November 5, 2007

Mr. Tom Jones

Division of Corporation Finance

Securities and Exchange Commission

100 F Street, N.E., Mail Stop 6010

Washington D.C. 20549

U.S.A.

Registration Statement on Form S-1

Filed on September 28, 2007

File No. 333-146377

Dear Mr. Jones:

On behalf of our client, MEMSIC, Inc. (“Memsic” or “the Company”), set forth below are the Company’s responses to your comment letter dated October 25, 2007 (the “Comment Letter”) with respect to the above-referenced Registration Statement on Form S-1 (the “Registration Statement”) filed with the Securities and Exchange Commission (the “Commission”) on September 28, 2007. We are also providing you in hard copy form a copy of Amendment No. 1 to the Registration Statement (“Amendment No. 1”), with exhibits to show changes made to the Registration Statement filed on September 28, 2007.

We would like to bring to your attention that in addition to the revisions made in response to the Staff’s comments, Amendment No.1 includes the Company’s September 30, 2007 interim financial statements and updated quarterly financial information.

For your convenience, we have reproduced the comments from the Commission’s staff (the “Staff”) in the order provided followed by Memsic’s

Mr. Tom Jones

Securities and Exchange Commission

November 5, 2007

RE: MEMSIC, Inc. S-1 Registration Statement (File No. 333-146377)

Page 2

corresponding response. All references in Memsic’s responses to pages and captioned sections are to Amendment No.1 to the Registration Statement as filed today. Capitalized terms used in this letter and not otherwise defined herein have the meaning ascribed to them in the prospectus included in Amendment No. 1.

Prospectus Cover Page

The Company will provide all non-Rule 430A information in a subsequent amendment to the Registration Statement prior to the circulation of any preliminary prospectus and acknowledges that the Staff may have additional comments thereafter.

The Company has provided the artwork it intends to use as Exhibit A hereto. The Company intends to use the artwork in the inside front cover of the prospectus.

The Company has deleted the reference to “Sole Book-Runner” on the cover page of the prospectus.

Overview, page 1

Mr. Tom Jones

Securities and Exchange Commission

November 5, 2007

RE: MEMSIC, Inc. S-1 Registration Statement (File No. 333-146377)

Page 3

In response to the Staff’s comment, the Company sets forth below independent sources of information to support each of the statements relating to the Company’s leadership and market standing. None of the cited reports or data was commissioned by the Company.

According to page 8 of Wicht Technologie Consulting feature article of May 2006 (Issue 2, Volume 1), commercialization of accelerometers in mobile phones began in 2003. See Exhibit B. The Company commenced sales of accelerometers in 2003 and sold 543,000 units of accelerometers to mobile phone manufacturers in 2004. Since 2005, the Company’s revenue from mobile phone applications has grown primarily in the China market. Sales to China mobile phone manufacturers through distributors increased from $0.3 million in 2005, to $6.2 million in 2006, and to $9.3 million in the first nine months of 2007.

In addition, the Company’s current largest end-customer is Tianyu, who according to iSuppli, is the third largest China based handset OEM. See Exhibit C. Tianyu has been a customer of the Company since 2006 and the Company believes Tianyu was one of the pioneers in the China market to introduce accelerometer-based features such as motion games and pedometers.

According to a report from Bear Stearns published in December 2006, shipments of mobile handsets in China increased from 36.4 million units in 2000 to an estimated 143.8 million units in 2006, representing a compound annual growth rate of 31.6%. See page 34 of Exhibit D.

According to page 12 of IDC report titled Worldwide Projector 2007-2010 Forecast and Analysis, total worldwide projector shipments were 4.79 million units in 2006. In the same year, the Company shipped approximately 1.24 million accelerometers (or approximately 26% of worldwide total) for projector usage. See Exhibit E. Most of the Company’s products were provided to prominent Japanese OEMs such as Epson, Sony, NEC, Panasonic and Toshiba. The function for projectors that require accelerometers are only incorporated in some higher end projectors, which consequently means that the Company’s market

Mr. Tom Jones

Securities and Exchange Commission

November 5, 2007

RE: MEMSIC, Inc. S-1 Registration Statement (File No. 333-146377)

Page 4

share in this smaller sub-segment is higher than the 26% of the worldwide total for all projectors noted above. Based on this information, the Company supplementally advises the Staff that the Company believes it is the single largest accelerometer provider for the projector market. However, the claims in the prospectus to be merely “among the leading providers” are due to a lack of independent tracking of this sub-segment of the projector market.

The Company supplementally advises the Staff that its customers include IBM, Sony, Mitsubishi and Autoliv Inc., each of which the Company respectfully submits is recognized as a leading international manufacturer.

The Company further supplementally advises the Staff that its China-based customers include Tianyu and Bird. According to a news article published in the Shanghai Daily on October 26, 2007 quoting a recent iSuppli report, Tianyu and Bird are expected to be the third and fourth, respectively, largest OEM handset makers in China in 2007 based on units sold. See Exhibit C.

The Company supplementally advises the Staff that the customer being referred to is Autoliv Inc., which the Company respectfully submits is recognized as a leading European automotive safety systems supplier.

Moreover, Datamonitor, an independent provider of online database and analysis services for key industry sectors, also states that Autoliv Inc. is a leading supplier of safety systems to the global automotive industry – page 5 of Autoliv Inc. Company Profile (publication date: January 2007, reference code: 4268). See Exhibit F.

According to a press release dated October 16, 2007 from Frost & Sullivan, an independent market research firm, the Company’s accelerometers (a) can withstand a theoretical shock limit of over

Mr. Tom Jones

Securities and Exchange Commission

November 5, 2007

RE: MEMSIC, Inc. S-1 Registration Statement (File No. 333-146377)

Page 5

50,000 g which is over five times that of traditional accelerometers; and (b) have the lowest failure rate for any device in its class.

The same press release also notes that the Company has a competitive edge over other MEMS inertial sensor manufacturers in terms of performance versus price. See Exhibit G.

On page 8 of the Wicht Technologie Consulting feature article, it is stated that the Company provides the lowest cost solution for 2-axis sensors. See Exhibit B.

The Company has updated and amended the disclosure on pages 1 and 38.

The Company supplementally advises the Staff that the Company has amended references to Autoliv Electronics in the disclosure to Autoliv Inc., parent company of Autoliv Electronics.

The Company also supplementally advises the Staff that Autoliv Inc. has historically been, and continues to be, the Company’s largest customer for automotive applications, and has accounted for a significant majority of the Company’s revenue for automotive application products during the periods presented in the financial statements. The Company has revised the disclosure to clarify the relevant statements on pages 1 and 62.

Industry Overview, page 2

Mr. Tom Jones

Securities and Exchange Commission

November 5, 2007

RE: MEMSIC, Inc. S-1 Registration Statement (File No. 333-146377)

Page 6

Also, tell us about any other relationship between you and the authors of the data.

The sources of the third-party data included in the prospectus are from: (1) the Frost & Sullivan Report on World MEMS Sensors Markets (the “Frost Report”), attached hereto as Exhibit H; and (2) the Quote Indemnification Agreement with Gartner, Inc. (the “Gartner Agreement”), attached hereto as Exhibit I. The relevant sections of the reports have been marked and keyed to the disclosure. The data in these two sources are publicly available, were not commissioned by the Company and were not prepared for use in the Registration Statement. Frost & Sullivan and Gartner, Inc. have consented to the Company’s use of their names and data. There are no relationships between the Company and the authors of these two reports.

Risk Factors, page 10

In response to the Staff’s comment, this information has been moved from page ii to page 5.

We depend and expect to continue to depend on a limited number, page 12

The Company respectfully submits that both the Company and its customers consider the identities of such customers to be highly confidential and commercially sensitive. In addition, the Company believes that, to prospective investors, the identities of its customers are of significantly less importance than a qualitative and quantitative description of the profiles of the Company’s largest customers and the extent to which revenue from such customers are relied upon. The Company believes that the current disclosure on pages 12, 40 and 72 is sufficient. Accordingly, the Company proposes not to specifically identify its largest customers in the prospectus.

Failure of suppliers to deliver on a timely basis, page 14

Mr. Tom Jones

Securities and Exchange Commission

November 5, 2007

RE: MEMSIC, Inc. S-1 Registration Statement (File No. 333-146377)

Page 7

Mr. Tom Jones

Securities and Exchange Commission

November 5, 2007

RE: MEMSIC, Inc. S-1 Registration Statement (File No. 333-146377)

Page 8

For the foregoing reasons, the Company respectfully submits that its purchase orders and quotations with its ceramic packaging materials suppliers and written agreement with its third party packaging service provider are not “material contracts” within the definition of Item 601(b)(10) of Regulation S-K, and as a result, are not required to be filed as exhibits.

Use of Proceeds, page 32

In response to the Staff’s comment, the Company has revised the disclosure on page 32 to state the approximate amount intended to be used for each purpose.

Capitalization, page 34

In response to the Staff’s comment, the Company has revised the disclosure on page 34.

In response to the Staff’s comment, the Company has revised the disclosure on page 34 to separately show a column for the pro forma effect of the conversion of the preferred shares.

Critical Accounting Policies, page 45

In response to the Staff’s comment, the Company has revised the disclosure on page 123 to identify Orchard Partners, Inc. as an expert and has filed its consent as an exhibit to Amendment No. 1.

Mr. Tom Jones

Securities and Exchange Commission

November 5, 2007

RE: MEMSIC, Inc. S-1 Registration Statement (File No. 333-146377)

Page 9

Stock-Based Compensation, page 47

The Company respectfully submits to the Staff that the Company and its underwriters do not presently have such information which would enable them to derive a sufficiently accurate estimated IPO price or price range for disclosure in the prospectus. However, as soon as an estimated IPO price or price range is determined, the Company will submit to the Staff its response to this question as well as the corresponding revision in the prospectus. The Company recognizes that the Staff will require a reasonable amount of time to review such amendments prior to considering any request for effectiveness.

Results of Operations, page 52

Six months ended June 30, 2007 compared to the six months ended June 30, 2006

Net Sales, page 52

In response to the Staff’s comment, the Company has added disclosure to quantify the impact of the increase in quantity sold and the decline in average selling prices of its products on net sales on pages 52 and 54.

Mr. Tom Jones

Securities and Exchange Commission

November 5, 2007

RE: MEMSIC, Inc. S-1 Registration Statement (File No. 333-146377)

Page 10

In response to the Staff’s comment, the Company has added disclosure to provide reasons for the change in revenues from material customers on pages 52 and 54.

Research and Development, page 53

In response to the Staff’s comment, the Company has revised the disclosure on pages 53 and 54.

Sales and Customers, page 70

The Company supplementally advises the Staff that the distribution agreements entered into by the Company and its distributors have been generally based on the Company’s form, and consequently contain substantially similar terms and conditions. The Company has filed as exhibits its distribution agreements with its largest distributor customer, World Peace Industrial Co., Ltd, or WPI. Please see Exhibits 10.3A and 10.3B as previously filed. In 2006 and for the nine months ended September 30, 2007, WPI accounted for 34.6% and 45.7%, respectively, of the Company’s total net sales. The Company has amended the disclosure to clarify that the description on pages 71 and 72 summarizes the material terms of the Company’s distribution agreements.

The Company supplementally advises the Staff that it generally does not enter into long-term agreements with its OEM and ODM customers. Sales to these customers are solely documented in quotations. The Company enters into these quotations in the ordinary course of its business. The Company has amended the disclosure to summarize the material terms of the quotations on page 72. Because these quotations are made in the ordinary course of the Company’s business, and the terms and conditions contained in each quotation apply only to a single transaction, the Company respectfully submits that its quotations with its OEM and ODM customers are not “material contracts” within the definition of Item 601(b)(10), and as a result, are not required to be filed as exhibits.

Mr. Tom Jones

Securities and Exchange Commission

November 5, 2007

RE: MEMSIC, Inc. S-1 Registration Statement (File No. 333-146377)

Page 11

Wafer Production, page 72

In response to the Staff’s comment, the Company has revised its disclosure to expand the discussion of the material terms of its agreements with TSMC and its two other foundry service providers on page 73.

The Company supplementally advises the Staff that with respect to the Company’s agreement with TSMC, the Company does not enter into long-term agreements with TSMC and places orders solely on a purchase order basis. Such information has been disclosed on pages 13 and 73. The Company enters into these purchase orders in the ordinary course of its business. The Company further supplementally advises the Staff that, although TSMC has to date produced substantially all of the wafers used by the Company in its products, the Company’s wafers use a standard CMOS process. See pages 1 and 62 for further discussion of the standard CMOS process. Accordingly, the Company believes that it is not “substantially dependent” on its relationship with TSMC.

With respect to the Company’s agreements with its two other foundry service providers, the Company supplementally advises the Staff that, orders placed under these agreements totaled $16,041 in 2006 and $88,562 for the nine months ended September 30, 2007, and are therefore insignificant compared to orders placed with TSMC. The Company supplementally advises the Staff that it does not believe purchases under these contracts will become a major part of its wafer requirements for the foreseeable future. Accordingly, the Company believes that it is not “substantially dependent” on its relationship with these foundry service providers.

For the foregoing reasons, the Company respectfully submits that its purchase orders with TSMC and agreements with the two other foundry service providers are not “material contracts” within the definition of Item 601(b)(10) of Regulation S-K, and as a result, are not required to be filed as exhibits.

Compensation Discussion and Analysis, page 88

Mr. Tom Jones

Securities and Exchange Commission

November 5, 2007

RE: MEMSIC, Inc. S-1 Registration Statement (File No. 333-146377)

Page 12

available on our website, for specific guidance in the preparation of this discussion. In addition to the specific comments that follow, please consider this report in providing a more fulsome compensation discussion and analysis in your amended filing. We may have further comment.

The Company has considered the guidance in Staff Observations in the Review of Executive Compensation Disclosure dated October 9, 2007 with respect to its responses herein and the Company has revised the “Compensation and Discussion and Analysis” in accordance therewith.

Elements of Compensation, page 89

In response to the Staff’s comment, the Company has provided additional disclosure on page 90. In addition, the Company has included a copy the 2006 Compensation & Entrepreneurship Report in Information Technology as Exhibit J hereto for the Staff’s reference.

In response to the Staff’s comment, the Company has provided additional disclosure on page 90.

Discretionary annual bonus, page 89

Mr. Tom Jones

Securities and Exchange Commission

November 5, 2007

RE: MEMSIC, Inc. S-1 Registration Statement (File No. 333-146377)

Page 13

In response to the Staff’s comment, the Company has provided additional disclosure on pages 91 and 92.

In response to the Staff’s comment, the Company has revised disclosure on pages 91 and 92.

Long term incentives, page 90

In response to the Staff’s comment, the Company has revised the disclosure to include the requested discussion on pages 92 and 93.

Grants of plan-based awards in 2006, page 91

Mr. Tom Jones

Securities and Exchange Commission

November 5, 2007

RE: MEMSIC, Inc. S-1 Registration Statement (File No. 333-146377)

Page 14

In response to the Staff’s comment, the Company has clarified its disclosure on page 94. The Company notes that none of the options in respect of 50,000 shares granted to Ms. Niu on November 9, 2006 at an exercise price of $0.77 shown in the table titled “Grants of plan-based awards in 2006” on page 94 had vested as of December 31, 2006. The shares referenced by footnote (1) on page 95 relates to the option granted on September 25, 2003 with an exercise price of $0.15, which had vested as of December 31, 2006. Such options were exercised by Ms. Niu in 2006.

2000 Omnibus Stock Plan, page 92

In response to the Staff’s comment, the Company has revised the disclosure on page 96.

2006 Director compensation, page 98

The options issued to Messrs. Blethen and Zavracky did not fully vest in 2005 and the Company has revised the disclosure on page 101 to provide greater clarity.

Certain Relationships and Related Party Transactions, page 99

In response to the Staff’s comment, the Company has revised the disclosure on page 102.

Relationship with InveStar and TSMC, page 101

In response to the Staff’s comment, the Company has revised the disclosure to provide such information on page 104.

Mr. Tom Jones

Securities and Exchange Commission

November 5, 2007

RE: MEMSIC, Inc. S-1 Registration Statement (File No. 333-146377)

Page 15

Policies and Procedures for Related Party Transactions, page 101

In response to the Staff’s comment, the Company has revised the disclosure on page 104.

Principal and Selling Shareholders, page 102

Please revise as appropriate.

The Company supplementally advises the Staff that currently no selling shareholders have been identified. The Staff’s comment is noted and the Company will provide this information in a subsequent amendment to the Registration Statement if selling shareholders are identified. The Company recognizes that the Staff will require a reasonable amount of time to review such amendments prior to considering any request for effectiveness.

Please refer to our response to comment 34.

Common Stock, page 106

In response to the Staff’s comment, the Company has provided disclosure on the number of holders of its common equity on page 109.

Mr. Tom Jones

Securities and Exchange Commission

November 5, 2007

RE: MEMSIC, Inc. S-1 Registration Statement (File No. 333-146377)

Page 16

Consolidated Financial Statements

In response to the Staff’s comment, the Company has updated the financial statements and related disclosure throughout the prospectus.

Note 3. Summary of Significant Accounting Policies, page F-I0

Note 10. Stock Incentive Plan, page F-22

Determination of Fair Value of Common Stock, page F-22

In response to the Staff’s comment, the Company has supplementally provided the requested schedule as Exhibit K which includes the compensation recorded for each of these issuances reconciled to the amounts recorded in the financial statements and the common shares issued during those periods.

The Company supplementally advises the Staff that the Series D financing was completed in December 2006. However, the Series D preferred shares were issued on December 2006 and April 2007 because closing of the transaction and subsequent payment and transfer of the shares with one investor was delayed until April 2007.

The Company further supplementally advises the Staff that, under the probability weighted expected returns method, or PWERM, the Company considered the value of the Series D preferred shares as well as the value of common shares in each scenario of (i) an initial public offering, or IPO; (ii) sale above the liquidation

Mr. Tom Jones

Securities and Exchange Commission

November 5, 2007

RE: MEMSIC, Inc. S-1 Registration Statement (File No. 333-146377)

Page 17

preference; (iii) sale at or below the liquidation preference; and (iv) remaining private. For the IPO and sale above liquidation preference scenarios, the Company discounted the future values indicated for Series D preferred shares and common shares to present value. In three of the four scenarios, the Company assumed conversion of the Series D preferred shares to common stock. The Company weighted each scenario according to an assessment of its probability and took into account that the probability weighting should approximate a price for the Series D preferred shares to the price paid for such shares in a market transaction. In aggregate, the three scenarios which indicated conversion to common were assigned a probability weighting of 70%. The value derived from such calculation for the Series D preferred shares as of December 31, 2006 was close to the price paid for those shares on December 22, 2006. The same scenarios and probability weightings provided a basis for valuing the common stock.

The Series D preferred shares are convertible into common stock, initially on a one-for-one basis. However, the Series D preferred shares are valued at a premium over the common shares because holders of the Series D shares are entitled to the following preferential terms:

The Company supplementally advises the Staff that the business events it considered in determining the fair value of its common

Mr. Tom Jones

Securities and Exchange Commission

November 5, 2007

RE: MEMSIC, Inc. S-1 Registration Statement (File No. 333-146377)

Page 18

stock include the Company’s historical financial performance, changes in our estimates of future performance, the risks associated with achieving these results, the trading prices of public companies that are, in material respects, comparable to the Company, the prices paid to acquire companies that are, in material respects, comparable to the Company, and the expected timing of a future liquidity event, such as an IPO or sale. The Company has increased its estimates of the fair value of its common stock as its financial performance has improved and as it has progressed toward a successful liquidity event.

For the period from November 1, 2006 to March 1, 2007, the estimated fair value of the Company’s ordinary shares increased from $1.47 per share to $1.61 per share due to the following factors:

For the period from March 1, 2007 to April 26, 2007, the estimated fair value of the Company’s ordinary shares increased from $1.61 per share to $1.85 per share due to the following factors:

For the period from April 26, 2007 to July 26, 2007, the estimated fair value of the Company’s ordinary shares increased from $1.85 per share to $3.42 per share due to the following factors:

Mr. Tom Jones

Securities and Exchange Commission

November 5, 2007

RE: MEMSIC, Inc. S-1 Registration Statement (File No. 333-146377)

Page 19

For the period from July 26, 2007 to August 22, 2007, the estimated fair value of the Company’s ordinary shares increased from $3.42 per share to $3.82 per share due to the following factors:

For the period from August 22, 2007 to September 30, 2007, the estimated fair value of the Company’s ordinary shares increased from $3.82 per share to $4.97 per share due to the following factors:

The Company has re-calibrated its estimates as necessary based on business events which provide independent indicators of the value of its shares. On December 22, 2006, it completed a Series D preferred stock financing priced at $2.20 per Series D share. The issuance of Series D preferred shares provided an opportunity for the Company to evaluate its estimated probabilities for future liquidity events. For its December 31, 2006 retrospective determination of fair value, the Company selected probabilities which generated a value for the Series D preferred shares which was consistent with the Series D price of $2.20 per share.

Mr. Tom Jones

Securities and Exchange Commission

November 5, 2007

RE: MEMSIC, Inc. S-1 Registration Statement (File No. 333-146377)

Page 20

The Company supplementally advises the Staff that in the first week of June 2007, prospective bookrunning underwriters provided it with their preliminary assessments of the value of the Company in an IPO. The range of values was very wide because of differences in assumptions regarding the timing of an IPO, the Company’s future performance and the selection of comparable companies. Based on these assessments, the Company assumed a higher probability of achieving an IPO by March 2008.

The Company has engaged Orchard Partners, Inc., an independent third party, to prepare retrospective and contemporaneous valuation since February 2006 to support management estimates of the fair value of the options granted. The fair market value of the Company’s common stock was estimated using a probability-weighted analysis of the present value of the returns afforded to its shareholders under each of four possible future scenarios: (i) an initial public offering, or IPO; (ii) sale above the liquidation preference; (iii) sale at or below the liquidation preference; and (iv) remaining private.

As of November 9, 2006, the Company estimated the fair value of its common stock at $1.47 per share which was supported by a retrospective appraisal performed by Orchard Partners, Inc. The Company maintained the probability of an IPO in March 2008 at 23% and the discount rate at 25%. Factors which contributed to an increase in the estimate of fair value were (a) continued revenue growth of more than 40% from the previous year and (b) shorter discount timeframe for a successful liquidity event.

As of December 31, 2006, the Company estimated the fair value of its common stock at $1.61 per share which was supported by a retrospective appraisal performed by Orchard Partners, Inc. The Company maintained the probability of an IPO in March 2008 at 23% and the discount rate at 25%. Using the same probabilities to value the Series D shares, the Company reached the same price of $2.20 per share as paid by the Series D investors on December 22, 2007. The key factor which contributed to an increase in the estimate of fair value of the common stock was the closing of the Series D financing round.

Mr. Tom Jones

Securities and Exchange Commission

November 5, 2007

RE: MEMSIC, Inc. S-1 Registration Statement (File No. 333-146377)

Page 21

As of March 31, 2007, the Company estimated the fair value of its common stock at $1.85 per share which was supported by a contemporaneous appraisal performed by Orchard Partners, Inc. The Company increased the probability of an IPO in March 2008 to 25% and maintained the discount rate at 25%. Factors which contributed to an increase in the estimate of fair value include: (a) over a 100% growth in revenue in the first quarter of 2007 as compared with the same period in 2006; and (b) the hiring of the Vice President of Marketing and Business Development.

As of June 30, 2007, the Company estimated the fair value of its common stock at $3.42 per share which was supported by a retrospective appraisal performed by Orchard Partners, Inc. The Company raised the probability of an IPO in March 2008 to 60% and decreased the discount rate to 20%. This probability reflected favorable meetings with underwriters in the first week of June 2007. Additional factors which contributed to an increase in the estimate of fair value include: (a) initial discussions with prospective underwriters about a potential IPO; (b) revenue growth of 67% and net income growth of 89% in the second quarter of 2007 as compared with the same period in 2006; and (c) the hiring of the Chief Financial Officer and Vice President of Engineering.

As of August 22, 2007, the Company estimated the fair value of its common stock at $3.82 per share which was supported by a contemporaneous appraisal performed by Orchard Partners, Inc. The Company increased the probability of an IPO in March 2008 to 70% and decreased the discount rate to 18%. Factors which contributed to an increase in the estimate of fair value include the Company’s financial performance and progress toward a successful liquidity event.

The Staff’s comment is acknowledged.

Mr. Tom Jones

Securities and Exchange Commission

November 5, 2007

RE: MEMSIC, Inc. S-1 Registration Statement (File No. 333-146377)

Page 22

Valuation of Stock Options, page F-24

In response to the Staff’s comment, the Company has revised the disclosure to provide such information on page F-25.

Note 14. Commitments and Contingencies, page F-31

Licensing Agreement and Marketing Agreements, page F-31

The Company respectfully advises the Staff that the technology which the Company obtained in 1999 was neither mature nor complete at that time. The technology had to be significantly developed or enhanced before the Company was able to use it in its production. Therefore, the Company historically classified the royalty expense related to this technology as general and administrative expenses rather than cost of sales. The Company believes the royalty expenses are immaterial to gross margin and to general and administrative expenses. Please see the table below. Since the royalty expenses are capped at $100,000, such amounts will diminish as a percentage of revenue and general and administrative expenses as our business continues to grow. The Company does not expect to enter into any significant licensing arrangements in the future.

Mr. Tom Jones

Securities and Exchange Commission

November 5, 2007

RE: MEMSIC, Inc. S-1 Registration Statement (File No. 333-146377)

Page 23

Recent Sales of Unregistered Securities, page II-2

In response to the Staff’s comment, the Company has provided additional disclosure on page II-2.

Undertakings, page II-3

In response to the Staff’s comment, the Company has amended the disclosure to provide such undertakings on page II-3.

Exhibit 23.1

The Staff’s comment is acknowledged and the Company will provide this in a subsequent amendment to the Registration Statement prior to requesting effectiveness. The Company has included a currently dated and signed consent from its independent auditors for purposes of this filing.

*********

Mr. Tom Jones

Securities and Exchange Commission

November 5, 2007

RE: MEMSIC, Inc. S-1 Registration Statement (File No. 333-146377)

Page 24

We appreciate the Staff’s agreement to review this letter and the Company’s Registration Statement. Please feel free to contact the undersigned in Hong Kong at the office: (852) 3740-4780, at home: (852) 2803-1823, or mobile phone: (852) 9460-8675 if you wish to discuss the Company’s revised submission.

David Lau, Citigroup Global Markets

John D. Young, Jr., Sullivan & Cromwell LLP

Edward Nelson, Ernst & Young

Exhibit A

MEMSIC

Exhibit B

Your Experts in Microtechnology and Electronics.

Think Small wtc Issue 2 volume 1 May 2006

The newsletter covering the frontiers of MEMS, optronics and nanotechnology

Published by WTC — Wicht Technologie Consulting

Contents

Editorial 2 MEMS News 2 Nanotechnology News 5 Optotechnology News 6 Feature Article 1, 8 “MEMS Inertial sensors” Interview 11 with Yang Zhao, CEO Memsic Events 12

Contributing staff: Henning Wicht. Jéremie Bouchaud, Olivier Nowak Richard Dixon, Bernardo Knoblich, Stefan De Haan

MEMS Inertial Sensors Go Consumer

by Richard Dixon and Jérémie Bouchaud

The market for MEMS inertial sensors (accelerometers and gyroscopes) is set to grow from $835 million in 2004 to over $1360 million in 2009 —a CAGR of 10%. Currently, the main applications are in the automotive industry. These markets are well established and growth rates range from a stagnant 1% for airbag acceleration sensors up to 8% for gyroscopes used in ESP units and GPS navigation assistance. Exciting for MEMS inertial sensors is the market opportunity for mobile applications and consumer electronics (see table on page 8). Over the next few years, we predict annual growth rates exceeding 30% for accelerometers. Mobile phones in particular will provide multi-axis accelerometers with interesting opportunities in menu navigation, gaming, image rotation, pedo-meters, GPS navigation and the like. Gyroscopes are largely servicing markets for image stabilization and HDD protection in camcorders. In contrast to the automotive sector, consumer applications feature relaxed specifications. Failure rates for automotive electronic control units (Ecu) that house airbag accelerometers must be less than 50 ppm, and down to a few ppm for ASIC5. Car manufacturers deploy reliable, high performance accelerometers that are relatively expensive (up to $5 to measure lateral acceleration in ESP units, for example). Mobile phones manufacturers on the other hand tolerate failure rates of 5000 ppm. Active control of the car motion is critical to safety whereas failure in consumer applications result more in an inconvenience. Sensor manufacturers can therefore sacrifice some accuracy and reliability to lower the price. (continued page 8) 800 $ millions 600 Gyroscopes Other Aerospace Accelerometers Accelerometers 400 Gyroscopes over 2004 200 Consumer & IT ;•33% CAGR over 2004 ra <1% CAGR over 2004 Automotive — 0 +8% CAGR over 2004 2004 Market for MEMS inertial sensors 2004—2009 2009 Li

Industry Quote

“In consumer electronics, the tolerance on all specifications [for accelerometers] is 10 to 20% and 4 to 8-bit accuracy are all that is needed. This compares to 1% tolerance and 12 to 14-bit accuracy in the automotive segment.” —Yang Zhao, CEO Memsic, see his interview page 11

WTC Wichtlechnologie Consulting Think small! issue 2, volume 1 May 2006 Page 1

Your Experts in Microtechnology and Electronics. wtc

Editorial

Dr. Henning Wicht, CEO

Why so much difference between the MEMS market forecasts? This question came up time and again—and several times at Semicon Europa this April. We had presented the NEXUS figures for MST!MEMS and Yole Development presented its figures for MEMS. Shortly thereafter InStat released a new MEMS market report. But do these forecasts measure the same thing? To compare apples with apples, you need to remove the value of the read-write (Rw) heads market from the NEXUS figures. Read-write heads account for half of the total market value in the NEXUS report but they are not accounted for in the other two reports. Yole also did not include growing polymer microsystems in its figures. Once you do remove the read- write heads, the figures are amazingly similar. The MEMS market was valued around $6bn to $7bn in 2005 and will be around $lObn to $l2bn at the end of the decade. There is also a consensus on major trends:

• Inkjet heads are stagnating.

