Semiconductor. The Big Cycle has begun. Overweight (Maintain) 2H13 Outlook. Anchor theme: Memory market entering Big Cycle on mobile demand growth

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1 The Big Cycle has begun Overweight (Maintain) 2H13 Outlook May 21, 213 Daewoo Securities Co., Ltd. James Song Joon-ho Jang Anchor theme: Memory market entering Big Cycle on mobile demand growth We believe the global semiconductor industry is entering a Big Cycle, in which capacity reductions will lead to a more favorable mobile supply/demand situation. We continue to maintain an aggressively Overweight position on the sector for 2H. The first half of 213 has been characterized by two major trends: 1) global memory chip makers capex and capacity discipline and 2) portfolio shifts from PC to mobile. The price of PC DRAM rose sharply in 1H, and the market s supply and demand conditions are expected to remain stable in 2H. Memory chip makers still remain conservative on capacity expansion and are continuing to increase the contribution of mobile DRAM to product mix. They are also working to bolster mobile solutions (LPDDR3 and solid-state drives (SSD)) and enhance cost efficiency (by shifting to 2nm-class DRAM). Recently, we have been seeing a dramatic increase in mobile DRAM content from 1GB to 2GB, and a number of smart devices adopting 3GB mobile DRAM are set to be released in 2H. The sharp expansion in memory content is likely to lead to a tighter mobile DRAM market in 2H. While memory chip suppliers are increasingly expanding their proportion of mobile DRAM production, we still believe supply will not be able to keep pace with growing demand. 2H top picks: SEC, SK Hynix, Eugene Technology, and Nepes Samsung Electronics (SEC; 593 KS/Buy/Maintain TP of W2,1,): We expect SEC to continue to deliver record-breaking earnings in 2Q and beyond, on the back of its growing dominance in the smartphone market. We anticipate the company will display the highest earnings among global IT stocks. SK Hynix (66 KS/Buy/Raise TP to W42,): SK Hynix should benefit from rising PC and server DRAM prices and growing shipments of mobile DRAM. We think the firm has the strongest earnings growth potential among large Korean IT stocks for 2Q and the following quarters. Eugene Technology (8437 KQ/Buy/Maintain TP of W28,): We expect memory chip makers capex to pick up in 2H. Eugene Technology stands to benefit from memory technology migration and is expected to diversify its client portfolio into non-memory makers. Nepes (3364 KQ/Buy/Maintain TP of W24,): A supplier of wafer packaging solutions for SEC s mobile application processors, Nepes is likely to gain meaningful earnings momentum from 2Q. We also project rapid earnings growth at its touch-panel subsidiary Nepes Display. 2H13 investment strategy: Memory market entering a Big Cycle Industry restructuring Growth of mobile devices Conservative capex Delays to tech migration Big cycle has begun in 213 Rapid growth of DRAM content Surge in SSD demand Source: Analysts who prepared this report are registered as research analysts in Korea but not in any other jurisdiction, including the U.S.

2 C O N T E N T S I. 2H investment strategy 3 [Big picture 1] Mobile revolution drives global memory chip market 3 [Big picture 2] SEC is bigger than Nokia in its heyday 4 [Big picture 3] Pillar of growth: The Google-SEC Qualcomm alliance 5 [Investment strategy 1] Undervalued stock with top-tier earnings 6 [Investment strategy 2] SEC and SK Hynix, beneficiaries of mobile DRAM growth 7 [Investment strategy 3] equipment: Beneficiaries of SEC s capex expansion 8 II. Memory market outlook 1 [PC DRAM price surge] Reasons for surge and 2H outlook 1 [Mobile DRAM market] Memory content of chips is surging 11 [Mobile DRAM supply and demand] SEC to display differentiated performance 12 [NAND demand] SSD demand growth is picking up 15 Reasons behind NAND supply increase: Capacity expansion and 3-bit MLC 16 III. Mobile AP industry trends, issues, and outlook 19 [SEC] Reasons behind the delayed adoption of Exynos 5 in the Galaxy S4 19 [Qualcomm s advance] Strong demand for Snapdragon 8 likely in 2H and beyond 2 [TSMC s growth] TSMC strengthening its foundry market dominance 21 [Outlook for SEC] 14nm FinFET technology to be a breakthrough in IV. Issue analysis Next-generation innovation 24 Wearable computing to become the next innovation 24 History and development of wearable computing 25 Smart glasses are already within sight 26 Medium- to long-term growth outlook for wearable computing 28 Samsung Electronics (593 KS) 29 SK Hynix (66 KS) 36 Eugene Technology (8437 KQ) 41 Nepes (3364 KQ) 45 2

3 May 21, 213 I. 2H investment strategy [Big picture 1] Mobile revolution drives global memory chip market In 213, we expect the global smartphone market to expand at least 32%, to W9mn units. Despite this healthy growth, the smartphone industry has further upside potential, given the overall size of the global handset market (1.7bn mobile phones). Thus, although concerns are mounting over a potential growth slowdown and the commoditization of smartphones, we believe that growth will remain intact until smartphone penetration reaches 7% (or 1.2bn units) globally. Meanwhile, PC demand is plunging as the global IT industry continues to shift toward mobile devices. Shipments contracted 14% YoY to 73mn units in 1Q, and, on a full-year basis, even if demand picks up in 2H, shipments are forecast at only 31mn PCs (-8.7% YoY). The mobile revolution has changed the landscape of the IT industry. 1) The memory chip market has undergone restructuring (Elpida s bankruptcy and Powerchip s exit from the DRAM business), 2) memory chip makers have turned conservative on capex expansion, and 3) product mix has changed drastically as mobile DRAM demand has surged. The proactive strategies of memory chip makers in response to rapidly changing demand have caused memory prices to fluctuate widely. Indeed, production cuts at the PC DRAM segment (to meet rising demand for mobile DRAM and NAND) sent PC DRAM prices soaring in 1H. Eventually, however, we expect mobile memory chips to become the main staple of the memory industry. Figure 1. Global memory market cycle [Restructuring] - ElpidaÊs bankruptcy - PowerchipÊs exit Server DRAM price increases SSD Demand surges [Conservative capex] - Limited expansion - NAND capacity growth (medium-/long-term) Mobile DRAM content expands [Demand] - Steady growth of mobile devices - Rapid growth of mobile DRAM content PC DRAM price soars [Supply] - Shift from PC to mobile DRAM - Delays to tech migration Source: 3

4 May 21, 213 [Big picture 2] SEC is bigger than Nokia in its heyday In 1H13, SEC s global smartphone market power strengthened further. The company is forecast to ship 8mn smartphones (vs. Apple s 3mn) in 2Q, grabbing 4% of the global market. For the full year, smartphone shipments are forecast at 33mn units for SEC and 16mn units for Apple. SEC seems unbeatable now, at least in terms of shipments. SEC in 213 is reminiscent of Nokia in its prime in the early 2s. However, we believe that SEC s dominance will be much larger in scope than Nokia s. Nokia s dominance was only felt in the handset industry, while that of SEC will be much more far-reaching thanks to its strong vertical integration. Indeed, SEC s market power is growing not only in smartphones, but also in smartphone parts, including mobile DRAM, NAND, AP, AMOLED, and rechargeable batteries. The company has far outgrown Apple in its influence in the demand and supply of major parts. In 2H, smartphone parts makers are anticipated to continue to report healthy earnings. We advise investors to pay special attention to parts in that are in short supply (to satisfy SEC s demand), such as mobile DRAM and camera modules. Figure 2. SEC expands market share: M/S to reach 4% in 214 (mn units) Smartphone shipments (L) (%) 1,5 SEC's M/S (R) Apple's M/S (R) SEC's smartphone market share to reach 4% in 214 1,1 1, , F 14F 15F Source: IDC, Gartner, Table 1. SEC s major supply chain Source: Company data, Parts Components Firms Domestic Overseas AP SEC (593 ) Qualcomm (QCOM) Baseband SEC (593) Qualcomm (QCOM) DRAM/NAND SEC (593) Display Panel Samsung Display On-cell touch Samsung Display Battery Li-Ion battery Samsung SDI (64) Substrate PCB SEMCO (915) Daeduck Electronics (86) Korea Circuit (781) FPCB Interflex (5137) Flexcom (6527) BH (946) Daeduck GDS (413) FC-CSP SEMCO (915) Camera Camera module SEC (593) SEMCO (915) Partron (917) 4

5 May 21, 213 [Big picture 3] Pillar of growth: The Google-SEC Qualcomm alliance Apple ushered in the mobile revolution with the iphone in 27, but the alliance of SEC (Galaxy) and Google (Android) seems to be taking over leadership. SEC s market share is nearing 4%, and Google s Android platform has gained a 65% share in the smartphone OS market. This is not the first time that Apple has failed to hold onto a lead. Back in 1976, Apple ushered in the PC era, but soon gave way to IBM and Microsoft in the 198s. In the mobile era, Apple created a new ecosystem, based on itunes, in an effort to avoid a repeat of history. However, it is still holding fast to a closed strategy for its hardware and software, as it did for PCs, while its rivals again promote open architecture. After the end-198s, the Wintel alliance (Microsoft s Windows and Intel s CPUs/IBM s computers) rode the wave of explosive PC demand growth. Intel started its business as a microprocessor supplier to IBM, but later became the standard of the CPU market, and enjoyed its golden days after the 199s with its Pentium processors. We note that the Microsoft IBM Intel alliance structure is similar to the current Google SEC Qualcomm alliance. SEC and Google are sharing the fruits of growth now, but they may eventually go their separate ways in the future, just as Microsoft and IBM did. The difference is that unlike IBM, SEC produces mobile APs on its own, which is positive, but the company will still need to gain dominance over Qualcomm to prolong its mobile revenue growth. Figure 3. The first PC by Apple - AppleI Figure 4. Relative share prices of Apple, MS, Intel, IBM,and HP (1/9=1) 1, 9, Windows 95 Windows 2 iphone 3GS 8, 7, 6, 5, 4, 3, 2, 1, Apple MS Intel IBM HP Source: World Wide Web Source: Bloomberg, Figure 5. The first smartphone by Apple - iphone Figure 6. Relative share prices of Apple, Google, SEC, and Qualcomm (-1Y=1) Apple Google SEC Qualcomm /12 7/12 9/12 11/12 1/13 3/13 5/13 Source: World Wide Web Source: Bloomberg, 5

