset revenue streams. We project feature phone share could level out around 1 with MediaTek keeping 657 and Spreadtrum taking 25%. Even if the larger players lose share, Coolsand would also enter the picture in 2012 and could capture some lowend volumes. For smartphones, we model a ramp up to 9 mn smartphone units in 2012 (out of 90 mn) and 24 mn in 2013 (out of 123 mn). By 2015, we project the company passing its feature phone share, modelling about 15% based on 94 mn smartphone units. Factoring in 24 mn smartphone units in 2013 Figure 31: MStar may succeed more on smartphones due to its late feature phone entry Shipments (mn) F 2012F 2013F 2014F 2015F Market share 18% 15% 12% 9% 6% 3% Feature phones Emerging mkt feature phone share Smartphones Emerging mkt smartphone share Due to blended pricing running at US$810 versus US$2.50$3.00 for a feature phone platform, the company could achieve crossover to over 5 of handset sales from smartphones by 4Q13. (3697.TW / 3697 TT) 13

14 Figure 32: MStar smartphone ramp up starts from 2012E Units (mn) Smartphones % of sales 30 9 Figure 33: 3G will quickly be the driver of handset sales Units (mn) 3G % of sales % 50 75% % 30 45% % 10 15% 1Q10 2Q10 3Q10 4Q10 1Q11 2Q11 3Q11 4Q11E 1Q12E 2Q12E 3Q12E 4Q12E 1Q13E 2Q13E 3Q13E 4Q13E 1Q14E 2Q14E 3Q14E 4Q14E 1Q15E 2Q15E 3Q15E 4Q15E 1Q10 2Q10 3Q10 4Q10 1Q11 2Q11 3Q11 4Q11E 1Q12E 2Q12E 3Q12E 4Q12E 1Q13E 2Q13E 3Q13E 4Q13E 1Q14E 2Q14E 3Q14E 4Q14E 1Q15E 2Q15E 3Q15E 4Q15E Mstar Feature Phone Mstar Smartphones Smartphone % of handset sales 2.5G units WCDMA units TDSCDMA units 3G % of handset sales Modest smartphone success has a notable impact We factor in MStar only gaining modest traction in a competitive space but even at that level having a sizeable impact. A 14% share of the Asian chipset market would scale handsets to 35% of MStar s total sales by 2015, up from only 12% of sales in About 13% chipset share in Asia would be 35% of sales for MStar Figure 34: Factoring only 13% Asian share by 2015E Whitebrand handsets (mn) MStar share (%) 1, , , F 2012F 2013F 2014F 2015F White brand handsets (mn) MStar units MStar share (%) Figure 35: Handsets could still reach 3 of sales Sales (NT$mn) Handsets % of sales 60, ,000 75% 40, ,000 45% 20, ,000 15% F 2012F 2013F 2014F 2015F MStar sales MStar handset sales MStar % of sales We estimate each additional 1% share in smartphones or 6 mn units will drive NT$1.14 incremental EPS for MStar. Figure 36: MStar earnings sensitivity to smartphone units and pricing (NT$) 2012 Sensitivity Smartphone units and EM share Smartphone units/pricing YoY $15 1% 2% 3% 27. $6.9 $13.23 $13.64 $14.58 $15.52 $ $7.4 $13.23 $13.66 $14.67 $15.67 $ $7.9 $13.23 $13.69 $14.76 $15.83 $ $8.4 $13.23 $13.72 $14.85 $15.99 $ $8.8 $13.23 $13.75 $14.95 $16.14 $ $9.3 $13.23 $13.78 $15.04 $16.30 $ $9.8 $13.23 $13.80 $15.13 $16.46 $17.78 EM Share: 1% 3% 6% 8% Smartphone Units: 6mn = NT$1.14 EPS. Smartphone ASPs. 5% = NT$0.10 EPS Smartphone ASP (3697.TW / 3697 TT) 14