• Inertial sensors keep growing now driven by consumer applications.

• DLP are growing in spite of strong price erosion.

• Microphones are skyrocketing. But those who would miss animated panel discussions need not worry. Whereas we and Yole Development agree on a 15–16% CAGR for the coming years, InStat forecasts a more modest 6.8% per year until 2010. We are more optimistic than others about the development of the RF-MEMS and MEMS microphones markets. They are more optimistic than us about micro bolometers and liquid lenses. Market forecasting is not an exact science and there will always be room for debate. That’s what makes our job interesting.

MST/MEMS market forecasts from NEXIS, Yole Development and InStat

Microsystem News

Micropelt forms company

Micropelt, a startup of the Fraunhofer Institute for Physical Measurement Techniques (Freiburg, Germany) that manufactures thin- film micropeltier coolers, is now a company. Funding is being provided by a number of institutions, including Infineon Semiconductor.

WTC comment: Micropeltiers join other technologies being considered for chip cooling, including spraying, ion drive airflow, electrokinetic pumps, liquid metal, thermotunnel effect and even nanotubes. According to NEXUS, there is currently no market for cooling devices, although a small opportunity worth $75 million could exist by 2009.

RF-MEMS resonators take on quartz timing market

SiTime has begun sampling a range of MEMS oscillators for consumer product timing applications. The SiT ixxx-series and SiT8002 generate frequencies from ito 125 MHz and are housed in with a CMOS driver in QFN-type packages that measure 2 x 2.5 x 0.85 mm3. Target applications are quartz oscillators in digital still cameras, portable media players and notebook computers, says the company. Eventually SiTime aims to penetrate the high end quartz oscillator market for signal references in cell phones. (continued next page) if Editorial Dr. Henning Wicht, CEO d Peltier coolers MST/MEMS market forecasts from N EXUS, Yole Development and I nStat $25bn NEXUS (includes RW heads) NEXUS (without RW heads) InStat Yole Development (does not include polymer)

$2Obn $l5bn $1 Obn $5bn $Obn 2004 2005 2006 2007 2008 2009 2010 WTC WichtlechnologieConsulting . ThinksmalH issue2,volumel . May2006 Page 2

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(continued from previous page) MEMS oscillators are tunable, and are significantly smaller and less susceptible to shock and vibration than quartz technology. SiTime claims that the company’s innovative wafer-scale packaging solution makes it competitive on price. This packaging technology is licensed from Bosch and is compatible with CMOS processing. It involves placing resonators on top of an SOT wafer and encapsulating with an epitaxial layer of silicon, facilitating sealing at high temperatures and creating a barrier to moisture. Currently, SiTime’s resonators are two-chip devices, which is a result of the economics of real estate required.

WTC comment: SiTime is one of three us start-ups currently active in RF-MEMS frequency control and timing applications. Discera will ramp resonators (serial production end 2006 or start of 2007), and Silicon Clocks will sample this year. Other larger players are Philips, Freescale and ST. The clock oscillator opportunity is $4 billion. While temperature stability, packaging have found solutions, some industry doubts will dissipate when serial production starts at Discera.

RF-MEMS switches go global

TeraVicta Technologies has chosen Richardson Electronics to globally distribute its RF-MEMS switches. They provide a combination of low insertion loss, high isolation, high linearity, size, power consumption and production advantages compared to equivalent GaAs FET and PiN diodes. Applica tions include automated test equipment (ATE), instrumentation, RF!wireless communications and RF switching. “Our patented, hermetic in-line chip- scale package is designed to improve RF performance and reduce cost by eliminating wire-bonds and leads”, said John Chimoures, vp of worldwide sales. Chimoures added that performance and cost advantages will drive markets for high-performance multi-mode / multi-band devices.

WTC comment: RF-MEM5 switches have been available from Matsushita Electric Works since October 2005, while Advantest has implemented its own RF-MEM5 relays into ATE equipment since late 2005. We expect an $80m market for RF-MEM5 switches in ATE andRF test in 2010.

RF MEMS Market II 2005-2009

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ST and ADI accelerometers power Nintendo controller

Nintendo has unveiled its new console that uses 3-axis accelerometers in the controllers. Tilt measurements allow players to move characters in the game, while the 3-axis acceleration sensing transforms the controller (that can be held in one hand) into a virtual sword, gearshift or musical instrument. The system comprises a main and a freestyle controllers, each using a motion sensor. Am is supplying the accelerometer for the main controller; and ST’S accelerometer won the socket for the freestyle unit. The Wii console will be available in the us at the 4th quarter of this year.

(Credit: Nintendo)

Controllers for the newWn Nintendon console

WTC comment: ADI’s 2-axis accelerometer has long been used in game cartridges for Nintendo’s Game Boy Advance. Sony disclosed that its Playstation 3 will include a videogame controller equipped with a 6-axis sensing system.

Methode and SensorDynamics cooperate on automotive

Methode Electronics International GmbH (Gau-Algeshiem, Germany) and SensorDynamics AG (Graz-Lebring, Austria) have agreed to cooperate on development and manufacturing of smart sensors. The partnership will leverage Methode’s expertise in sensor modules and eddy current inductive sensing and SensorDynamics’ modules and MEMS-based sensors, which include inertial devices and heat resistors. The technology will initially be developed for automotive and eventually industrial applications. The partnership has already sealed an order from a Japanese OEM, and is working with a major European tier I supplier to launch the program in May 2007.

WTC comment: SensorDynamics worked with the Fraunhofer Institute for Silicon Technology on a gyroscope using surface micromachined thick poly-Si and wafer level encapsulation — this product is initially targeting automotive applications such as ESP and navigation.

Automotive markets for gyroscopes will grow at around 8% annually to reach over $510m in 2009.

HDD hits density of 170 Gb/in2

Alps will begin production of hard disc drives (Hun) with 170 Gb/in2 at its plants in Japan and China in mid-2006. The new drives employ tunneling magneto resistive perpendicular thin-film heads — a structure consisting of a few nano-meters of insulating layer sandwiched between highly magnetic layers. Under an applied magnetic field, this structure exhibits a tunnel effect in which an electric signal runs through the insulating body. The thin insulation layer endows low resistance and stability.

Applications include 1.0” (and smaller) to 3.5” HDD for Pcs, DVD recorders, car navigation systems, MP3 and cell phones.

WTC comment: Small-format HDD5 boost the market for RW heads. According to NExus, HDD in phones, cameras, TV recorders, MP3 players jump from $180m in 2004 to $3bn in 2009. MiniHDD and Flash will coexist in mobile TV phones and iPod players. Small format HDD also drives 3D accelerometer markets (free-fall detection).

Philips spin-out is planning electrowetting mobile displays

Philips Research and New Venture Partners LLC announced a spin-out company to commercialize electrowetting displays invented by Philips Research.

Cyan clock with a 2.5” diagonal. (160 dpi pixels)

Liquavista B.V. will commercialize the technology for MP3 players, watches, cameras, mobile phones, DVD players, and automotive applications and enable new markets for Tv-on-mobile. The company claims the new displays will “revolutionize” the mobile display market with bright vivid colours and video viewable in bright sunlight, in addition to substantial power savings over existing technologies. Manufacturing is compatible with existing LCD infrastructure, says the company. Demonstrations are planned for the upcoming Society for Information Display exhibit in San Francisco on June 6—8, 2006.

WTC comment: Electrowetting displays are part of a group ofMsT reflective display technologies, e.g. iMoD from Qualcomm. We do not expect electrowetting displays to enter cell phones before 2009 at the earliest.

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Nanotechnology News wtc

Infrared light detector built with nanotubes

US researchers have used carbon nanotubes (CNT) to build an infrared bolometer—a device whose resistance changes with temperature as a function of incoming radiation. The bolometer is made by suspending a 0.5 mm wide film of single-walled carbon nanotubes (swNT) over a 3.5 mm gap between two electrical contacts.

A group led by Professor Robert Haddon at the University of California found the absorption coefficient for the SWNT film was 10 times higher than HgCdTe. The best results were obtained from a 40nm thick film, which exhibited a resistance ratio of 100 at 4.2K and 300K, in addition to a responsivity up to 1000V!W

“We have shown that the introduction of various chemical species — such as octadecylamine and polyamino benzene sulphonic acid — greatly affects the electrical resistivity properties of CNT films:’ said Haddon. Two-dimensional arrays of such devices could find applications in thermal imaging, spectroscopy and astronomy.

WTC comment: Microbolometers are sensitive devices that operate in adverse conditions — an advatange over low cost thermopiles. They cost thousands of dollars which limits their use to medical and military applications. The market will grow at 10% annually to $80m in 2009.

Philips makes molecular electronics breakthrough

Philips Research and the University of Groningen have reported high yields for arrays of molecular diodes fabricated using standard substrates. The molecular diodes, which are as thin as one molecule (1.5 nm) — are suitable for integration into standard plastic electronics circuits, say the researchers, who reported the results in Nature (May 4, 2006 Volume 440, Number 7089).

Although still a relatively new field, molecular electronics is regarded as the evolution of plastic electronics. Instead of employing photolithography or printing techniques to make nano-scale circuit features, molecular electronics relies on 1-2 nm thick organic molecules that spontaneously form the correct structures via self-organisation. To form a cirucit the molecular layer is sandwiched between electrondes, and it is this step that can lead to problems.Many approaches attempt to deposit a metal electrode directly onto LI Scientists from Philips Research and the Dutch University of Groningen holding a molecular dec tronics based diode formed from solution. this monolayer, but shorting occurs due to contacts forming between the electrodes as the layers are so thin. The key to the Dutch technology is the deposition of an additional plastic electrode layer on to the monolayer prior to the deposition of the metallic electrode. The plastic electrode protects the monolayer and enables a improved deposition of a gold electrode.

“Plastic electronics is very promising for the manufacture of electronics where low temperature or low cost in-line processing techniques are required:’ said Dago de Leeuw of Philips Research. Dc Leeuw added that the approach would not compete with siliconic technology.

Scientists from Philips Research and the Dutch University of Groningen holding a molecular electronics-based diode formed from solution.

(Credit Philips)

“Thin” graphite could alter view of electronics

A report in Science Express (an online version of ScienceElectronics Weekly) from April 13 highlights work by American and French researchers which shows that thin layers of graphite-known as graphene- could provide devices “of a kind that don’t really have an analogue in silicon-based electronics”. Graphene has a similar “chicken wire” structure to unrolled carbon nanotubes. The researchers, from Georgia Tech and the Centre National de la Recherche Scientifique (CNRS), hope to demonstrate electronic devices that manipulate electrons as waves rather than particles — a very different way of approaching electronics.

According to Professor Walt de Heer from Georgia Tech’s school of physics, integrated electronic structures would work on diffraction of electrons rather than diffusion, offering very small devices with high efficiencies and low power consumption. In addition, as graphene can be patterned by traditional lithography, it would be better for mass production than nanotubes.

Graphene circuitry employs narrow ribbon structures to confine the electrons using quantum effects similar to carbon nanotubes. The graphene is obtained by baking SiC wafers to remove the Si. Devices are initially produced using spin-coated layers and standard photolithography (see image). The researchers claim a mobility of 25,000 cm2! Vs, compared with 1,500 cm2!Vs for doped Si. r’I

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Optotechnology News.

Startup raises $7.5m for nanotech solar cells

Innovalight, a Santa Clara, CA startup developing nanotechnology-based printed solar cells has been awarded a series B cash injection of $7.5 million. Innovalight will use the funding to develop low-cost solutions for solar cells based on silicon ink technology. Today most solar energy modules are made from costly crystalline Si wafers that are currently in short supply due to semiconductor demand.

Conrad Burke shows off Innovalights solution based nano silicon crystals near Oakland, CA Si particles have direct bandgaps, are tunable and due to their solvent base can be applied using existing cheap roll-to-roll approaches already used for printing film or paper. If proven, says president and CEO Conrad Burke, this method could alter the cost structure for producing solar-generated electricity up to ten-fold. How efficient the crystals are has not been revealed. White OLEDs challenge bulbs US researchers have improved the efficiency of white OLED5 to deliver a peak of 38 lm/W (vs. 15 lm/W for incandescent bulbs). One of the reseachers, Prof. Mark Thompson from the University of Southern California said the same structure could eventually achieve 60 lm/W According to an article in Electronics Weekly (26/04/06), the devices cover the red and green spectrum with phosphorescent molecules and use a fluorophore species for the blue. The fluorophore appears to improve lifetime issues associated with other blue phosphors and which has held up OLED development, say the researchers. Generally, manufacturing costs and lifetimes for white OLED5 remain an open question, but red, green and blue OLED5 outlive incandescent bulbs. Olympus and Movaz joint venture targets optical networks Olympus and Movaz Networks have launched Olympus Microsystems America, to be located in San Jose, CA. The joint venture company will initially service the optical equipment market. Its first product is a compact reconfigurable optical add-drop optical module (bAUM) with MEMS wavelength switch, ASIC5 and optics. The first networks featuring Movaz’s ROADM were deployed last August at NASA Goddard Space Flight Center as well as universities. As part of the jv Movaz will augment patented optical switching technologies and engineering resources with Olympus’ established MEMS foundry services and optical technology. The new entity anticipates sales of $60m in 5 years, and also intends to develop a range of variable optical attenuators, small switches, optical cross connects, aspheric lenses and tunable filters. WTC comment: Olympus’forecast of $60m within 5 years is rather optimistic. NEXUS Iliforecasts MOEMS for telecom to be worth $170m in 2009. Companies such as JDSU, Dicon, Lightconnect and Bookham are already well established. Micro-mirrors eye ophthalmology improvements Physical Sciences has chosen Boston Microsystems (BMC) to supply its multi-deformable mirror for use in an adaptive optics spectral domain optical coherence tomography (AoSDOCT) system. According to the company, the aberration compensation of BMC’s component is said to allow better resolution imaging of the human retina than previously. Multi deformable mirror 0 0 0 WTC comment: There are a number of players supplying micro mirrors for adaptive optics used in ophthalmology: LETI with Mauna Kea Technologies (France), FhG IPMS with Perfect Vision (Germany) and Topcon (Japan). CNT offers promise for printable solar cells Eikos Inc. and the National Renewable Energy Laboratory (NREL) have make a significant step towards fully printable organic solar cells, which are under consideration as a potentially attractive alternative to silicon-based solar cells. Such devices are expected to be cheaper, offer more efficient and flexible manufacturing, and lower

weight. (continued next page) if -. I l-’o_ 0”o • Innovalight’s non-toxic nanosized WTC WichtlechnologieConsulting . ThinksmalH issue2,volumel . May2006 Page 6

Your Experts in Microtechnology and Electronics. Optotechnology news wit Eikos “Invisicon” CNT conductive coatings were used to created organic solar cell structures with an efficiency of 2.6% — competitive with commonly used indium tin oxide (ITo) transparent conductors. Additionally, similar coatings replaced both ITO and PolyEthyleneDiOxyThiophene (PEDOT) commonly used as transparent electrodes in organic cells and demonstrated 1.5% efficiency, as well as further reducing the number of layers and cell costs. According to Eikos, ITO is expensive and optically, electronically and chemically problematic, while PEDOT: PSS is sensitive to moisture and uv, for example. The work is being carried out as part of a us Department of Energy contract, under which NREL!Eikos have also produced a thin-film copper indium gallium diselenide (GIGs) solar cell with a 12.98% energy conversion efficiency. This was achieved by replacing ZnO with GIGS incorporating GNT. “These are exciting developments for the solar community which is now one step closer to achieving a fully printable solar cell:’ said program manager Jorma Peltola. “Our Invisicon technology will provide equal efficiency to conventional cells, at less than half the cost, with less weight and more flexibility:’ GA Tech and Solvay sign $3m deal for OLED research Georgia Institute of Technology’s Center for Organic Photonics and Electronics (GOPE) and Solvay have inked a $3 million deal for OLED research. Solvay, an international chemical and pharmaceutical group with HQ in Brussels, will employ the institute’s modeling, synthesis, fabrication and testing heritage. COPE has developed an OLED platform technology capable of large- area coverage with ink-jet printing and patterning with photolithography. Specifically, exposing the OLED material to uv makes it insoluble and maintains its stability at high temperatures, allowing multi-layered solid-state devices. Multi layered OLED Varioptic receives $20m with 3rd round of financing Varioptic, a company that develops liquid-based autofocus lenses for consumer applications, has received $20 million in its third round of financing, inclding additional backers. CEO Etienne Pail- lard said the company recently obtained full qualification to meet mobile phone industry requirements from a leading camera module manufacturer. Founded in 2002, Varioptic also recently installed a semi-automated pilot production line. Vertilas laser development program gets boost In more funding news, Vertilas, a Bavarian developer of long-wavelength vertical cavity surface emitting lasers (vGsELs), has raised $4.38 million in a third round of VG funding. The com pany’s InP single- and multi-mode diodes operate at 10 Gb/s modulation bandwidths with 3 nm tuning ranges and cover wavelengths spanning 1.3 to 2 im. Applications include telecommunications, gas spectroscopy, tunable diode laser absorption spectroscopy (TDLAS). OLED and paper-like displays to top $10 billion by 2011 Combined sales of OLED5 and paper- like displays will reach $10.2 billion by 2011, says market reserch company NanoMarkets (Glen Allen, VA). Just 2 years later, this market will accelerate even faster to reach $14.7 billion. According to the company, roll-to- roll display production processes are increasingly viable making manufacturing more efficient. In addition, advances in inks and equipment are enabling printed OLED displays, significantly reducing the capital costs associated with display manufacturing. These factors will drive down the total cost. The main applications over the next 5 years are for OLED televisions, a market worth $2.2 billion. OLED5 will take business from LGD5 as color quality and resolution improve to standards necessary for the TV market. A second major market worth $1.7 billion, is serviced by flexible OLED displays that increase the utility of mobile devices like phones and PDA5. Meanwhile, the major market for paper-like displays are shelf-edge displays, which will reach $1.2 billion in revenues. These thin displays will enable retailers to continuously update their product information. Please send your news to: Dr Richard Dixon richarddixon@wtc consulLde an In In WTC WichtlechnologieConsulung . ThinksmalH issue2volumel . May2006 Page 7

Your Experts in Microtechnology and Electronics. Feature Article wtc MEMS Inertial Sensors Go Consumer Continued from page 1 Tn-axis accelerometers for mobile applications At least 10 companies are working on tn-axis MEMS accelerometers, some of which were initially developed for the automotive industry. Three axes sensing is needed to fully describe three-dimensional motion, although certain applications benefit from 2-axis devices if one axis (like the horizon) is assumed fixed or for a simple 2D (tilt) game in a cell phone. With few exceptions accelerometers work by measuring the motion of a proof mass versus a fixed frame or reference. The main sensing approaches are capacitive (e.g. Bosch, Freescale, Kionix, OKI Electric, STMicroelectronics and Analog Devices), piezoresistive (e.g. Hitachi Metals, Matsushita, Fujitsu, and Hokuriku) or less common thermal accelerometers from sole proponent MEMSIC (with 2-axis and 3-axis in development). Each has its advantages but price is the bottom line. Requirements for cell phones Mobile phone integrators want the following attributes from accelerometers: • Small packages, e.g. 3.5 x 3.5 mm2 and 1 mm thick or less • Sensor and signal conditioning ASIC in the same package • Digital output • Power consumption < 3 mW (1 mA @ 3V). Many devices feature a microwatt-level sleep mode to reduce power consumption further • Compatibility with lead- free soldering processes • Availability in volume for $1.35 or less in next 2—3 years. These conditions have already been met. The smallest acceler ometer to date is made by Hitachi Metals, a 3-axis device in a 12 mm3 (3.4 x 3.7 x 0.92) package at least 50% smaller than its nearest competitor. The lowest cost 3-axis sensors come from Analog Devices or Freescale ($2 in volume). MEMSIC provides the lowest cost solution for 2-axis sensors (now under $1 and $0.50 expected in 2007). Meanwhile, the power consumption prize goes to Analog Devices’ ADXL33O with power consumption well under 1 mW Gyroscopes improve picture quality Today, gyroscopes are used in image stabilization, where two axes of motion sensing are needed to remove vibration and shake. While other approaches are also used to damp vibration, gyros are a superior solution. (continued next page) r- PDA Digital still cameras (D SC) Camcorders Function Pedometer, image rotation, menu scroll, gaming, free-fall detection (HDD protection), navigation Navigation IMU, Web content navigation — Image stabilisation Examples of products NTT DoCoMo pedometer (2003) Vodafone image rotation (2004) Samsung SGH E760, Nokia 3230 (navigation and gaming) Toshiba PocketPC e740 All Panasonic DSCs, e.g. Lumix ($200), PentaxOptio AlO ($350) Canon, Sony DSC5 Upper end: Panasonic (over $1500) High end: JVC3OGb,Toshiba 60Gb IBM, Toshiba, Apple laptops Status of commercialisation Accelerometer in cell phone since 2003 Gyroscope expected in 2007—2008 2-or 3-axis accelerometer 2-axis gyroscope Two 1-axis gyroscopes or one 2-axis gyroscope Two 2-axis accelerometers Two 1-axis gyroscopes or one 2-axis gyroscope 2-or 3-axis accelerometer Demonstrator in 2002 at Paris PDA show Gyroscope established since late 1990s Accelerometer emerging Gyroscope established since late 1990s Free-fall detection established Other applications emerging Established Established Applications of MEMS accelerometers and gyroscopes in consumer products Consumer product Cell phones MEMS inertial device(s) 2-or 3-axis accelerometer, 1-or 2-axis gyroscope Image stabilisation, free-fall detection (HDD protection) Laptops — MP3 players Others: toys, games, personal transporter, robots Free fall detection (HDD protection), GPS dead-reckoning assist (anti-theft) Free fall (HDD protection) Realistic motion iPod with hard disc drive Nintendo’s Kirby “Tilt-n-Tumble”GameBoy Microsoft gamepad “Sidewinder Freestyle Pro Segway, Sony Aibo robot, Sony PS3 3-axis accelerometer 2-or 3-axis accelerometers, 1-or 2-axis gyroscopes WTC WichtlechnologieConsulting . ThinksmalH issue2,volumel . May2006 Page 8

Your Experts in Microtechnology and Electronics. Feature Article wtc Gyroscopes have been a feature of the top range of Panasonic camcorders for some years. They are now also employed in some Pentax and Panasonic digital still cameras costing as little as $250. Interestingly, MEMS gyroscopes are also used for HDD free-fall protection in recent camcorders from jvc and Toshiba (these camcorders retail for over $1,000). Most commercial gyros are vibratory and use the transfer of energy between two vibration modes caused by Coriolis force. They are challenging to manufacture (hence their higher cost compared to accelerometers), being essentially two very high performing MEM5 devices in single device, usually a self tuned resonator for drive and micro-g for the sensing. Compared to automotive applications, packages in consumer electronics are about 1110th the size (targeting 25 mm3). The resolution requirements are lower, i.e. 5—10 O/ compared to 0.1—1 O/ in cars. A gyro is a larger device than an accelerometer, and can require as much as 10 times more power due to the higher drive requirements (5 V). There are many different sensing approaches and materials employed to make MEM5 gyroscopess. Silicon micromachined capacitive gyros are produced by Analog Devices and Kionix. Piezo-ceramic devices are available from NEC Tokin and Murata, thin-film resonators deposited with PZT from Matsushita, quartz from Seiko Epson and Microcomponents (part of Swatch). These are all single axis solutions. Currently, Murata manufactures a piezoceramic single-axis solution that costs $7—8. Sony and Invensense are examples of companies with two-axis solutions estimated to cost under $10. Today, the smallest packaged device is 21 mm3 — a single axis quartz piezoelectric gyroscope from Seiko Epson. At 6 mW, it is also the lowest power solution, in part due to a lower drive voltage compared to 5V drive capacitive gyroscopes. The cell phone remains the dangling carrot for gyroscopes, but they are still too expensive for this application. Cell phone companies tell us the acceptable price is somewhere around $3—S for 2-axis sensing for an application like GP5 navigation. (continued next poge) ‘te NEXUS Market Analysis for MEMS and Microsystems III, 2005-2009 Coordinated byWTC in collaboration with NEXUS 26 MEMS I MST products 8 application fields 240 pages 55 tables and graphs Published: December 2005 Price: $1300 I €1100, excluding VAT What readers are saying “This provides a good perspective on mst gyros and their applications. The reporting at the component level is a timely and helpful description of this growing and important market.” — Bob Sulouff, Director Business Development Analog Devices, Micromachined Products Division “The report combines a very good survey of the entire field of products that are available in MEMS technology with detailed and precise information on important parameters such as market size, sales price, important vendors, etc. I appreciate both aspects of the study very much.” — Dr Peter Ernst BOSGH, Product Planning and Marketing Sensors WTC — Wicht Technologie Consu ting . Think sma II issue 2, volume] . May 2006 Page 9

Your Experts in Microtechnology and Electronics. Feature Article wtc Currently it is not clear which technology or solution will win. While Sony is manufacturing a quartz 2-axis gyro, Murata is developing silicon capacitive micromachined sensing elements (in parallel to its ceramic gyros) to meet the consumer price targets. We believe the route for low cost 2-axis gyros will likely be a monolithic silicon capacitive solution. This is an important consideration to reduce package size and for integration of the ASIC. Inertia I measurement units arrive on consumer markets There is a trend in consumer markets to integrate accelerometers and gyroscopes into inertial measurement unit (IMu) modules. This follows the military muster and recent automotive trends. In automotive, module are partitioned to provide measurement in four degrees- of-freedom (D0F) to be distributed between navigation and vehicle dynamics (e.g. vehicles from Volvo and Fiat). IMU5 are targeting navigation applications in PDA5 and mobile phones. AKM already supplies an electronic compass, albeit with a 3-axis magnetometer and mixed-signal processor in phones from NEC, Sanyo, SonyEricsson and LG. One application that has gained traction in Japan is an electronic compass that allows the calculation of the position of the constellations. AKM is working on compasses that include a 3-axis accelerometer, due in 2007. The package size is 4.8 x 4.8 x 1.3 mm3. A leading Asian supplier is also developing a navigation module, first using a 3-axis accelerometer and magnetometers, and subsequently a 2-axis gyro. The first IMU with MEMS sensors are estimated to cost $20, e.g. for high-end PDA5. In 2—3 years time we believe $6—8 is the goal, whereby a gyro will need to cost under $5 for two axes. Prices of IMU modules for mobile phone will eventually range from $5 to $7 depending on the sensors that are included. 3-axis accelerometer $lto$1,5 2-axis gyroscope $4to$5 or micro-controller unit (ASIC+software) $2 3-axis magnetometers $1.5 Packaging and assembly $0.5 ThtoIIMU:$5.5 to$9 Estimated cost breakdown ofa MEMS IMU for consumer in 2009 An important requirement is the signal processing algorithm — which is non-trivial for five or six degrees-of-freedom. In contrast to the automotive industry, consumer integrators prefer to plug and play. Three ways to deal with tight margins in consumer markets Finally, let’s look at how to make money in the consumer sensor market, where margins are tight. 1. Prices can be pressured downwards and better margins generated when sensors are developed to be transparent to CMOS processes. An example is MEMSIC that uses fabs to produce its low cost dual axis accelerometers in high volume. 2. The margin for an IMU module is higher than for sensors alone. 3. There are also opportunities for companies providing algorithms for IMUS. These are required to harness the power of a 5- to 6-axis functionality by turning the complex signal signatures into commands and for signal recalibration in real time. Summary Accelerometers have already met the requirements in terms of size, power and cost to open the markets for mobile consumer electronic. However, we believe it is will be a considerable challenge to reach the price target of $1 and below set by cell phone integrators for 3-axis devices. Gyroscopes remain challenging to manufacture. There is great interest in a 2-axis gyro costing under $5. It would expand the applications of gyroscopes from image stabilization in digital still cameras and camcorders to cell phone cameras, navigation IMU5 and even further into protection of hard disc drive. In the next issue of Think Small!: OLED displays 44 Accelerometers Gyroscopes 2004 2009 2004 2009 Consumer&IT 50 212 44.5 111 Automotive 324 338 352 516 13 41 30 86 Other 20 38 1 18 ‘ Total 407 629 427.5 731_—: World markets for MEMS inertial sensors 2004 and 2009 ($ million) WTC WichtlechnologieConsulting . ThinksmalH issue2,volumel . May2006 Page 10