6 May 21, 213 [Investment strategy 1] Undervalued stock with top-tier earnings SEC s shares are stagnating at around W1.5mn, as foreign investors continue to reduce their positions in the Korean market (including SEC). 1) The KOSPI seems increasingly less attractive these days, with geopolitical risks rising in the Korean peninsula. In addition, soaring Japanese stocks on yen depreciation may also have contributed to sluggish demand for Korean stocks. Toyota s shares have reported an impressive 8% rise recently. 2) Concerns over smartphone commoditization, and the resultant deterioration of margins, are weighing heavily on SEC s shares. Indeed, investors are voicing concerns that SEC s growth may decelerate, citing Apple s slowing growth. Smartphone margins are set to fall when competition from Chinese smartphone makers increases in earnest, and SEC s reliance on the smartphone segment, currently at 75% of its total operating profit, seems too high. Thus, earnings growth is anticipated to peak out after 2Q-3Q. Moreover, SEC s latest model, the Galaxy S4, failed to live up to expectations. Nonetheless, we believe that these worries may dissipate due to the following: 1) Yen depreciation is behind the robust rise of Japanese stocks. Since some blue-chip stocks now seem expensive, foreign investors will quickly realize their gains if the US$/JPY rate shows the slightest sign of decline. In this case, foreign investors may turn their eyes to other Asian markets, including Korea. 2) As concerns over growth deceleration, commoditization, and margin deterioration seem largely legitimate, the only way for SEC to assuage investors concerns will be delivering better-thanexpected smartphone sales and earnings growth, and gaining market share. If the company s operating profit exceeds W1tr in 2Q, it will match the levels of top-tier global tech firms. The company s stock, trading at a 213F P/B of 1.7x and a P/E of 8x, seems undervalued. Once sales of the Galaxy S4 pick up full swing in the early 3Q, earnings momentum will likely re-emerge. Figure 7. JPY/USD F/X rate and major Japanese IT players share prices Figure 8. SEC s quarterly OP and share price (JPY/USD) (1/1/1=1) 13 JPY/USD F/X rate (L) 27 Sony (R) Sharp (R) 24 Toshiba (R) Hitachi (R) (Wtr) SEC's quarterly OP (L) SEC's share price (R) (Wmn) F -.1 Source: Bloomberg, Source: Company data, 6

7 May 21, 213 [Investment strategy 2] SEC and SK Hynix, beneficiaries of mobile DRAM growth Memory content grew steadily during the PC period, but as smartphones started to replace PCs, mobile DRAM content growth has picked up speed. Indeed, smartphones mobile DRAM content doubled to 2GB in 2Q in just one year. At this pace, the mobile DRAM content of high-end smartphones is forecast to nearly double (3-4GB) in 1H14 (and mobile DRAM is expected to jump from 2GB to 3.5GB). This pace of growth is unprecedented, especially compared to growth in the PC market. Thus, the existing demand/supply management mechanism is very likely to result in supply shortages for mobile component makers (demand surge supply shortage supply increase demand/supply balance). SEC has secured a 4% share in smartphones and 6% in mobile DRAM globally. If demand for 2GB mobile DRAM picks up quickly after 2Q, supply should tighten further, which should benefit SEC and SK Hynix. Figure 9. Increase in mobile DRAM content (GB/system) (bn GB) 2.5 Mobile DRAM adoption in smartphones (L) Mobile DRAM demand from smartphones (R) Mobile DRAM adoption to increase rapidly F 14F 15F. Source: IDC, Gartner, Figure 1. SK Hynix s quarterly OP and share price (Wbn) Quarterly OP (L) 1,2 SK Hynix's share price (R) (W') , F Source: Company data, 7

8 May 21, 213 [Investment strategy 3] equipment: Beneficiaries of SEC s capex expansion In its 1Q earnings conference call, SEC guided flat capex YoY in 213 and suggested more intensive spending in 2H. In 1Q, the firm spent W3.9tr on capex, including W1.5tr on semiconductor and W1.5tr on display panels. We forecast 213 full-year capex at around W23.7tr, with W13tr going to semiconductor (W7tr on memory and W6tr on non-memory) and W8tr to display panels (W6tr on AMOLED). We raised our forecast for SEC s semiconductor capex. The company resumed the construction of its S3 line in Hwaseong. In addition, it is likely to place equipment orders for its new NAND line in Xian. For the S3 line, the company is expected to make investments in the 14nm FinFET process, while investments in 3D V-NAND are anticipated at the Chinese NAND line. In 212, equipment companies share prices plunged despite a sharp growth in earnings. The absence of orders in 2H, in contrast to strong orders in 1H, appears to have depressed share prices. This year, however, the shares of semiconductor equipment companies have risen sharply from the 2H12 levels, without a surge in earnings, on expectations for accelerating order growth into 2H13. We expect the shares of equipment companies, namely Eugene Technology, to increase steadily on the back of semiconductor companies continuous investments toward setting up processes at new production lines. Table 2. SEC s capex trends and forecasts by division (Wbn, %) F Total (Wbn) Semi DP IM CE (%) Semi. 75% 56% 56% 62% 46% 66% 55% DP 15% 34% 29% 3% 4% 22% 34% IM 2% 2% 3% 2% 3% 3% 3% CE 8% 8% 12% 5% 11% 9% 8% YoY growth Total Semi DP IM CE Source: Company data, estimates Figure 11. SEC s capex by division (Wtr) 3 Total capex 25 DP IM CE F Source: Company data, estimates 8

9 May 21, 213 Table 3. Global semiconductor players valuations (Wbn, %, x) Market Revenue OP OP margin NP P/E P/B ROE cap 13F 14F 13F 14F 13F 14F 13F 14F 13F 14F 13F 14F 13F 14F SEC 22,57 238,1 285,594 41,9 46, ,433 39, SK Hynix 21,311 14,136 15,192 2,96 3, ,456 2, Qualcomm 128,724 27,365 3,558 9,634 1, ,941 9, Intel 133,658 6,48 62,6 14,24 15, ,868 11, TSMC 11,418 22,59 26,126 8,15 9, ,998 7, Micron 13,3 9,643 11, , Nanya 4,924 1,6 1, Inotera 2,141 1,815 1, Toshiba 25,198 68,778 71,178 3,633 4, ,738 1, SanDisk 16,35 6,47 7,91 1,567 1, ,93 1, ASML 36,546 6,995 8,971 1,56 2, ,372 2, AMAT 2,79 8,714 1,638 1,11 2, , TEL 11,39 6,84 6, Advantest 3,884 1,672 1, Average Source: Bloomberg, Table 4. Global display players valuations (Wbn, %, x) Market Revenues OP OP margin NP P/E P/B ROE cap 13F 14F 13F 14F 13F 14F 13F 13F 14F 13F 14F 13F 14F LG Display 1,949 3,137 31,275 1, AUO 4,826 15,681 16, CMI 6,886 19,339 19, Sharp 7,86 28,219 28, Average LG Electronics 13,877 59,746 63,955 1,741 2, , Samsung SDI 5,854 5,687 6, Panasonic 24,74 8,314 8,381 2,659 3, , Pioneer 989 5,88 5, Sony 23,871 78,51 79,48 2,314 2, Hitachi 41,451 1,194 11,21 5,723 6, ,68 3, Average Source: Bloomberg, Table 5. Global handset players valuations (Wbn, %, x) Market Revenues OP OP margin NP P/E P/B ROE cap 13F 14F 13F 14F 13F 14F 13F 13F 14F 13F 14F 13F 14F SEC 22,57 238,1 285,594 41,9 46, ,433 39, LGE 13,877 59,746 63,955 1,741 2, , Apple 454,85 191,556 29,744 54,552 59, ,664 44, Nokia 15,828 38,751 39, , HTC 9,296 1,15 11, RIM - 15,77 14, Average Source: Bloomberg, 9

10 May 21, 213 II. Memory market outlook [PC DRAM price surge] Reasons for surge and 2H outlook In 1H13, PC DRAM prices rose more than expected. PC DRAM contract prices that stood at just US$.83 in end-december jumped 8% to US$1.5 in end-april. Why did DRAM prices surge despite a sharp contraction in PC demand in 1H? To answer this question, we should take a closer look at supply and demand dynamics. In 1Q13, global PC demand shrank 14% YoY. However, the proportion of PC DRAM production at global DRAM makers averaged 25% in 1Q with monthly PC DRAM capacity standing at just 27, wafers/month. The decrease in PC DRAM supply sharply outpaced the decrease in demand, leading to a surge in PC DRAM prices. In 2H, PC DRAM prices are projected to rise further to US$ , and stabilize at US$1.5 at end Major module producers, including Kingston, have purchased PC DRAM at US$.8; thus, they should be able to realize profits at prices over US$1.5. However, the volume of their selling is unlikely to be large enough to push down prices sharply. The current PC DRAM cycle is different from past cycles in two ways. First, major DRAM producers, namely SEC, are anticipated to expand the proportion of mobile DRAM production going forward. Second, Taiwanese second-tier DRAM makers such as Powerchip, have withdrawn from the DRAM market after selling their fabs to non-memory makers. Accordingly, we believe a steady decrease in supply will prop up PC DRAM prices going forward. Figure 12. PC DRAM price (US$) DDR3 2Gb spot price DDR3 2Gb contract price Quarterly avg. contract price KDB Daewoo forecast Elpida bankruptcy 1/11 7/11 1/12 7/12 1/13 7/13 1/14 1/14 Source: DRAMeXchange, estimates Major DRAM players' expansion of mobile DRAM production 1

11 May 21, 213 [Mobile DRAM market] Memory content of chips is surging Recent key trends in the mobile DRAM market include: 1) a marked increase in memory content per mobile device (1GB 2GB), and 2) a change in companies flagship products (LPDDR2 LPDDR3). In particular, an increase in memory content is expected to give a big boost to the mobile DRAM market. Assuming that 36mn smartphones (4% of the smartphones to be produced this year) use 2GB mobile DRAM, annual demand from 2GB DRAM-use smartphones should reach 72mn GB (2GB x 36mn). This forecast is 167% greater than the total mobile DRAM content of high-end smartphones (27mn units; 4% of full-year smartphone production in 212) last year. The projected demand is close to last year s total smartphone-use mobile DRAM demand of 79mn GB. This year, total mobile DRAM demand is estimated at 1.59bn GB, including smartphone-use DRAM demand of 1.1bn GB, growing 1% from last year. Meanwhile, the entire DRAM market s bit growth is projected at just 3%. As smartphones use of 2GB mobile DRAM is anticipated to pick up after 2Q, mobile DRAM supply is likely to become tight during 2Q-3Q13. Figure 13. Global smartphone shipments and mobile DRAM content (mn units) 1,5 1,2 Smartphone shipments (L) Mobile DRAM content in smartphones (R) 1,1 (GB/system) 3. 1, Smartphone shipments and mobile DRAM content to continue rising F 14F 15F Source: IDC, Gartner, estimates Figure 14. Global mobile DRAM demand; % of total DRAM demand (1Gb eq. bn units) (%) 4 Mobile DRAM demand (L) 6 % of total DRAM demand (R) F 14F 15F 2 1 Source: IDC, Gartner, estimates 11

