China Telecom is on the way to become the largest cloud operator in China after 63.4% YoY revenue growth reported in 1H23. Their unique extreme vertical integration approach allows higher operating leverage compared to none-telco cloud operators. We estimate EBIT breakeven in later 2023 or 2024. Reiterate BUY, raising target price from HK$4.85 to HK$5.70 as we roll over DCF based valuation to 2024. Ample upside is expected once their Cloud profitability becomes transparent.
　　Key Factors for Rating
　　After 63.4% YoY cloud revenue growth in mid-term 2023, China Telecom is on the way to reach their full year 2023 target of RMB100bn revenue for Cloud computing. Being the No.1 government public cloud infrastructure provider in China, No.1 in Desktop as a service provider (DaaS) and enjoying 60% share in SASAC’s 40 industrial public cloud projects, their Tianyi Cloud ( 天 翼 云 ) will become the largest cloud operator outpacing their internet competitors.
　　China Telecom is building their cloud infrastructure through an extreme vertical integrated approach called Cloud-Network Integration (云网结合). Their cloud will include full stack hardware (such as Zijin DPU), proprietary operating system and cloud native database, with nationwide computation power networks (算力 网络) in 2+4+31 structure, one-city-one-cloud resource pool in 270 cities plus cloud intelligent computing and supercomputing networks.
　　Their unique Cloud-network integration approach offers significantly higher operating leverage compared with their internet competitors, meaning lower OPEX as a % of sales and therefore quicker to reach EBIT breakeven as the Company’s cloud revenue maintained 59% YoY growth in 2023E.
　　Key Risks for Rating
　　China Telecom and their major vendors are currently under US sanction; regulatory uncertainties might prevent the Company from obtaining the technology required to develop their network infrastructure projects and therefore negatively affect their businesses and profitability.
　　Valuation
　　Reiterate BUY on China Telecom as our Chinese telco top call, raising target price from HK$4.85 to HK$5.70 as we extend our target fair value from DCF end 2023E to 2024E, maintaining risk free assumption of 5.0% unchanged.
　　Our revised target price of HK$5.70 is about 1x P/B 2023E with expected dividend yield of 7.5% in 2024E based on our estimated earnings and 70% dividend payout.
　　We see the H-share to have ample room for further upgrade despite 33.4% YTD performance thanks to their solid 1H results and improving dividend, and expect further upside to be priced in when Tianyi Cloud’s operating and financial performance become clearer, while market confidence on their cloud operation will materialise with reasonable valuation comparable to none-telco cloud companies. Assuming Tianyi’s Cloud revenue to reach RMB100bn as management guided, 5x P/S 2023E will indicate a market valuation of RMB500bn, on par with the Group’s current valuation at HK$536bn.