Your Experts in Microtechnology and Electronics. p Interview wit Yang Zhao, CEO of MEMSIC Inc. WTC: MEMSIC’s 2-axis accelerometers operate on very different principles to other accelerometers. Are there specific advantages? Yang Zhao (YZ): Our accelerometer is distinct because of its unique thermal design. A gas bubble made of heated air replaces the proof mass in a conventional MEMS micromachined accelerometer. We can change the gases if necessary, for example, a heavier gas increases the signal. Our device may not have the lowest power consumption, but price and package size are more important factors. At the end of the day, OEM compare a sensor against his system design power budget, not sensors from other makers. WTC: We note the device also leverages CMOS processes. YZ: The front-end is a standard 14- mask CMOS process. We have high volume manufacturing partnerships with TSMC and Nantong-Fujitsu packaging foundry. We perform the final product testing and proprietary wafer process production in our class 100 facility outside Shanghai. Using CMOS, additional circuitry can be incorporated into custom versions for high volume applications. The accelerometers are factory programmable at the end of the manufacturing cycle, they have no moving parts and are particle free, eliminating stiction problems. This results in highly robust sensor, which is a major advantage for our customers’ manufacturing operations, where (unlike capacitive based accelerometers) they can be treated like any other component without any special handling. WTC: Which applications are finding most traction? YZ: We see a big market opportunity in mobile phones and consumer electronics, including HDD protection in laptops and MP3 players. We supply to notebooks from IBM, which leverages a MEMSIC 2-axis accelerometer to measure tilt and sudden motion and park the head before the notebook goes into freefall. This way the HDD head will have enough time to return to the safe place. If just detecting free fall, there will not be enough time for head to react. This is the right solution for HDD protection compared to the more expensive 3-axis solution. IBM expects a 2- axis sensor to cost under $1 in volume, despite the notebook cost of $1,000. We also see interesting opportunities for toys and game controllers, for example. Consumer applications require sensors costing less than $1, which is a price we can currently meet with our 2-axis device in high volume. However, we also make high performance accelerometers with on-chip digital signal processing that meet stringent automotive specifications for ESP, roll detection and alarms, e.g. through our partnership with Texas Instruments. We ship accelerometers to TomTom, a major supplier of GPS navigation systems for cars and PDA5. WTC: Which specifications differ? YZ: In consumer electronics, the tolerance on all specifications is 10 to 20% and 4 to 8-bit accuracy are all that is needed. This compares to 1% and 12 to 14-bit accuracy in the automotive segment. Dr Yang Zhao Before founding NA M , Dr. hao had been a key member in Analog Devices M M division for seven years. Dr. hao has a Ph.D. in FE from Princeton plus two Master degrees in both Physics and FE. He holds nine US patents in circuit, process ing, packaging and NA M technologies. WTC: Your current product portfolio features 2-axis accelerometers while the consumer market is clearly moving to 3-axis devices. How do you compete? YZ: A 3-axis sensor costing $2-3 today is not going to open the market for mobile phones. In low cost phones the bill-of-materials is as low as $20, and the OEM will not pay $1 for a sensor, whether 3-axis or 2-axis. If the sensor costs $0.5, this will open up the market. In fact, with one or two exceptions, 95% of mobile phone applications for accelerometers do not require 3-axis sensing. However,

a 5% share of the mobile phone market is worth only $50 million. By comparison we estimate that at $0.5, the opportunity could be as great as $400 million. (continued next page, 3rd column) Ef WTC WichtlechnologieConsulung . ThinksmalH issue2volumel . May2006 Page 11

Your Experts in Microtechnology and Electronics. Events wtc —I- NEXUS market report and road- map in single package The “NEXUS Market Analysis for MEMS amd Microsystems 2005—2009” and the “NExus Product-technology Road- map for Microsystems” had previously been available only separately. WTC is now offering the two reports as a single package for €1300, saving €500 (over 25%) on the individual prices. Meet WTC at the following events: Event Date Location Booth # / Presentation microDay May 18 Luzern “Who earns good money with MEMS” MRS Spring May29 June 2 Nice “Wide bandgap roadmap” Sensor+Test May30 June 1 Nuremberg Hall 4, Booth #624 “World markets for MEMS 2005 2009” lnt.Microwave Symposium June 11—16 San Francisco on arrangement to meet WTC supports EU project developing smart biosensors WTC is one of 29 partners taking part in Smart Integrated Biodiagnostic Systems for Healthcare (SmartHEALTH ), a recently funded EU integrated project led by the University of Newcastle upon Tyne collaborating to develop biosensor technologies. Over the next four years, the international consortium of four universities, seven research institutes, 11 SME5, 3 large corporate entities (including Olivetti) and four clinical centres will work toward a fusion of microsystems-based in vitro diagnostics and advanced information management technologies that enable desktop and portable biodiagnostics systems. Specifically, these systems will target the early detection of breast, colorectal and cervical cancer through microsys tem solutions that enable blood or tissue samples to be tested quickly and accurately for cancer-specific markers. WTC is leading a workpackage focusing on aspects of business development and exploitation of these systems and is linked to another on knowledge management and dissemination. WTC will investigate commercial aspects relating to the instruments and consumables, exploitation paths, effects on current industry sturcture and roadmapping, economic boundary conditions for system and disposables, market entry strategy, etc. (interview w/ Dr. Yang Zhao, continued from p.10) Obviously if the 3-axis device is available the OEM will take the additional functionality, but a 3-axis sensor for $1 is still 2—3 years away. We can supply 2-axis devices for under $1 in volume and will reduce this to $0.5 in the near future by relaxing the resolution and functionality further. We are also working on a monolithic 3-axis thermal device. Details of its operations will be revealed in 3Q2006. Even with our 3-axis sensor, we still expect the larger market to come from lower priced 2-axis device because the 2-axis will remain at half price of the 3-axis for the next few years. We welcome your comments and feedback about this newsletter and its contents. Please contact: Richard Dixon richard.dixon@wtc-consult.de Phone +4989207 026 070 SmartHEALTH Integrated Project wtc WTC—Wicht Technologie Consulting is a consulting company specialised in microsystems and microelec m pr nt tronics. WTC offers customised market analysis, strategy planning, roadmapping, business development and search for technology partners. We also offer several off-the-shelf market reports (see www.wtc-consult.de for more information) and organise conferences on behalf of third-parties. Our customers include small, medium-sized and large companies as well as research institutions and public organisations. WTC was founded in 2000 by Dr Henning Wicht and now employs 10 consultants. WTC — Wicht Technologie Consulting Frauenplatz 5 80331 Mimich Germany Phone Fax Internet: E-Mail: +49 (0)89 2070 260-0 +49 (0)89 2070 260-99 www.wtc-consult.de info@wtc-consult.de Managing Director: Dr. Henning Wicht Ust-Id.No. DE 813044351 WTC—WichtlechnoloqieConsulting . Thinksmall! issue2,volumel . May2006 Page 12

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Mobile phone makers will face a “shuffle” of market positions after China announced two weeks ago that it would relax license regulations for handset manufacturing.

Put simply speaking it means that a heap of new players, most of them with unknown brands, will appear in the world’s biggest cell phone market.

China’s State Council has abolished some 186 administrative examination and approval items covering mobile communication systems and terminals. The move indicates that the country will formally cancel the mobile phone production license examination and approval system, which started about a decade ago.

Chinese companies intending to manufacture phones had to have at least 200 million yuan

(US$26.31 million) in registered capital and get approval from the National Development and Reform Commission (NDRC). Then, if they wanted to sell phones in China, manufacturing companies had to have their products quality tested and authorized by the Ministry of Information Industry (MII).

Now with the altered regulations, the NDRC is not involved in the process and handset makers can sell phones after passing the MII test.

China may skip phone generation Mobile market moves under full stream Mobile phones see rapid growth Mobile phone users top 515 min by August

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Mobile phone makers dial themselves brand new marketplace – china.org.cn Page 2 of 5

“The omission of the NDRC shows the government is willing to establish a market-oriented industry environment,” said Kevin Wang, an analyst for the US-based research firm iSuppli.

China has licensed 90 firms to produce mobile phones with an annual production capacity of 600 million units, 50 percent over the combined domestic demand of 100 million units and export demand of 300 million units, according to MII.

Long period

“The oversupply has existed for a long period and it’s not necessary for a government regulation,” said United Securities Co in a recent note.

Now is the time to let the market rule and see qualified new players replace the market positions held by established companies which depended heavily on the income from renting licenses to other companies, according to United Securities.

The new players, largely unknown by established industry players, have challenged and even surpassed leading domestic firms like Ningbo Bird and TCL Communications.

“Tianyu is new star in the industry with its strong experience in electronics retail industry,” said Wang.

Tianyu, the Beijing-based handset vendor, is expected to sell 13 million mobile phone units in 2007, a 113.1-percent growth year-on-year to become China’s No. 3 OEM (original equipment manufacturer) maker. Bird, which led the OEM market in 2006, is expected to sell 12.5 million units this year and will come in at No. 4 position behind Tianyu, according to iSuppli.

“Tianyu uses heavy promotional methods in smaller cities such as offering high under-table commissions to traders. It is not the traditional way to compete,” said a Nokia China official.

The Nokia official admitted that Nokia’s sales had been affected by new brands like Tianyu in the

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Mobile phone makers dial themselves brand new marketplace — china.org.cn Page 3 of 5 second or third-tier markets.

ZTE and Huawei, which focused on telecom equipment market during the handset license period, are expected to become the top two OEM handset makers in China. ZTE is expected to sell 23 million phones in 2007, a 215.1-percent growth year-on-year, according to iSuppli.

Foreign-brands, which haven’t established a foothold in China, are also eager to penetrate the domestic market after the loosening of the regulations.

Research In Motion (RIM), the developer of BlackBerry, will sell its popular Email phones in China by the end of this year through the distribution partner Alcatel Lucent, the companies announced this week.

“BlackBerry will grab market share in the high-end market and influence brands like Dopod, Nokia and Motorola,” said Sandy Shen, an analyst at US-based Gartner Inc.

Other foreign giants like Hewlett-Packard and Palm, also intend to sell phones directly in China in future.

Fierce competition

Traditional market leaders, like Bird, TCL and Amoi, have suffered from the fierce competition.

Bird posted a loss of 237.2 million yuan (US$31.18 million) in the first half and Amoi reported a loss of 350 million yuan in the first six months.

The “black phones”—handsets sold in the market without government approval—are also expected to become legal under the new regulations.

From January to June, 23.43 million “black phones” were sold in China, compared with 71.47 million

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Mobile phone makers dial themselves brand new marketplace — china.org.cn Page 4 of 5

licensed handsets, according to CCID Consulting, a research firm under MII.

Some of these phones will become legal but others, including copies of famous brands and low quality models, will not as they not want to take the MII quality test, according to Jiang Lifeng, a CCID analyst.

The new policy will attract more players and boost related phone design sectors and this trend will accelerate China’s transition from a manufacture base to a design center, according to Wang.

(Shanghai Daily October 26, 2007)

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Exhibit D

BEAR STEARNS

Asian Equity Research

DECEMBER 7, 2006

China Telecom Services & Equipment

‘Twas the Night before 3G…

Divergent Returns for Telcos and Equipment Vendors

POSITIONING FOR THE INEVITABLE. With 3G licensing expected in first-quarter 2007, we expect divergent near-term stock performance for China’s telecom operators and equipment vendors. Generally speaking, we expect equipment stocks to gain momentum while the telcos begin to reflect higher operating risks in 2007.

NEGATIVE ON CHINESE TELECOM SECTOR. Chinese telcos have always been expensive relative to returns generated, and are now expensive relative to growth and free cash flow (FCF) as well. Among Asia’s mature telecom markets, Japan and Korea are more attractively valued, offering superior returns and medium-term growth. We rate the Asian Telecom Services sector Market Weight.

MAINTAIN MARKET OVERWEIGHT ON ASIAN TELECOM EQUIPMENT SECTOR. Global consolidation, China’s 3G transition, and potentially large TD SCDMA investments will all benefit Chinese telecom infrastructure vendors such as ZTE Corp., China GrenTech, and Huawei, in our opinion. Handsets have been strong in 2006, but the mix has shifted to the low end. We expect strong shipments in 2007 and an ASP recovery in 2008.

TOP PICKS: CHINA UNICOM, CHINA GRENTECH. We remain positive on China Unicom due to its strong FCF, rising margins, and insulation from 3G risks. As for equipment, we believe China GrenTech is an overlooked play on 3G wireless spending, sector consolidation, and local sourcing of base station RF components.

Research Analysts

Evan Erlanson, CFA

Adam B. Clark

Bear Stearns Asia Ltd. Hong Kong

Regulated by the Securities and

Futures Commission of Hong Kong

U.S. investors contact your Bear, Stearns & Co. Inc. registered representative at 1-800-999-2000

Bear Stearns 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. Customers of Bear Stearns in the United States can receive independent, third-party research on the company or companies covered in this report, at no cost to them, where such research is available. Customers can access this independent research at www.bearstearns.com/independentresearch or can call (800) 517-2327 to request a copy of this research. Investors should consider this report as only a single factor in making their investment decision.

PLEASE READ THE IMPORTANT DISCLOSURE AND ANALYST CERTIFICATION INFORMATION IN THE ADDENDUM SECTION OF THIS REPORT.

BEAR STEARNS

BEAR STEARNS

Asian Equity Research

Table of Contents Page

On the Eve of 3G, Focus on Telecom Turnarounds and Equipment Upside 4

China Telecom Operators: Refining Our Macro View 10

China Telecom Equipment: Capex and Handset Trends 18

China Handset Market Analysis 33

Companies 45

China Mobile Ltd.: Imminent 3G Catalyst Could Burst the Liquidity Bubble 46 China Unicom Ltd.: Turnaround Story with Least Exposure to 3G Risk 54

China Telecom Corp.: Positive Momentum on 3G Newsflow, Weak Fundamentals62 China GrenTech Corp.: Top 3G Pick: Value, Well-Placed for Cyclical and Secular Growth 69

ZTE Corp.: China’s 3G Proxy, But How Much Upside Remains? 78

All pricing is as of the market close on Dec 5, 2006, unless otherwise indicated.

BEAR STEARNS ASIA LTD. Page 3

Asian Equity Research

BEAR STEARNS

On the Eve of 3G, Focus on Telecom Turnarounds and Equipment Upside

Viewed in aggregate, the Chinese telecom services market is more expensive than other mature Asian markets, with weaker growth prospects. Returns are also lower than elsewhere relative to the cost of capital: China’s aggregate ROE (17.3%) is higher than that of the Korean or Japanese markets, but Chinese telcos are also trading at 3.1x price to book (note: book value is understated due to historical asset write-downs).

China’s telecom revenue growth is uninspiring: we estimate 2006 revenue and net income growth at 11.1% and 9.5% year on year, respectively. We expect a further moderation over the medium term with three-year revenue and earnings CAGRs of 6.7% and 7.4%, respectively. We therefore believe that, at a market capitalization of US$244 billion, China’s telecommunications services sector is comparatively overvalued on most valuation measures, as illustrated in Figure 1. Given our negative view on the services sector as a whole, we believe that the best investment opportunities can be found in turnaround stories such as China Unicom (762.HK-HK$9.14/CHU-US$11.86; Outperform/Market Weight) and equipment plays such as China GrenTech (GRRF-US$16.55; Outperform/Market Overweight).

Figure 1. China Telecom Services Sector Compared with Korea and Japan: Valuation vs. Growth and Returns

'06E-'09E

Market Cap '06E FCF FCF Yield (%) ROE/Cost of '06E Revenue '07E Revenue

Earnings '06E P/E (x) P/BV (x)

(US$bn)(US$bn)(FCFF/EV) Equity (Ke) *(US$bn) Growth (%)

Growth

China 244,043 17.8 7.4% 13,615 5.2% 1.2 3.1 81,283 10.2%

Korea 43,595 12.7 9.1% 3,890 7.2% 1.4 1.9 34,546 1.3%

Japan ** 184,065 17.5 18.1% 6,855 3.1% 1.9 1.7 123,348 1.4%

Note: Companies included: China (China Mobile, China Unicom, China Telecom, China Netcom [Not Rated]); Korea (SK Telecom, KT Freetel, LG Telecom, KT Corp); Japan (NTT DoCoMo, KDDI, NTT [Not Rated]).

*Cost of Equity Assumptions are based on individual companies’ cost of equity, weighted by shareholders equity: China (13.9%, assuming 8% equity premium); Korea (10.8%, assuming 8% equity premium); Japan (5.2%, assuming 5% equity premium).

**For Japan, “2006E” denotes the fiscal year ended March 2007. We use NTT’s consolidated financials in our analysis except in the case of total market revenue, where we exclude NTT DoCoMo’s revenues to more accurately reflect actual market size. This is not an issue in China or Korea.

Source: Company data, IBES consensus estimates for Not Rated companies, Bear Stearns Asia Ltd. estimates.

CHINA MOBILE HAS GROWN THROUGH MOBILE SUBSTITUTION AND MARKET SHARE GAINS…WHAT NOW?

The investment community subscribes to the view that China’s telecom services industry is experiencing a demand-driven growth inflection that justifies higher valuations. Valuations have been pushed higher still by an ongoing flow of liquidity into China’s domestic plays. In fact, we note that Chinese telecom industry revenue growth has been fairly flat for the past three years (12.5% in 2004, 11.8% in 2005, and 11.4% year-on-year growth in January to October 2006), with only China Mobile (941.HK-HK$63.75/CHL-US$41.54; Underperform/Market Weight) growing faster than the industry-wide three-year revenue growth CAGR of 11.9% (China Mobile’s revenue grew at a 2003-06E CAGR of 17.8% while all other operators grew in single-digit percentage terms). China Mobile has experienced a significant rise in revenue growth (to 20% in 2006E from 11% in 2003) for two main reasons: 1) mobile substitution; and 2) market share gains against a single, weaker competitor (i.e., China Unicom) with significant capacity (and financial) constraints. The main

Page 4 CHINA TELECOM SERVICES & EQUIPMENT: ’TWAS THE NIGHT BEFORE 3G…

BEAR STEARNS

Asian Equity Research

risk for China Mobile is a slowdown or reversal in its market share gains and a rise in opex:revenue, which we expect to happen in 2008 when at least one new operator enters the wireless market.

As for telecom equipment, we see a fairly rosy outlook for the next three years due to strong subscriber net additions, accelerating network traffic growth, and the transition to 3G.

Handset Demand Accelerating in 2007, ASP Recovery in 2008. China’s handset market has already picked up pace considerably in 2006: we expect shipment growth of 19% in 2006, up from 10% in 2005. The introduction of ultra-low-end models (which began to impact the market in second-quarter 2006) and diminished PAS competition have been the major drivers for Nokia (NOK-US$20.46; Outperform/Market Weight) and Motorola (MOT-US$22.02; Outperform/Market Weight) in particular. We expect these trends to continue in 2007, followed by a recovery in high-end handset demand in 2008. ASPs have fallen at a faster rate in second-half 2006 due to a low-end mix and we expect this trend to continue in 2007. In 2008, we expect the upgrade and replacement markets to take over following the launch of 3G networks and the shift to a more subsidy-driven handset market as competition for high-end subscribers intensifies.

Strong Wireless Spending to Support Chinese Equipment Vendors in 2007-08. We have already seen a pickup in overall telecom capital expenditure in

2006, with all growth attributable to wireless spending being undertaken by operators and the government. We expect spending momentum and market share gains to drive strong earnings growth for China GrenTech and ZTE Corp. (763.HK-HK$38.70; Peer Perform/Market Overweight) in 2007. Other factors contributing to strength for leading Chinese telecom equipment vendors (and component makers) will be: 1) price stabilization due to migration to next-generation equipment; 2) strong market share in TD SCDMA; 3) global consolidation in the telecom equipment sector; and 4) the trend toward local manufacturing and component sourcing among global equipment vendors.

STOCK PICKS

The Chinese telecom and telecom equipment sectors have seen mixed performance in 2006: China Mobile has outperformed the other telcos, wireless has outperformed wireline, and, until recently, the telecom equipment stocks were underperformers. Over the past month, however, we have begun to see sector rotation into equipment and wireline stocks, as well as a renewed interest in China Unicom as an asset play. Given these changes, we currently hold the following views on our Chinese telecom services and equipment universe.

China Mobile (Underperform): Expensive on Most Measures, Identifiable Downside Catalyst. China Mobile’s current valuation implies much more optimistic earnings growth and FCF prospects than we are forecasting. A 2006E P/E of 20.1x) is already about 30% above China Mobile’s historical P/E trading range of 10x to 15x. We believe that these valuation levels can only be sustained if 3G licenses are postponed indefinitely, a highly unlikely scenario. It is more likely that 3G licenses

BEAR STEARNS ASIA LTD. Page 5

BEAR STEARNS

Asian Equity Research

will be issued in first-quarter 2007 and that China Mobile will be given the task of commercializing the TD SCDMA 3G standard. This will be a large negative catalyst for China Mobile that we expect to bring about a de-rating of the stock within the next three to four months. Our DCF-based year-end 2007 target price of HK$49 (ADR: $31.50) implies downside of 23% from current levels.

China Unicom (Outperform): Low-end Specialist with Strong FCF and Margin Upside. China Unicom is the only Chinese operator for which we can identify solid fundamental reasons to be positive over the medium term. First, FCF is strong and improving, making China Unicom the only operator in our universe that currently looks undervalued on a DCF basis. Second, we believe that China Unicom has room for operating margin improvements from lower spending on CDMA marketing and a rising proportion of GSM revenue. Third, we expect China Unicom to be relatively unaffected by the competitive pressures of 3G. While we expect the number two operator to lose market share, we believe that China Unicom’s low-end prepaid focus will insulate it from the competitive pressures affecting the high-end of the market. Our year-end 2007 target price of HK$10 (ADR: $12.90) implies upside of 9.4% from current levels.

China Telecom (Peer Perform): 3G…A Boon in Theory, but We Would Sell After Licensing. We believe that China Telecom (728.HK-HK$4.01/CHA-US$51.76; Peer Perform/Market Weight) will continue to benefit from the perception that it is a cheap (albeit ex-growth) telecom play with an option attached (potential launch of wireless services, the next “growth driver”). The shares are currently trading at a 2007E P/E of 12.8x, and P/B of 1.6x with a 2006E ROE of 11.7%. Unfortunately, we see two problems with the transition to 3G as China Telecom’s main growth driver: 1) the diversion of investment and focus to the wireless business is likely to lead to an even faster decline in fixed-line revenue; and 2) the launch of 3G services is likely to involve a heavy marketing outlay, mainly on handset subsidies, given China Telecom’s stated intention of targeting high-end subscribers. We do not expect IPTV to be a large contributor. That said, we expect China Telecom to outperform China Mobile over the next three to four months, especially if (as we expect) China Telecom receives a WCDMA license. Our year-end 2007 target price of HK$3.10 (ADR: $39.80) implies downside of 22.7% from current levels.

China GrenTech (Outperform): Cheapest 3G Play, Most Sustainable Growth. We believe that China GrenTech is an overlooked beneficiary of multiple trends in the telecom services and equipment space. The company is trading on an estimated 2007 P/E of 13.3x and is expected to increase earnings at a three-year CAGR of 24.4%. China GrenTech’s main earnings drivers include marketwide wireless capex, greenfield wireless builds and technology upgrades, consolidation in the wireless coverage space, and a rapidly growing base station component business that benefits from the trend toward local component sourcing by all wireless infrastructure vendors. Our year-end 2007 target price of US$20 implies upside of 20.8% from current levels.

ZTE Corp. (Peer Perform): 3G A Secondary Driver, Downside Risk at Current Valuation. We downgraded ZTE to Peer Perform on November 21 from Outperform

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because we believe that, at current valuations, downside risk is beginning to outweigh upside risks for China’s second-largest telecom equipment vendor. Apart from valuation, we believe that ZTE’s strong recent performance owes much to its proxy status as a China 3G/TD SCDMA play, which could lead to future disappointments, in our view. First, ZTE does not derive a large proportion of its revenue from domestic sales of non-PAS wireless infrastructure: we estimate that domestic wireless infrastructure will constitute just 11% of 2006 revenue and 19% of 2007 revenue, even with fairly optimistic domestic 3G spending and market share assumptions. Second, ZTE’s main source of earnings growth over the past three years – international equipment sales – may slow down over the next three years due to a high base effect, slow capex growth in emerging markets, and the fact that low-margin products (e.g., broadband access equipment and handsets) constitute an increasing proportion of marginal growth. Finally, we are concerned that ZTE may lose its proxy status as the largest listed Chinese equipment vendor if its local competitors choose to tap the equity markets to take advantage of the massive public exposure that is likely to surround the final issuance of 3G licenses in China. Our year-end 2007 target price of HK$31.00 implies downside of 19.9% from current levels.

BEAR STEARNS ASIA LTD. Page 7

BEAR STEARNS

Asian Equity Research

Figure 2. Global Wireless Operator Comparables

Price Mkt Cap Ent Val EV/EBITDA EBITDA CAGR P/E EV/Revenue Rev CAGR Capex/ Rev YTD

Ticker Rating

(local $)(US$ mn)(US$ mn) 06E 07E 06E—09E 06E 07E 06E 07E 06E—09E 05A Share Price

Asia Wireless Services (Market Weight)

China Mobile 941 HK U 63.75 172,816 161,596 7.6x 6.3x 10.4% 20.0x 15.4x 4.3x 3.6x 12.0% 27.2% 74%

China Unicom 762 HK O 9.14 15,664 18,544 4.6x 4.3x 9.2% 21.6x 17.2x 1.5x 1.4x 6.6% 19.1% 45%

SK Telecom 017670 KS O 216,000 19,029 22,104 4.7x 4.6x 3.6% 11.3x 9.3x 1.9x 1.9x 2.6% 14.4% 19%

KTF 032390 KS P 30,450 6,648 8,215 4.4x 4.2x 2.0% 15.4x 14.3x 1.2x 1.2x 2.1% 11.8% 24%

LG Telecom 032640 KS P 10,900 3,279 4,065 5.3x 4.8x 5.0% 15.1x 8.9x 1.0x 0.9x 2.1% 9.5% 64%

NTT DoCoMo 9437 JP O 180,000 73,322 73,929 5.3x 5.3x 2.7% 16.3x 15.9x 1.8x 1.8x 2.1% 18.6% 0%

KDDI 9433 JP O 791,000 30,473 35,970 5.8x 5.4x 6.4% 16.4x 15.5x 1.2x 1.2x 4.9% 13.5% 16%

Taiwan Mobile 3045 TT NR 31.85 4,894 4,585 5.6x 5.6x 1.0% 9.7x 11.5x 2.5x 2.5x 0.9% 5.4% -16%

Far EasTone 4904 TT NR 36.80 4,413 4,332 4.7x 4.7x 0.9% 10.4x 10.5x 2.0x 2.0x 1.2% 8.6% -1%

Advanced Info Services ADVANC TB NR 82.00 6,796 6,754 5.2x 4.8x 2.0% 13.3x 12.1x 2.6x 2.4x 3.0% 17.5% -24%

Total Access Comm. TAC SP NR 4.44 2,106 3,220 6.5x 5.6x 10.6% 15.0x 11.0x 2.3x 2.1x 7.2% 1.2% 6%

Globe Telecom Inc GLO PM NR 1,235.0 3,289 3,922 5.2x 4.8x 1.2% 13.7x 12.1x 3.1x 2.9x 1.5% 27.1% 68%

MobileOne M1 SP NR 2.11 1,357 1,438 6.7x 6.6x -0.8% 12.6x 12.3x 2.8x 2.8x -0.4% 8.0% 0%

Maxis MAXIS MK NR 10.00 7,075 7,237 6.9x 6.5x 0.9% 14.2x 14.3x 3.5x 3.1x 8.8% 18.0% 19%

Bharti Airtel BHARTI IN NR 638.80 27,197 28,349 18.1x 12.9x 27.1% 32.4x 23.1x 7.0x 5.1x 24.6% 47.4% 85%

Hutchison Telecom 2332 HK P 17.18 10,512 14,768 10.4x 7.7x 27.3% 235.5x 64.2x 3.4x 2.6x 21.8% 19.4% 59%

Average 6.7x 5.9x 29.6x 16.7x 2.6x 2.3x

Latin America Wireless Services (Market Overweight (Mexico); Market Overweight (Brazil)), Covered by Rizwan Ali

Telemig Celular TMB O 36.77 301 318 4.3x 3.9x 8.2% 10.0x 7.8x 1.1x 1.0x 7.5% 19.0% -7%

Tele Celular Sul TSU O 33.93 2,862 2,769 7.7x 6.2x 15.8% 17.4x 11.9x 2.1x 1.9x 8.6% 23.4% 34%

Tele Norte Celular TCN P 8.95 28 107 6.0x 5.3x 12.2% NM 24.3x 0.8x 0.8x 6.6% 10.0% 20%

America Movil AMX O 45.67 7,554 7,861 11.4x 9.8x 13.1% 20.2x 17.2x 4.1x 3.7x 8.7% 21.3% 56%

Vivo VIV O 8.10 3,413 2,490 4.3x 3.8x 6.0% 7.9x 5.7x 1.7x 1.6x 4.0% 15.7% -8%

Average 6.7x 5.8x 18.7x 15.0x 2.0x 1.8x

EMEA Wireless Services (Market Weight), Covered by Rizwan Ali

Orascom Telecom OTLD.LI P 331.40 12,693 3,192 9.3x 7.7x 11.4% 16.7x 13.4x 4.1x 3.5x 9.6% 51.7% 11%

Turkcell TKC O 12.70 11,176 11,554 8.9x 7.9x 9.4% 14.7x 12.8x 3.5x 3.3x 6.7% 19.2% -7%

Partner Communications PTNR US NR 11.71 1,802 4,182 10.5x 10.4x NA 11.6x 10.4x 3.6x 0.9x NA 9.7% 30%

Average 9.6x 8.7x 14.3x 12.2x 3.8x 2.5x

European Wireless Services (Market Underweight), Covered by Fanos Hira

Vodafone VOD L U 1.38 143,910 161,280 7.6x 7.7x 1.1% 13.0x 13.8x 5.1x 5.1x 1.3% 17.5% 10%

Mobistar MSTAR.BR P 63.95 5,390 7,301 7.0x 7.0x 1.6% 14.4x 14.6x 3.6x 3.6x 1.5% 13.4% -5%

Cosmote COSr.AT P 21.20 9,421 12,727 8.4x 7.3x 11.6% 21.8x 18.1x 4.2x 3.6x 10.4% 14.6% 13%

Average 7.3x 7.3x 13.7x 14.2x 4.3x 4.1x

North American Wireless Operators (Market Weight), Covered by Phil Cusick

Sprint Nextel Corp S P 19.50 54,161 71,000 5.6x 5.4x 8.0% 15.8x 14.6x 1.7x 1.7x 1.9% 14.2% -8%

Dobson Communications DCEL O 8.70 1,485 4,009 9.2x 7.9x 8.0% NM 22.2x 3.2x 2.9x 4.4% 12.4% 16%

Alltel AT P 58.25 21,764 24,477 9.4x 8.4x 8.0% 20.6x 19.9x 3.1x 2.9x 4.7% 15.1% 13%

U.S. Cellular USM P 67.36 3,651 6,087 7.2x 6.3x 8.0% 35.8x 29.3x 1.9x 1.8x 5.4% 19.6% 36%

Leap Wireless LEAP P 57.09 3,869 4,873 18.5x 12.1x 8.0% NM NM 4.2x 3.3x 17.9% 22.1% 51%

Rogers Communications RG O 74.34 4,180 11,084 4.0x 3.4x 8.0% 45.6x 33.9x 1.2x 1.1x 7.3% 17.7% 39%

Average 9.0x 7.2x 29.5x 24.0x 2.6x 2.3x

Bear Stearns Rating System: Sector Ratings—Market Overweight (MO), Market Weight (MW), Market Underweight (MU) / Stock Ratings—Outperform (O), Peer Perform (P), Underperform (U) 1.) SmarTone has a June YE.