12 May 21, 213 [Mobile DRAM supply and demand] SEC to display differentiated performance SEC is anticipated to display differentiated performance this year due to the transition from LPDDR2 to LPDDR3. Currently, SEC is the only company that mass-produces 2GB LPDDR3, although SK Hynix and Elpida are also expected to commence LPDDR3 production in the near term. If all high-end smartphones were to use LPDDR3 this year, LPDDR3 would account for 45% (.5 bn GB/1.59bn GB) of total mobile DRAM demand. And, if SEC claims 6% of the global mobile DRAM market, the company would have difficulty meeting rapid LPDDR3 demand growth. In that case, some high-end smartphones would have to be equipped with 2GB LPDDR2. If SEC focuses on LPDDR3 production, the company will not be capable of meeting demand for LPDDR2. Thus, the company should have to increase outsourcing for LPDDR2. Recently, Elpida received mobile DRAM orders from SEC. If smartphones use of 2GB memory increases faster than expected in 2H, the mobile DRAM market should face supply shortages in the short term. If a supply shortage occurs, Apple might have difficulties in securing mobile DRAM due to its weakened market dominance. Figure 15. LPDDR2 vs. LPDDR3 Source: JEDEC Figure 16. Low-power consumption DRAM (LPDDR3, DDR3L) prices Figure 17. Global mobile DRAM M/S breakdown (1Q13) Other:.3% Elpida: 22.6% SEC: 54.1% SK Hynix: 2.5% Micron: 2.5% Source: isuppli Source: IDC, Gartner, estimates 12

13 May 21, 213 Figure 18. Annual DRAM demand and supply bit growth (%) DRAM demand bit growth DRAM supply bit growth F 14F Source: IDC, Gartner, estimates Figure 19. DRAM market supply/demand (1Gb eq.bn units) 1. DRAM demand (L) DRAM supply (L) Oversupply (R) (%) F -1 Source: IDC, Gartner, estimates Figure 2. Mobile DRAM market supply/demand (1Gb eq. bn units) (%) Mobile DRAM demand (L) Mobile DRAM supply (L) Oversupply (R) Possibility of mobile DRAM shortage from 2H F -1 Source: IDC, Gartner, estimates 13

14 May 21, 213 Table 6. Global DRAM supply/demand metrics 1Q12 2Q12 3Q12 4Q12 1Q13 2Q13F 3Q13F 4Q13F F 14F Supply/demand (%) DRAM demand (1Gb eq. mn) 5,945 6,142 6,65 6,952 7,64 8,151 8,741 9,123 2,614 25,645 33,619 43,192 QoQ/YoY growth (%) DRAM supply (1Gb eq. mn) 5,916 6,321 6,53 7,34 7,146 7,87 8,423 8,877 21,28 26,16 32,254 4,831 QoQ/YoY growth (%) ASP (US$) QoQ/YoY growth (%) Revenue (US$bn) QoQ/YoY growth (%) DRAM demand by application (1Gb eq. mn) PC 2,998 3,34 3,217 3,295 2,864 3,28 3,226 3,438 11,348 12,544 12,556 12,853 Server ,34 1,85 3,8 3,778 3,954 4,745 Module ,44 1,657 1,458 1,64 Mobile 1,126 1,352 1,667 2,187 2,336 2,775 3,47 4,125 3,178 6,332 12,76 21,771 Consumer ,41 1,584 1,745 1,919 Other ,2 3 DRAM demand proportion by application (%) PC Server Module Mobile Consumer Other DRAM supply by players (1Gb eq. mn) SEC 2,28 2,189 2,298 2,47 2,347 2,487 2,818 2,971 8,111 8,986 1,623 13,598 SK Hynix 1,816 1,943 1,846 2,363 2,433 2,798 2,91 2,998 5,285 7,967 11,14 14,482 Micron ,12 1,92 2,289 3,126 3,916 4,856 Elpida 1,2 1,83 1,169 1,216 1,216 1,313 1,418 1,532 3,714 4,47 5,479 6,794 Powerchip Nanya ,12 Bit growth (%) SEC SK Hynix Micron Elpida Powerchip Nanya Source: estimates 14

15 May 21, 213 [NAND demand] SSD demand growth is picking up This year, demand for embedded NAND chips continues to account for a large portion (45%) of total NAND demand. Unlike mobile DRAM, however, growth in embedded NAND content per device is expected to be limited, as 16GB or 32GB of flash memory is sufficient for general smartphone usage. Mobile device sales are anticipated to grow 41% YoY to 1.1bn units (9mn for smartphones and 2mn for tablet PCs), and growth in embedded NAND demand is projected to slightly outpace mobile device sales growth to reach 45%. The SSD market should have a significant impact on NAND demand growth this year. SSD prices have already fallen to the point at which explosive demand growth could be triggered (below US$1 per GB). As a result, demand growth has been picking up recently. Currently, some Samsung 25GB 84 Series SSDs are selling at less than US$2 at Amazon.com. We take notice of SSDs for their high memory content. Assuming that 3% of 2mn notebook PCs that are produced annually use 128GB SSDs, NAND demand from SSDs should reach 7.7bn GB, which is similar to the NAND demand of 32mn smartphones (38% of this year s smartphone demand) using 24GB. Recently, SEC began to roll out 128Gb 3-bit multi-level cells (MLC) using 16nm-process technology. The production of 128Gb chips should boost SEC s price competitiveness and efficiency in high-capacity SSD production, as 128GB SSDs require just eight 128Gb chips (vs Gb chips previously). In addition, Samsung's 128Gb NAND flash (based on the toggle DDR 2. interface) raised the speed of data transfer to 4Mbps. Accordingly, SEC is expected to maintain its leadership in the SSD market (current market share estimated at 4%) for a protracted period of time. Figure 21. NAND demand from notebooks (1Gb eq, bn units) NAND demand from SSD notebooks (L) % of demand from SSD notebooks (R) Decrease in SSD prices will rapidly increase adoption Source: IDC, Gartner, estimates F 14F 15F (%) Figure 22. SSD-use NAND demand (1GB eq, bn units) (%) 6 SSD-use NAND demand (L) 4 % of SSD-use demand in total NAND demand (R) F 14F 15F Source: IDC, Gartner, estimates Figure 23. SSD price trends on Amazon.com Figure 24. SEC s SSD 84 vs. HDD (seconds) (seconds) Boot PC Open DWG file Copy one movie file Open PSD file Boot PC Open DWG file Copy one movie file Open PSD file (Windows 7 SP1 x64) (31MB) with AutoCAD (3.83GB) (418MB) with Photoshop (Windows 7 SP1 x64) (31MB) with AutoCAD (3.83GB) (418MB) with Photoshop Source: Amazon.com Source: Company data 15

16 May 21, 213 Reasons behind NAND supply increase: Capacity expansion and 3-bit MLC The NAND market is less likely to experience supply shortages than the mobile DRAM market, as: 1) NAND capacity will likely increase as opposed to DRAM capacity. SEC plans to operate a new NAND line in Xian, China, in 1H14, and Toshiba could expand the capacity of its Fab 5. Furthermore, Micron plans to switch the DRAM capacity of its Singapore fab to NAND capacity. On a positive note, however, major memory makers that had gone through sharp price declines due to their heavy dependence on demand from Apple have become more cautious about capacity expansion. 2) Productivity should climb. In particular, SEC has been displaying higher-than-expected bit growth thanks to an increase in 3-bit MLC NAND flash production. Given its NAND shipment growth in 1H, we expect SEC to record NAND bit growth of more than 6% this year. Since SEC s global NAND market share stands at 4-45%, global NAND supply bit growth will likely exceed 5% (vs. the previous forecast of 45%) this year, even if other NAND makers, including Toshiba, exhibit only mid-4% NAND bit growth. Figure 25. Global NAND capacity and growth (12" eq. wafers/month) 1.5 Global NAND capacity (L) Growth rate (YoY, R) (%) Gradual increase expected from 1H F -2 Source: IDC, Gartner, estimates Figure 26. SEC s Annual NAND bit growth and ASP (%) SEC's annual NAND bit growth (L) SEC's annual NAND ASP growth rate (R) (%) F 14F -7 Source: Company data, estimates 16

17 May 21, 213 Figure 27. Annual NAND demand and supply bit growth (%) NAND demand bit growth NAND supply bit growth F 14F Source: IDC, Gartner, estimates Figure 28. NAND market supply/demand (16Gb eq. bn units) 8 NAND supply (L) NAND demand (L) Oversupply (R) (%) 15 6 NAND supply/demand to remain in balance F -1 Source: IDC, Gartner, estimates Figure 29. NAND 64Gb MLC price (US$) NAND 64Gb MLC spot price NAND 64Gb MLC contract price Quarterly avg. contract price KDB Daewoo forecast 2 SEC reduced capacity; Toshiba cut prouduction (by 3%) 1/11 7/11 1/12 7/12 1/13 7/13 1/14 Source: DRAMeXchange, estimates 17

18 May 21, 213 Table 7. Global NAND supply/demand 1Q12 2Q12 3Q12 4Q12 1Q13 2Q13F 3Q13F 4Q13F F 214F Supply/demand (%) NAND demand (1GB eq. mn) 5,77 6,476 7,713 9,623 1,88 1,774 12,466 13,58 18,34 29,582 46,97 75,379 QoQ/YoY growth (%) NAND supply (1GB eq. mn) 5,922 6,943 7,568 8,961 9,452 11,86 12,29 12,851 18,84 29,394 45,418 72,157 QoQ/YoY growth (%) ASP (US$) QoQ/YoY growth (%) Revenue (US$bn) QoQ/YoY growth (%) NAND demand by application (1GB eq. mn) Handset 2,986 3,229 3,982 4,996 5,51 5,254 6,145 7,61 8,994 15,194 23,51 36,865 SSD ,176 1,731 2,257 2,496 3,186 3,55 2,77 4,6 11,489 23,715 Tablet ,225 1,176 1,44 1,62 1,68 1,441 3,27 5,916 8,4 Memory card ,8 1,3 1,2 Digital camera ,688 1,826 1,656 1,6 MP ,472 1,525 1,596 1,8 USB ,369 1,55 1,71 1,6 Other NAND demand proportion by application (%) Handset SSD Tablet Memory card Digital camera MP USB Others NAND supply by player (1GB eq. mn) SEC 1,94 2,551 2,832 3,398 3,772 4,283 4,537 4,84 7,233 1,684 17,396 27,833 Toshiba + SanDisk 2,211 2,41 2,53 3,11 2,981 3,747 4,32 4,217 6,553 1,161 14,976 23,213 Micron (IMFT) 1,57 1,174 1,362 1,566 1,722 1,877 2,159 2,483 2,64 5,159 8,242 13,599 SK Hynix ,54 1,151 1,222 2,39 2,991 4,34 6,887 Bit growth (%) SEC Toshiba + SanDisk Micron (IMFT) SK Hynix Source: estimates 18