15 Settops add a growth driver MStar provides single chips, demodulators and the settop backend across standard and high definition settops for freetoair, paytv and operator businesses in cable, satellite and terrestrial. The company is a recent entrant (over the past two years) but is gaining good traction by porting its fieldtested DTV stack. The company has enabled its technology for main regional standards including DVBT, DVBS2 and ISDBT. In the first phase of the company s history, MStar was selling its HD solution into retail channels for freetoair settops with price points under US$5. In the past year, the company has been integrating conditional access security algorithms into its firmware to penetrate HD cable operators at price points in the US$1015 range. MStar now has integrated in five of the six CA vendors encryption algorithms. The company has been qualified in several China cable operators, a SouthEast Asia operator and Taiwan Broadband Corporation. The settop business is split between Broadcom and STM which have high market share at the cable vendors and emerging market suppliers, including Hi Silicon, ALi and SunPlus in addition to MStar. MStar is a new entrant, so it has a small market share in this category. The settop business is on track to almost double from NT$800 mn in 2010 to NT$1.5 bn in 2011 and we project sales to again double in 2012, modelling NT$3.4 bn in sales. The company should have an added boost by starting shipments into the cable space at higher ASPs. We factor in market share expanding to 25% of the industry by 2015, a level that would take settops to 15% of sales. MStar is growing its settop business off a low base CA settops started to ship at the end of 2Q11 at a higher ASP Figure 37: Settop market penetration emerging Settops (mn) MStar share (%) F 2012F 2013F 2014F 2015F Settop market MStar units MStar share (%) Figure 38: Settops could approach 15% of sales Sales (NT$mn) Handsets % of sales 60, ,000 75% 40, ,000 45% 20, ,000 15% F 2012F 2013F 2014F 2015F MStar sales MStar settop sales MStar % of sales (3697.TW / 3697 TT) 15

16 Solid growth and profitability outlook MStar has had mild growth and good control on its cost structure over the past few years. The company s sales growth has entered a slower growth phase with mature TVs and monitors dominating revenues until handsets and settops grow bigger. At the same time, GMs have remained in the low4 range and operating margins near 2. MStar has maintained GMs in the low4 range and operating margins near 2 since 2009 Figure 39: MStar margins have remained stable Sales (NT$mn) Margin (%) 10, , , , , Q09 2Q09 3Q09 4Q09 1Q10 2Q10 3Q10 4Q10 1Q11 2Q11 3Q11 4Q11E Sales GM % Op Margin % A, E.. The company is engaging in steady growth of its headcount to diversify into additional product areas including the engineering and supportintensive baseband category. Sales per employee have dipped from US$650,000 to US$600,000, as the company invests in new product areas, spending 15% of sales or about US$100,000 per R&D employee to grow the business. MStar has seen a slight dip in sales per headcount as it invests more in new product development Figure 40: MStar sales efficiency dipping slightly to invest in new product areas Employees Sales/opex per employee (US$) 3, ,000 3, ,000 2,500 2,000 1, , , ,000 1, , , Employees R&D Employees Sales/employee R&D / R&D employee (3697.TW / 3697 TT) 16

17 MStar s human resources concentrated in engineering. The company had 2,534 employees as of the end of 2Q11, with 66% from R&D and of that 8 with a Master s or a PhD degree. Engineers represent 66% of the company s workforce Figure 41: MStar employee mix weighs towards R&D Sales & Admin 34% College 19% Figure 42: MStar R&D engineers possess advanced degrees PhD 5% Junior College 2% R&D Staff 66% Masters 74% Source: Company data Source: Company data MStar: 3Q11 delivered upside; 4Q11 guided flat MStar s 3Q11 results had slight upside, and on 8 November, management guided for inline 4Q11 results. The company s 3Q11 sales grew 12% QoQ to NT$9.3 bn, GMs were at the highend of 4042% guidance at 42.1%, driving EPS to NT$3.06. Management has guided for inline 4Q11 results: 3% to +3% QoQ revenue growth with GM guidance remaining 4042% as lowmargin handsets should grow fasters than overall sales. 3Q11 results had slight upside; 4Q11 has been guided (8 November) for inline results Figure 43: MStar summary of CS 3Q/4Q11 and estimates 3Q11 4Q11 1Q (NT$ mn) Actual Guidance CS Street Guidance CS Street CS Street CS Street CS Street Net sales $9,327 NT$8.8$9.2bn $9,590 $9,332 NT$9.3$9.9bn $9,089 $8,905 $35,474 $35,455 $41,880 $40,929 $47,989 $47,367 Chg 11.7% % 1.6% 3% to +3% 5.2% 4.6% 5.6% 4.7% 18.1% 15.4% 14.6% 15.7% GM (%) 42.1% 4042% 41.9% 4042% 41.8% 41.9% 41.6% 41.5% R&D 1,247 1,259 1,247 4,961 5,233 5,719 SG&A % % 968 3,445 4,061 4,458 Op. M (%) 18.3% 1519% 18.6% 18.2% 1519% 17.5% % 18.5% 19.4% % 19.2% Net income 1,618 1,731 1,619 1,554 1,558 6,291 6,180 7,853 7,506 9,327 8,652 EPS (NT$) $3.06 $3.27 $3.09 $2.94 $2.96 $11.89 $11.99 $14.85 $14.26 $17.64 $16.92 P/E Multiple , Bloomberg consensus Growth in 3Q11 was led by newer product areas. We believe wireless sales grew about 3 QoQ as units grew to 14.5 mn. Settops also grew about 2 QoQ to NT$352 mn or 4% of sales as the company s conditional access HD settops began to ship into a European and Latin American cable operator. The mature business also saw seasonal growth, with LCD TV +11% QoQ while monitors were flat. Growth is being driven by the newer product segments handsets and settops (3697.TW / 3697 TT) 17