2.) NTT DoCoMo, Vodafone KK and KDDI have March year ends, hence FY2005 relates to the year ending March 2006, FY2006 relates to the year ending March 2007 etc. 3.) Vodafone and Panafon have March year ends hence 2005 relates to the year ending March 2006, 2006 relates to the year ending March 2007 etc.

4.) Vodafone net income estimates have excluded goodwill amortisation 5.) TIM and TEM net income estimates have excluded exceptional items 6.) Operating Free Cash Flow is defined as EBITDA—Capex

Source: Bear Stearns & Co., Bear Stearns International Ltd, Bear Stearns Asia Ltd., IBES consensus estimates for Not Rated companies

Page 8 CHINA TELECOM SERVICES & EQUIPMENT: ’TWAS THE NIGHT BEFORE 3G…

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Figure 3. Global Fixed Line and Integrated Operator Comparables

Ticker Rating Price Mkt Cap Ent Val Div Yield P/E EV/EBITDA EV/Revenue Capex/ Rev YTD

(local $)(US$ mn)(US$ mn) 05A 06E 07E 06E 07E 06E 07E 05A Share Price

Asia Wireline Services (Market Weight)

China Netcom 906 HK NR 16.16 13,795 23,439 0.2% 9.2 x 9.1 x 4.1x 4.0x 2.1x 2.1x 31.3% 28.8%

China Telecom 728 HK P 4.01 41,767 58,512 1.9% 12.1 x 12.8 x 5.0x 5.1x 2.6x 2.6x 31.8% 40.7%

Hanaro 033630 KS NR 7,910 1,993 2,935 0.0% NM 21.7 x 7.0x 5.1x 1.6x 1.6x 19.6% 54.8%

KT Corp. 030200 KS P 48,250 14,639 19,926 6.2% 9.3 x 9.7 x 4.8x 4.8x 1.6x 1.6x 18.8% 18.1%

PCCW 8 HK P 4.81 4,173 6,230 3.8% 13.4 x 11.8 x 6.8x NA 1.9x NA 6.3% 0.7%

Singtel ST SP NR 2.97 30,650 34,283 3.5% 14.1 x 13.4 x 10.9x 10.9x 4.0x 4.0x 13.0% 14.3%

Chunghwa Telecom 2412 TT NR 59.80 17,903 15,901 7.8% 13.1 x 12.5 x 5.3x 5.2x 2.8x 2.8x 12.5% 7.4%

Indosat ISAT IJ NR 5,900.00 3,519 4,607 2.6% 19.3 x 16.9 x 5.9x 5.2x 3.4x 3.0x 58.4% 6.3%

NTT 9432 JP NR 586,000 80,270 109,676 1.0% 16.1 x 15.5 x 3.8x 3.8x 1.2x 1.2x 15.8% 9.3%

PT Telekomunikasi TLKM IJ NR 10,500 23,236 24,061 1.4% 18.1 x 15.9 x 6.8x 5.9x 4.3x 3.7x 29.0% 78.0%

Telstra TLS AU NR 3.79 49,817 61,780 8.7% 14.1 x 13.4 x 8.0x 7.7x 3.4x 3.3x 16.0% -3.6%

Telecom Corp. NZ TEL NZ NR 4.49 6,126 8,649 8.5% 10.8 x 11.3 x 5.9x 6.0x 2.1x 2.1x 14.9% -25.3%

Average 4.1% 14.1 x 14.1 x 6.2 x 5.8 x 2.6 x 2.6 x 21.5%

Latin America Telecommunications Services (Market Overweight (Brazil, Chile, Mexico). Market Underweight (Argentina, Venezuela)), Covered by Rizwan Ali

Telecom Argentina—ADR TEO P 17.88 3,520 4,686 0.0% 32.0 x 30.0 x 6.0x 5.1x 2.0x 1.9x 9.6% 38.7%

Brazil Telecom—ADR BRP O 38.93 2,834 4,683 0.0% 14.0 x 11.3 x 2.9x 3.0x 2.0x 2.2x 39.3% 4.2%

Telmex—ADR TMX O 27.21 26,929 39,245 0.0% 9.5 x 10.2 x 5.7x 6.1x 2.5x 2.7x 13.6% 10.3%

CANTV—ADR VNT P 19.55 2,223 3,410 8.8% 6.2 x 4.8 x 4.3x 3.4x 1.3x 1.1x 18.1% 36.7%

CTC—ADR CTC O 8.08 1,765 2,943 2.7% 49.6 x 32.3 x 5.8x 5.7x 2.8x 2.7x 13.2% -8.2%

Average 2.3% 22.3 x 17.7 x 4.9 x 4.7 x 2.1 x 2.1 x 18.8%

European PTOs(Market Underweight), Covered by Johnathan Dann

BT Group BT.L O 2.91 47,623 88,527 4.1% 13.2 x 12.9 x 8.0x 7.9x 2.2x 2.2x 16.1% 30.5%

Deutsche Telekom DTEGn.DE U 13.31 77,975 129,326 5.4% 15.5 x 21.6 x 5.1x 5.2x 1.6x 1.6x 15.6% -5.5%

France Telecom FTE.PA P 19.59 67,911 126,969 6.1% 11.6 x 12.4 x 5.0x 5.2x 1.8x 1.9x 12.3% -6.7%

KPN NV KPN.AS P 10.47 28,391 40,108 4.3% 13.9 x 14.4 x 6.2x 6.3x 2.5x 2.5x 11.8% 23.6%

Swisscom AG SCMN VX P 442.25 29,900 31,327 3.6% 14.7 x 13.3 x 6.8x 6.6x 2.8x 2.8x 11.2% 7.3%

Telecom Italia TLIT.MI O 2.27 56,584 106,422 6.2% 15.2 x 15.2 x 6.1x 6.1x 2.5x 2.5x 16.9% -7.8%

Telefonica TEF.MC O 15.53 101,779 172,273 3.2% 15.7 x 13.6 x 6.6x 6.3x 2.5x 2.4x 14.3% 22.2%

Telenor TEL.OL O 114.00 30,738 38,579 1.8% 13.6 x 15.7 x 7.5x 6.5x 2.7x 2.4x 23.8% 72.1%

Average 4.3% 14.2 x 14.9 x 6.4 x 6.3 x 2.3 x 2.3 x 15.2%

Bear Stearns Rating System: Sector Ratings—Market Overweight (MO), Market Weight (MW), Market Underweight (MU) / Stock Ratings—Outperform (O), Peer Perform (P), Underperform (U) 0.) KT Corp. valuations are based on "normalized net income", excluding gains from sale of SK Telecom holdings 1.) China Telecom Valuations are based on "adjusted financials", excluding upfront connection fees 2.) Singtel has a March YE.

3.) NTT has a March YE

4.) Telecom Corp and Telstra has a June YE 5.) AT&T exclude Broadband from 2003 and beyond 6.) Operating Free Cash Flow is defined as EBITDA—Capex

7.) CE defined as Cash Earnings = Net Income + Depreciation

Source: Bear Stearns & Co., Bear Stearns International Ltd, Bear Stearns Asia Ltd., IBES consensus estimates for Not Rated companies

BEAR STEARNS ASIA LTD.

Page 9

BEAR STEARNS

Asian Equity Research

China Telecom Operators: Refining Our Macro View

Wireless Subscriber Trends: China Mobile’s Dominance to Continue?

We have recently revised our high-level subscriber assumptions for China. We have raised our 2006 wireless (ex-PAS) subscriber growth estimate slightly due to observed monthly net addition trends during the first ten months of 2006. We expect annual net additions of 67.6 million subscribers in 2006, representing a 15.4% increase from the 58.6 million subscribers reported in 2005. However, including PAS net additions, we expect total wireless net additions to be relatively flat at 78.6 million subscribers in 2006, compared with 79.8 million subscribers in 2005. Therefore, we believe that declining PAS net additions and GSM-PAS substitution have been the key factors driving subscriber net addition and market share trends for the wireless operators in 2006.

GSM Strength Expected to Continue. We expect GSM to remain the dominant technology in terms of total subscribers and net additions, and forecast GSM net additions of 66.0 million subscribers in 2006, up 23% from 53.7 million subscribers in 2005, comprising 84.1% of total market net additions. We view competitive pricing (particularly versus PAS) and increased availability of ultra-low-end GSM handsets to be the main drivers of the stronger GSM net addition trend, particularly in rural areas. China Mobile has been particularly aggressive in opening this new market segment. We also believe that China Unicom’s GSM network is well positioned to benefit from strength in the low-end market.

PAS Decline is Accelerating. Monthly PAS net additions have slowed considerably over the past year, dropping to 81,000 in October 2006 from 1.4 million in October 2005. We currently forecast full-year net additions of 8.8 million in 2006, compared with 21.0 million subscribers last year. GSM voice pricing (on a per-minute basis) has been falling more rapidly than comparable pricing on China’s PAS networks. Fixed-line operators have in many cases effectively raised PAS pricing by giving away fewer free minutes to new PAS subscribers. PAS handset subsidies have also disappeared in most cities recently surveyed, and are now used mainly as a tool to retain existing fixed-line subscribers. At the same time, pricing on newly introduced (i.e., not end-of-life products) entry-level GSM handsets has fallen by about 30% year on year, while PAS handset pricing has been stable. Therefore, we believe that there has been increasing substitution between PAS and GSM in the China market, contributing to stronger GSM subscriber growth.

CDMA Net Additions Stabilizing at a Low Level. Due to China Unicom’s shift to a more GSM-focused strategy, CDMA net additions remain weak, but have been fairly stable over the past 12 months. We expect full-year CDMA additions of about 3.7 million in 2006, equal to less than one month of net additions for China’s GSM networks. CDMA continues to suffer from a range of issues, including weak branding, expensive handsets, and poor handset selection.

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Asian Equity Research

FIXED-LINE OPERATORS MAY ONCE AGAIN ROCK THE BOAT

CHINA UNICOM THE BEST 3G PLAY BY VIRTUE OF AVOIDANCE

Based on current subscriber trends, we believe that China Mobile and China Unicom’s GSM networks will continue to attract most of China’s net subscriber additions over the next 24 months. Over the longer term, following the entry of one or both fixed-line operators into the mobile market (after 3G license issuance), we expect China Mobile’s dominance to be threatened, particularly in the high-end segment.

While China Unicom’s experience with CDMA demonstrates the difficulty of introducing a new wireless technology to China’s mass market, it is also important to keep in mind that the fixed-line operators have, in the past, demonstrated an ability to rock the boat, having developed a 93 million PAS subscriber base, most of this between 2003 and 2005. This is an even more considerable accomplishment after taking into account the regulatory and technical limitations involved with PAS technology. As a consequence, we believe that China’s fixed-line operators could create significant headaches for China Mobile. At a minimum, the new entrants will likely introduce pricing pressure and additional operating costs to the incumbent’s lucrative postpaid segment, even assuming that the fixed-line operators capture a relatively small share of overall net additions.

We remain convinced that China Unicom, with its predominantly low-end subscriber base, is the best-positioned operator going into 3G, as it will be able to maintain relatively low levels of capex and could be relatively unaffected by aggressive high-end competition from new 3G license holders. While China Unicom classifies about 62% of its total subscriber base (and 51% of its GSM subscribers) as postpaid, we note that China Unicom’s postpaid subscribers have ARPU that is about the same as that of China Mobile’s prepaid subscribers, and that China Unicom’s postpaid GSM ARPM (as measured by our bottom-up market pricing surveys) is already at a large discount not only to China Mobile’s postpaid pricing but also to China Unicom’s own prepaid GSM pricing.

BEAR STEARNS ASIA LTD. Page 11

BEAR STEARNS

Asian Equity Research

Figure 4. China Subscriber Summary

CAGR

YE 31 Dec 2002A 2003A 2004A 2005A 2006E 2007E 2008E 2009E 2010E '06E-'09E

Population (mn) 1,285 1,292 1,300 1,308 1,316 1,323 1,330 1,337 1,343 1%

Total Subscribers: Fixed & Wireless (000) 419,193 522,433 631,816 728,678 818,310 898,531 973,474 1,046,466 1,115,202 9%

Wireless 217,822 296,524 383,734 463,572 542,144 616,430 690,748 765,715 838,143 12%

GSM 197,543 240,068 291,295 345,009 411,049 476,310 522,183 549,049 560,589 10%

CDMA 7,231 19,060 28,078 33,236 37,008 40,177 42,704 44,460 45,889 6%

3G----- 1,056 24,573 69,719 130,018 NM

PAS 13,048 37,396 64,361 85,327 94,087 98,887 101,287 102,487 101,647 3%

Fixed Line (excluding PAS subs) 201,371 225,909 248,082 265,106 276,166 282,101 282,726 280,751 277,059 1%

Penetration (%)

Wireless (ex PAS) 15.9% 20.1% 24.6% 28.9% 34.1% 39.1% 44.3% 49.6% 54.8% NM

- Wireless (including PAS) 17.0% 22.9% 29.5% 35.4% 41.2% 46.6% 51.9% 57.3% 62.4% NM

Fixed Line (excluding PAS) 15.7% 17.5% 19.1% 20.3% 21.0% 21.3% 21.3% 21.0% 20.6% NM

- Fixed Line (including PAS) 16.7% 20.4% 24.0% 26.8% 28.1% 28.8% 28.9% 28.7% 28.2% NM

Wireless Net Additions by Technology (000) 68,159 78,702 87,210 79,838 78,572 74,286 74,318 74,967 72,428 -2%

GSM 52,731 42,525 51,227 53,714 66,040 65,261 45,873 26,866 11,540 -26%

CDMA 7,231 11,829 9,018 5,158 3,772 3,169 2,528 1,756 1,429 -23%

3G*----- 1,056 23,517 45,145 60,300 NM

PAS 8,197 24,348 26,965 20,966 8,760 4,800 2,400 1,200(840) -48%

Wireless Subscribers by Operator (000) 217,822 296,524 383,734 462,754 541,888 616,174 690,492 765,459 837,887 12%

1) China Mobile (CHL) (listco) 117,676 141,616 204,292 246,652 300,900 353,709 403,333 449,068 483,504 14%

2) China Mobile Communications Corp (parentco) 18,928 24,497—————NM

3) China Unicom (CHU) (listco) 67,669 91,515 112,081 127,793 142,350 158,193 171,447 181,568 190,902 8%

4) China United Telecommunications Corp (parentco) 501 1,500 3,000 3,800 4,807 5,641 6,051 6,257 6,448 9%

5) China Telecom Corp (CHA) (listco) 10,786 25,566 42,167 57,100 63,532 66,700 75,428 90,913 114,579 13%

6) China Telecom Group (parentco) 18 34 70 80 90 90 90 70 50 -8%

7) China Netcom (CN) (listco) 1,403 7,423 15,073 27,329 30,209 31,841 34,143 37,582 42,403 8%

8) China Netcom Group (parentco) 841 4,373 7,051———— NM

Subscribers by Operator: Fixed Line 214,419 263,305 312,443 349,615 369,997 380,732 383,757 382,982 378,450 1%

China Telecom Corp (CHA) 133,057 160,989 186,648 210,090 222,532 228,880 230,416 229,526 226,605 1%

China Telecom Group 197 274 377 520 556 581 598 607 611 3%

China Netcom Group Corp (10 provs) 58,358 69,614 80,383 115,328 119,609 121,241 121,211 120,371 118,756 0%

China Netcom Parentco 19,205 24,459 27,696———— NM

Others (Railcom, Unicom, Private Networks, Etc.) 3,602 7,969 17,339 23,677 27,300 30,030 31,532 32,477 32,477 6%

Note: *3G denotes WCDMA/TD-SCDMA subscribers.

Source: Company and MII data, Bear Stearns Asia Ltd. estimates.

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Figure 5. China: Monthly Subscriber Statistics – GSM and CDMA Net Additions

Monthly GSM Net Additions (mn)

8.0

6.8 7.0

6.0

5.2 5.2 5.4 5.3 5.5 4.9 4.9 4.9 5.0 5.1 5.0 5.2 5.0 4.6 4.4 4.4 4.2 4.3 4.2 4.4 4.4 4.3 4.0 4.2 4.2 4.3 4.3 4.2 4.2 3.9 4.0 3.8

3.0 2.0 1.0 -

06 06 6—04—04—04—04—04—04 t—04—04—04—05—0 5—05—0 5y—05—0 5—05—05—05—05v—05c—05—06 r—06—06—06—06—06—06 t—0 AprMay J un J ul Aug Sep Oc Nov Dec J an Fe b Mar Apr Ju n Ju l A ug Se p Oct No De Jan -Feb M a Apr Jun Jul Aug -Sep Oc

M a May

China Monthly CDMA Net Additions (mn)

1.0 0.9

- 0 4—04—0 4—04 0 4—0 4—04—05—05—05—0 5—05—05—0 5—05—05—0 5—05—06—0 6—06—0 6—06—0 6—06 0 6—0 6 y—04 c—04 c—05 y—06

Apr Jun JulAug Sep -Oc tNov De Jan F eb Mar Apr Jun JulAug Sep Oct NovDe Jan F eb Mar Apr Jun Ju l A ugSep -O ct M a M ay M a

Source: Company data, MII, Bear Stearns Asia Ltd.

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Wireless Usage and Pricing Trends: Elasticity Driving Increased Usage

We expect marketwide wireless average revenue per minute (ARPM) to decline 15.9% in 2006 compared with a 16.2% decline in 2005, driven by competition and an increasing mix of low-end subscribers. Aggressive pricing and efforts to penetrate the rural market by China Mobile will remain the main factors driving prices down. Price declines, along with subscriber growth, have driven a rapid increase in overall network traffic, with total network minutes increasing 35.4% year on year in 2006E compared with 32.6% in 2005. Network traffic growth has been driven mainly by strong growth in GSM subscribers and rising demand elasticity at China Mobile.

Figure 6. China: Marketwide Usage and Pricing Trends

7,000 0.35 Network Minutes (bn) ARPM (CNY) 6,000 0.30

5,000 0.25

4,000 0.20 Usage (bn min) 3,000 0.15 ARPM (CNY) 2,000 0.10

1,000 0.05

—2003A 2004A 2005A 2006E 2007E 2008E 2009E 2010E 2011E 2012E 2013E 2014E 2015E

Source: Company data, Bear Stearns Asia Ltd. estimates.

HIGH ELASTICITY HAS DRIVEN CHINA

MOBILE’S USAGE GROWTH; CHINA UNICOM’S ELASTICITY EXPECTED TO RISE DUE TO NETWORK IMPROVEMENTS

We calculate historical wireless demand elasticity by dividing the annual change in minutes of use (MOU) by the annual change in ARPM. Based on the first nine months of operating data from China Mobile and China Unicom, we expect China Mobile’s demand elasticity to reach 1.46 for prepaid customers and 1.28 for postpaid customers. We believe that China Mobile has been able to achieve these levels of elasticity through aggressive price-cutting and the introduction of innovative pricing plans. However, over time, we expect the company’s elasticity to decline as blended MOU nears 450 minutes per month and postpaid subscriber usage reaches 900 minutes per month. China Unicom, on the other hand, has seen lower elasticity levels due to less-aggressive prepaid pricing cuts and lower network quality. We expect China Unicom’s elasticity to rise as it raises network capacity and focuses more on prepaid subscriber and usage growth.

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Figure 7. China: Wireless Price Elasticity of Demand (Delta MOU/Delta ARPM)

2.00

1.50 1.25 1.00 0.75 0.50 0.25 -(0.25) (0.50)

(0.75)

2004A 2005A 2006E 2007E 2008E 2009E 2010E 2011E

Source: Company data, Bear Stearns Asia Ltd. estimates.

Fixed Line: Are China’s Consumers Hanging Up on Fixed Line?

We believe that we are seeing the beginning of a sustained decline in fixed-line telephony revenue in China. While we still expect total fixed-line subscribers to increase 4.1% in 2006, subscriber additions have declined sharply, falling to 830,000 per month in October from 2 million or more per month in July. In third-quarter 2006, China Telecom reported lackluster line growth while China Netcom (906.HK-HK$16.16/CN-US$41.40-Not Rated) reported actual net disconnects in residential fixed lines. Much, but not all, of the weakness can be explained by PAS net additions. We believe that the main reason for the slowdown, however, is the fixed-line operators’ change in growth strategy in the run-up to expected 3G licensing: with 3G (and its associated capex and marketing costs) right around the corner, we believe that China Telecom and China Netcom are simply cutting back on promotional activity to conserve cash. We expect that minimal levels of subscriber growth will persist over the next two years before the market as a whole begins to experience net line losses in 2009 as a result of mobile substitution.

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Figure 8. China: Fixed-Line Subscriber Trends

400,000 35.0% Fixed Line Subs, ex-PAS ('000) YoY Growth % 350,000 30.0%

300,000 25.0% 250,000 20.0% 200,000 15.0% 150,000 10.0% 100,000 5.0% 50,000 0.0%

0 -5.0% 1999A 2000A 2001A 2002A 2003A 2004A 2005A 2006E 2007E 2008E 2009E 2010E 2011E 2012E 2013E 2014E 2015E

Source: Company and MII Data, Bear Stearns Asia Ltd. estimates.

FIXED-LINE

SUBSCRIBER GROWTH MASKING MOU DECLINES, BUT SUBSCRIBER GROWTH RUNNING OUT

Mobile and Fixed-Line Usage Trends

High-level data on China’s telecom industry suggests that consumers are migrating usage en masse from fixed-line to mobile services. China’s total fixed-line voice traffic began declining for the first time in 2006 due to mobile substitution. Since January 2004, China’s fixed-line traffic has remained relatively flat, while traffic on China’s mobile networks has more than doubled. This, however, is not surprising given the much faster subscriber growth rate of mobile services.

However, flat monthly network usage on China’s fixed-line networks has persisted in an environment of relatively steady fixed-line subscriber additions, masking a significant decline in MOU. Fixed-line MOU has been declining steadily, falling 28.4% between January 2004 and October 2006. If we extrapolate this long-term trend into the future, we expect total voice usage on China’s fixed-line networks to begin to decline in late 2006 or early 2007, because we believe that subscriber additions will be not be sufficient to support growth in network traffic.

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Figure 9. China Nationwide Network Traffic Data

China Network Traffic Trends: Monthly Network Minutes (Fixed Line vs. Mobile)

- 20.0 40.0 60.0 80.0 100.0 120.0 140.0 160.0 180.0 Jan-04 Feb-04 Mar-04 Apr-04 May-04 Jun-04 Jul-04 Aug-04 Sep-04 Oct-04 Nov-04 Dec-04 Jan-05 Feb-05 Fixed Line n/w min (bn) Mar-05 Apr-05 May-05 Jun-05 Jul-05 Aug-05 Sep-05 Oct-05 Nov-05 Mobile n/w min (bn) Dec-05 Jan-06 Feb-06 Mar-06 Apr-06 May-06 Jun-06 Jul-06 Aug-06 Sep-06 Oct-06

China Network Traffic Trends: Average Monthly MOU per Sub (Fixed Line vs. Mobile)

- 50.0 100.0 150.0 200.0 250.0 300.0 350.0 400.0 Jan-04 Feb-04 Mar-04 Apr-04 May-04 Jun-04 Jul-04 Aug-04 Sep-04 Oct-04 Nov-04 Dec-04 Jan-05 Feb-05 Fixed Line MOU (min/mo) Mar-05 Apr-05 May-05 Jun-05 Jul-05 Aug-05 Sep-05 Oct-05 Nov-05 Dec-05 Mobile MOU (min/mo) Jan-06 Feb-06 Mar-06 Apr-06 May-06 Jun-06 Jul-06 Aug-06 Sep-06 Oct-06

Note: For fixed line, one pulse is assumed to equal one minute. Mobile MOU data are as reported by the MII. Fixed-line data includes PAS subscribers. Source: MII, Bear Stearns Asia Ltd. estimates.

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Asian Equity Research

China Telecom Equipment: Capex and Handset Trends

From a vendor standpoint, 2006 has turned out much better than expected in terms of both telecom capex and handset shipments. This has reinforced our positive stance on the Chinese telecom equipment sector and wireless equipment vendor China GrenTech in particular. We downgraded ZTE Corp. to Peer Perform from Outperform on November 21, 2006, because we believe the stock is trading slightly above fair value and could be vulnerable to uncertainty over 3G license timing after recent strong performance. As for handsets, we believe that the leading global handset vendors will continue to benefit from the continued growth (in both volume and value terms) of the Chinese handset market. In this section, we will address the following:

Telecom infrastructure discussion points include: 2006 capex seasonality; 3G equipment market (TD SCDMA and WCDMA); the recent uptick in “residual capex” attributable to spending outside of China’s listed operators; IPTV developments (regulatory and commercial) and the equipment market opportunity for IPTV; wireless coverage market; and the PAS infrastructure market outlook.

Handsets: We have recently updated our China handset supply and demand macro to reflect higher estimated subscriber growth in 2006 and 2007. We have also updated our macro to reflect reported third-quarter shipments on a vendor-by-vendor basis; ASP trends for new handset introductions; and individual vendors’ own reported handset shipment data.

Analysis of Telecom Infrastructure Spending

Chinese telecom capex has surprised on the upside year to date due to a combination of factors, including: accelerating network traffic growth; faster-than-expected subscriber growth; and, we hypothesize, wireless spending by unlisted operators (and possibly the Chinese government). We believe that we are witnessing the beginning of a three-year wireless capex boom that will culminate in 2008 with the fixed-line operators’ wireless market debut.

2006 Year-to-Date Statistics Point to 16.6% Capex Growth; 31.5% Wireless Capex Growth. We recently raised our estimate of 2006 capex by 5.5% to CNY237 billion (US$29.7 billion). The revision was due almost entirely to our belief that wireless capex will rise by 31.5% year on year in 2006. We believe that GSM and 3G capex are contributing all of the growth in 2006 wireless capex, while CDMA is declining by an estimated 77.7% year on year. We expect wireline capex (including PAS) to experience a single-digit percentage decline in 2006.

Monthly and Quarterly Telco Capex. As seen in Figure 10 below, capex began to spike upward in June 2006 and has yet to show signs of slowing. Third-quarter seasonality was stronger than usual, rising 5.7% quarter on quarter – over the past three years, third-quarter capex has declined by 20%, 18%, and 13% quarter on quarter, respectively.

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Telco Capex Seasonality. Our annual estimate implies normal to slightly weak seasonality in the fourth quarter (40% of full-year capex and quarter-on-quarter growth of 65%). Over the past three years, fourth-quarter capex has ranged from 35% to 45% of full-year capex and has grown from 52% to 114% quarter on quarter. China’s back-end-loaded seasonality pattern is due to the budgeting process and drawn-out payment cycle of the state-owned telecom operators.