19 May 21, 213 III. Mobile AP industry trends, issues, and outlook [SEC] Reasons behind the delayed adoption of Exynos 5 in the Galaxy S4 Early this year, SEC launched an Exynos 5 octa-core processor and started to adopt it in its Galaxy S4 smartphone. Recently, however, the Korean titan is adopting Qualcomm s Snapdragon 6 for 9% of its Galaxy S4 devices. We believe it is important for investors to understand the reasons behind this shift. First, let us take a look at the Exynos 5. This octa-core processor is based on ARM s big.little architecture, combining four A15 cores which enable high performance (big) and four A7 cores which consume less power (LITTLE). If this technology operates efficiently, it could lead to both higher performance and lower power consumption. The problem lies in the fact that the big.little technology is still in its early stages of development. The developmental stages of this technology are: 1) cluster migration 2) CPU (core) migration 3) multi-processing. The Exynos 5 is based on cluster migration, which drives four cores simultaneously, making a reduction in power consumption unlikely. Since cores are recognized and operated at the OS/kernel, octa-core processor technology is unlikely to improve until Key Lime Pie, the next version of Android OS, is released. Figure 3. Octa-core technology: Cluster migration CPU migration Multi-processing Source: Company data Figure 31. Exynos 5 s cluster migration: 4 cores operate simultaneously Figure 32. First stage of octa-core technology: Cluster migration Source: ARM Source: Industry data 19

20 May 21, 213 [Qualcomm s advance] Strong demand for Snapdragon 8 likely in 2H and beyond SEC and Apple use separate application processors (AP) and baseband processors (BP) in their smartphone models (vs. one-chip solutions). Qualcomm s Snapdragon and TI s OMAP were adopted mostly in low-end smartphones, as their performance was weaker than SEC s Exynos and Apple s AP. In 2H12, Qualcomm released Snapdragon S4 (MSM896), which integrates APs and BPs. The Snapdragon S4 displayed improved performance thanks to its adoption of Krait CPU technology and created strong demand in the low-end smartphone market, leading to supply shortages at TSMC s foundries. In 1H13, Qualcomm rolled out the Snapdragon 6 (which does not include a BP), throwing down the gauntlet to SEC and Apple in the two-chip solution market. The Snapdragon 6 features a Krait 3 CPU running at up to 1.9GHz, and an Adreno 32 GPU with up to four times the performance of the Adreno 225. At present, the Galaxy S4 smartphones sold overseas mostly adopt Qualcomm s Snapdragon 6 for AP and MDM9215M or 9615M for BP. Qualcomm plans to start the commercial production of the Snapdragon 8 in end-may. The Snapdragon 8, an integrated chip that supports LTE-A technology (as opposed to the 6 model), features Krait 4 CPU technology running up to 2.3Ghz and an Adreno 33 GPU (supporting 4K resolution). Qualcomm highlights the fact that the Snapdragon 8 is 4% faster than the 6 model. We believe that the Snapdragon 8 will be highly marketable in 2H and beyond. Table 8. Comparison of Qualcomm s and SEC s major APs Snapdragon 8 Snapdragon 6 Exynos 541 Process TSMC 28nm HPM (HKMG) TSMC 28nm LP (SiON) SEC 28nm HKMG CPU Krait 4 core (Quad-core/ max 2.3 GHz) Krait 3 core (Quad-core/ Max 1.9GHz) Cortex-A7 1.2GHz (Quad-core) Cortex-A15 1.8GHz (Quad-core) 4+4 big.little technology Memory LPDDR3 LPDDR2/LPDDR3 LPDDR3 GPU Adreno 33 Adreno 32 PowerVR SGX554MP3 Video 496 x 216p 192 x 18p 18p Display 256 x 248/4K display 248 x 1536/18p 256 x 16 DSP Hexagon QDS6V5A/6MHz DTS-HD, Dolby Digital Plus Hexagon QDS6V4/5MHz? One-chip O X X Modem spec. LTE-A 15Mbps LTE 75Mbps LTE 75Mbps USB USB 3./2. USB 2. USB 3. Bluetooth Bluetooth 4. Bluetooth 4. X WiFi IEEE n/ac (2.4/5GHz) IEEE n/ac (2.4/5GHz) GPS gpsone Gen8B gpsone Gen8A X Camera 55MP 21MP? Source: Company data, X 2

21 May 21, 213 [TSMC s growth] TSMC strengthening its foundry market dominance TSMC of Taiwan is a major dedicated independent semiconductor foundry whose customers include top-tier global chip makers. TSMC had difficulties stabilizing 28nm process yields until the end of 1H12. As such, when Qualcomm released the Snapdragon S4 in 2H12, TSMC could not meet demand from Qualcomm. Therefore, Qualcomm requested SEC to produce the Snapdragon S4, although the Korean chipmaker is its competitor in the AP market. However, TSMC addressed the yield issues in 3Q12 and has expanded its 28nm capacity since then. In 1Q13, TSMC saw its growth potential recover, generating revenue of NT$132.8bn (+25.8% YoY), OP margin of 33.5%, and ROE of 21.3%. The percentage of 28nm production out of the company s total production increased from 5% in 1Q12 to 24% in 1Q13. The company s 2Q13 revenue and OP margin guidances stand at NT$ bn and 35-37%, respectively. TSMC raised its planned 213 investments from US$9bn to US$1bn in 1H. The company plans to expand the capacity of its Fab 15 and increase the percentage of 28nm production from 24% (5, wafers/month) to 5% (1, wafers/month) by year-end. In 214, the company plans to start the full-scale commercial production of 2nm and 16nm FinFET processes (test production likely in 2H13). Notably, we believe that Apple s A7 processors could be produced by TSMC, instead of SEC, from 214. In summary, TSMC is bolstering its presence in the semiconductor foundry market through aggressive capex, next-generation process development, and customer base expansion. As such, risks facing SEC include: 1) the potential loss of customers, including Apple, and 2) competition with TSMC in the mass FinFET process production. Figure 33. TSMC s quarterly revenue Figure 34. TSMC s process breakdown as of 1Q13 (NT$bn) (%) TSMC's quarterly revenue (L) 16 5 YoY growth rate (R) F -5 Source: TSMC, Source: TSMC Figure 35. TSMC s 4/45nm and below revenue Figure 36. TSMC s capacity Source: TSMC Source: TSMC 21

22 May 21, 213 [Outlook for SEC] 14nm FinFET technology to be a breakthrough in 214 SEC s system LSI business is likely to face a bumpy road ahead, given: 1) the Exynos 5 s technical issues, 2) the Snapdragon 8 s high marketability, 3) TSMC s aggressive moves, 4) the potential loss of Apple as a customer, and 5) accelerating efforts to enter the mobile chip market by Intel (which holds a superior technology, Tri-Gate). This year, these risks have already been affecting earnings at SEC s system LSI division. The division s 213 operating profit had been initially expected to reach more than W2.5tr thanks to capacity expansion at the S1 and S2 lines in 212, but, now, it appears as though operating profit will not exceed even W1.5tr. System LSI revenue is estimated to have reached only W3.5tr in 1Q. And Earnings at the system LSI division are likely to be further weighed down after 1Q by a decline in Apple s smartphone shipments and the low adoption of the Exynos 5 in the Galaxy S4. In 2H, although SEC should improve the Exynos 5, it is essential for the company to come up with an integrated chip solution that will be able to compete with the Snapdragon 8. Indeed, although non-memory makers will likely have significant growth opportunities in the mobile market, their success will hinge on their strategic direction and focus. Therefore, SEC may need to combine the development of BPs at the wireless division and APs at the system LSI division. What will be the breakthrough for SEC s system LSI division in 214 and beyond? SEC has recently unveiled its 14nm FinFET test chip and resumed the construction of the S3 line in Gyeonggi province. Both Intel and TSMC also plan to start the commercial production of 14nm and 16nm FinFET processes. If SEC gains the upper hand in 14nm FinFET production, the company will be able to both expand its foundry customer base and diversify its product portfolio to include an integrated chip and micro-server-use CPU. Figure 37. Intel s 3D FinFET Tri-Gate technology Figure 38. Revenue and OP at SEC s system LSI division (Wtr) 2 SEC's system LSI revenue (L) SEC's system LSI OP (R) (Wtr) F 14F 15F Source: SemiWiki.com Source: Company data, estimates 22

23 May 21, 213 Figure 39. Global AP M/S breakdown (212) Broadcom, 3% ST-Ericsson, 3% Nvidia, 2% Marvell, 4% Other, 4% TI, 4% MediaTek, 5% Qualcomm, 48% SEC, 11% Apple, 15% Source: IDC, Figure 4. Major AP players (Qualcomm, TSMC, Intel and MediaTek) relative share performances (1/1/8=1) Qualcomm MediaTek TSMC Intel Source: Bloomberg, Figure 41. Global AP market revenue and growth Figure 42. Major AP players revenue trends (US$bn) Total revenue (L) Growth rate (YoY, R) (%) (US$bn) Qualcomm TI Samsung Other Marvell Apple Broadcom MediaTek Source: IDC, Source: IDC, 23

24 May 21, 213 IV. Issue analysis Next-generation innovation Wearable computing to become the next innovation What is the next disruptive innovation after the smartphone? The Samsung Economic Research Institute recently called attention to seven disruptive innovations that could potentially break through in the years to come: 1) wearable computing, 2) 3D printing, 3) context-aware computing, 4) driverless cars, 5) ultra-light materials, 6) gene therapy, and 7) next-generation batteries. But Tesla Motors electric vehicle could have more potential to be the iphone of the automotive industry than Goggle s driverless car, in our view. Under the leadership of CEO Elon Musk (who was the inspiration for the Tony Stark character in the Iron Man movies), Tesla Motors successfully commercialized its electric vehicles (after which the company s stock jumped twofold in just one month). For smartphones, there are still many features that can bring about improvements despite ongoing commoditization, such as: 1) flexible displays, 2) 3D hologram keyboards/displays, and 3) various sensors. However, we believe that demand for new devices and a more interactive user experience will take technologies to the next level within the next two to three years in the form of wearable computing technology, which will allow smart devices to interact more closely and intimately with the human body and senses. Figure 43. Major developments in computing Source: Yonsei University Media System Lab Figure 44. The iphone of the auto industry Tesla Motors EV Figure 45. Tesla Motors share price (US$) 1 Tesla Motors' share price /11 7/11 1/12 7/12 1/13 Source: Tesla Motors Source: Bloomberg, 24

25 May 21, 213 History and development of wearable computing While the mobile revolution started with the iphone in 27 (and the ipad a few years later), the concept was born much earlier in 1983 for the ipad and the early 2s for the iphone. The history of wearable computing is also longer than many assume. Professor Steve Mann, the father of wearable computing, has studied various types of wearable computing devices since the 198s. In the mid-199s, he developed a web streaming system which enabled the transmission of live videos in real time. Moreover, one of his inventions in the 2s is very similar to Google Glass. Early-stage wearable computing technologies were used in national defense, but applications started to broaden in the 2s to other sectors, including firefighting, logistics, factory automation, etc. Around 21, sports, apparel/fashion and healthcare joined the list of wearable computing beneficiaries. Mr. Pranav Mistry s revolutionary SixthSense device is one of the most prominent examples of wearable computing technologies. We believe that the technological environment is ripe for the growth of wearable computing. And the key to success is whether wearable computing devices will be able to generate a new user experience and more economic value than current mobile devices. Figure 46. Professor Steve Mann of University of Toronto: Developer of wearable computing Source: Steve Mann s blog Figure 47. SixthSense (MIT Media Lab) Figure 48. Zach King adopts SixthSense in tablet PC Source: MIT Media Lab Source: YouTube - ipad 2 Hologram Setting 25