18 Figure 44: MStar unit assumptions for 3Q11/4Q11 Sales by product 3Q11 4Q11E 1Q12E 2011F 2012F NT$mn Actual New New New New Comments Handset units (mn) Market share growing off a low base Handset ASPs (US$) $2.76 $2.62 $2.55 $2.79 $2.96 ASPs up in 2012 from smartphones Wireless 1,155 1,560 1,450 4,254 7,962 Strong growth penetrating the market QoQ and YoY 29% 35% 7% 27 87% LCD TV 6,430 6,149 5,754 24,255 25,064 Unit growth is modest QoQ and YoY 11% 4% 6% 3% 3% Monitors 1,090 1, ,392 4,174 Mature units and stable share QoQ and YoY 6% 5% 17% 5% Settops ,479 3,352 Designs wins at cable operators QoQ and YoY 21% 62% 1 76% 127% Other ,094 1,328 CS Total Revenue 9,327 9,590 9,089 35,474 41,880 QoQ and YoY 12% 3% 5% 6% 18% For 4Q11, guidance is overall flat QoQ, with LCD TV and monitors down mildly and settops and handsets continuing to see solid growth off a lower base. We project handset sales rising another 35% QoQ and units rising to 20 mn units or 3% of the industry and 7% of the Asian brand share. MStar results and guidance in line with its peers MStar s sales growth in 3Q11 was 12% QoQ, near MediaTek s +11% QoQ but lagged Spreadtrum, which grew 15% QoQ due to its concentrated revenue in wireless. MStar s baseband shipments are more dependent on its own share than the market at this stage, with unit growth at 38% QoQ versus MediaTek at 21% and Spreadtrum at 19%. We believe ASPs for MStar still lag due to less 3G or smartphone business. Forward guidance was between peers at 3% to +3% QoQ versus MediaTek s 2% to +5% QoQ and Spreadtrum s +2 to +5% QoQ. MediaTek still retains 300 bp higher GMs than MStar although due to higher opex intensity it has 350 bp lower operating margins than MStar. MStar growing in line with its peers in 2H11 Figure 45: MStar 3Q11 comparisons with MediaTek and Spreadtrum (US$ mn) P&L Metrics MStar Mediatek Spreadtrum Total Sales $322.7 $808.9 $184.8 QoQ change 11.7% 11.4% 15.4% YoY change 0.9% 17.1% 92. Forward Sales (QoQ) 3% to +3% 2% to +5% +2% to +5% Gross Margin % 42.1% 45.1% 41.8% Op Margin % 18.3% 15.8% 21.4% Baseband metrics MStar Mediatek Spreadtrum Baseband Units QoQ Change 38% 21% 19% YoY Change 383% 15% 119% Baseband ASPs $2.8 $3.8 $3.3 QoQ Change 6% 4% 3% YoY Change 28% 23% 12% Baseband Revenue $40.0 $582.2 $184.8 For the period, we believe TVs and monitors will see flat to slightly down revenue streams. The growth engine will increasingly come from handsets due to the much larger size from that endmarket, with settops also driving incremental growth. (3697.TW / 3697 TT) 18

19 Figure 46: MStar sales growth led by handsets and settops through 2015E NT$mn unless noted F 2012F 2013F 2014F 2015F Feature phones (mn) ASPs (US$) $0.00 $3.62 $2.79 $2.36 $2.00 $1.71 $1.45 Smartphones (mn) ASPs (US$) $0.00 $0.00 $0.00 $8.36 $7.58 $6.68 $5.93 Handset Revenue 0 1,151 4,254 7,962 11,476 15,171 20,595 LCD TV 21,507 25,118 24,255 25,064 24,988 24,851 24,202 LCD Monitor 5,250 5,301 4,392 4,174 4,050 3,833 3,628 STB ,479 3,352 6,257 7,153 7,296 Other (GPS, RFID) 844 1,187 1,094 1,328 1, Total Revenue 27,712 33,595 35,474 41,880 47,989 52,001 56,529 GM % 42.9% 42.3% 41.9% 41.6% 41.5% 41.3% 40.9% Op M% 20.2% 20.7% 18.2% 19.4% 20.3% 19.9% 19.2% EPS $12.98 $13.40 $11.89 $14.85 $17.64 $18.67 $19.63 Strong balance sheet MStar s fabless model, strong display share and profitability have lifted its balance sheet. Figure 47: MStar balance sheet summary Balance Sheet (NT$ mn) 3Q11A 2Q11 Diff % 3 Yr Avg +/ Avg Cash and Investments 24,854 26,485 6% 18,338 6,517 Total Debt , Net Cash 23,986 25,617 6% 17,061 6,925 Net Cash/Share MStar has 25% of its market cap in cash Accts. Receivable 5,408 4,331 25% 4, Receivable Days Inventory 4,052 3,906 4% 3, Inventory Days Accounts Payable Days Cash Conversion Cycle SH Equity 30,978 27,873 11% 23,547 7,431 Book Value / Share The company exited 3Q11 with NT$24 bn net cash and investments or NT$45 cash per share (about 25% of market cap). Inventory dropped from 74 days to 68 days, below its longterm target levels. Overall cash conversion cycle was in line with history at 71 days. Figure 48: MStar historical inventory days Inventory (NT$mn) 6,000 5,000 4,000 3,000 2,000 1,000 2Q09 3Q09 4Q09 1Q10 2Q10 3Q10 4Q10 1Q11 Inventory Days Q11 3Q11 Figure 49: MStar historical accounts receivable Receivables (NT$mn) 6,000 5,000 4,000 3,000 2,000 1,000 2Q09 3Q09 4Q09 1Q10 2Q10 3Q10 4Q10 1Q11 2Q11 Receivable Days 3Q11 4Q11E Inventory Inventory Days Accounts receivable A/R DSOs (3697.TW / 3697 TT) 19