Figure 10. China: Monthly and Quarterly Telecom Capex

CHINA MONTHLY Telecom Capex (US$ bn)

7.0

6.0

5.1

5.0

4.2

2.0 2.3 2.1 2.2 2.0 2.0 2.0 2.1 2.0 2.0 1.9 2.0 1.8 1.7 1.7 1.7 1.5 1.5 1.6 1.4 1.7 1.5 1.6 1.3 1.0 1.0 0.9 1.1 1.0 1.0 0.8 0.7 0.5

0.0

Jan 03 Feb 03 March 03 April 03 May 03 June 03 July 03 Aug 03 Sept 03 Oct 03 Nov 03 Dec 03 Jan 04 Feb 04 Mar 04 Apr 04 May 04 Jun 04 Jul 04 Aug 04 Sep 04 Oct 04 Nov 04 Dec 04 Jan 05 Feb 05 Mar 05 Apr 05 May 05 Jun 05 Jul 05 Aug 05 Sep 05 Oct 05 Nov 05 Dec 05 Jan 06 Feb 06 Mar 06 Apr 06 May 06 Jun 06 Jul 06 Aug 06 Sep 06 Oct 06 Nov 06E Dec 06E

CHINA QUARTERLY Telecom Capex (US$ bn)

bn) $18.0

+18.1% YoY

-12.1%

YoY YoY $7.2 $6.9 $7.3 +8.9% $6.8 $6.0 $6.1 YoY $5.5 $5.3 $6.0 $3.4 $3.4 $3.8 $2.6

$0.0

Q1 03 Q2 03 Q3 03 Q4 03 Q1 04 Q2 04 Q3 04 Q4 04 Q1 05 Q2 05 Q3 05 Q4 05 Q1 06 Q2 06 Q3 06 Q4 06E

Source: MII data, Bear Stearns Asia Ltd. estimates.

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Asian Equity Research

Wireless Capex: “Residual” Spending of US$6.4 billion in 2006, Up 60% Year on Year

Subtracting estimated listed operator capex (for China Mobile, China Unicom, China Telecom, and China Netcom) from our total capex estimate yields a “residual capex” figure of CNY50.7 billion (US$6.4 billion), versus CNY33.0 billion (US$4.0 billion) in 2005. Other operators: Apart from the listed companies, the only discrete operators in China are ChinaSat, China Railcom, Guizhou Unicom, and Tibet Telecom. Parent company capex: (China Mobile Communications Corp., China United Telecommunications Corp. [CMCC], China Telecom Corp. [CTC], and China Network Communications Group Corp. [CNCG]): For the past two years, due to the fact that most provincial telecom subsidiaries of the big four telco groups had been acquired by the listed companies, the main components of parent company spending were the Unicom CDMA network and the nationwide interprovincial backbones of CMCC and CTC.

CDMA Less of a Factor in 2006: From 43% to 6% of Residual Capex. What makes the jump in residual capex even more surprising is the fact that CDMA capex, once the largest component of the residual figure, is declining by nearly 80% in 2006, comprising just 6% of residual capex versus 43% in 2005.

Other Residual Capex. Based on the trends taking shape in the first three quarters of 2006, we estimate that the non-CDMA portion of residual capex will rise 154% year on year in 2006 to CNY47.5 billion. We assume that Guizhou Unicom, Tibet Telecom, China Sat, Railcom, and interprovincial backbone spending rises to CNY22.5 billion in 2006 from CNY18.7 billion in 2005.

A New Category in 2006 – Parent Company 3G Spending. We believe that most of the 2006 increase in residual spending is coming from 3G spending at the parent company level. We believe this spending has been taking place in preparation for more extensive TD SCDMA commercial trials conducted by China Telecom, China Mobile and China Netcom, beginning with Beijing on November 5 and Shanghai on November 15. This is consistent with the timing of the ramp in overall telco capex, which began in June (+21% year on year) and continued into September (+41% year on year).

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Figure 11. Interim Capex by Operator, Residual Capex

160.0

CHL CHU CHA CN Others (Residual) 140.0

38.0

120.0

21.0

100.0

60.0 40.0 20.0 -

1H 05 2H 05 1H 06 2H 06E

Source: MII, Bear Stearns Asia Ltd. estimates, Operator data.

3G…Coming Soon to 12 Cities Near You

We believe that the push to issue 3G licenses is gathering momentum as we approach year-end. Key recent developments include:

Statements by National Development and Reform Commission (NDRC) officials reaffirming China’s commitment to launch 3G services before the 2008 Olympics and voicing support for the TD SCDMA standard, now deemed “mature.”

The recent launch (November 6) of commercial TD SCDMA trials in Beijing, Qingdao, Baoding, and Xiamen, with subscriber targets in each city ranging from 1,000 to 5,000 in the initial stages.

The launch of a more extensive commercial trial on November 15 (following the outcome of the above trials) in the above cities, in addition to Shanghai. The second round of trials is intended to broaden the focus subscriber base and will last until the end of December.

We believe that trials would be expanded to another seven cities during this period, including Hong Kong, Qinhuangdao, Tianjin, Shenyang, Guangzhou,

Shenzhen, and the Chongqing special municipality. These cities have been chosen for testing due to their size, economic importance, and varying levels of involvement in the 2008 Olympics. On November 22, Sina Tech news reported that Datang Mobile has signed an agreement with Hong Kong’s Wireless Technology Industry Association (WTIA) to construct a TD SCDMA test network in Hong Kong’s Cyberport area.

Reports that TD SCDMA chipset vendors are placing sizeable TD SCDMA baseband chipset orders with foundries, one example being chipset design house Commit’s order, placed with TSMC in third-quarter 2006.

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TD SCDMA handsets gaining regulatory approval: handsets from vendors including ZTE, LG Electronics (066570.KS-KRW53,900-Peer Perform/Market Overweight), Holley, Inventec Appliances, Haier, Simtech (Sim Technology), Bird, Hisense, Lenovo (992.HK-HK$3.17-Peer Perform/Market Weight), Longcheer, Amoi, and Xinyoutong (a local vendor) all underwent testing and gained approval for use in commercial TD SCDMA trials in late October. We expect the range of vendors and handsets to increase as trials take place.

Our 3G Base Case Scenario. We still expect China’s 3G licenses to be issued in two stages: TD SCDMA in first-quarter 2007 and WCDMA/CDMA2000 in second-quarter 2007. However, based on recent capex trends and discussions with vendors, we believe that 3G network builds (TD SCDMA, WCDMA, and EV DO) are already underway, potentially shortening the time lag between 3G license issuance and actual commercialization. We are interested in the implications of the large residual capex number noted above and are now taking the view that the official 3G licenses will be less of a catalyst for network rollout than a “rubber stamp” on the rollouts currently in progress.

Which 3G Standard? Our base case assumes the following technology split between operators: China Mobile (TD SCDMA); China Telecom (WCDMA); China Netcom (WCDMA); and China Unicom (CDMA2000, specifically EV DO Rev. A). Our reasoning is as follows:

China Mobile ? TD SCDMA: China Mobile is the only operator that can make

TD SCDMA a success, in our view. Reasons include the company’s huge scale, leverage and existing purchasing relationships with handset suppliers (key to ensuring adequate supply of handsets), and its extensive retail network. Regulatory perspective: China Mobile is also increasingly dominant in the wireless business, so designating it as the TD SCDMA operator might give China’s other 3G operators more of a fighting chance.

China Telecom ? WCDMA: Realistically, China Telecom can only be competitive if it is able to compete using a mature 3G standard with a well-developed handset supply chain. Given China Telecom’s stated strategy of targeting high-end subscribers in urban areas (initially, at least), we believe that pursuing a subsidy-driven strategy accompanied by fixed-mobile bundling discounts is likely the only way that China Telecom will be able to wrest enough subscribers from the incumbents to establish a critical mass of wireless subscribers.

China Netcom ? WCDMA: Same argument as in the case of China Telecom, only more so, due to the relative weakness of China Netcom’s brand and balance sheet.

China Unicom ? EV DO, Pursues Incremental GSM Upgrades: We assume that China Unicom remains intact (i.e., no breakup) and that CUTC undertakes a gradual upgrade to EV DO Rev A to accommodate its heavy data users.

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Based on this expected 3G scenario, we expect continuous wireless capex expansion in 2007 and 2008, followed by a slight downtick in 2009 on completion of large initial network rollouts/upgrades. We expect 2G spending to go into a sustained decline, as illustrated in Figure 12. While it is difficult to estimate how much spending will be apportioned to TD SCDMA versus WCDMA infrastructure within the 3G category, we believe that the spending ratio will be roughly 50:50 in our base case scenario.

We note, however, that estimates vary: CCID Consulting, the quasi-official research consultancy affiliated with the Ministry of Information Industry (MII), estimated in its February 2006 report “China 3G Market and Telecom Equipment Development and Research in 2005-2006” that TD SCDMA spending would amount to CNY109 billion in the first five years of network rollout, compared with WCDMA investment of CNY86 billion and CDMA2000 investment of CNY55 billion. We discuss 3G network rollout assumptions on an individual operator basis in the section below.

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Figure 12. Aggregate Wireless Capex Breakdown by Technology and Group

Capex (CNY bn)

240,000

220,000 GSM 3G CDMA 200,000 10,337

7,670

180,000

6,044

160,000

3,200

140,000

120,000 14,300 34,809 62,611 109,984

104,599

100,000

80,000 5,865 60,000

98,891 89,775

40,000 83,945

63,367 62,912

20,000 -

2005A 2006E 2007E 2008E 2009E

CHINA WIRELESS CAPEX ESTIMATES

2001A 2002A 2003A 2004A 2005A 2006E 2007E 2008E 2009E TOTAL WIRELESS REVENUE (US$ bn) 19.9 23.5 27.6 34.0 40.1 48.2 57.3 65.0 69.8

- Change YoY 18.4% 17.4% 23.2% 18.0% 20.2% 18.9% 13.3% 7.5%

TOTAL WIRELESS CAPEX (US$ bn) 18.9 12.7 12.6 12.7 12.7 17.2 20.3 24.0 22.9

- Change YoY (US$ terms) -32.7% -1.4% 1.0% 0.3% 35.3% 18.0% 18.3% -4.6%—Change YoY (CNY terms) -32.7% -1.4% 1.0% -0.8% 31.5% 15.7% 15.9% -4.6%

WIRELESS CAPEX / REVENUE (%) 95.3% 54.2% 45.5% 37.3% 31.7% 35.7% 35.4% 37.0% 32.8%

Wireless Capex by Technology (CNY mn) 156,650 105,406 103,936 104,990 104,110 136,900 158,430 183,688 175,181

- GSM Coverage (and Other) Spending 133,708 88,826 83,156 82,253 83,945 98,891 89,775 63,367 62,912—CDMA 19,200 13,500 17,700 20,785 14,300 3,200 6,044 10,337 7,670—3G (WCDMA, TD-SCDMA) & Others * 3,742 3,080 3,080 1,952 5,865 34,809 62,611 109,984 104,599

Wireless Capex by Group (CNY mn) 156,650 105,406 103,936 104,990 104,110 136,900 158,430 183,688 175,181

China Mobile ** 84,860 61,106 59,036 64,600 71,500 85,000 90,000 90,000 88,000 China Unicom *** 71,800 44,300 44,900 40,390 32,610 26,900 29,744 34,037 30,370 Fixed Line Operators (China Telecom & Netcom) 28,686 59,651 56,811 OTHERS: MII, Gov't, Parentco 3G Capex———- 25,000 10,000—-

Share of Wireless Capex (%)

China Mobile Communications Group 54.2% 58.0% 56.8% 61.5% 68.7% 62.1% 56.8% 49.0% 50.2% China Unicom Group 45.8% 42.0% 43.2% 38.5% 31.3% 19.6% 18.8% 18.5% 17.3% Fixed Line Operators (China Telecom & Netcom) 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 18.1% 32.5% 32.4% OTHERS: MII, Gov't, Parentco 3G Capex 0.0% 0.0% 0.0% 0.0% 0.0% 18.3% 6.3% 0.0% 0.0%

** Note: China Mobile capex includes parentco capex before 2005, when all provinces were included in listco. *** Note: Unicom capex includes CDMA capex undertaken by parentco.

Source: MII, Bear Stearns Asia Ltd. estimates, Operator Data

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BEAR STEARNS

Wireless Capex Versus Revenue and Network Traffic

The capex:network traffic relationship is a key driver of returns for the wireless industry as a whole as we approach the launch of 3G services and the market entry of new competitors. We view the capex:incremental minute ratio as a sanity check on our capex:revenue assumptions. Key drivers of 2006-07 capex are: 1) subscriber growth; 2) continued rapid growth in network traffic; and 3) software upgrades to accommodate regulatory requirements for wireless value-added services (VAS) billing (and future 3G data service requirements). Parent company spending on trial 3G networks is another key driver of spending for the next six months, in our view. We expect China Telecom and China Netcom and/or their respective parent companies to begin investing aggressively in 3G infrastructure in second-half 2007.

Figure 13 shows our high-level assumptions for capex, network traffic, and wireless revenue growth, assuming that both China Telecom and China Netcom begin investing in wireless networks in 2007 and launch commercial wireless services in mid-2008. We note that trends in network traffic growth have been closely correlated with trends in the ratio of capex to revenue, whereas revenue growth trends have not been so reliable. Examining the three-line chart below, we observe the following:

Causes of the 2002-05 Downtrend in Capex:Revenue. On an industrywide basis, the decline in capex:revenue from 54% to 32% during this period was driven by falling network traffic growth rates, declining GSM capex (by China Unicom), and a steep falloff in GSM equipment pricing. The lack of correlation between revenue growth and the capex:revenue trend is mainly due to competitive shifts and the resulting price trends. In 2003 in particular, pricing pressure stemming from the twin onslaught of CDMA and PAS placed pressure on both high-end and low-end voice pricing, causing a slowdown in revenue growth as voice pricing declines outpaced minute growth. The subsequent recovery in revenue growth in 2004 and 2005 was due to rising wireless VAS ARPU and voice price stabilization, combined with steady subscriber growth.

2005-07E – Rising Capex:Revenue, Steady Revenue Growth. Wireless capex:revenue bottomed in 2005 and is expected to rise steadily until 2008. The inflection can be attributed to a reversal in some of the trends noted for 2002-05.

Specifically, capex per incremental minute may rise due to 3G infrastructure investments; lower overall capacity utilization; and China Unicom’s and China Mobile’s continued investment in 2G infrastructure.

2008E-10E – Revenue Slowdown as Price Declines Outpace Minute Growth Once Again. In 2008 we expect capex (as well as capex:revenue) to peak while revenue growth falls off significantly. This will likely be caused by a more aggressive and prolonged version of the dynamic that accompanied the introduction of CDMA in 2002-03 – i.e., the construction of new networks and the introduction of aggressive voice price plans aimed at existing high-end subscribers. We expect the key differences between 2003 and 2008 to be: 1) the larger scale and better positioning of the new entrants; and 2) much lower subscriber growth, estimated at 13.5% in 2008 versus 30% in 2003. We believe

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that 2008 is the first year in which the incumbent wireless players will see significant erosion in returns, caused by rising capex and falling revenue growth. However, as we expect most of the new network capacity (hence pricing pressure) to be targeted at high-end subscribers in urban areas, we believe that China Mobile will be more exposed to price competition than China Unciom.

Figure 13. Aggregate Wireless Capex in the Context of Revenue and Network Traffic

70.0%

Capex:Revenue Rev Growth N/W Traffic Growth

60.0%

54.2%

32.8%

19.3%

0.0%

2002A 2003A 2004A 2005A 2006E 2007E 2008E 2009E 2010E 2011E

Aggregate Network Minutes and Implied Capex per Incremental Network Minute

Minutes (bn) US$

3,500 0.120

3,000 0.096 N/W Minutes (bn) (LHS) Capex / Increm. Minute (US$)

0.100

2,500

0.034 0.040 1,000

0.020 500

—2002A 2003A 2004A 2005A 2006E 2007E 2008E 2009E

Aggregate Wireless Capex and Capex:Revenue

Capex (CNY bn)(%)

220,000 70.0% 200,000 Capex Capex:Revenue (%) 60.0% 180,000 54.2% 160,000 45.5% 50.0% 140,000

100,000

- 0.0% 2002A 2003A 2004A 2005A 2006E 2007E 2008E 2009E

Note: Future revenue, network traffic, and capex estimates include contribution from new wireless market entrants China Telecom and China Netcom, assuming that each launches wireless networks in their respective operating areas.

Source: MII Data, Bear Stearns Asia Ltd. estimates.

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Capex Drivers for Individual Operators

China Mobile: Minute Growth, Rural Push. In 2005-06, China Mobile raised capex in response to demand for more capacity and the strategic push into rural markets. The operator has seen decent returns on this investment due to stable pricing and minimal competition (China Mobile is now garnering 80% of net wireless additions). China Mobile’s ROE has been on the rise for the past three years: since falling to a low of 17.4% in 2003 (6.8% on an adjusted basis, accounting for historical goodwill write-offs not recognized on the P&L) ROE is expected to reach 22.1% in 2006. We note, however, that China Mobile’s capex per incremental network minute is no longer falling at the same pace as in 2002-05 and will likely remain flat at around US$0.03 for the next two years, in our view.

Capacity Trends: China Mobile’s stated network capacity utilization has fallen steadily since year-end 2004. Stated network utilization rate was 84% in December 2004, 82% in December 2005, and 83% in June 2006. We expect China Mobile to end the year with network capacity utilization of 81%.

Indoor Coverage: China Mobile initiated a quality of service (QoS) campaign in 2003-04 to differentiate itself from China Unicom on indoor QoS, spending heavily on in-building (with an emphasis on elevator coverage in high-rise office buildings) and underground coverage. We believe that China Mobile’s coverage spending peaked in 2004, fell in 2005, and remained flat in 2006.

3G Impact on Capex Trends. We expect China Mobile’s 3G rollout to have the most impact in 2007 and 2008 due to the operator’s need to undertake 3G upgrades in 20-30 major cities while at the same time maintaining quality of coverage on its 2G network. Nonetheless, China Mobile’s scale will likely allow it to perform a 3G upgrade without increasing capex:revenue. The choice of TD SCDMA versus WCDMA does not affect our capex estimates for China Mobile. While WCDMA would be a smoother upgrade path for the GSM operator, TD SCDMA equipment will likely come at a lower price, being sourced primarily from domestic vendors. We believe that China Mobile’s main 3G-related concern will not be capex but postpaid price erosion and subscriber retention costs, which would be much higher in a TD SCDMA scenario, in our view.

Figure 14. China Mobile Capex:Incremental Minute and Capex:Revenue Trends

CHL: Total Network Minutes and Implied Capex per Incremental Network Minute CHL: Capex and Capex:Revenue

Minutes (bn) US$

3,000 0.100

0.070 2,000

1,500 0.050

0.036 0.036

0.040

0.030 0.030

1,000

0.022 0.030 0.030

0.020 500 0.010

—2002A 2003A 2004A 2005A 2006E 2007E 2008E 2009E

CHL: Capex and Capex:Revenue

Capex (CNY bn)(%)

120,000 50% 110,000 Capex Capex:Revenue (%) 45% 100,000 38% 40% 90,000

33%

32% 35% 80,000 29% 29%

70,000 26% 30%

23%

60,000 21% 25% 50,000 20% 40,000 15% 30,000 10% 20,000 10,000 5%

- 0% 2002A 2003A 2004A 2005A 2006E 2007E 2008E 2009E

Source: Company Data, Bear Stearns Asia Ltd. estimates.

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China Unicom: GSM Capacity; GPRS Upgrades. China Unicom’s capex trajectory looks slightly different than China Mobile’s. Historically, China Unicom has had slightly higher capex per network minute than China Mobile for a few reasons. (Note that for China Unicom we compare listco capex excluding fixed-line spending to GSM network minutes, as the Unicom CDMA network is owned by CUTC). The biggest reasons for China Unicom’s higher cost per minute are scale and spectrum: China Unicom has just 6x2 Mhz of spectrum in the 900Mhz range, with 10x2Mhz in the 1800Mhz range, giving it a higher cost of network buildout compared with China Mobile, which has more than twice China Unicom’s overall spectrum, most of it in the 900Mhz range. China Mobile also has much larger purchasing scale than China Unicom and has sought to leverage this scale by centralizing equipment procurement, allowing it to negotiate more aggressively on equipment pricing. Nonetheless, China Unicom’s capex per minute is declining to levels that rival China Mobile’s, particularly given China Mobile’s added burden of upgrading to 3G beginning in 2007.

Capacity Trends: China Unicom has operated above its stated GSM network capacity for the past two years and has only recently clawed its way back to full network utilization. The utilization rate was 100% in December 2004, 106% in December 2005, and 100% in June 2006. We expect China Unicom to end the year at 97% of stated GSM network capacity.

Indoor Coverage: China Unicom began installing indoor coverage systems later than China Mobile and when it did begin, it was for the CDMA network, then thought to be the company’s future growth driver and high-end offering. Now China Unicom has cut back on CDMA coverage and is attempting to be more competitive on GSM indoor coverage. This is particularly important in the larger cities, where China Unicom is upgrading to GPRS.

3G to Have Minimal Effect on China Unicom’s Capex Plans. We expect China Unicom to maintain flat wireless network capex in 2007-08 after an estimated 32% increase (taking into account capex related to GSM, transmission, and other shared facilities) in 2006. We believe that China Unicom will apply most of its network spending to GPRS upgrades, capacity expansion, and indoor coverage (also a type of capacity expansion). It is also likely to expand its coverage in smaller cities and towns where the company does not face the same spectrum shortages currently being encountered in some of the highly penetrated coastal cities. In general, we expect China Unicom to benefit from its continued focus on GSM/GPRS. Given China Unicom’s mass-market strategy, network capacity and QoS are the main constraints to network traffic growth (China Unicom’s main revenue driver). Fortunately for China Unicom, capacity and QoS are also some of the easiest issues to address, due to continued declines in legacy 2G equipment.

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Figure 15. China Unicom Capex:Incremental Minute and Capex:Revenue Trends

CHU: GSM Network Minutes and Implied Capex per Incremental Network Minute CHU: Capex and Capex:Non-CDMA Revenue

Minutes (bn) US$

600 0.100

0.070 400 0.060

0.048

300 0.046 0.050

0.038

0.030

0.034

0.020 100 0.010

—2002A 2003A 2004A 2005A 2006E 2007E 2008E 2009E

Capex (CNY bn)(%)

60,000 100% 55,000 87% Capex Capex:Revenue (%) 90% 50,000 80% 45,000

64% 70% 40,000 35,000 52% 60% 30,000 50%

38%

25,000 40%

32% 29%

20,000 27%

30% 15,000

30%

20% 10,000 5,000 10%

- 0% 2002A 2003A 2004A 2005A 2006E 2007E 2008E 2009E

Source: Company Data, Bear Stearns Asia Ltd. estimates.

China Telecom: Fixed Line & PAS Slowdown; Broadband Growth; 3G Network Strategy. The capex drivers for a fixed/wireless local loop/broadband operator experiencing fixed-mobile substitution are more complex than in the case for China Unicom and China Mobile. Network traffic was fairly stagnant from 2002 to 2005, and then began dropping in 2006 rendering incremental network capacity cost analysis irrelevant. Nearly half of China Telecom’s spending for the past two years has been directed to wireless local loop (PAS) and broadband. PAS has acted as a stop-gap measure for the wireline operators as they await 3G licensing, boosting telephony “line” growth and buffering the decline in wireline MOU. All of China Telecom’s incremental revenue, however, has come from broadband and VAS (much of which is related to PAS users).

Broadband Capex Likely to Be the Most Stable. We believe that broadband spending is the one area of fixed-line spending that is likely to remain at or near current levels, even in the event that China Telecom receives a 3G license. This will be driven by steady broadband subscriber growth, bandwidth upgrades, and investment in new services, notably IPTV. We believe that broadband (classified by China Telecom as “Internet and data”) capex will remain flat in 2006 and decline by 10% in 2007, assuming flat net additions and declining cost of equipment.

IPTV Potential Still Limited. IPTV has gained a bit of traction, with the recent award of a fourth nationwide license to China Radio International (CRI), a state-run radio company under the direct supervision of the State Administration of Radio Film and Television (SARFT). No licenses have been issued to telecom operators and China Telecom does not expect SARFT to issue licenses to the telcos. Therefore, IPTV will continue to be offered through partnerships between IPTV license holders and network operators. Due to the decentralized structure of SARFT, telecom operators must form cooperative ventures with IPTV license-holders at the local level, which we expect to severely limit the speed of development of IPTV services in new areas.

PAS Spending Declining to Maintenance Levels. We estimate that China Telecom has lowered PAS capex by around 35% in 2006, from approximately CNY8.3 billion in 2005. China Telecom has recently focused mainly on network optimization (e.g.,

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services, BTS relocation, and indoor coverage), however, which means that the traditional PAS equipment vendors likely saw equipment orders drop by more than 35% during the year. We estimate that China Telecom will invest approximately CNY 1,000 million (about 18.5% of its total PAS capex) on indoor coverage in 2006, up 40-45% year on year. The indoor push has two motivations: 1) to improve the notoriously bad quality of PAS indoor reception (due to the low-power design of the network), hence boosting at-home usage and MOU; and 2) 3G preparation: having a PAS coverage system already in place would allow the operator to quickly upgrade to 3G simply by adding a 3G repeater (as well as compatible trunk amplifiers).

3G Network Buildout Strategy: Going Toe-to-Toe with China Mobile. China Telecom has stated that its 3G strategy will be based around comprehensive network builds in major cities, but this does not tell the whole story. We believe that China Telecom’s strategy is to take a large share of China Mobile’s existing postpaid subscriber base, as well as a large proportion of marketwide net additions in the first two years following network launch. China Telecom (and probably China Netcom as well) have learned a lesson from China Unicom’s experience with CDMA and will seek to front-end-load network spending and marketing expenditure in order to establish critical mass and a positive brand image from the outset. Based on our conversations with regional China Telecom subsidiaries and equipment vendors, we believe that from China Telecom’s perspective, “comprehensive” implies the following prioritization of network coverage:

1) Matching China Mobile in First-Tier Markets. China Telecom will attempt to match China Mobile’s network coverage and quality of service (QoS) in the wealthier first-tier “megacities” such as Shenzhen, Shanghai, and Tianjin. We believe that there are about 20 such cities in China.

2) Focused Coverage in Secondary Cities. In large urban markets with economic significance but lower affordability and smaller populations than the megacities, China Telecom will focus on broad outdoor coverage with indoor coverage being focused on major office complexes, five-star hotels, and well-trafficked shopping areas.

3) “Presence” in Third-Tier Cities. In cities with large populations but lower affordability, China Telecom will likely seek to establish an initial presence with thin network coverage and minimal indoor coverage.

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Figure 16. CHA Capex:Incremental Minute and Capex:Revenue Trends

CHA: Fixed Line & PAS Network Minutes and Implied Capex per Incremental Network Minute CHA: Capex and Capex:Revenue

Minutes (bn) US$

-0.192 -0.233 -0.241

0.00 —0.50 (10) -1.00 (20) -1.50

-2.379

Capex (CNY bn)(%)

80000 80% Capex Capex:Revenue (%) 70000 70%

60000 60%

50000 46% 50%

44%

40000 37% 40%

33%

30%

30000 24% 30%

22%

20000 26% 20%

10000 10%

0 0% 2002A 2003A 2004A 2005A 2006E 2007E 2008E 2009E

Source: Company Data, Bear Stearns Asia Ltd. estimates.

IPTV MARKET OPPORTUNITY WILL BE LIMITED

IPTV: Not Bullish on Outlook for Operators or Vendors

In the medium term, we believe that IPTV investment will likely be limited by the continued existence of regulatory obstacles in most major cities, the high cost of IPTV services, and a lack of content differentiation vis-à-vis cable. There are currently four IPTV license holders in China, including Shanghai Media Group, CCTV, Guangdong Southern Media, and China Radio International (CRI) (a state-run radio company under the direct supervision of SARFT).

For example, Shanghai Telecom’s IPTV service currently offers three tiers of service priced at CNY1,660, CNY1,700 and CNY1,900 per year, respectively. In Beijing, China Netcom’s users must pay an upfront set-top box fee of CNY1,000 (currently on special offer for CNY500) and CNY60 per month for 20 TV channels. We believe that IPTV prices are much higher than comparable digital cable offerings and that bandwidth requirements remain the biggest bottleneck for the development of IPTV.

Thus far, no licenses have been issued to telecom operators and China Telecom does not expect SARFT to issue licenses to the telcos in future. Therefore, IPTV will continue to be offered through partnerships between IPTV license holders and network operators. Due to the decentralized structure of SARFT, telecom operators must form cooperative ventures with IPTV license holders at the local level, which we expect to severely limit the speed of development of IPTV services in new areas.

IPTV Services Market: Subscriber Growth. Li Yanfeng, an analyst for CCID (a consultancy affiliated with the MII), recently estimated that IPTV users could reach 550,000-600,000 by year-end 2006 (Jiangsu: 100,000, Guangdong: 100,000, Beijing: 100,000, Shanghai: 100,000 (from 30,000 presently), Harbin: 100,000, Fujian: 49,000, Yunnan: 19,000 and Shaanxi: 30,000). We see this as a slightly optimistic estimate (China Telecom expects Shanghai to reach only 50,000 subscribers by year end, for example), but note that this represents just 1.1% of China’s current broadband subscriber base and only 0.2% of total TV households. Even if one assumes that IPTV subscribers reach five million over the next three to four years, this would not contribute significantly to fixed line revenue growth.