26 May 21, 213 Smart glasses are already within sight Google unveiled a Google Glass prototype in April, and commercialization is scheduled to take place within this year. Equipped with a 5-megapixel camera, see-through prism displays (64 x 36), bone-conduction speakers and a GPS, Google Glass uses WiFi and Bluetooth connections. It weighs 36g, and enables users to make phone calls, take pictures, search for information, navigate maps, etc. Applications also allow users to experience augmented reality and access locationbased services. Other than Google, Vuzix (in partnership with Nokia) of the US, Epson and Brother (Japan), Lumus (Israel), and Laster (France) have also developed smart glasses. In Korea, Accupix developed a see-closed type model, while Elentec is developing a see-through type model. Meanwhile, many companies, including Apple, Google, SEC, and Microsoft, are also developing smart watches. However, as they are expected to perform tasks such as making calls, sending e- mails, playing music, etc., their functions will be basically the same with those of smartphones except for some healthcare-related functions. Technological barriers also seem low overall, except for those related to flexible displays and batteries. Other wearable computing technologies include: 1) Microsoft s OmniTouch (a wearable computer that allows touchscreen interaction), 2) MYO (a wearable gesture controlled armband), 3) Digits (a sensor worn on the wrist that allows for the control of electronic devices with hand gestures), and 4) Leap Motion (advanced motion sensor technology). However, smart glasses seem most promising, with the potential to someday create a market as big as that of smartphones. Figure 49. Google Glass Figure 5. Google Glass UX Source: Google Source: YouTube Glass How-to: Getting Started Figure 51. Smart watch Figure 52. Google Glass provides new UX Source: World Wide Web Source: YouTube Google Glass Smart Glasses Official Promo Video 26

27 May 21, 213 Figure 53. Leap Motion Motion recognition device via LEDs, cameras, etc. (US$7) Source: Leap Motion Figure 54. MYO Band-type motion recognition device (expected in 2H13, US$149) Source: MYO Figure 55. Microsoft s OmniTouch Input keyboard via wearable projector Source: Microsoft 27

28 May 21, 213 Medium- to long-term growth outlook for wearable computing The smartphone market is estimated to reach US$27bn (9mn units) this year. SEC s IT & Mobile Communications (IM) division s revenue is forecast at W138tr. Google Glass is expected to sell at around US$3-6 initially, but the price needs to fall to around US$2 for the product to join the mainstream. What will smart glasses offer to users? The potential is unlimited, as Google s demo video suggests. The identification of criminals will become easier for the police, military operations can become more efficient, and surgery could be easier to perform. For golfers, rangefinders will no longer be necessary. It may take a while before smart glasses secure firm footing in the market due to privacy concerns, etc. Major market research firms including ABI Research forecast that the smart glass market will reach US$4.6-6bn by 216, but we have a brighter outlook: US$12bn for 216, and US$27bn for 218. Many view the alliance between SEC (hardware) and Google (software) as a risk for SEC, because Google can break up the partnership at any time. However, since Google has yet to establish a strong position in hardware, the company is unlikely to sever its relationship with SEC in the smartphone market. Moreover, Google s contribution to the development of wearable computing should be positive for SEC, because mobile AP and memory chips are essential to enabling the user interface of smart glasses. We expect the smart glass market to reach 1mn units (per year) in 217, which is not as far away as it sounds. So, the question is, who will dominate the wearable computing market? Figure 56. Smart glass market forecasts (mn units) Smart glass revenue (R) Smart glass shipments (L) 15 (US$bn) F 15F 16F 17F 18F 1 5 Source: 28

29 May 21, 213 Samsung Electronics (593 KS) Look for the strongest earnings performance among global IT players Technology (Maintain) Buy Target Price (12M, W) 2,1, Share Price (5/2/13, W) 1,497, Expected Return 4% OP (13F, Wbn) 41,9 Consensus OP (13F, Wbn) 41,247 EPS Growth (13F, %) 44.2 Market EPS Growth (13F, %) 21.6 P/E (13F, x) 7.6 Market P/E (13F, x) 9.4 KOSPI 1, Market Cap (Wbn) 22,57 Shares Outstanding (mn) 17 Free Float (%) 71.2 Foreign Ownership (%) 42.6 Beta (12M) Week Low (W) 1,91, 52-Week High (W) 1,584, (%) 1M 6M 12M Absolute Relative Share price 13 KOSPI /12 9/12 1/13 5/13 2H outlook: Earnings to outperform the global IT sector beginning in 2Q Samsung Electronics (SEC) has delivered a better-than-expected performance in the smartphone market thus far this year, quelling widespread market concerns over the company s 213 earnings growth. SEC has overtaken Apple in the high-end segment and is continuing to grow in the mid- to low-end segment as well as the tablet market. We expect the company s global smartphone market share to reach 38% in 2Q. We forecast operating profit to top W1tr from 2Q. As such, we believe SEC will generate the strongest earnings among major global IT players in 2Q, outstripping the likes of Apple, Google, and Microsoft. For 3Q, we expect another record-setting quarter, with an operating profit of W11.5tr. For the full year, we forecast revenue at W23.8bn (+18.4% YoY) and operating profit at W41tr (+41.2% YoY). Catalyst: Growing smartphone dominance surpassing Nokia in its heyday The market s take on the new Galaxy S4 remains mixed. In 2Q, we estimate Galaxy S4 shipments to be only 22mn units (vs. our previous forecast of 25mn units), mainly due to component issues (AMOLED, etc.). However, we expect shipments to get back on track to around 3mn units from 3Q, as the new model becomes more widely supported by mobile carriers worldwide. In 213, we forecast SEC smartphone shipments to grow to 328mn units, up 52% YoY from 216mn units in 212. On a quarterly basis, we forecast 8mn units in 2Q, 86mn units in 3Q, and 92mn units in 4Q. SEC s rising dominance in the smartphone market may be reminiscent of Nokia in its heyday. However, we think SEC has far superior footing than Nokia (at any point during its boom years), thanks to its robust vertical integration across major components. In 2H, the company should further benefit from major components like DRAM, NAND, and AMOLED. Valuation: Maintain TP of 2,1,; Foreigners likely to increase exposure The stock is trading at a 213F P/B of just 1.7x and a P/E of just 7.8x. The recent continued net selling of foreign investors can be explained by two factors. First, it can be seen as part of foreign investors underweight position in the broader domestic stock market, as investors have continued to flock to the Japanese market on the recent weakening of the yen against the dollar. Another reason behind the foreign selling is worries over smartphone commoditization and margin compression, as some consider SEC s heavy reliance on smartphones (7% of operating profit) a mid- to long-term risk. We expect to see a shift in such negative sentiment from 2Q. It is highly likely that once the sharp yen depreciation tapers off and foreign investors take profit from Japanese stocks, many investors will once again increase their exposure to SEC. As for concerns over a smartphone slowdown, we think SEC s record-high earnings will eventually put such worries to rest. With the company s earnings likely to outperform the global IT sector, we see little reason for the stock to continue to be undervalued. FY (Dec.) 12/1 12/11 12/12 12/13F 12/14F 12/15F Revenue (Wbn) 154,63 165,2 21,14 238,1 285, ,766 OP (Wbn) 17,297 15,644 29,49 41,9 46,825 51,2 OP Margin (%) NP (Wbn) 15,799 13,383 23,185 33,433 39,175 43,129 EPS (W) 92,863 78,66 136, ,511 23, ,54 ROE (%) P/E (x) P/B (x) Notes: All figures are based on consolidated K-IFRS; NP refers to profit attributable to controlling interests Source: Company data, estimates 29

30 May 21, 213 Table 9. P/B valuation (W, %) 213F Comments Share price 1,497, A BPS 889,9 B P/B 1.68 C=A/B ROE 25.3% D Earnings yield 15.% E=D/C Risk-free rate (3-year government bond) 2.8% F Risk premium 12.3% G=E-F Target risk premium 8.% H Target earnings yield 1.8% I=F+H Target P/B 2.35 J=D/I Target price 2,1, K=B*J Source: Company data, estimates Table 1. EV/EBITDA and SOTP valuation (Wbn, W, x) 213F Comments EBITDA 57,738 DRAM 6,3 NAND 4,99 System LSI 4,554 Display panel 9,634 IM 29,945 CE 2,314 EV/EBITDA 4.3 DRAM 4. SK Hynix: 4.6x NAND 4. Toshiba: 7.2x System LSI 3.6 Intel: 5.3x, TSMC: 7.8x, Qualcomm: 9.2x Display panel 3. LGD: 2.3x IM 5. Apple: 5.x CE 2.5 Sony: 4.3x EV A 245,968 DRAM 25,22 NAND 19,96 System LSI 16,394 Display panel 28,93 IM 149,724 CE 5,786 Net debt B -31,23 Cash & cash equivalents: W43.6tr as of 1Q13 Investment securitiesc 19,892 25% discount to MV and BV for listed firms Treasury shares D 15,73 25% discount to MV Shareholders equity E = A B + C + D 312,137 Value per share 2,1, Source: Company data, estimates 3

31 May 21, 213 Earnings outlook 213F OP of W41tr (+41.2% YoY) We project 213 full-year revenue at W238tr (+18.4% YoY) and operating profit at W4tr (+41.2% YoY; OP margin of 17.1%). We keep our 213 smartphone shipment estimate unchanged at 328mn units. On a quarterly basis, we forecast 8mn units in 2Q, 86mn units in 3Q, and 92mn units in 4Q (7mn units in 1Q). Galaxy S4 shipments are estimated at 22mn units in 2Q and 3mn units in 3Q. We expect earnings growth to gain momentum in 2Q and 3Q, with quarterly operating profit forecast at W1.3tr in 2Q, W11.5tr in 3Q, and W1.4tr in 4Q (vs. W8.78tr in 1Q). By business unit, we estimate 213 operating profit at W28.8tr (+48% YoY) for IM, W6tr (+4% YoY) for semiconductor, W4tr (+23% YoY) for display panel (DP) and W1.6tr (- 3% YoY) for consumer electronics (CE). As such, the IM division should account for the largest percentage (7%) of overall operating profit. Table 11. Quarterly and annual earnings (Wbn, %) 1Q12 2Q12 3Q12 4Q12 1Q13 2Q13F 3Q13F 4Q13F F 214F Revenue 45,271 47,597 52,177 56,59 52,87 58,5 62,468 64, ,2 21,14 238,1 285,594 QoQ growth YoY growth CE div. 11,5 12,83 12,22 14,56 11,24 11,34 12,764 13,282 47,2 51,11 48,626 54,594 IM div. 22,47 23,36 29,3 3,71 32,82 33,233 35,891 36,834 67,44 15,84 138, ,392 DS div. - 7,98 8,6 8,72 9,59 8,58 9,189 1,396 1,624 36,99 34,89 38,79 39,46 DS div. - DP 8,54 8,25 8,46 7,75 7,11 7,833 8,366 8,77 29,23 33, 32,15 45,673 COGS 3,138 29,971 31,99 34,553 31,38 34,249 36,856 38, , , , ,212 Gross profit 15,132 17,626 2,188 21,56 21,49 23,8 25,612 25,849 52,857 74,452 96, ,381 GP margin SG&A 9,496 11,232 12,194 12,48 12,71 13,457 14,95 15,481 37,42 45,42 55,742 64,557 % of revenue Operating profit 5,69 6,46 8,6 8,84 8,78 1,344 11,517 1,368 15,644 29,5 41,9 46,825 QoQ growth YoY growth CE div ,55 2,33 1,622 2,64 IM div. 4,18 4,13 5,63 5,47 6,51 7,358 7,829 7,9 8,13 19,41 28,787 29,315 DS div ,3 1,15 1,42 1,7 1,494 1,844 1,628 7,33 4,3 6,36 9,272 DS div. - DP ,9 1, ,11 1, ,23 3,964 6,174 OP margin CE div IM div DS div DS div. - DP Net profit 4,861 5,49 6,425 6,851 6,963 8,212 9,134 8,326 13,383 23,185 33,433 39,175 QoQ growth YoY growth Note: Under consolidated K-IFRS Source: estimates Table 12. Earnings forecast revisions (Wbn, %) Previous Revised % chg. 13F 14F 13F 14F 13F 14F Comments Revenue 238,1 285, ,1 285,594.. OP 4,22 44,164 41,9 46, IM division s robust earnings Net profit 32,635 37,18 33,433 39, OP margin Net margin Source: estimates 31