20 Free cash flow solid The company has also generated consistent positive free cash flow due to its good profitability and small requirements for capex only on buildings and engineering tools. We estimate the company will generate NT$911 bn free cash flow or NT$1620 in FCF/share over , reflecting a 1215% FCF yield. The company targets a 75% payout rate, which should also place its dividend yield at 5% in 2012 and 6% in We expect the company to also use its balance sheet to invest in additional IP and design teams and support the share price with buybacks. Free cashtoenterprise value is 1215% from 2010 to 2012E allowing a solid 6% dividend yield Figure 50: MStar generates solid positive FCF: A 1315% FCF yield Annual (NT$mn) CY07 CY08 CY09 CY10E CY11E CY12E CY13E CY0713E Avg Revenue 12,563 15,177 27,712 33,594 35,474 41,880 47,989 24,904 Capital spending , Capex/Revenue (%) 2.3% 4.5% % 0.7% % Dep and amort ,077 1,291 1,282 1, Depr/Revenue (%) 3% 4% 3% 3% 4% 3% 3% 3.5% Operating cash flow 3,220 3,310 7,662 5,196 8,905 8,178 10,257 5,659 Free cash flow 3,504 3,991 8,775 5,352 9,142 8,597 10,737 6,153 FCF and Dividend Yields CY07 CY08 CY09 CY10E CY11E CY12E CY13E CY0713E Avg FCF / Share (NT$) FCF Yield (%) FCF / EV (%) Dividend per share (NT$) PreDividend close (NT$) Dividend Yield (%) 1.6% 6.8% % 4.9% (3697.TW / 3697 TT) 20

21 Valuation remains reasonable We initiate coverage on MStar with an OUTPERFORM rating and NT$223 target price, based on 15x 2012E EPS of NT$14.85, in line with its Asian and overseas peer average. We believe MStar is an attractive investment due to its potential upside to grow handsets and settops, stable and profitable margin profile and cash flow and valuation support. Initiate with an OUTPERFORM and a NT$223 target price Figure 51: MStar valuation versus its Taiwanese peers Stock prices in local currency (NT$/US$) Price Mkt Cap EV/Sales (x) P/E Multiple (x) P/B Multiple (x) Company Ticker 11/16/2011 (US$mn) Select Asian fabless semiconductors MStar 3697.TW 175 3, MediaTek 2454.TW , Spreadtrum SPRD , n.a Realtek 2379.TW Median Mean Highgrowth semiconductors Broadcom BRCM , Marvell MRVL , Silicon Labs SLAB , Median Mean CS HOLT arrives at an even higher valuation We use CS HOLT, a CS valuation tool that derives the stock price based on a company s cash flow return on investment (CFROI ) and asset growth. The default setting, which fades away high return companies longterm towards an average return warrants a NT$186 stock price based on consensus EPS and NT$293 based on IBES sales and EBITDA expectations. Based on our modelled sales growth, EBITDA and investment plans through 2015E, CS HOLT yields a valuation of US$238. See figure 52. Figure 52: CS HOLT valuation supports further upside for MStar to NT$238 Semiconductors Price: (Novem ber 11, 2011) Market Cap : TWD Warranted P ri ce : TWD (35%) CS HOLT suggests a slightly higher valuation of US$238, based on our growth and profitability assumptions Source: Company data, Credit Suisse HOLT (3697.TW / 3697 TT) 21