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IPTV Equipment Opportunity. We expect the IPTV equipment market (platforms and set-top boxes) will be modest in size, failing a major regulatory breakthrough, and we expect most of the benefits of IPTV spending to accrue to chipset manufacturers and broadband equipment vendors, who will likely have to upgrade operators’ existing systems to enable more interactive forms of IPTV. We recently learned from China Telecom that its total capex on IPTV systems in Shanghai (with subscriber capacity of 100,000) amounted to CNY50 million (US$6 million) and that set-top boxes were averaging CNY800 currently, with an expected annual price decline of 20%. We estimate the size of China’s total IPTV equipment market optimistically at US$80 million in 2006, rising to US$200 million in 2007, assuming that subscriber net additions triple year on year, and that equipment pricing falls by 20%. IPTV equipment appears to be a crowded market, however, with multiple vendors competing for business, hence margins are likely to be lower than average.

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China Handset Market Analysis

Estimating the size of China’s handset market is more of an art than a science, due to the many factors complicating data collection and reconciliation. We expect 2006 handset shipments to grow by 19% year on year, with the top-four players in the market growing shipments by an estimated 57%. As shown in Figure 17, we estimate 2006 handset shipments and sell-through at 143.8 million and 137.0 million units, respectively.

Fourth-quarter 2006 Outlook. While we do not currently see signs of abnormal inventory buildup in the market, we expect fourth-quarter shipments to rise by just 3% quarter on quarter following 12% quarter-on-quarter growth in third-quarter 2006. While this is slower than growth recorded in fourth-quarter 2005, we note that China’s fourth- and first-quarter seasonality tends to vary according to the timing of Chinese New Year (CNY). As handset production stops during the two weeks surrounding CNY, most vendors tend to stock the retail channels in the three to four weeks preceding CNY. The lunar holiday has fallen on the following dates in 2005, 2006, and 2007:

2005: February 9-11 2006: January 28-31 2007: February 17-20

Later Chinese New Year Points to Weaker Fourth Quarter, Stronger First-Quarter Seasonality. For example, fourth-quarter 2005 handset shipment seasonality was strong, rising 15.5% quarter on quarter, while first-quarter 2006 was weak, down 7.1% sequentially, reflecting inventory builds at year-end 2005. With Chinese New Year coming 20 days later (starting on February 17) than in 2006 (January 28), we believe that a slow fourth-quarter 2006 will be followed by a strong first-quarter 2007, with sequential shipment growth estimated at 5%-10%.

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Figure 17. China Handset Demand Model (Annual)

Shipments 2000A 2001A 2002A 2003A 2004A 2005A 2006E 2007E 2008E

GSM 36.4 46.6 60.2 85.9 96.9 113.6 137.0 157.0 159.5 CDMA—- 8.0 9.8 12.4 7.0 6.7 9.2 10.8 3G (WCDMA & TD SCDMA)—————6.9 38.1

TOTAL 36.4 46.6 68.2 95.7 109.3 120.6 143.8 173.1 208.4

GSM Growth (%) 27.7% 29.2% 42.8% 12.8% 17.2% 20.7% 14.6% 1.6% CDMA Growth (%) 23% 26% -43% -4% 37% 17% W-CDMA + TD SCDMA Growth (%) 453% Growth (%) 28% 46% 40% 14% 10% 19% 20% 20%

Inventory Build/(Drawdown) 1.8 (1.7) 7.6 17.1 10.2 10.7 6.7 7.0 6.7

Sell-Through

GSM 34.6 48.2 53.2 65.8 90.1 104.0 131.0 150.8 153.5 CDMA—0.0 7.3 12.8 9.1 6.0 6.0 8.4 10.1 3G (WCDMA & TD SCDMA)—————6.9 38.1

TOTAL 34.6 48.2 60.6 78.6 99.2 110.0 137.0 166.1 201.8 Growth (%) 39% 26% 30% 26% 11% 25% 21% 21%

Source: Company Data, CCID, Bear Stearns Asia Ltd.

2007 Outlook: Strong Low-end GSM Growth, CDMA Pickup

In 2007, we expect marketwide ASPs to continue falling while handset shipment volumes grow by 20%, slightly faster than the 19% expected in 2006. We expect 2007 shipment growth of 20% and sell-through growth of 21%, with overall market shipments totaling 173.1 million (an estimated 15.9% of global handset shipments (our global telecom equipment team estimates 2006 handset shipments at 972 million (growing 23% year over year), rising to 1,088 million in 2007). Growth will be driven by strong GSM net additions, greater penetration of ultra-low-end handsets, a slight (replacement-driven) pickup in CDMA shipments, and a continued shortening of the GSM handset replacement cycle, which we estimate at 4.5 years, slightly faster than the 4.6 years estimated for 2006. Note: while the estimated 37% pickup in CDMA shipments in 2007 may seem optimistic, CDMA shipments have been increasing steadily since fourth-quarter 2005 even though CDMA net additions have been fairly flat at around 250,000-350,000 per month since October 2005. We view this as an indication that replacement sales are beginning to contribute to CDMA handset demand.

Handset Unit Versus Revenue Growth. We estimate that China’s overall handset revenue grew by 13% in 2006, based on sell-through estimates, our knowledge of ASP trends in the first to third quarter and our estimated 3% sequential ASP decline in fourth-quarter 2006. We expect handset ASP to decline at a slightly slower pace (a decline of 8%) in 2007 as much of the shift to ultra-low-end has already taken place in 2006.

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Figure 18. China Handset Market: Quarterly Shipments and Sell-Through

Units (mn)

45

30 25 20 15 10 5

0

Q103A Q203A Q303A Q403A Q104A Q204A Q304A Q404A Q105A Q205A Q305A Q405A Q106A Q206A Q306A Q406E

Shipments, Sell-through & Inventory

Q103A Q203A Q303A Q403A Q104A Q204A Q304A Q404A Q105A Q205A Q305A Q405A Q106A Q206A Q306A Q406E Shipments 24.7 20.7 23.7 26.6 28.0 25.4 27.4 28.5 30.7 27.8 28.8 33.3 30.9 34.6 38.6 39.7

GSM 22.9 19.2 20.7 23.1 25.4 22.8 23.4 25.3 28.8 25.8 27.2 31.8 29.4 32.9 36.9 37.8 CDMA 1.8 1.5 3.0 3.5 2.6 2.6 4.0 3.2 2.0 2.0 1.6 1.5 1.5 1.7 1.7 1.8

Sell-Through 16.8 14.3 22.1 25.4 31.8 22.2 22.2 22.9 25.0 26.5 27.5 31.1 32.1 34.0 34.3 36.7

GSM 15.3 11.4 18.0 21.1 29.1 20.1 20.1 20.8 23.3 24.7 26.2 29.8 30.8 32.5 32.7 35.1 CDMA 1.5 2.9 4.1 4.3 2.7 2.2 2.1 2.1 1.7 1.7 1.3 1.3 1.3 1.5 1.6 1.6

Incremental Inventory 7.9 6.4 1.6 1.2 (3.9) 3.2 5.2 5.7 5.8 1.3 1.3 2.2 (1.2) 0.6 4.3 3.0

GSM 7.7 7.8 2.7 2.0 (3.7) 2.7 3.3 4.5 5.5 1.0 1.0 2.0 (1.4) 0.5 4.2 2.8 CDMA 0.3 (1.4) (1.1) (0.8) (0.2) 0.4 1.9 1.1 0.3 0.3 0.3 0.2 0.2 0.1 0.1 0.2

Source: Company Data, CCID, Bear Stearns Asia Ltd. estimates.

RECENT

DEVELOPMENTS AND SHORT-TERM OUTLOOK

In the first nine months of 2006, China’s handset market underwent the following changes:

ASPs declined sharply (17% year on year ) after two years of being flat.

Shipments increased by 19% year on year after a two-year slowdown.

The number of new handset models introduced in January-September increased to 444 in 2006, a 61% year-on-year increase.

The top-two handset players increased market share by an estimated 1140bps.

The affordability threshold of wireless services was lowered considerably as Motorola and Nokia introduced sub-US$50 models to China in second-quarter 2006.

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The Candybar returned as the dominant form factor, rising from 34.5% of new models in third-quarter 2005 to 74.6% of new models in third-quarter 2006. We believe this is due to a rise in the proportion of low-end models and “slider” handsets, which are classified as candybars.

Figure 19. China Handset Market: Quarterly Shipments, Sell-Through

Sources Of Sell-Through

I. Sell-Through From Net Adds (mn)

45.0

40.0 Secondhand/Dup SIMs S-T from Net Adds Nominal Net Adds 35.0 30.0 25.0 20.0 15.0 10.0 14.5 16.9 5.0 9.8 7.9 8.1 9.2 9.6 9.7 10.4 6.7 7.5 7.5 -(5.0) (3.7) (10.0)(6.7)(6.1)(6.4) (6.6) (6.8) (7.0) (7.2) (7.1) (7.5) (6.4) (15.0) (14.8) (20.0) Q104A Q204A Q304A Q404A Q105A Q205A Q305A Q405A Q106A Q206A Q306A Q406E

II. Sell-Through From Churn (mn)

45.0

40.0 Churners w/o new hsets S-T from Churn Total Disconnects 35.0 30.0 25.0 20.0 15.0 10.0 4.6 4.7 4.9 3.1 3.3 3.5 4.0 5.0 2.6 2.4 2.5 2.6 5.0 -(5.0) (10.0) (15.0)(13.1) (14.2)(13.4) (13.9) (20.0)(16.3) (17.4) (18.1) (25.0)(20.6) (24.5) (22.6) (23.1)(24.1) (30.0) Q104A Q204A Q304A Q404A Q105A Q205A Q305A Q405A Q106A Q206A Q306A Q406E

Iii. Qtly Inventory Build / (Drawdown) (mn)

10.0 9.0 8.0 7.0 6.0 5.0 4.0

- 0.6 (1.2) (1.0) (2.0) (3.9) (3.0) (4.0) (5.0)

Q104A Q204A Q304A Q404A Q105A Q205A Q305A Q405A Q106A Q206A Q306A Q406E

Iii. Replacement Sales (mn)

45.0

GSM/GPRS CDMA 40.0

35.0

30.0

0.8 25.0 0.7 0.8 0.5 0.5 20.0 0.4 0.4 0.3 15.0 0.3 0.3 0.3 0.3 10.0 19.7 19.7 21.3 15.9 18.4 18.1 12.6 11.6 11.6 12.1 14.0 15.3 5.0 -

Q104A Q204A Q304A Q404A Q105A Q205A Q305A Q405A Q106A Q206A Q306A Q406E

Source: Company Data, Bear Stearns Asia Ltd. estimates.

ASP Trends. In determining quarterly ASP directional trends, we rely mainly on CCID estimates (although we believe that CCID underestimates the ASP level for reasons discussed later). According to CCID, handset ASP fell by 2.9% sequentially in first-half 2006, and by 10.7% quarter on quarter in third-quarter 2006. It appears that a dramatic shift toward the low-end occurred in the second and third quarters, with a 35% sequential drop in the average price of new models introduced in the second quarter the most likely cause of the decline in third-quarter ASPs. This is an unprecedented ASP shift that reflects both a competitive handset environment and

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China Mobile’s increased focus on rural subscriber growth. While China’s overall handset ASP is still high, relative to global handset ASPs, at an estimated US$166 in second-quarter 2006, handset vendors and wireless operators seem to have made an abrupt shift in strategy that could be felt for some time. We believe that the key driver of this shift was Motorola’s introduction of the low-end C118 model (retailing at around US$55) in first-half 2006. This handset, featuring a color screen, suddenly redefined the low-end handset category, forcing other vendors (notably Nokia) to lower the pricing of competing entry-level monochrome and color-screen handsets.

Figure 20 below compares the trends in: 1) the prices of newly introduced handsets models; and 2) handset ASPs. We note that CCID’s handset ASP is significantly lower than our own estimate, as CCID estimates do not account for “gray market” handsets (mainly handsets manufactured for export that remain inside China), which we estimate at around 20% of Chinese handset sales (some industry participants claim that the ratio is closer to 30%).

Figure 20. Officially Reported (CCID) Handset Pricing: Pricing of New Models and ASP (Qtly)

Q104A Q204A Q304A Q404A Q105A Q205A Q305A Q405A Q106A Q206A Q306A Q406E

# of Models Introduced 92 97 92 112 50 110 116 179 112 147 185 220 New Models: % Candybar 25.0% 23.7% 32.6% 33.9% 30.0% 33.6% 34.5% 40.2% 61.6% 72.8% 74.6% 75% New Model ASP (CNY) 2,640 2,436 2,692 2,473 2,495 2,265 2,157 2,055 2,271 1,467 1,923 1,542 New Model ASP (US$) $ 319 $ 294 $ 325 $ 299 $ 301 $ 274 $ 265 $ 254 $ 282 $ 183 $ 241 $ 195—CNY Change (QoQ) (%) -3.6% -7.7% 10.5% -8.1% 0.9% -9.2% -4.8% -4.7% 10.6% -35.4% 31.1% -19.8%—US$ Change (Q0Q) (%) -7.7% 10.5% -8.1% 0.9% -9.2% -3.2% -4.0% 11.0% -35.1% 31.8% -19.2% % of Handsets in Price Range:—Under US$120 (%) 3.3% 4.1% 3.3% 8.9% 0.0% 10.0% 11.2% 12.3% 11.6% 23.8% 21.6% 23.0%—US$120-240 (%) 43.5% 48.5% 42.4% 49.1% 54.0% 53.6% 52.6% 57.5% 53.6% 51.7% 50.3% 51.0%—US$240-360 (%) 25.0% 26.8% 28.3% 18.8% 22.0% 13.6% 19.0% 15.1% 13.4% 8.8% 15.7% 15.0%—US$360-480 (%) 18.5% 11.3% 8.7% 9.8% 12.0% 10.9% 10.3% 7.3% 9.8% 10.9% 5.9% 7.0%—US$480-600 (%) 3.3% 8.2% 8.7% 5.4% 2.0% 7.3% 4.3% 4.5% 5.4% 2.0% 3.2% 2.0%—Over US$600 (%) 6.5% 1.0% 8.7% 8.0% 10.0% 4.5% 2.6% 3.4% 6.3% 2.7% 3.2% 2.0%

CHINA: HANDSET MARKET ASP VS. AVG. PRICE OF NEW MODELS

$450

Avg. Price of New Models Marketwide ASP $400

$350 $325 $319

) $299 $301 $ $294 $282 $300 $274 $265 $254

Price (US $241 $250

Handset $183 $195 $200

$150 $175 $171 $173 $177 $175 $172 $166 $162 $169 $165 $148 $145 $100

$50

Q104A Q204A Q304A Q404A Q105A Q205A Q305A Q405A Q106A Q206A Q306A Q406E

Source: CCID data, Bear Stearns Asia Ltd. estimates.

Market Share Trends: Leaders Consolidating Share, Most Domestic Vendors Dying Off. In our latest survey of the Chinese handset market (“Off-Road Wireless Survey VI: Wireless Services and Handset Trends in Ten Chinese Cities,” July 2006) we noted that the retail presence of most domestic vendors (Lenovo being the only exception) continued to weaken compared to late 2005, while Motorola and Nokia had strengthened. Handset shipment data bear out this observation, with domestic

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vendor market share (of shipments) declining to 21.5% in third-quarter 2006, compared with 29.3% in second-quarter 2006 and 38.8% in third-quarter 2005. Meanwhile the market share of the top-two market players accounted for an estimated 53.9% of total shipments in third-quarter 2006, versus 48.8% in second-quarter 2006 and 42.5% in third-quarter 2005. Many factors caused this shift in market share: apart from superior products, branding and distribution strategies on the part of Motorola and Nokia, we believe that another key dynamic working in favour of the top-two vendors is the rise of the gray market as a more legitimate distribution channel.

2006 Market Share Trends and 2007 Outlook. In 2006, domestic vendor market share again dropped sharply, as expected (see Figure 21 below). We believe that Lenovo and Bird are likely to be the only domestic vendors retaining significant market share in 2007. Remaining vendors have proven uncompetitive due to the changing structure of handset distribution and retail, the extreme competitiveness of every segment of the market (low-, mid-, and high-end) and the top-two vendors’ more aggressive push in second-tier, third-tier, and county-level cities, where local vendors had previously been able to compete because of their distribution advantages. Finally, we note that Samsung (005930.KS-KRW638,000-Outperform/Market Weight) and Sony-Ericsson have been steadily gaining share, primarily through strong high-end offerings. Key market share developments are as follows:

?? We expect domestic vendors’ market share to decline throughout 2006 for a full-year market share of 24.5% compared with 40% in 2005. We expect Bird to maintain low-single-digit market share in 2007: Bird has been more successful than other brands due to its larger scale, based partly on its overseas business. Lenovo will likely be the largest domestic vendor in 2006, with 6% estimated market share. Lenovo has relied heavily on outsourced design and has been moderately successful in the mid- to high-end handset segments. We believe that Lenovo has benefited from its status as one of China’s best PC/consumer electronics brands, relationships with nationwide retail chains, and its well-developed network of service centers. Vendors that have fallen off the map in the past nine months we believe include: Haier, Konka, Capitel, Panda (bankrupt), Daxian, Hisense, and Soutec, among others.

?? Nokia has continued to gain share in the Chinese market based on the popularity of its high-end handsets, growing unit volumes by 62% year on year in third-quarter 2006. Based on our own handset surveys, we believe that Nokia’s China ASP has also trended upward due to a higher-end product mix. Despite our earlier concerns about a potential market share struggle at the low end due to Motorola’s recent push into this segment, Nokia seems to be growing steadily with a more diverse product portfolio than before.

China continues to be one of Motorola’s fastest growing markets, growing 87% year on year in third-quarter 2006, according to our estimates. Factors behind Motorola’s impressive growth include strong product design and continued restructuring of the distribution channel. Key products include the MING PDA

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phone, the RAZR in all its forms, and the low-end C118. Interestingly, Motorola’s ASP trend (as measured by our survey) is the opposite of Nokia’s, falling steadily for the past year. We believe that this trend owes much to the steep declines (intentional) in the ageing RAZR product and, importantly, Motorola’s push into the ultra-low-end handset market.

Figure 21. Chinese Handset Market Share Trends

2005A Vendor Market Share

2006E Vendor Market Share

Motorola

12% Nokia 27%

OTHERS

29% Samsung 11%

Bird Sony-Ericsson TCL 6% 4% ZTE 3% LGE

3% 1% Lenovo 4%

Nokia 36%

Motorola Samsung 17% 13%

Sony-Ericsson OTHERS 5% 14% Bird Lenovo LGE

4%

6% 2% TCL

ZTE

2% 1%

HSET SHIPMENTS: MKT SHARE Q104A Q204A Q304A Q404A Q105A Q205A Q305A Q405A Q106A Q206A Q306A Q406E 2003A 2004A 2005A 2006E 2007E

Motorola 10.0% 10.7% 10.6% 12.3% 11.5% 11.5% 13.0% 12.9% 14.6% 15.0% 18.1% 19.0% 11.0% 10.9% 12.3% 16.9% 19.0% Nokia 15.0% 16.5% 16.8% 20.7% 23.1% 26.6% 29.5% 28.5% 35.3% 33.8% 35.8% 36.0% 9.5% 17.3% 26.9% 35.2% 36.0% Samsung 6.4% 8.3% 11.5% 9.4% 10.8% 9.1% 9.5% 13.4% 12.0% 12.8% 13.4% 14.7% 8.9% 8.9% 10.8% 13.3% 15.0% Sony-Ericsson 3.5% 2.3% 3.1% 3.2% 2.5% 5.2% 4.3% 3.1% 3.6% 4.6% 5.2% 7.0% 1.0% 3.1% 3.7% 5.2% 7.0% LGE 1.1% 2.5% 3.2% 1.7% 2.1% 1.5% 1.1% 1.0% 1.4% 2.3% 2.3% 2.8% 1.2% 2.1% 1.4% 2.2% 2.7% Bird 10.8% 10.6% 9.6% 9.0% 7.4% 7.9% 5.5% 5.3% 5.9% 3.9% 3.7% 4.0% 11.3% 10.0% 6.5% 4.3% 4.0% TCL 8.1% 8.2% 6.4% 3.6% 4.9% 2.6% 4.4% 2.1% 3.8% 4.0% 0.5% 2.0% 10.1% 6.5% 3.5% 2.5% 1.0% Lenovo 0.8% 0.8% 0.8% 0.9% 2.5% 3.6% 5.2% 5.5% 5.7% 5.8% 5.1% 5.5% 1.0% 0.8% 4.2% 5.5% 6.0% ZTE 2.7% 1.2% 2.9% 3.2% 2.6% 2.5% 3.5% 2.1% 1.3% 1.2% 1.0% 1.0% 2.0% 2.5% 2.7% 1.1% 1.0% OTHERS 41.5% 39.0% 35.1% 36.0% 32.6% 29.4% 24.0% 25.9% 16.6% 16.6% 14.8% 8.0% 44.2% 37.9% 28.0% 13.7% 8.3% Foreign Vendors 50.3% 49.3% 55.0% 53.2% 56.6% 58.4% 61.2% 63.1% 69.1% 70.7% 78.5% 82.5% 43.8% 52.0% 59.9% 75.7% 80.7% Domestic Vendors 49.7% 50.7% 45.0% 46.8% 43.4% 41.6% 38.8% 36.9% 30.9% 29.3% 21.5% 17.5% 56.2% 48.0% 40.1% 24.3% 19.3%

Source: CCID, Company Data, Bear Stearns Asia Ltd. estimates.

PAS Handset Market

Oversupply and Inventory Issues. The market outlook for PAS handsets is negative, with net additions now clearly in a sustained downturn. In addition, we believe that channel inventory from first-half 2006 is still being cleared. The key reason for the PAS slowdown, as discussed earlier, is a reduction in fixed-line operators’ PAS handset subsidies and free minute giveaways for new subscribers. The advent of PIM (personal identity module) card-enabled PAS handsets may also cut into handset sales as subscribers need no longer purchase separate devices for different localities, but can now just swap PIM cards. We believe that the fixed-line operators now view PAS more as a fixed-line subscriber retention tool and a means of boosting fixed-line usage rather than a driver of line additions.

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PAS Net Additions Down 59.6% to 8.09 million in Jan-Oct 2006, Likely Falling to 4.8 million in 2007. PAS net additions have declined by more than expected in 2006 due to more competition from cheaper GSM voice pricing, lower-cost GSM handsets, and diminished promotions (including handset subsidies and free minutes of usage) from the PAS operators (China Telecom and China Netcom). In 2006, we have been surprised by the pace of the falloff in PAS net additions and have twice lowered our net addition forecast: from 12.6 million to 10 million in July and again from 10 million to 8.8 million in October. We note that PAS subscriber acquisition seasonality has historically been weighted toward the first half: in 2005 72.3% of full-year net additions occurred in the first six months of the year. Our current estimate implies 335,000 per month of PAS net additions in both November and December, which could be on the high side.

PAS Handset Inventory Problem Remains. We estimate that the top-three PAS handset vendors alone exceeded total PAS market demand in first-half 2006, shipping 7.3 million handsets (UTStarcom-4.0 million; Inventec-2.1 million; ZTE-1.2 million) versus total PAS net additions of 6.72 million. We believe that third-quarter shipments amounted to 2.45 million (UTSI-1.55 million; Inventec-500,000; ZTE-400,000), exceeding PAS net additions by 1.17 million.

How Big Is the PAS Replacement Market? While some would argue that there is a sizeable PAS replacement market that could boost PAS handset demand beyond levels indicated by net subscriber additions, we note several factors offsetting replacement demand. The second-hand market is one detractor from overall demand: second-hand PAS handsets are widely available from street hawkers and in handset shops nationwide, detracting from entry-level demand for new handsets. Some second-hand handsets even come with CNY100-300 in free minutes included. The standardization of PIM (personal identity module) cards is another offsetting factor: most new PAS handsets are PIM-card based and many PAS subscribers hold duplicate SIM cards for use in different localities, inflating the true number of PAS net additions. We believe that there was considerable PAS handset inventory build in first-half 2006 and that handset shipments will fall by more than 50% sequentially in the second half Most of the shortfall will likely be felt in fourth-quarter 2006, when PAS inventories begin to be drawn down amid weak net additions.

Implications for ZTE and UTStarcom. UTStarcom (UTSI-US$8.85; Underperform/Market Overweight) is the vendor most affected by the PAS market slowdown, in our view, deriving 18% and 28% of its first-half 2006 revenue and gross profit, respectively, from PAS handsets. ZTE is not significantly impacted by the decline in PAS handset shipments as: 1) the vendor had already lost its strong No.2 position in the PAS market by 2005; and 2) ZTE is now deriving more than half of its handset revenues from international markets. We estimate that ZTE drew only 5% and 4% of revenue and gross profit from PAS handsets in first-half 2006.

CDMA Handset Market

More Focus, Consolidation, Slight Rebound in 2007. The CDMA handset market has declined by an estimated 4.5% in 2006 (compared to a 43% contraction in 2005) due to Unicom’s reduction in promotional activities (e.g., subsidies and/or free minutes), declining CDMA net additions, and deteriorating subscriber quality. Deteriorating subscriber quality, evidenced by the recent declines in CDMA MOU,

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has been driven by China Unicom’s diminished use of subsidies and shift toward prepaid (and quasi-prepaid) plans, which have higher voice pricing.

In the past 12 months we have noticed that CDMA handset selection has become smaller, particularly at the low end of the market. Some vendors (e.g., Hisense, ZTE, Nokia, Sanyo and Daxian) are even exiting the market. CDMA handset pricing is still much higher than GSM handset pricing (at a median price of approximately US$285 versus a GSM median retail price of US$190), meaning that the entry threshold to the CDMA network remains high unless a subscriber chooses to sign up for a one- to two-year subsidy-linked CDMA price plan. However, we believe that the CDMA market may undergo the following changes in the next 12 months:

Non-UIM-R Handsets Hitting the Market: China Unicom recently received MII approval to sell non-UIM-R card-enabled handsets. We expect this to benefit China Unicom with regard to handset cost and time to market. As China is one of the only markets where UIM-enabled CDMA handsets have been the norm (for regulatory purposes), China Unicom’s handsets have been relatively expensive, as each model must be produced in smaller batches specifically for use in China.

The UIM requirement has also meant long delays in delivering new models to market: for example, the first CDMA Motorola Razr V3 hit the China market in fourth-quarter 2005, nearly a year after the introduction of the GSM Razr. We believe the relaxation of the UIM requirement will allow China Unicom to introduce CDMA handsets soon after their introduction in Korea and the U.S., making China Unicom’s CDMA offering more competitive with the GSM networks.

SK Telecom Joint Procurement: Following China Unicom’s issuance of a convertible bond to SK Telecom (017670.KS-213,500-Outperform/Market Weight), the two companies have sought ways to work together on service offerings and handset procurement. Recently, the two companies announced that China Unicom, SK Telecom, and S-Fone (SKT’s Vietnamese affiliate) would jointly procure handsets beginning in early 2007 so as to create better economies of scale. The cooperation will initially entail simultaneous sourcing of handsets for all three markets from LG Electronics, Samsung, and Motorola. The first phase will be joint sourcing of six high-end models in the first half of 2007, with volumes of 300,000-500,000 units per model. SKT and China Unicom plan to further expand the scale of handset sourcing thereafter, focusing on both low-end and high-end models.

Replacement Market Driving a 2007 Rebound. We note that CDMA handset shipments and sell-through seem to be recovering as a function of rising replacement sales. CDMA handset shipments bottomed out in 2006 as a result of: 1) inventory drawdown; 2) a 28% year-on-year decline in CDMA net additions; 3) aggressive price competition from GSM handsets; and 4) a slow implied replacement cycle of 12.3 years. We believe, however, that CDMA handset shipments will likely rise from 6 million in 2006E to 8.4 million in 2007E due mainly to a pickup in replacement sales as replacement years shorten to between eight and ten years, which is still a

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very extended cycle, owing to the fact that the majority of today’s CDMA subscriber base joined the network only in the past four years.

We remain negative, however, on the overall CDMA market opportunity due to Unicom’s poor execution and inconsistent CDMA strategy. CDMA voice pricing is at the low end of the range, with per-minute pricing that is cheaper than GSM and on par with PAS, but handsets are generally more expensive than GSM handsets. Furthermore, the CDMA network is still perceived by consumers to be inferior to that of China Mobile’s GSM network despite the fact that CDMA capacity utilization is much lower. We believe that just 4.9 million CDMA handsets were shipped domestically in the first to third quarters of 2006, and that CDMA handset sell-through amounted to 4.4 million. We expect shipments of 1.8 million in fourth-quarter 2006, with sell-through of 1.6 million.

Handset Distribution Trends

Figure 22 illustrates recent trends in handset distribution, as officially reported. We note that the most important incremental change in the distribution system – the growing size and legitimacy of the gray market – is not captured in these data. The chart does illustrate that two channels in particular, the “chain stores” and “household electronics stores,” have been gaining share of handset distribution while the independent retail (referring mainly to standalone vendor-owned stores and agents) and operator channels have lost market share.

Figure 22. Officially Reported (CCID) Handset Distribution Channel Trends

Handset Sell Through (000s)

35,000 30,000 25,000 20,000 15,000 10,000 5,000 -

1Q 05 2Q 05 3Q 05 4Q 05 1Q 06 2Q 06 3Q 06 Indep Retail Chain Stores HH Electronic Stores Supermarkets Operators IT Channels Other

Source: CCID data, Bear Stearns Asia Ltd. estimates.

Note: CCID’s estimates of sell-through are cited here to illustrate trends and proportion rather than absolute sell-through volumes.