32 May 21, 213 Figure 57. Annual operating profit (Wtr) Annual operating profit (L) (%) 5 YoY growth (R) F 14F 15F -1 Source: Company data, estimates Figure 58. Annual operating profit by division (Wtr) DP IM CE F 14F 15F Source: Company data, estimates Figure 59. Quarterly operating profit by division (Wtr) DP IM CE Q8 1Q9 1Q1 1Q11 1Q12 1Q13 Source: Company data, estimates 32

33 May 21, 213 Table 13. IM division's earnings (Wbn, %, US$, mn units) IM 1Q12 2Q12 3Q12 4Q12 1Q13 2Q13F 3Q13F 4Q13F F 14F Revenue 22,47 23,36 29,3 3,71 32,82 33,233 35,891 36,834 67,44 15,84 138, ,392 QoQ/YoY growth OP 4,18 4,13 5,63 5,47 6,51 7,358 7,829 7,9 8,13 19,41 28,787 29,315 QoQ/YoY growth OP margin Handset Revenue 21,21 22,43 28,4 29,6 31,77 32,233 34,891 35,834 67,44 15,84 138, ,392 QoQ/YoY growth OP 4,97 4,814 5,36 5,59 6,295 7,358 7,829 7,9 8,79 19,861 28,572 29,135 QoQ/YoY growth OP margin % Handset shipments QoQ/YoY growth Smartphone shipments QoQ/YoY growth Smartphone ASP QoQ/YoY growth Source: Company data, estimates Table 14. DP division's earnings (Wbn, %, US$, units) DP 1Q12 2Q12 3Q12 4Q12 1Q13 2Q13F 3Q13F 4Q13F F 14F Revenue 8,54 8,25 8,46 7,75 7,11 7,833 8,366 8,77 29,23 33, 32,15 45,673 QoQ/YoY growth OP ,9 1, ,11 1, ,23 3,964 6,174 QoQ/YoY growth OP margin LCD Revenue 6,18 5,634 5,4 4,96 4,615 4,61 4,724 4,628 22,736 28,633 28,633 27,64 QoQ/YoY growth OP , ,898 QoQ/YoY growth OP margin Shipments 45,14 46,484 46,149 45,69 44,418 45,648 47,356 47, , , , ,412 QoQ/YoY growth TV ASP QoQ/YoY growth Samsung Mobile Display Revenue 2,36 2,616 3,6 2,79 2,93 3,222 3,641 4,78 6,494 1,826 13,872 18,33 QoQ/YoY growth OP , ,289 3,289 4,276 QoQ/YoY growth OP margin Source: Company data, estimates 33

34 May 21, 213 Table 15. SEC s semiconductor division's earnings (Wbn,%) 1Q12 2Q12 3Q12 4Q12 1Q13 2Q13F 3Q13F 4Q13F F 14F Revenue 7,98 8,6 8,72 9,59 8,58 9,189 1,396 1,624 36,99 34,89 38,79 39,46 QoQ/YoY growth -13.% 7.8% 1.4% 1.% -1.5% 7.1% 13.1% 2.2% -1.7% -5.7% 11.2%.7% OP 7 1,3 1,15 1,42 1,7 1,494 1,844 1,628 7,33 4,3 6,36 9,272 QoQ/YoY growth -69.7% 47.1% 11.7% 23.5% -24.6% 39.6% 23.4% -11.7% -27.6% -41.3% 4.4% 53.6% OP margin 8.8% 12.% 13.2% 14.8% 12.5% 16.3% 17.7% 15.3% 19.8% 12.3% 15.6% 23.7% Memory Revenue 4,89 5,42 5,22 5,33 5,12 5,729 6,377 6,137 22,71 2,86 23,362 28,988 QoQ/YoY growth -1.3% 1.8% -3.7% 2.1% -3.9% 11.9% 11.3% -3.8% -12.1% -8.1% 12.% 24.1% OP ,236 1,423 1,2 4,218 3,349 4,76 7,294 QoQ/YoY growth -45.7% 67.8% -14.6% 6.9% -.8% 37.2% 15.1% -15.7% -51.3% -2.6% 42.1% 53.2% OP margin 12.1% 18.4% 16.3% 17.1% 17.6% 21.6% 22.3% 19.5% 18.6% 16.1% 2.4% 25.2% Non-memory Revenue 3,9 3,18 3,5 4,26 3,46 3,461 4,2 4,488 14,28 14,3 15,428 15,856 QoQ/YoY growth -16.9% 2.9% 1.1% 21.7% -18.8%.% 16.2% 11.6% 2.9% -1.8% 1.% 2.8% OP ,112 1,31 1,224 1,978 QoQ/YoY growth -91.3% -68.1% 158.4% 26.9% -66.% 46.9% 52.3% 12.4% 113.4% -66.9% 18.7% 61.6% OP margin 3.4% 1.1% 11.2% 11.7% 4.9% 7.2% 9.4% 9.5% 21.8% 7.4% 7.9% 12.5% DRAM Revenue 3,858 4,39 4,36 3,845 3,682 3,913 4,33 4,259 16,522 16,48 16,184 14,47 QoQ/YoY growth -4.8% 11.7% -6.4% -4.7% -4.2% 6.3% 1.7% -1.7% -15.% -2.9%.8% -11.% OP ,522 2,519 2,886 3,569 QoQ/YoY growth -15.4% 21.1% -3.9% -6.% -6.9% 56.% 18.9% -14.5% -47.% -28.5% 14.6% 23.7% OP margin 17.% 18.5% 13.6% 13.4% 13.1% 19.2% 2.6% 17.9% 21.3% 15.7% 17.8% 24.8% Shipments (1Gb eq, mn units) 2,64 2,81 2,95 3,172 3,13 3,193 3,618 3,815 8,972 11,537 13,639 17,458 Bit growth (QoQ/YoY) 3.% 7.9% 5.% 7.5% -5.% 6.% 13.3% 5.4% 54.% 28.6% 18.2% 28.% ASP (1Gb eq, US$) QoQ/YoY growth -9.9% -18.1% -9.7% -9.1% -4.5%.5% 1.5% -1.4% -37.3% -38.5% -19.5% -25.% NAND Revenue 2,147 2,44 2,388 2,56 2,681 3,59 3,289 3,121 1,27 9,48 12,151 14,581 QoQ/YoY growth -11.8% 13.7% -2.1% 4.9% 7.% 14.1% 7.5% -5.1% 8.7% -7.7% 28.2% 2.% OP ,946 1,696 2,714 3,724 QoQ/YoY growth -51.3% 18.9% 19.9% 22.6% 4.9% 21.5% 11.% -17.% -36.9% -12.9% 6.1% 37.2% OP margin 14.7% 15.4% 18.9% 22.1% 21.6% 23.% 23.8% 2.8% 19.% 17.9% 22.3% 25.5% Shipments (16Gb eq, mn units) 984 1,319 1,464 1,757 1,95 2,214 2,345 2,484 3,738 5,523 8,993 14,388 Bit growth (QoQ/YoY) % 34% 11% 2% 11% 14% 6% 6% 81% 48% 63% 6% ASP (16Gb eq, US$) QoQ/YoY growth -1% -18% -1% -9% -4% % 1% -1% -37% -39% -19% -25% AP Revenue 1,21 1,462 1,632 2,278 1,1 1,518 1,98 2,244 5,779 6,581 6,842 7,856 QoQ/YoY growth -3.9% 2.8% 11.6% 39.6% -51.7% 38.% 3.4% 13.3% 176.4% 13.9% 4.% 14.8% OP , ,178 QoQ/YoY growth -72.4% 96.4% 28.8% 58.2% -8.1% 97.1% 82.6% 13.3% 397.% -11.6% -1.7% 43.7% OP margin 8.% 13.% 15.% 17.% 7.% 1.% 14.% 14.% 18.% 14.% 12.% 15.% Shipment (mn units) Bit growth (QoQ/YoY) -29.4% 16.7% 14.3% 18.8% -47.4% 2.% 25.% 13.3% 133.% 23.5% -11.5% 15.% ASP (US$) QoQ/YoY growth.%.%.% 22.2% -9.1% 15.% 4.3%.% 23.5% -9.2% 2.2% -.2% Source: Company data, estimates 34

35 May 21, 213 Samsung Electronics (593 KS/TP: W2,1,) Comprehensive Income Statement (Summarized) Statement of Financial Condition (Summarized) (Wbn) 12/12 12/13F 12/14F 12/15F (Wbn) 12/12 12/13F 12/14F 12/15F Revenue 21,14 238,1 285, ,766 Current Assets 87,269 11, ,24 183,345 Cost of Sales 126, , , ,775 Cash and Cash Equivalents 18,792 34,599 57,634 88,494 Gross Profit 74,452 96, , ,991 AR & Other Receivables 26,675 3,749 36,897 4,795 SG&A Expenses 45,42 55,742 64,557 68,971 Inventories 17,747 2,459 24,549 27,142 Operating Profit (Adj) 29,49 41,9 46,825 51,2 Other Current Assets 5,399 6,224 7,468 8,257 Operating Profit 29,49 41,9 46,825 51,2 Non-Current Assets 93,83 18,153 12,47 129,989 Non-Operating Profit 866 1,733 3,116 3,879 Investments in Associates 8,786 9,772 1,759 11,745 Net Financial Income ,23-1,992 Property, Plant and Equipment 68,485 76,214 85,812 93,682 Net Gain from Inv in Associates Intangible Assets 3,73 3,591 3,493 3,416 Pretax Profit 29,915 42,742 49,941 54,899 Total Assets 181,72 218,84 265, ,334 Income Tax 6,7 8,649 1,16 11,19 Current Liabilities 46,933 51,66 6,3 65,779 Profit from Continuing Operations 23,845 34,93 39,835 43,789 AP & Other Payables 16,889 19,469 23,362 25,83 Profit from Discontinued Operations Short-Term Financial Liabilities 9,443 8,443 8,443 8,443 Net Profit 23,845 34,93 39,835 43,789 Other Current Liabilities 2,61 23,748 28,496 31,56 Controlling Interests 23,185 33,433 39,175 43,129 Non-Current Liabilities 12,658 14,662 15,787 16,743 Non-Controlling Interests Long-Term Financial Liabilities 5,452 4,952 4,952 4,952 Total Comprehensive Profit 22,128 32,376 38,118 42,72 Other Non-Current Liabilities 5,476 7,369 8,494 9,45 Controlling Interests 21,499 31,747 37,489 41,443 Total Liabilities 59,591 66,322 76,87 82,523 Non-Controlling Interests Controlling Interests 117,94 147,54 183,88 224,538 EBITDA 44,671 55,47 62,915 68,816 Capital Stock FCF (Free Cash Flow) 13,31 22,596 23,548 3,438 Capital Surplus 4,44 4,44 4,44 4,44 EBITDA Margin (%) Retained Earnings 119, ,81 19, ,488 Operating Profit Margin (%) Non-Controlling Interests 4,386 5,15 5,644 6,273 Net Profit Margin (%) Stockholders' Equity 121,48 152, ,524 23,811 Cash Flows (Summarized) Forecasts/Valuations (Summarized) (Wbn) 12/12 12/13F 12/14F 12/15F 12/12 12/13F 12/14F 12/15F Cash Flows from Op Activities 36,647 44,847 48,57 55,242 P/E (x) Net Profit 23,845 34,93 39,835 43,789 P/CF (x) Non-Cash Income and Expense 22,76 42,567 23,8 25,27 P/B (x) Depreciation 14,835 13,671 15,43 17,13 EV/EBITDA (x) Amortization EPS (W) 136, ,511 23, ,54 Others -2, CFPS (W) 228,11 281, , ,17 Chg in Working Capital -5,778-1,911-4,32-2,465 BPS (W) 79, ,9 1,13,4 1,342, Chg in AR & Other Receivables -2,568-4,75-6,148-3,898 DPS (W) 8, 8, 5,5 8, Chg in Inventories -4,12-2,711-4,9-2,594 Payout ratio (%) Chg in AP & Other Payables ,58 3,892 2,468 Dividend Yield (%) Income Tax Paid -4,18-8,649-1,16-11,19 Revenue Growth (%) Cash Flows from Inv Activities -29,419-25,75-23,827-23,64 EBITDA Growth (%) Chg in PP&E -22,321-21,4-25, -25, Operating Profit Growth (%) Chg in Intangible Assets EPS Growth (%) Chg in Financial Assets -7,319-5, Accounts Receivable Turnover (x) Others 81 1,24 1,763 2,525 Inventory Turnover (x) Cash Flows from Fin Activities -2,441-3,289-1,646-1,318 Accounts Payable Turnover (x) Chg in Financial Liabilities 539-1,5 ROA (%) Chg in Equity 89 ROE (%) Dividends Paid -1,265-1,272-1, ROIC (%) Others -1, Liability to Equity Ratio (%) Increase (Decrease) in Cash 4,1 15,88 23,35 3,86 Current Ratio (%) Beginning Balance 14,692 18,792 34,599 57,634 Net Debt to Equity Ratio (%) Ending Balance 18,792 34,599 57,634 88,494 Interest Coverage Ratio (x) Source: Company data, estimates 35

36 May 21, 213 SK Hynix (66 KS) Strongest earnings momentum among domestic IT stocks Technology (Maintain) Buy Target Price (12M, W) 42, Share Price (5/2/13, W) 3,7 Expected Return 37% OP (13F, Wbn) 2,96 Consensus OP (13F, Wbn) 2,387 EPS Growth (13F, %) TTB Market EPS Growth (13F, %) 21.6 P/E (13F, x) 8.9 Market P/E (13F, x) 9.4 KOSPI 1, Market Cap (Wbn) 21,311 Shares Outstanding (mn) 694 Free Float (%) 75.4 Foreign Ownership (%) 29. Beta (12M) Week Low (W) 2,1 52-Week High (W) 3,85 (%) 1M 6M 12M Absolute Relative Share price 12 KOSPI /12 9/12 1/13 5/13 2H outlook: Strongest earnings momentum among domestic IT firms For 2H, we believe SK Hynix will post quarterly operating profit close to W1tr. Other positive drivers are emerging on top of the continued rise in DRAM prices, including higher server DRAM prices and growing mobile DRAM shipments. Additionally, the company has seen larger-than-expected cost benefits from the weakening of the yen, as it sources 6% of its wafers from Japan. We raised our 2Q earnings estimates to W3.66tr in revenue (+32% QoQ, +39% YoY) and W852bn in operating profit (+169% QoQ, +21,473% YoY; OP margin of 23.3%). Earnings visibility has further improved since mid-2q and we forecast operating profit of W967bn in 3Q and W824bn in 4Q. For the full year, we expect revenue and operating profit to hit W14.1tr (+39.1% YoY) and W2.96tr (turning to profit YoY), respectively. Catalysts: Rise in both PC/server DRAM prices & mobile DRAM volume/prices Sustained rise in PC and server DRAM prices: In May, the PC DRAM contract price is expected to continue its uptrend, jumping 1% MoM to US$28 for 4GB (US$1.58 for 2Gb DDR3). We even see risks of prices breaking above US$3 on further production cutbacks (to accommodate mobile chip production) in 2H. Server DRAM prices are also likely to remain on the rise, to at least US$6 in May from US$58 (+7.4% MoM) in April (based on 8GB). Increase in mobile DRAM shipments and prices: As we head towards 3Q, shipment growth and price increases in mobile DRAM are becoming more evident. We have recently been seeing two favorable shifts in the high-end smartphone market: 1) a sharp increase in average content per device (from 1GB to 2GB), and 2) a change in the core chip used in devices (from LPDDR2 to LPDDR3). In particular, SEC s increasing proportion of LPDDR3 production has been tightening the LPDDR2 and MCP markets. SK Hynix is also well-positioned to benefit from the growth of Chinese smartphone makers. Valuation: Raise TP to W42,; 213 OP of W3tr in sight We lift our target price for SK Hynix to W42, (from W38,), which corresponds to a 213F P/B of 2.7x and P/E of 12x. We sharply revised up our 213F operating profit by 37% to W2.96tr (from W2.15tr), driving up our 213F ROE to 22.7% (from 16.6%). The stock is currently trading at a 213F P/B of 2x and P/E of 8.3x, which we believe does not fully reflect the firm s stronger-than-expected earnings potential. We estimate 213 annual EBITDA at W6tr. Even if the company spends W3.5tr on capex, this would still leave it with a free cash flow (FCF) of W2tr. We could even see a higher FCF of more than W2.5tr in 214, given disciplined capex and capacity, and the robust growth potential of mobile DRAM and SSD. We believe the memory industry is entering a Big Cycle, in which industry restructuring and reduced production pushes PC DRAM prices up sharply and triggers a surge in average content for mobile DRAM and SSD. FY (Dec.) 12/1 12/11 12/12 12/13F 12/14F 12/15F Revenue (Wbn) 12,16 1,396 1,162 14,136 15,192 15,181 OP (Wbn) 2, ,96 3,469 3,18 OP Margin (%) NP (Wbn) 2, ,456 2,99 2,751 EPS (W) 4, ,538 4,38 3,963 ROE (%) P/E (x) P/B (x) Notes: All figures are based on consolidated K-IFRS; NP refers to profit attributable to controlling interests Source: Company data, estimates 36

37 May 21, 213 Table 16. P/B valuation (W, x, %) 213F Notes Share price 3,7 A 213F BPS 15,69 B P/B 1.97 C=A/B 213F ROE 22.7% D Earnings yield 11.5% E=D/C Risk-free rate (3-year government bond) 2.6% F Risk premium 8.9% G=E-F Target risk premium 5.8% H Target earnings yield 8.4% I=F+H Target P/B 2.7 J=D/I Target price 42, K=B*J Source: Company data, estimates Figure month forward P/B band (W') x 2.x x 1.2x.8x F Source: Company data, estimates Figure 61. Quarterly OP and share price (Wbn) 1,2 Quarterly operating profit (L) SK Hynix's share price (R) (W') , F Source: Company data, estimates 37

38 May 21, 213 Table 17. Quarterly and annual earnings (Wbn, %) 1Q12 2Q12 3Q12 4Q12 1Q13 2Q13F 3Q13F 4Q13F F 214F Revenue 2,388 2,632 2,423 2,718 2,781 3,661 3,94 3,754 1,396 1,162 14,136 15,192 QoQ growth YoY growth DRAM 1,695 1,974 1,696 1,875 1,975 2,696 2,898 2,776 7,418 7,241 1,345 1,98 NAND , ,977 2,921 3,792 4,213 COGS 2,178 2,155 2,14 2,24 2,18 2,349 2,513 2,45 8,721 8,551 9,322 9,723 Gross profit ,312 1,427 1,34 1,675 1,611 4,814 5,469 SG&A ,36 1,839 1,846 2, Operating profit ,96 3,469 QoQ growth TTR TTB TTR TTB YoY growth TTR RR TTB TTB TTR TTB 17.2 DRAM ,581 2,953 NAND EBITDA ,89 1,619 1,754 1,63 3,572 2,976 6,64 7,78 Net profit ,456 2,99 GP margin OP margin DRAM NAND EBITDA margin NP margin Notes: Under consolidated K-IFRS; TTR refers to turning to red ; TTB refers to turning to black ; RR refers to remaining red Source: Company data, estimates Table 18. Earnings forecast revisions (Wbn, %) Previous Revised % chg. 13F 14F 13F 14F 13F 14F Revenue 12,828 14,28 14,136 15, OP 2,154 2,812 2,96 3, Net profit 1,734 2,387 2,456 2, OP margin NP margin Source: estimates Comments - Increase in mobile-related memory demand and PC DRAM price, cost improvements, etc. Figure 62. Annual operating profit and OP margin Figure 63. Quarterly operating profit and OP margin (Wtr) SK Hynix's annual OP (L) OP margin (R) (Wbn) 1,2 8 4 SK Hynix's quarterly OP (L) OP margin (R) , F 14F F Source: Company data, estimates Source: Company data, estimates 38