Gray and Black Market Handsets. In our most recent survey, one of the most interesting developments in the handset retail scene was the increasing prevalence of gray market handset outlets existing in parallel with mainstream retail channels. While the gray market has long been present in China, we have seen a definite uptick

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in the presence of gray market handsets on the market over the past six months. We now believe that gray market sales make up about 20% of total sell-through in the China market.

Gray market handset vendors sell illegally imported handsets, thereby avoiding China’s import and VAT taxes, and are priced at anywhere from 15% to 50% below the normal retail price for the same handset, with more expensive handsets generally enjoying greater discounts. Occasionally the gray market also offers handsets not yet introduced in the China market or that will never be introduced in China, such as Sharp handsets originally intended for distribution to SmarTone customers in Hong Kong or LG’s “3” brand 3G handsets. Since nearly all gray market handsets lack warranty coverage inside China, gray market vendors have begun to provide their own service guarantees and have also increased their visibility, even going so far as to set up boutique-like retail shops intended to give customers greater confidence in the products.

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Companies

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China Mobile Ltd.

(941.HK-HK$63.75 / CHL-US$41.54)

CHINA MOBILE LTD

High: 69.40 HKD0.10 Low: 35.60 607355 12/1/05 to 12/4/06 Last: 63.30 HKD

70 60 50 40

Millions 81.6

40.8

Dec Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov

Source: FactSet Research Systems Inc.

Stock Rating Underperform

Sector Rating Market Weight

Target Price

HK$49.00 (US$31.50 ADS)

Valuation Method

52-Week Range

HK$35.05-HK$69.70 US$22.70-US$45.27

GAAP EPS EPADS 2005: CNY2.69 US$1.64 2006E: CNY3.25 US$2.04 2007E: CNY4.14 US$2.65

Note: Employee stock options are inmaterial to earnings estimates

P/E

2006E: 20.1x 20.4x 2007E: 15.4x 15.7x

Yield

1.9%

Com. Shares (mil)

19,938

Equity Market Capitalization (mil)

US$162,998

Book Value per Share

HK$15.31

Est. 5-Yr EPS Growth Rate

8.4%

Exchange Rate

US$ = CNY7.96

Imminent 3G Catalyst Could Burst the Liquidity Bubble

We recently updated our estimates to reflect slightly more positive 2007 subscriber and price elasticity assumptions. As a result, we raised our 2007 EPS estimate by 4% to CNY4.14 (US$2.65 per ADS) from CNY3.98 (US$2.54 per ADS).

Benign Environment to Persist into 2007. We expect a benign competitive environment to persist until late 2007, as competitors’ 3G networks will not likely launch before late 2007, even if licenses are issued in the first quarter. We assume that China Mobile maintains a dominant share of net adds and we have modeled in a 0.4% blended ARPU decline in 2007, compared with an expected decline of 0.9% in 2006.

... But 3G and Competitive Risks Should Not Be Overlooked.

Current valuations imply that 3G will be a non-issue for China Mobile. However, competition from PAS and CDMA has buffeted China Mobile in the past and we think 3G could have a much greater impact on the company. We also worry that attempts to wrest high-end subscribers from China Mobile may provoke a response that is worse than the loss of share itself.

DCF-based Price Target of HK$49 (US$31.50/ADS). We recently revisited our DCF valuation model for China Mobile and arrived at a new price target of HK$49. Our target implies a forward 2007E P/E of 11.9x and EV/EBITDA of 4.5x, compared with our forecast three-year (2006-09E) EPS CAGR of just 10.8% in CNY terms. Risks to our price target include continued 3G delays, and competitive and regulatory risks.

Another Valuation Bubble? We do not understand investors’ current enthusiasm for China Mobile, given its valuation of 20x 2007E EPS and 7.3x 2006E EBITDA. Admittedly, China

Mobile’s operating performance has been strong, but the operator has not traded at current valuation levels since the end of the tech/telco bubble in 2001. Are things really “different this time” or is China Mobile’s run-up mainly a function of liquidity?

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Overview: Overvalued and Exposed to 3G Risks, Despite Likely Strong Operating Performance in 2007. We believe that China Mobile is currently expensive based on our DCF analysis, as well as on a forward P/E to EPS growth basis. We are also concerned over the potential for 3G to upset the favorable set of conditions that the market is currently extrapolating far into the future. Therefore, while we expect that China Mobile may continue to post strong operational results in 2007, we remain cautious on the shares, which in absolute terms are currently near a six-year high. China Mobile has not traded at these valuation levels (7.6x 2006E EBITDA, 20.0x 2006E earnings) since the tail-end of the tech/telecom bubble in early 2001.

Figure 23. Historical Perspective: A New Bubble?

China Mobile Prospective P/E Bands

80

Tail End of 25x

60 Tech / Telco Bubble Bubble?

20x

$40

HK 15x

20 10x 5.0x

0

Jan 01 Jan 02 Jan 03 Jan 04 Jan 05 Jan 06

Source: Bloomberg, Company Data, Bear Stearns Asia Ltd. estimates.

Revised Estimates: Factoring in Updated Subscriber and Elasticity Assumptions. We recently revised our assumptions based on slightly more optimistic subscriber forecasts and updated elasticity assumptions for 2007 and beyond. Our 2007 EPS estimate increased by 4% to CNY4.14 (US$2.65/ADS) from CNY3.98 (US$2.54/ADS). Despite our negative view on the company, we are currently modeling a relatively benign competitive scenario and pricing environment. As a result of the above changes to our model and more generous DCF assumptions, we increased our year-end 2007 price target to HK$49.00 (US$31.50/ADS) from HK$44.10 (US$28.40/ADS) (see our note of November 13, “Imminent 3G Catalyst Could Burst the Liquidity Bubble”). This price target implies a 2007E P/E of 11.9x and EV/EBITDA of 4.5x. This compares with our expected three-year (2006-09E) EPS CAGR of 10.8%. We have based our price target on a five-year DCF analysis, which yields a theoretical fair value per share of HK$48.80 (US$31.40/ADS). Our DCF currently assumes a WACC of 13.0% and an exit EBITDA multiple of 6.5x (in line with China Mobile’s forward EBITDA multiple).

China Mobile: The Most Exposed to 3G Risk from New Entrants. We believe that China Mobile has the most exposure to downside 3G risks from a number of standpoints. We believe that, going forward, the competitive battle in China’s telecom market will be fought on two fronts: 1) operators will continue to compete for new subscribers, which will increasingly come from rural areas; and 2) 3G will likely mean a renewed battle for high-end urban subscribers.

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Rural Market: The Advantage Remains with China Mobile (for Now). In the rural market, we expect China Mobile will continue to pursue its low-cost strategy of cost-efficient investment (including using low-cost domestic equipment and low-cost technologies, such as half-rate), low subscriber acquisition costs (no subsidies, using cheap advertising media such as wall ads, etc.) and low-cost distribution (using local “agents” rather than investing in expensive distribution channels). We believe that this strategy will continue to serve China Mobile well in the near term. However, we believe that China Unicom could also replicate this strategy, implying slightly more rural competition in the future. If China Telecom were to acquire a 2G mobile network from China Unicom (not currently our base case scenario for telecom restructuring), we believe it would be an even more formidable competitor, owing to brand name and China Telecom’s greater physical presence in the rural market. In the near term, we expect that China Mobile’s push into rural areas, combined with a relatively benign pre-3G competitive environment in higher penetration areas will allow it to maintain its dominant share of market net additions. We currently assume that China Mobile’s total subscriber base grows by 17.6% in 2007, implying a 76% market share of net additions, slightly lower than the 77.7% achieved in 2006E.

Urban Warfare: 3G Entrants Likely to Pay Up for High-End Subs. Longer-term, we expect to see a more competitive environment in urban areas, prompted by the entry of new competitors beginning in late 2007 following the issuance of 3G licenses. In our current base case scenario, China Mobile will be awarded a nationwide TD SCDMA license and China Telecom will be awarded a WCDMA license, putting China Mobile at a long-term disadvantage in the 3G market (which we assume will initially be a high-end market segment). If the reverse were true (TD SCDMA were taken up by China Telecom), we believe this would be good long-term news for China Mobile. Nonetheless, were China Telecom to adopt the TD SCDMA standard, we believe it could still make a deep competitive impact on the market. Just three years ago China Telecom made a serious impact on wireless pricing using an obsolete Japanese wireless technology (PAS/PHS) with limited mobility and virtually non-existent indoor coverage.

As China Telecom already has a wireless service (PAS) that addresses the low-end segment, we expect that in our 3G scenario it would use its technology advantages –better handset selection and more stable infrastructure – to compete for subscribers in China’s high-end urban markets. We expect that China Telecom would likely offer heavily subsidized WCDMA handsets to its fixed-line subscriber base in affluent areas, a demographic that overlaps with China Mobile’s high-end postpaid subscriber base. China Telecom has proven to be a credible competitor at the low end in the past, with the introduction of PAS in major cities in 2003-04. The recent PAS slowdown has stemmed less from China Telecom’s inability to compete than from uncertainty over 3G licensing. This uncertainty, combined with the need to conserve cash, has constrained China Telecom’s PAS ambitions during the past two years, we believe, allowing China Mobile to regain lost market share.

In our 3G scenario, we expect that China Mobile would respond to China Telecom’s aggression with competitive postpaid pricing and subsidies, driving up subscriber retention costs and pushing down postpaid voice ARPU. Despite the fact that more

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than 90% of China Mobile’s net subscriber additions are now coming from the prepaid segment, the postpaid user base is important as it generates a disproportionate amount of China Mobile’s total usage revenues and network traffic. We also assume that a disproportionate portion of China Mobile’s VAS and monthly fee revenue is also attributable to postpaid subscribers. Our assumption that China Mobile would react strongly to high-end competition is supported by recent history, as it did just that in 2002 and 2003 when its high-end subscriber base was targeted by China Unicom’s CDMA network, albeit briefly. We believe that China Mobile’s reaction would be even stronger in the case of 3G competition because its TD SCDMA offering would be at a disadvantage (primarily from a handset selection standpoint) to China Telecom’s WCDMA. In comparison, CDMA was at a significant disadvantage to GSM at the time of China Unicom’s launch, due to the difficulty and high cost of sourcing and distributing removable user identity module (R-UIM)-enabled CDMA handsets.

Figure 24. China Mobile: Contract Usage Revenue, Network Traffic and Avg. Subscribers as a % of Total

80.0%

Usage Revenue Traffic Avg. Subs 70.0%

60.0% 50.0% 40.0% 30.0% 20.0% 10.0%

0.0%

2002PF 2003A 2004A 2005A 2006E 2007E 2008E 2009E 2010E 2011E 2012E 2013E 2014E 2015E

Source: Company Data, Bear Stearns Asia Ltd. estimates.

TD-SCDMA: Can White Elephants Also Run Fast? As mentioned above, in our base case 3G licensing scenario, China Mobile is awarded a TD-SCDMA license and China Telecom (possibly along with China Netcom) will receive a WCDMA license. If this came to pass, we believe that China Mobile would become much less dominant, as it would be forced to compete using a non-global standard. 3G licensing could be the event that would transform the self-styled “running elephant” into something more ponderous, not to mention fairer-skinned.

We expect that the experience with TD-SCDMA in China could be similar or even more challenging than China Unicom’s CDMA launch. China Unicom’s CDMA network, now widely acknowledged to be a white elephant, created a turning point for the entire market by reducing the No.2 operator’s competitiveness in GSM services. Granted, China Mobile would likely have an advantage that Unicom did not: being able to offer roaming onto its 2G network from day one, making for a smoother transition to the new standard. That said, we believe that handsets are the key disadvantage of TD-SCDMA, potentially creating serious problems for China Mobile’s 3G rollout. Unlike operators in Japan and Korea, which are closely

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involved in the handset design and procurement process, Chinese operators have relied primarily on the open market to supply handsets. This practice has allowed China’s GSM operators (especially China Mobile) to benefit from the large selection of handsets designed for the global standard. With the launch of TD-SCDMA in China, however, China Mobile will need to get more involved in the handset design and procurement process in order to ensure that it can offer customers a competitive range of handsets. This is an area in which China Mobile has had limited experience to date.

ARPU and MOU Trends. As seen in Figure 25, China Mobile’s ARPU has been quite steady for the past year. As the subscriber base matures, however, we expect to see more evidence of ARPU and MOU seasonality. We are beginning to see significant Chinese New Year seasonality, as in first-quarter 2006 when ARPU and MOU fell sharply, only to recover in the second quarter. We expect stable ARPU and rising MOU to persist in the fourth quarter of 2006 and in 2007.

Figure 25. China Mobile: Quarterly ARPU, MOU and ARPM Trends

120

100 97.7

90.9 89.5 89.7 90.0 90.4 87.5 85.6

80

ARPU

ARPU ARPU

+9.2% ARPU ARPU

60 ARPU +4.0% ARPU +4.8%

-1.6% +0.4% +0.5% -4.0% ARPU

ARPU (CNY) -12.4% 40

20

0

A A

05A0 505A05A06A06A0 606E

1Q 2Q 3Q 4Q 1Q 2Q 3Q 4Q

450.0 0.5

MOU (LHS) ARPM (RHS)

406

400.0 390 0.4

373 355 349

350.0 338 338 0.4

318

300.0 0.3

0.28 0.28 0.27

MOU 0.26 ARPM (CNY)

ARPM 0.24 0.24

250.0 ARPM 0.3

ARPM +5.8% 0.23

-5.5% ARPM 0.22 -2.1% -1.9% ARPM ARPM

-13.8% -0.4% ARPM

200.0 ARPM 0.2

-3.9%

-3.4%

150.0 0.2

100.0 0.1

A A A A A A A E 0 50 50 50 50 60 60 60 6 1 Q 2 Q 3 Q 4 Q 1 Q 2 Q 3 Q 4 Q

Source: Company Data, Bear Stearns Asia Ltd. estimates.

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Figure 26. China Mobile: Summary & Ratios (Based on 31 Provinces)

CAGR

YE 31 Dec (CNY mn) 2004A PF 2005A 2006E 2007E 2008E 2009E 2010E '06E-'09E '06E-'11E Per Share

EPS (HKD) 2.05 2.56 3.18 4.13 4.49 4.49 4.56 12.2% 9.3% DPS (HKD) 0.66 1.02 1.27 1.73 2.25 3.14 3.19 35.3% 25.5% CEPS (HKD) 4.43 5.25 6.71 8.27 9.26 9.59 9.78 12.6% 8.9% FCFPS (HKD) 1.83 2.54 3.18 4.56 5.07 5.16 5.35 17.5% 14.5% Book Value per share (HKD) 11.08 13.03 15.31 18.01 20.62 21.97 23.34 12.8% 9.7% Net Cash per share (HKD) 1.11 3.70 4.52 7.99 9.84 11.51 13.90 36.6% 30.4%

Value

EV/Subscriber (Pro Forma) (US$) 880 723 616 515 447 392 352 NM NM EV/Revenue (x) 5.9x 5.0x 4.1x 3.5x 3.1x 2.9x 2.8x NM NM EV/EBITDA (x) 10.7x 9.1x 7.3x 6.0x 5.6x 5.4x 5.3x NM NM Price/ Book (x) 6.1x 5.2x 4.4x 3.8x 3.3x 3.1x 2.9x NM NM P/E (x) 31.1x 24.9x 20.1x 15.4x 14.2x 14.2x 14.0x NM NM P/CE (x) 15.3x 12.9x 10.1x 8.2x 7.3x 7.1x 6.9x NM NM EV/FCF (x) 31.4x 22.8x 18.7x 13.3x 12.2x 12.0x 11.5x NM NM

Yield Analysis

FCF Yield 3.2% 4.4% 5.3% 7.5% 8.2% 8.3% 8.7% NM NM Dividend Yield 1.0% 1.5% 1.9% 2.6% 3.3% 4.6% 4.7% NM NM Earnings Yield 3.2% 4.0% 5.0% 6.5% 7.0% 7.0% 7.2% NM NM

Profit & Loss

Revenue 203,993 243,041 292,445 348,351 387,680 410,349 424,851 12.0% 8.8% Reported EBITDA 112,916 133,338 165,746 200,975 217,552 222,835 226,551 10.4% 7.6% EBIT 59,568 73,686 90,294 113,736 119,424 118,460 120,161 9.5% 7.6% Depreciation & Amortization 50,005 56,368 72,017 82,605 93,194 99,650 102,159 11.4% 7.7% Pretax Profit 62,893 78,264 95,639 121,197 128,332 127,917 129,926 10.2% 8.1% Net Income 43,207 53,549 64,652 82,414 87,907 87,879 89,259 10.8% 8.4%

Profitability

Reported EBITDA Margin 55.4% 54.9% 56.7% 57.7% 56.1% 54.3% 53.3% (237 bps) (318 bps) Reported EBIT Margin 29.2% 30.3% 30.9% 32.6% 30.8% 28.9% 28.3% (201 bps) (166 bps) Net Profit Margin 21.2% 22.0% 22.1% 23.7% 22.7% 21.4% 21.0%(69 bps) (41 bps)

Momentum*

Revenue growth 13.9% 19.1% 20.3% 19.1% 11.3% 5.8% 3.5% NM NM EBITDA growth 11.1% 18.1% 24.3% 21.3% 8.2% 2.4% 1.7% NM NM EPS growth 26.4% 23.2% 20.7% 27.5% 6.7% 0.0% 1.6% NM NM

* Growth rates are calculated on a pro forma basis, excluding the effects of mid-year acquisitions

^ Including debt owed to parent company.

Source: Company Data, Bear Stearns Asia Ltd. estimates.

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Summary of Assumptions (Based on 31 Provinces)

YE 31 Dec 2004PF 2005A 2006E 2007E 2008E 2009E 2010E '06E-'09E '06E-'11E ARPU & Revenue

Blended ARPU (CNY) 92 90 89 89 85 80 76 -3.4% -3.5%—Usage ARPU 62 58 56 54 50 43 38 -8.3% -8.6%—Monthly Fee ARPU 12 9 8 7 6 6 5 -11.3% -8.7%—Connection Fee ARPU —————NM NM

- VAS & Other ARPU 18 23 25 27 30 31 33 8.1% 6.2% Wireless Data & VAS / ARPU (%) 19.9% 25.2% 28.0% 30.8% 34.7% 39.2% 43.0% NM NM Total Revenue (CNY mn) 203,993 243,041 292,445 348,351 387,680 410,349 424,851 12.0% 8.8% ARPU GROWTH (Based on Pro Forma 31 Prov) -6.9% -2.1% -0.9% -0.4% -3.8% -6.0% -5.4% NM NM Contract ARPU 168 186 200 214 219 225 230 4.0% 3.4% Prepaid ARPU 56 55 56 56 54 48 43 -4.5% -5.5%

Usage & SMS Assumptions

Total Network Minutes (bn) 661 903 1,258 1,645 2,033 2,551 3,100 26.6% 22.7% —Growth (%) 49% 37% 39% 31% 24% 26% 22% NM NM Blended MOU (Mo) 297 334 383 419 448 499 554 9.2% 8.8% —Contract MOU 517 589 679 747 822 885 925 9.2% 7.0% —Prepaid MOU 194 241 294 334 360 414 476 12.1% 11.7% Blended ARPM (ARPU/MOU) 0.31 0.27 0.23 0.21 0.19 0.16 0.14 -11.6% -11.3% —Contract 0.33 0.32 0.29 0.29 0.27 0.25 0.25 -4.8% -3.4% —Prepaid 0.29 0.23 0.19 0.17 0.15 0.12 0.09 -14.8% -15.4% Blended Usage Tariff (Usage ARPU/MOU) 0.21 0.17 0.15 0.13 0.11 0.09 0.07 -16.1% -16.0% Total SMS Sent (mn) 172,600 249,609 342,095 451,036 556,919 645,616 716,934 23.6% 17.9% SMS Per User / Mo. (Avg.) 78 92 104 115 123 126 128 6.6% 4.5%

Subscriber Assumptions

Period end Subscribers (000s) 204,292 246,652 300,900 353,709 403,333 449,068 483,504 14.3% 11.4% —Contract Subscribers (000s) 59,887 61,311 65,300 69,240 74,301 79,424 82,695 6.7% 5.3% —Prepaid Subscribers (000s) 144,405 185,341 235,600 284,470 329,032 369,645 400,809 16.2% 12.8% Average Subscribers (000s) 185,203 225,472 273,776 327,305 378,521 426,200 466,286 15.9% 12.8% Net Additions (000s) 38,179 42,360 54,248 52,809 49,623 45,735 34,436 -5.5% -10.1% Gross Additions (000s) 67,293 92,956 122,692 137,909 163,180 173,595 172,701 12.3% 8.0% Churn (annual) (%) 15.7% 22.4% 25.0% 26.0% 30.0% 30.0% 29.7% NM NM

Operating Expenses as % of Service Revenue

Selling & Promotions 14.2% 14.0% 14.2% 13.9% 15.6% 16.3% 16.2% 214 bps 194 bps Other SG&A 18.6% 19.0% 16.5% 15.9% 15.7% 15.7% 15.8%(77 bps)(82 bps) Net Interconnection Expense 4.2% 3.7% 4.4% 4.2% 3.9% 4.0% 4.1%(32 bps)(53 bps)

—Interconnection Revenue 2.1% 2.5% 2.4% 2.5% 2.5% 2.6% 2.6% 13 bps(6 bps) —Interconnection Expense 6.2% 6.3% 6.8% 6.7% 6.4% 6.6% 6.7%(19 bps)(58 bps) Leased Line Costs as % of Service Revenue 2.1% 1.3% 0.9% 0.8% 0.7% 0.7% 0.7%(24 bps)(23 bps) Personnel Expenses as % of Service Revenue 5.3% 5.8% 6.1% 6.3% 6.8% 7.5% 8.2% 141 bps 259 bps Depreciation as % of Total Revenue 23.5% 23.2% 24.6% 23.7% 24.0% 24.3% 24.0%(34 bps) (124 bps)

Capital Expenditure (All Figures are Pro Forma) **

Pro Forma Capex (CNY mn) 64,700 71,500 85,000 90,000 90,000 88,000 85,000 1.2% -1.2% Pro Forma Capex (US$ bn) 7.81 8.73 10.68 11.53 11.76 11.50 11.11 2.5% -0.4% Capex/Revenue (%) 31.7% 29.4% 29.1% 25.8% 23.2% 21.4% 20.0% (762 bps) (1,115 bps)

* Outgoing MOU includes On-net calls.

** Reported Capex, not including deferred capex recognition related to construction in progress.

Source: Company Data, Bear Stearns Asia Ltd. estimates.

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Figure 28. China Mobile: Discounted Cash Flow Analysis

FY Ending Dec. 31: 2003A 2004A 2005A 2006E 2007E 2008E 2009E 2010E 2011E

EBIT 54,282 59,568 73,686 90,294 113,736 119,424 118,460 120,161 130,484 Effective tax rate 35% 31% 32% 32% 32% 32% 31% 31% 31% EBIT * (1-t) 35,400 40,944 50,454 61,039 77,340 81,805 81,382 82,551 89,643 + Depreciation and Amortization 44,714 50,005 56,368 72,017 82,605 93,194 99,650 102,159 104,471 + (Inc) / Dec in working capital 12,825 12,292 17,822 16,600 21,118 14,146 7,852 5,026 8,018 + Capex(59,600)(64,700)(71,500)(85,000)(90,000)(90,000)(88,000)(85,000)(80,000) Free Cash Flow 33,339 38,541 53,144 64,656 91,064 99,145 100,884 104,736 122,131 US$ mn 4,026 4,655 6,418 7,809 10,998 11,974 12,184 12,649 14,750

Weighted Average Cost of Capital

Risk Free Rate 2.9% Market Risk Premium 8.0% Beta 1.59 Cost of Equity 15.6% Cost of Debt 3.8% Effective Tax Rate 33.0% After-Tax Cost of Debt 2.55% Equity / Total Capitalization 80.0% Debt / Total Capitalization 20.0% WACC 13.0%

Terminal Value Assumptions

EXIT EBITDA Multiple (x) 6.5x

DCF Valuation

PV of First 5 Years FCF 358,627 Terminal EBITDA 250,798 Terminal Value 884,598 Total Enterprise Value (CNY) 1,243,225 Net Debt (2006E) 87,829 Equity Value (HKD) 1,129,214

Raw DCF Equity Value Per Share HKD 57.40 Raw DCF Equity Value Per ADS USD 36.89

Theoretical Fair Value Per Share HKD 48.80 Theoretical fair value Per ADS USD 31.40

Terminal Value % of DCF Valuation 71.2% Implied Perpetual Growth Rate of FCFF -0.80%

China Mobile Ltd.: Discounted Cash Flow Analysis

225,000

EBIT*(1-T) Depreciation Change in Net Working Capital Capex Free Cash Flow 200,000 175,000 150,000 125,000 100,000 75,000

CNY mn 50,000 25,000 -(25,000) (50,000) (75,000) (100,000) (125,000)

2003A 2004A 2005A 2006E 2007E 2008E

China Mobile Ltd.: Sensitivity—Equity Value Per Share to WACC and Exit EBITDA Multiple

WACC

Terminal EBITDA Multiple ### 9.0% 10.0% 11.0% 12.0% 13.0% 14.0% 15.0% 16.0% 17.0% 5.5x ### 51.00 48.90 46.80 44.90 43.10 41.30 39.70 38.10 36.60 6.0x ### 54.40 52.10 50.00 47.90 45.90 44.00 42.30 40.60 39.00

46.20

Source: Company Data, Bear Stearns Asia Ltd. estimates.

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China Unicom Ltd.

(762.HK-HK$9.14/$11.91)

CHINA UNICOM

High: 9.25 HKD0.10 Low: 6.25 626383 12/1/05 to 12/4/06 Last: 8.58 HKD

9.0 8.5 8.0 7.5 7.0 6.5

Millions 84.9

42.4

Dec Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov

Source: FactSet Research Systems Inc.

Stock Rating Outperform

Sector Rating Market Weight

Target Price

HK$10.00 (US$12.90 / ADS)

Valuation Method

Forward P/E multiple

52-Week Range

HK$6.20-HK$9.60 US$8.03-US$12.07

GAAP EPS EPADS 2005: CNY0.391 US$0.48 2006E: CNY0.434 US$0.55 2007E: CNY0.532 US$0.68

Note: Employee stock options are inmaterial to earnings estimates

P/E

2006E: 21.5x 21.7x 2007E: 17.2x 17.5x

Yield

1.2%

Com. Shares (mil)

12,607

Equity Market Capitalization (mil)

US$14,811

Book Value per Share

HK$6.23

Est. 5-Yr EPS Growth Rate

18.5%

Exchange Rate

US$ = CNY7.96

Turnaround Story with Least Exposure to 3G Risk

China Unicom remains our top pick in China’s telecom services space due to its improving business fundamentals, strong cash flows and reasonable valuation. Despite China Unicom’s recent strong share price performance, we believe there is still upside from current levels. We reiterate our Outperform rating and have recently raised our year-end 2007 price target to HK$10 (US$12.90 / ADR).

Business Transformation Continues. China Unicom’s shift of emphasis from CDMA to GSM began bearing fruit in first-half 2006. We believe that China Unicom will continue benefiting from this strategic shift in the second half of the year and in 2007. We forecast declining CDMA marketing costs and a rising proportion of higher-margin GSM revenues versus overall revenues. We believe investors may be underestimating the EPS impact of lower CDMA subscriber acquisition costs (SACs).

Most 3G Scenarios Favor Low-end Specialist China Unicom.

We see China Unicom as the best-positioned Chinese operator going into 3G license issuance, as its business will not likely change significantly in our base case 3G licensing scenario. We do not expect 3G competition to become an issue for China Unicom until 2009, when new entrants begin to shift their marketing efforts from high-end to mass-market subscribers.

Valuation Reasonable Despite Recent Runup. We consider

China Unicom attractively valued at 17.2x 2007E earnings and 4.0x EV/EBITDA versus a three-year (2006E-09E) EPS CAGR of 20.3%. Our year-end 2007 price target of HK$10.00 (US$12.90 per ADR) implies a 2007E P/E of 18.9x and EV/EBITDA of 4.3x. China Unicom looks even more attractive based on DCF, which yields a theoretical fair value per share of HK$11.20 (US$14.30 per ADR).

Risks to our price target and investment outlook include regulatory changes and competitive risks.

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Overview: Our Favorite Chinese Telco. We like China Unicom for its improving business fundamentals, strong cash flows and limited downside from 3G license issuance. Despite the company’s recent strong share price performance, we believe there is still upside from current levels. We maintain our Outperform rating and year-end 2007 price target of HK$10.00 (US$12.90 per ADR). Our DCF analysis yields a hypothetical fair value per share of HK$11.20 (US$14.30 per ADR).

Business Transformation Likely to Continue. We expect China Unicom to continue to benefit from improved fundamental operating trends set in motion by management’s decision to deemphasize the company’s beleaguered CDMA segment. We have long believed that China Unicom would be better off reducing its exposure to CDMA, rather than swimming against the tide and attempting to grow the CDMA business. We believe that China Unicom’s management is currently on the right track in attempting to keep CDMA marketing costs down. China Unicom’s rebranding initiative has also taken hold, allowing the operator to create well-defined product segments spanning both the CDMA and GSM networks. The results of this strategic shift are apparent in the company’s results for the first nine months of 2006, which show year-on-year EBITDA margin improvements in each quarter. We estimate that China Unicom’s full-year 2006 EBITDA margin will rise by 99bps year on year. Our 2007 estimates assume a modest EBITDA margin improvement of 16bps.