39 May 21, 213 Table 19. Major metrics and forecasts for the DRAM division (Wbn, %) 1Q12 2Q12 3Q12 4Q12 1Q13 2Q13F 3Q13F 4Q13F F 14F Revenue 1,695 1,974 1,696 1,875 1,975 2,696 2,898 2,776 7,418 7,241 1,345 1,98 Operating profit ,581 2,953 OP margin Shipments (1Gb eq. mn) 1,772 1,896 1,81 2,35 2,374 2,73 2,839 2,925 5,156 7,773 1,868 14,129 Bit growth ASP (1Gb eq. US$) ASP growth Source: Company data, estimates Table 2. Major metrics and forecasts for the NAND division (Wbn, %) 1Q12 2Q12 3Q12 4Q12 1Q13 2Q13F 3Q13F 4Q13F F 14F Revenue , ,977 2,921 3,792 4,213 Operating profit OP margin % Shipments (16Gb eq. mn) ,17 1,492 2,199 3,49 Bit growth ASP(16Gb eq. US$) ASP growth Source: Company data, estimates Figure 64. Operating profit by division Figure 65. OP margin by division (Wbn) DRAM division's OP (%) DRAM division's OP margin 1,2 NAND division's OP 6 NAND division's OP margin F F Source: Company data, estimates Source: Company data, estimates Figure 66. Annual DRAM bit growth and ASP growth Figure 67. Annual NAND bit growth and ASP growth (%) 8 DRAM bit growth (YoY) ASP (YoY) (%) 16 NAND bit growth (YoY) ASP (YoY) F 14F F 14F Source: Company data, estimates Source: Company data, estimates 39

40 May 21, 213 SK Hynix (66 KS/TP: W42,) Comprehensive Income Statement (Summarized) Statement of Financial Condition (Summarized) (Wbn) 12/12 12/13F 12/14F 12/15F (Wbn) 12/12 12/13F 12/14F 12/15F Revenue 1,162 14,136 15,192 15,181 Current Assets 5,314 7,586 9,631 11,23 Cost of Sales 8,551 9,33 9,723 9,91 Cash and Cash Equivalents 658 2,6 3,672 5,22 Gross Profit 1,611 4,86 5,469 5,28 AR & Other Receivables 1,832 2,43 2,592 2,438 SG&A Expenses 1,839 1,846 2, 2,1 Inventories 1,59 1,82 1,975 1,974 Operating Profit (Adj) ,96 3,469 3,18 Other Current Assets Operating Profit ,96 3,469 3,18 Non-Current Assets 13,335 13,864 13,952 14,37 Non-Operating Profit Investments in Associates Net Financial Income Property, Plant and Equipment 11,586 11,968 11,967 12,346 Net Gain from Inv in Associates 17 Intangible Assets 984 1,56 1,15 1,143 Pretax Profit ,747 3,35 3,124 Total Assets 18,649 21,45 23,583 25,393 Income Tax Current Liabilities 4,441 4,97 4,669 4,367 Profit from Continuing Operations ,456 2,99 2,751 AP & Other Payables 1,335 1,82 1,861 1,86 Profit from Discontinued Operations Short-Term Financial Liabilities 2,736 2,636 2,236 1,936 Net Profit ,456 2,99 2,751 Other Current Liabilities Controlling Interests ,456 2,99 2,751 Non-Current Liabilities 4,468 4,591 4,444 4,215 Non-Controlling Interests Long-Term Financial Liabilities 3,754 3,454 3,54 2,554 Total Comprehensive Profit ,15 2,685 2,445 Other Non-Current Liabilities Controlling Interests ,15 2,682 2,442 Total Liabilities 8,99 9,561 9,113 8,582 Non-Controlling Interests 3 3 Controlling Interests 9,74 11,89 14,468 16,86 EBITDA 2,976 6,64 7,78 6,919 Capital Stock 3,488 3,488 3,488 3,488 FCF (Free Cash Flow) -1,655 1,841 2,741 2,536 Capital Surplus 3,54 3,54 3,54 3,54 EBITDA Margin (%) Retained Earnings 3,313 5,769 8,655 11,32 Operating Profit Margin (%) Non-Controlling Interests Net Profit Margin (%) Stockholders' Equity 9,739 11,89 14,47 16,811 Cash Flows (Summarized) Forecasts/Valuations (Summarized) (Wbn) 12/12 12/13F 12/14F 12/15F 12/12 12/13F 12/14F 12/15F Cash Flows from Op Activities 2,393 5,541 6,411 6,7 P/E (x) Net Profit ,456 2,99 2,751 P/CF (x) Non-Cash Income and Expense 3,382 3,69 4,88 4,169 P/B (x) Depreciation 3,58 3,19 3,51 3,621 EV/EBITDA (x) Amortization EPS (W) ,538 4,38 3,963 Others CFPS (W) 4,467 8,1 9,57 9,35 Chg in Working Capital BPS (W) 12,615 15,69 19,251 22,563 Chg in AR & Other Receivables DPS (W) Chg in Inventories Payout ratio (%) Chg in AP & Other Payables Dividend Yield (%) Income Tax Paid Revenue Growth (%) Cash Flows from Inv Activities -4,64-3,497-3,553-3,998 EBITDA Growth (%) Chg in PP&E -3,737-3,4-3,5-4, Operating Profit Growth (%) TTR TTB Chg in Intangible Assets EPS Growth (%) RR TTB Chg in Financial Assets -49 Accounts Receivable Turnover (x) Others Inventory Turnover (x) Cash Flows from Fin Activities 1, ,192-1,154 Accounts Payable Turnover (x) Chg in Financial Liabilities ROA (%) Chg in Equity 2,329 ROE (%) Dividends Paid ROIC (%) Others Liability to Equity Ratio (%) Increase (Decrease) in Cash ,348 1,666 1,548 Current Ratio (%) Beginning Balance 1, ,6 3,672 Net Debt to Equity Ratio (%) Ending Balance 658 2,6 3,672 5,22 Interest Coverage Ratio (x) Source: Company data, estimates 4

41 May 21, 213 Eugene Technology (8437 KQ) Betting on a solid long-term vision Technology (Maintain) Buy Target Price (12M, W) 28, Share Price (5/2/13, W) 21,2 Expected Return 32% OP (13F, Wbn) 53 Consensus OP (13F, Wbn) 56 EPS Growth (13F, %).3 Market EPS Growth (13F, %) 21.6 P/E (13F, x) 1.1 Market P/E (13F, x) 9.4 KOSDAQ Market Cap (Wbn) 447 Shares Outstanding (mn) 21 Free Float (%) 61.5 Foreign Ownership (%) 12.7 Beta (12M) Week Low (W) 11,2 52-Week High (W) 24,8 (%) 1M 6M 12M Absolute Relative Share price 13 KOSDAQ /12 9/12 1/13 5/13 2H outlook: A major beneficiary of growing memory capex Eugene Technology is a leading deposition equipment manufacturer, holding a 1% global market share in single-type low pressure chemical vapor deposition (LPCVD). After a period of contraction in 2H12, memory makers have been slowly increasing capex. In 2H, we expect stronger demand for deposition equipment driven by memory chip makers tech migration and SEC s NAND capacity ramp-ups. For 213, we estimate revenue at W18.7bn (+7.4% YoY) and operating profit at W53.1bn (-.9% YoY; OP margin of 29.4%). We project quarterly operating profit to gain solid momentum toward 2H, from W22.6bn in 1Q and W35.9bn in 2Q to W56.8bn in 3Q and W65.5bn in 4Q. Recently, deposition equipment demand has been growing on the back of the migration to: 1) 1nm NAND and 2) 2nm mobile DRAM. Later this year, we also expect SEC to invest in 3D V-NAND. Catalyst: Non-memory penetration to gain momentum in 2H In 213, we see two new growth engines for Eugene Technology: 1) cyclic CVD, a type of atomic layer deposition (ALD) equipment, and 2) selective epitaxial growth (SEG) used in non-memory manufacturing. Cyclic CVD revenue is estimated to climb from W26.5bn in 212 to W52bn in 213, accounting for 3% of total revenue. The company should begin supplying SEG equipment to foreign non-memory chipmakers from 2H. Eugene Technology was selected as the only domestic equipment maker to participate in an 18 wafer technology consortium (led by the International SEMATECH Manufacturing Initiative), together with global chip makers like Intel, SEC and GlobalFoundries, and TSMC. With Intel and other major non-memory manufacturers aiming to build 18 inch lines in 214, this should present a major growth engine for Eugene Technology over the medium- to long-term. Valuation: One of the few good equipment plays in the long term Although some worries have been raised over the pace of Eugene Technology s rally, we believe the biggest driver of equipment stocks will the sustained flow of their earnings growth. The company is expected to continue solid growth beyond 2H13 and into 214, with revenue and operating profit of W225.5bn (+24.8% YoY) and W66.5bn (+25% YoY), respectively. In our view, such expectations of sustained growth have been the biggest reason behind the stock s continued rally, despite its relatively unimpressive annual earnings growth for 213. We believe Eugene Technology is one of only a handful of good equipment plays over the medium- to long-term, given its solid vision for the future. The stock is currently trading at a 213F P/E of 8.8x, which appears cheap given: 1) the projected memory capex pickup, 2) the company s global competitiveness in deposition equipment, and 3) potential customer expansion into global non-memory firms. We reiterate our target price of W28, (based on 213F P/E of 12x). FY (Dec.) 12/1 12/11 12/12 12/13F 12/14F 12/15F Revenue (Wbn) OP (Wbn) OP Margin (%) NP (Wbn) EPS (W) 776 1,217 2,421 2,428 2,936 3,555 ROE (%) P/E (x) P/B (x) Notes: All figures are based on non-consolidated K-IFRS Source: Company data, estimates 41

42 May 21, 213 Table 21. Quarterly and annual earnings (Wbn, %) 1Q12 2Q12 3Q12 4Q12 1Q13F 2Q13F 3Q13F 4Q13F F 214F Revenue QoQ growth YoY growth LPCVD Plasma system Cyclic CVD Gross profit SG&A expenses Operating profit QoQ growth YoY growth Net profit QoQ growth YoY growth GP margin OP margin NP margin Source: Company data, estimates Table 22. Earnings forecast revisions (Wbn, %) Previous Revised % chg. 13F 14F 13F 14F 13F 14F Revenue OP Net profit OP margin Net margin Source: estimates Figure 68. Annual revenue and OP Figure 69. Quarterly revenue and OP (Wbn) (Wbn) (Wbn) (Wbn) 3 Annual revenue (L) 1 8 Quarterly revenue (L) 3 25 Annual operating profit (R) 8 Quarterly operating profit (R) F 14F 15F F Source: Company data, estimates Source: Company data, estimates 42

43 May 21, 213 Figure 7. SEC s NAND tech migration 1% 75% 5% 25% 15nm 19nm 22nm 3nm 4nm 5nm 6nm % 1Q8 1Q9 1Q1 1Q11 1Q12 1Q13F Source: Company data, estimates Figure 71. Major players 3D NAND structures Source: Industry data Figure 72. SEC s V-NAND (TCAT) structure Figure 73. SEC s V-NAND production process Source: Industry data Source: Industry data 43