CDMA Marketing Expense Declining Relative to CDMA Service Revenue.

We attribute China Unicom’s recent margin improvement mainly to the downtrend in the ratio of CDMA marketing expenses:CDMA service revenue, as well as the downtrend in CDMA/total service revenue. We estimate that CDMA marketing costs fell to 35.6% of CDMA service revenue in 2006 from 41% in 2005. We also believe we are being quite conservative in our assumption that CDMA marketing expense remains at 34%-36% of CDMA service revenue in 2007-08E (versus a 16.2% marketing cost:revenue ratio for China Unicom’s GSM business and an estimated 14.2% for China Mobile). Our marketing cost assumption actually implies a rise in the average subsidy cost per CDMA handset sold.

CDMA Cash Cost Analysis. By the end of 2006, we expect that China Unicom will have only CNY1.2 billion in unamortized customer acquisition costs remaining on its balance sheet. As a result, we expect CDMA marketing costs to become increasingly aligned with current marketing and promotional activity being undertaken by China Unicom. We estimate that China Unicom will amortize CNY4.1 billion in marketing costs incurred in prior periods during 2006, down from CNY5.9 billion in 2005. We also estimate that the effective cash marketing expense per gross addition will fall to around US$100 at the end of 2006. While we assume that the effective cash CDMA SAC stays at around the US$100 level in the future, we also note that China Unicom earnings are very sensitive to CDMA SAC trends and would react very positively to any cost savings on the handset side. We also believe that joint procurement efforts with SK Telecom could potentially enable China Unicom to procure a more attractive and competitive selection of CDMA handsets, maybe even at lower price points, although we do not currently assume this.

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Figure 29. China Unicom: Analysis of CDMA Marketing Costs, Expensed and Capitalized

CDMA Selling & Marketing Costs EXPENSED on P&L 1H 04A 2H 04A 1H 05A 2H 05A 1H 06A 2H 06E

Amortization of Capitalized Marketing Cost 3,051 3,069 3,124 2,824 2,391 1,734 Expenses Recognized Upfront 2,348 2,869 2,789 2,572 2,835 2,694 Gross Additions (Pro Forma) 6,257 6,797 5,372 4,954 5,079 4,614

Reported CDMA Marketing Expenses 5,399 5,938 5,913 5,396 5,226 4,428

Reported CDMA Marketing Cost / Gross Add (CNY) 863 874 1,101 1,089 1,029 960 Reported CDMA Marketing Cost / Gross Add (US$) 104 106 133 134 128 121

CASH CDMA Selling & Marketing Cost 1H 04A 2H 04A 1H 05A 2H 05A 1H 06A 2H 06E

BOP Deferred Cust. Acquis. Costs 4,892 3,247 4,745 4,171 2,944 1,904 EOP Deferred Cust. Acquis. Costs 3,247 4,745 4,171 2,944 1,904 1,181

Net Incremental Capitalized Acquisition Cost 1,406 4,567 2,550 1,597 1,351 1,012

CDMA: Cash Marketing Cost / Gross Add (CNY) 600 1,094 994 841 824 803 CDMA: Cash Marketing Cost / Gross Add (US$) 72 132 120 104 103 101

CNY/US$ assumption 8.28 8.28 8.28 8.10 8.03 7.95

Source: Company Data, Bear Stearns Asia Ltd. estimates.

GSM Transformation to Drive Revenue, EPS Growth. We expect the revitalization of China Unicom’s profitable GSM business to be the key driver of future revenue and EPS growth. We expect China Unicom’s GSM service revenue will grow at a three-year (2006-09E) CAGR of 10.1% based on improvements in branding, marketing, network quality (including technology upgrades), and capacity improvements. China Unicom’s GSM network has been operating well in excess of stated capacity for the past two years. Capacity utilization reached 100% by the end of 2004, and rose to 106% by year-end 2005 before falling to 100% by the end of first-half 2006. High utilization is clearly one of the biggest limitations for China Unicom: without excess capacity, it is difficult to lower prices, attract new subscribers, and remain competitive. Due to continued network optimization and capacity improvements, we expect utilization on China Unicom’s network to fall to 98% by year-end 2006 and 92% by year-end 2007, giving China Unicom more headroom to compete. As China Unicom grows its GSM service revenues, we expect the proportion of higher-margin GSM revenues to increase to 66.4% of total service revenues in 2006 from 61.9% in 2005, and 68.5% in 2007E. We believe that this favorable revenue mix shift, combined with lower CDMA SAC will drive EPS growth at a three-year (2006-09E) CAGR of 20.3% in CNY terms.

Improving Cash Flows. We expect China Unicom’s improving business fundamentals to drive steady free cash flow growth. Based on our current assumptions, we expect China Unicom’s free cash flow to be CNY11.4 billion in 2006, growing at a three-year (2006-09E) CAGR of 13% and a five year (2006-11E) CAGR of 16%. China Unicom is likely to have the healthiest FCF yields in its peer group for the next three years, in our view, given the relative stability of its business and falling capex:revenue.

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Figure 30. China Unicom: Free Cash Flow Composition

50,000

45,000 EBIT*(1-T) Depreciation Change in NWC Capex FCF

40,000 35,000 30,000 25,000 20,000 15,000 CNY mn 10,000 5,000 -

(5,000) 2003A 2004A 2005A 2006E 2007E 2008E 2009E 2010E (10,000) (15,000) (20,000) (25,000) (30,000)

Source: Company Data, Bear Stearns Asia Ltd. estimates.

Limited Downside from 3G. We believe that China Unicom has limited exposure to downside risks from the issuance of 3G licenses under most scenarios.

Base Case Scenario. In our base case scenario, China Unicom receives a license to upgrade its existing CDMA 1x network to EV-DO, which would involve a relatively small amount of capex that would, in any case, be undertaken by China Unicom’s parent company. In this scenario, we assume that not much would change for China Unicom. EV-DO would likely be rolled out relatively quickly and China Unicom would likely market the service as a niche wireless broadband product for business travelers that wish to use EV-DO as a remote broadband solution. We expect that there would be relatively little competitive pressure on China Unicom’s core GSM business, as we expect that most of the new competition would be at the high end, not a focus area for China Unicom. Although China Unicom classifies 51% of its subscribers as “postpaid,” we believe that most of these subscribers would be classified as prepaid by China Mobile.

WCDMA License Scenario. In the low-probability event that China Unicom receives a WCDMA license, it would gain a 3G upgrade path for its existing GSM subscriber base. We think that this would also likely provide China

Unicom with an entrée into the high-end market by giving it a technological advantage from which to attack China Mobile’s high-end subscriber base. However, we believe that China Unicom would take a cautious approach to its initial rollout of WCDMA (as has been the case with China Unicom’s GPRS upgrades, which began in earnest only in 2006). We think that a WCDMA scenario would weaken earnings in the short term, but would be positive in the long term as China Unicom would benefit from adopting a mainstream 3G technology. We believe that this scenario would also be taken very positively by the market.

Breakup Scenarios. For the past two years, the market has been rife with speculation that China Unicom would be split up and merged with China’s fixed-

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line operators or somehow induced to sell one of its networks to China Telecom. While we do not currently believe that these scenarios are likely, we think that most such scenarios would be positive for China Unicom shareholders. A breakup of China Unicom or a sale of GSM assets would require the purchaser(s) to pay a premium to China Unicom’s current market value. We believe that, from China Unicom’s perspective, a parent company disposal of the CDMA network would be positive even if the listed company were not compensated for the disposal of CDMA subscribers.

?? TD-SCDMA License Scenario. We believe that the only negative 3G scenario would be if China Unicom were required to roll out TD-SCDMA alongside its two existing 2G networks. However, we currently believe that the likelihood of this outcome is extremely small. First, a TD-SCDMA license would mean that China Unicom would become a three-network operator. Second, we believe that China Unicom would be less well-positioned than either China Mobile or China Telecom to make TD-SCDMA a success: China Unicom is smaller than both China Mobile and China Telecom in terms of subscribers and capex budget; China Unicom would not be as focused (either in terms of network spending or marketing activity) as either China Telecom or China Mobile in its deployment of TD-SCDMA technology; and China Unicom’s franchise and distribution network is weaker than either China Mobile or China Telecom’s in the first-tier cities that will be the focal points of 3G investment and competition.

Given the above scenarios, we believe that China Unicom will have the most limited downside from 3G of any of China’s operators. We expect that China Mobile will suffer a competitive onslaught from new 3G competitors attacking its valuable high-end segment, while fixed-line operators will likely be forced to offer gigantic subsidies to attract high-end subscribers as they build greenfield 3G networks.

Valuation Still Reasonable, Especially on DCF. We believe that China Unicom is valued attractively at 17.2x 2007E earnings compared with our expected three-year (2006-09E) EPS CAGR of 20.3%. Our year-end 2007 price target of HK$10.00 (US$12.90 per ADR) implies a 2007E P/E of 18.9x. Our DCF valuation yields a theoretical fair value per share of HK$11.20 (US$14.30 per ADS), assuming a WACC of 10%, an exit EBITDA multiple of 4.0x, and a 10% public market discount. We note that China Unicom is the only Chinese operator in our universe currently trading at a discount to its DCF-derived fair value.

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Figure 31. China Unicom: Discounted Cash Flow Analysis

FY Ending Dec. 31: 2003A 2004A 2005A 2006E 2007E 2008E 2009E 2010E 2011E

EBIT 8,514 7,956 8,072 9,101 9,546 11,095 13,317 15,516 16,940 Effective tax rate 31% 32% 31% 30% 30% 30% 30% 30% 30% EBIT * (1-t) 5,877 5,397 5,605 6,330 6,639 7,716 9,262 10,791 11,782 + Depreciation and Amortization 16,385 19,063 20,368 22,622 24,788 26,956 28,026 29,102 30,354 + (Inc) / Dec in working capital 2,258(524) 3,831 5,487 2,001 1,650 1,254 1,309 1,080 + Capex(21,089)(19,107)(16,643)(23,000)(23,000)(23,000)(22,000)(20,000)(19,000) Unlevered Free Cash Flow 3,430 4,829 13,190 11,439 10,427 13,322 16,543 21,202 24,216 US$ mn 414 583 1,611 1,437 1,336 1,741 2,162 2,771 3,165

Weighted Average Cost of Capital

Risk Free Rate 2.90% Market Risk Premium 8.00% Beta 1.28 Cost of Equity 13.1% Cost of Debt 3.9% Tax Rate 33.0% After-Tax Cost of Debt 2.61% Equity / Total Capitalization (Steady State 70.0% Debt / Total Capitalization 30.0%

WACC 10.0%

Terminal Value Assumptions

EXIT EBITDA Multiple 4.0x

DCF Valuation

PV of First 5 Years FCF 62,468 Terminal EBITDA 46,863 Terminal Value 116,490 Total Enterprise Value (CNY) 178,958 Net Debt (2006E) 19,105 Equity Value (HKD mn) 156,230

Raw DCF Equity Value Per Share HKD 12.40 Raw DCF Equity Value Per ADS USD 15.90

Theoretical Fair Value Per Share HKD 11.20 Theoretical Fair Value Per ADS USD 14.30

Terminal Value % of DCF Valuation 65.1% Implied Perpetual Growth Rate of FCFF -1.5%

Source: Company Data, Bear Stearns Asia Ltd. estimates,

Figure 32. China Unicom: Discounted Cash Flow – Sensitivity of Equity Value per Share to WACC and Exit EBITDA Multiple

WACC

Exit EBITDA Multiple # 8.0% 8.5% 9.0% 9.5% 10.0% 10.5% 11.0% 11.5% 12.0% 3.0 x # 10.00 9.80 9.50 9.40 9.20 8.90 8.70 8.60 8.40 3.5 x # 11.20 10.90 10.60 10.40 10.20 10.00 9.70 9.50 9.30

4.0 x # 12.20 12.00 11.70 11.40 11.20 11.00 10.70 10.40 10.30 4.5 x # 13.30 13.10 12.80 12.50 12.20 12.00 11.70 11.40 11.20 5.0 x # 14.50 14.10 13.90 13.50 13.20 13.00 12.70 12.40

12.20

Source: Company Data, Bear Stearns Asia Ltd. estimates.

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Figure 33. China Unicom: Financial Summary (based on Reported Financials)

CAGR

2003A 2004A 2005A 2006E 2007E 2008E 2009E '06E-'09E '06E-'11E Per Share

Diluted EPS (CNY) 0.336 0.348 0.391 0.434 0.532 0.614 0.756 20.3% 18.5% EPS (HKD) 0.32 0.33 0.37 0.42 0.53 0.62 0.77 21.9% 19.4%—EPADS (USD) 0.41 0.42 0.48 0.55 0.68 0.80 0.99 21.9% 19.0% DPS (HKD) 0.09 0.09 0.10 0.11 0.16 0.22 0.27 34.6% 30.2%—DPADS (USD) 0.12 0.12 0.13 0.14 0.20 0.28 0.35 34.6% 30.2% CEPS (HKD) 1.54 1.75 1.91 2.18 2.49 2.80 3.03 11.6% 9.8%—CEPADS (USD) 1.98 2.25 2.45 2.80 3.20 3.60 3.89 11.6% 9.8% Book Value per Share (HKD) 5.21 5.43 5.75 6.23 6.72 7.26 7.76 7.6% NM

Value

EV/Sub YE (US$) 205 148 131 121 111 104 99 NM NM EV/Revenue 2.0 1.7 1.6 1.5 1.3 1.3 1.2 NM NM EV/EBITDA 5.5 5.1 4.8 4.3 4.0 3.6 3.3 NM NM Price/ Book 1.8 1.7 1.6 1.5 1.4 1.3 1.2 NM NM P/E 29.0 28.0 24.6 21.5 17.2 14.6 11.9 NM NM P/CE 5.9 5.2 4.8 4.2 3.7 3.3 3.0 NM NM EV/FCF 39.9 28.4 10.4 12.0 13.1 10.3 8.3 NM NM

Yield Analysis

FCF Yield ** 2.4% 3.3% 9.1% 8.2% 7.6% 9.9% 12.3% NM NM Dividend Yield 1.0% 1.0% 1.1% 1.2% 1.7% 2.4% 2.9% NM NM Earnings Yield 3.4% 3.6% 4.1% 4.6% 5.8% 6.8% 8.4% NM NM

Balance Sheet

Shareholders Equity 69,615 72,810 76,284 80,336 85,029 90,059 96,258 6.2% 6.6% Adjusted Shareholders Equity 81,177 84,372 87,846 91,898 96,591 101,621 107,820 5.5% 3.8% Net Debt/ Equity 63.6% 56.1% 37.0% 23.8% 12.5% cash cash NM NM

Efficiency

ROE (Average) 6.2% 6.2% 6.6% 7.0% 8.1% 8.8% 10.2% NM NM ROA (Average) 2.8% 3.0% 3.4% 3.9% 4.7% 5.4% 6.5% NM NM ROIC (Average) 3.7% 4.5% 5.3% 6.6% 8.7% 10.8% 15.0% NM NM

Profitability

Reported EBITDA Margin 36.8% 34.1% 32.7% 33.7% 33.8% 35.2% 36.2% NM NM Reported EBIT Margin 12.6% 10.0% 9.3% 9.7% 9.4% 10.2% 11.7% NM NM Net Profit Margin 6.2% 5.5% 5.7% 5.8% 6.6% 7.1% 8.4% NM NM

Momentum *

Services Revenue Growth 38.3% 10.7% 10.5% 6.9% 8.4% 7.3% 5.8% NM NM EBITDA Growth 13.5% -0.7% 5.3% 11.5% 8.2% 10.8% 8.7% NM NM Net Income Growth 5.9% -24.0% 12.4% 11.0% 22.4% 15.4% 23.2% NM NM EPS Growth 5.8% -24.2% 12.4% 11.0% 22.4% 15.4% 23.2% NM NM

* 2003 & 2004 growth rates calculated on the basis of pro forma results for 30 provinces.

** FCF Yield calculated as Unlevered FCF/Enterprise Value

Source: Company Data, Bear Stearns Asia Ltd. estimates.

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Figure 34. China Unicom: Summary of Assumptions

Based on Reported Historical Results CAGR YE 31 Dec 2003A 2004A 2005A 2006E 2007E 2008E 2009E 2010E '06E-'09E ARPU / Revenue Blended ARPU (GSM & CDMA) (CNY) 67.5 58.0 55.4 53.6 52.6 51.7 51.2 51.3 -1.5% Total Revenue (CNY mn) 67,636 79,332 87,050 94,254 101,536 108,240 114,137 120,167 6.6% GSM ARPU (CNY) 56.9 49.5 48.5 49.5 49.5 49.7 49.6 49.8 0.0%

- Usage ARPU 41 34 30 30 28 27 26 25 -4.7%—Monthly Fee ARPU 10 7 6 6 5 5 5 4 -6.6%—Data ARPU 2 2 4 4 4 5 5 5 4.0%—VAS & Other ARPU 1 3 5 6 8 9 10 11 15.6%—Interconnection & Other ARPU 3 3 3 4 4 4 5 5 9.1%

CDMA ARPU 128.4 86.3 75.9 65.5 61.5 57.8 56.1 56.1 -5.0%

- Usage ARPU * 90 58 46 36 32 28 26 26 -10.0%—Monthly Fee ARPU 27 17 14 13 11 11 10 10 -6.5%—VAS & Other ARPU 7 9 13 13 14 15 16 16 5.2%—Interconnection & Other ARPU 5 3 4 4 4 4 4 4 3.1% ARPU GROWTH (2003 and 2004 are Pro Forma) -4.9% -13.2% -4.4% -3.2% -2.0% -1.7% -0.9% 0.2% NM

- GSM ARPU Growth (%) -16% -13% -2% 2% 0% 0% 0% 0% NM —CDMA ARPU Growth (%) -26% -32% -12% -14% -6% -6% -3% 0% NM

Revenue Growth 34.6% 9.7% 9.7% 8.3% 7.7% 6.6% 5.4% 5.3% NM

Usage Assumptions

Total Network Minutes (bn) 167 261 319 397 471 569 664 745 18.7% —Growth (%) 70% 36% 22% 24% 19% 21% 17% 12% NM Blended MOU (Mo) 198 214 222 245 261 288 313 333 8.6% GSM 175 190 202 235 256 287 318 341 10.6% CDMA 338 292 277 274 276 290 300 310 3.1% Blended ARPM (ARPU/MOU) (CNY/min.) 0.34 0.27 0.250 0.22 0.20 0.18 0.16 0.15 -9.3% GSM 0.32 0.26 0.240 0.21 0.19 0.17 0.16 0.15 -9.5% CDMA 0.38 0.30 0.274 0.24 0.22 0.20 0.19 0.18 -7.9% Blended Usage Tariff (Usage ARPU/MOU) 0.24 0.18 0.15 0.13 0.11 0.09 0.08 0.07 -13.6% GSM 0.24 0.18 0.15 0.13 0.11 0.09 0.08 0.07 -13.8% CDMA 0.27 0.20 0.17 0.13 0.12 0.10 0.09 0.08 -12.7%

Subscriber Assumptions

Period end Subscribers (000s) 80,833 112,082 127,794 142,350 158,193 171,447 181,568 190,902 8.4% Pro Forma Subscriber Growth (%) 35.4% 22.5% 14.0% 11.4% 11.1% 8.4% 5.9% 5.1% —Contract GSM Subscribers (000s) 32,458 42,844 48,166 54,300 61,615 67,556 72,008 75,975 9.9% —Prepaid GSM Subscribers (000s) 31,465 41,423 46,905 51,800 57,318 62,179 66,127 70,094 8.5% —CDMA Contract Subscribers (000s) 16,046 25,824 30,010 33,300 36,160 38,489 40,124 41,454 6.4% —CDMA Prepaid Subscribers (000s) 864 1,991 2,713 2,950 3,101 3,223 3,309 3,379 3.9%

Operating Expenses / Service Revene (%)

Leased lines 1.3% 1.0% 0.9% 0.7% 0.6% 0.6% 0.6% 0.5% NM Leased CDMA Capacity 5.7% 9.0% 9.9% 9.5% 9.2% 8.6% 8.3% 8.1% NM Net Interconnection Expense (GSM, CDMA & Fixed Line 4.5% 4.6% 3.5% 2.8% 2.9% 2.8% 2.8% 2.9% NM

—Interconnection charges 9.6% 9.9% 9.9% 9.9% 10.3% 11.0% 11.7% 12.3% NM —Interconnection revenue 5.1% 5.3% 6.4% 7.1% 7.4% 8.2% 9.0% 9.4% NM

Personnel 7.4% 6.1% 6.9% 8.0% 8.7% 8.9% 9.3% 9.4% NM Sales and Marketing 24.4% 25.5% 25.2% 23.5% 23.1% 21.6% 20.3% 19.5% NM General Admin and Other 14.7% 14.1% 14.4% 14.7% 14.0% 13.8% 13.1% 12.5% NM Opex (ex Dep.): Service Revenue (%) 63.0% 65.5% 67.2% 66.3% 66.0% 64.5% 63.3% 62.3% NM

Capital Expenditure

Capex (Reported) 19,755 18,164 17,613 23,000 23,000 23,000 22,000 20,000 -1.5% Capex / Service Revenue (%) 30.8% 23.8% 20.9% 25.5% 23.5% 21.9% 19.9% 17.1% NM

—Capex / Service Revenue (ex CDMA) (%) 41.7% 34.9% 31.1% 36.5% 33.0% 30.0% 26.8% 22.9% NM Subscriber Capacity (GSM) (000 subs) 68,050 84,552 89,461 107,172 122,611 136,563 145,406 153,757 10.7% Capex / Avg. Subscriber $ 34 $ 22 $ 18 $ 21 $ 20 $ 18 $ 16 $ 14 -8.7% Capex per Net Addition $ 113 $ 107 $ 137 $ 198 $ 186 $ 227 $ 284 $ 280 12.7% Capex / Incremental Minute (US$) 0.061 0.063 0.055 0.044 0.047 0.037 0.035 0.037 -7.2% * Outgoing MOU includes On-net calls.

** Segmental EBITDA margin excludes equipment sales and cost.

Source: Company Data, Bear Stearns Asia Ltd. estimates.

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China Telecom Corp.

(728.HK-HK$4.01/CHA-US$51.76)

CHINA TELECOM CORP

High: 3.74 'H'CNY1 Low: 2.35 655933 12/1/05 to 12/4/06 Last: 3.47 HKD

3.6

3.2

2.8

2.6

Millions 520

260 China Telecom could outperform in the near term, we believe, Dec Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov due to the perception of Chinese fixed-line operators as cheap Source: FactSet Research Systems Inc. options on 3G growth. This could lead to continued rotation out of wireless operators and into fixed-line operators. However, we

Stock Rating maintain our Peer Perform rating on the stock and HK$3.10 Peer Perform year-end 2007 target price (ADR: US$39.80) due to our fundamental view that China Telecom’s fixed-line business is Sector Rating deteriorating, and 3G will not boost company earnings in the

Market Weight medium term.

Target Price

Telecom’s telephony revenues began declining this year, a

Valuation Method

Forward P/E multiple process that we believe will likely accelerate as PAS/wireline capex falls. Discouraging trends in the local voice business

52-Week Range

HK$2.275-HK$4.12 include weaker subscriber growth and falling MOU due to US$29.62-US$52.50 mobile substitution. We expect China Telecom’s recurring GAAP EPS EPADS revenue and EPS to grow at a three-year (2006E-09E) CAGR of 2005: CNY0.277 US$3.47 0.3% and negative 8.2%, respectively.

2006E: CNY0.274 US$3.51

2007E: CNY0.264 US$3.45 ?? Broadband and Value-Added Services Not big Enough to

Note: Employee stock options are inmaterial to Offset Telephony Decline. Broadband and VAS are China earnings estimates

Telecom’s two key growth areas. While we expect these P/E businesses to grow by 10%-14% over the next three years, they 2006E: 14.8x 14.7x account for just 24% of 2006E revenues, not big enough to offset

2007E: 14.7x 15.0x

declining local, DLD and ILD revenues.

Yield

1.9%

3G May Mean Earnings Decline. While we expect 3G licenses

Com. Shares (mil)

to be positive for sentiment toward China Telecom, we think the

80,932

actual launch of wireless services is likely to disappoint investor Equity Market Capitalization (mil) earnings expectations. Apart from higher capex, efforts to enter

US$41,714

the high end of China’s mobile market will necessitate high Book Value per Share marketing expenditure and potential startup losses.

HK$2.45

Est. 5-Yr EPS Growth Rate ?? Valuation: Cheaper than Peers, but Still Not Attractive.

1.0%

China Telecom currently trades at 14.7x 2007E P/E and 5.1x Exchange Rate 2007E EV/EBITDA, which we view as expensive relative to

US$ = CNY7.96

growth. Our DCF-based target price of HK$3.10 (ADR: US$39.80) assumes a WACC of 8.9%, exit EBITDA multiple of 5x and 10% public market discount.

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Overview: Mobile Ambitions Overshadowed by Declining Core Business and Uncertain 3G Economics. We are optimistic on the outlook for China Telecom’s near-term stock performance, which is being driven by strong performance of the Chinese wireless operators and positive sentiment on hopes that imminent 3G licensing will improve the company’s long-term outlook. Longer term, however, we remain concerned about China Telecom’s declining core fixed-line business. Given our base case assumption of a greenfield 3G build, we also expect the reality of building a 3G network (heavy capex and marketing expenditures and a deteriorating competitive environment) to disappoint the market’s current expectations regarding China Telecom’s potential foray into mobile (renewed top- and bottom-line growth and competitive leverage from China Telecom’s existing fixed-line subscriber base). Weighing the short-term positives against the long-term concerns, we maintain our Peer Perform rating. We recently raised our year-end 2007 price target to HK$3.10 (US$39.80 per ADR) from HK$2.80, which implies 9% downside from current levels (please refer to our note “Positive Momentum on 3G News flow, but Weak Fundamental Outlook”, November 13th).

3G Licensing Fuelling Positive Near-Term Sentiment. We believe that the market’s expectation of imminent 3G licensing in China will continue to fuel positive sentiment toward China’s fixed-line operators – particularly China Telecom – that that are expected to receive licenses. We believe that our base case 3G scenario, with China Telecom receiving a WCDMA license and mobile incumbent China Mobile receiving a TD-SCDMA license, would likely be positive for China Telecom shares in the near term. If China Telecom were to receive an existing 2G network (likely from China Unicom) in an industry restructuring, we believe that this would also be viewed positively by investors. In fact, even if China Telecom were saddled with TD-SCDMA responsibility, by far the “worst case” 3G scenario for China Telecom, in our view, the news could be viewed positively by investors due to the expectation that the MII would compensate for the technological disadvantage via subsidies and potential asymmetric regulation. In addition, we think that China Telecom could also benefit from a near-term rotation out of the mobile operators and into the fixed-line carriers, as China Telecom has underperformed year to date (up 41%) versus China Mobile (+74%) and China Unicom (+45%).

Fixed-Line Business in Sustained Decline. We expect China Telecom’s fixed-line business to enter prolonged decline in 2006, driven by mobile substitution and continued intense competition in DLD and ILD (also caused by mobile operators) in China. We expect to see continued strong performance from the company’s growth segments, Internet and VAS, but this growth is simply insufficient to offset declines in China Telecom’s core business, we feel.

?? Local Voice: Mobile Operators Eating China Telecom’s Lunch. We believe that 2006 will be the first year that China Telecom experiences an absolute revenue decline in its local telephony business, with revenue expected to decline by 4.2% year on year to CNY77.6 billion. We expect total fixed-lines in service (including PAS) to grow by a tepid 5.9% to 222.5 million. We expect 51.7% of China Telecom’s 12.4 million 2006 net additions will come from PAS subscribers. However, PAS is now being primarily marketed to existing fixed-

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line subscribers as a subscriber retention tool, and we believe that existing fixed line subscribers now comprise more than 50% of PAS net adds in some areas. Therefore, we expect to see a 14.3% decline in MOU in 2006 (compared with an 8.3% decline in 2005) as many of these “new” PAS additions will actually cannibalize existing fixed-line MOU. We expect that residential lines, the largest single pool of subscribers, will grow by just 2.8% in 2006 to 121.3 million. We also assume that China Telecom will begin to see residential line loss beginning in 2008, which could prove generous given that China Telecom’s northern neighbor China Netcom experienced sequential net residential line losses in third-quarter 2006.

?? 3G Licensing Could Exacerbate Existing Trends. Our current model assumes a continuation of existing trends, with total subscribers growing at a snail-like three-year (2006-09E) CAGR of 1.0% and MOU declining at a three-year CAGR of 7.4%, resulting in a three-year local voice revenue CAGR of -6.3% over the period. We believe these assumptions are reasonable in a status quo scenario (i.e., not factoring in 3G). However, these trends could potentially become more pronounced as China Telecom begins to roll out 3G, as we expect that the company would reallocate significant amounts of capex, marketing expenditure and labor away from fixed line and toward 3G.

?? DLD and ILD Declines to Persist. China Telecom saw declining DLD and ILD revenues in 2005 due to market share shifts and VOIP tariff competition among China’s fixed-line and mobile operators. We expect these trends to continue in 2006 and future years. We have forecast growth in ILD traffic in 2008 due to the Beijing Olympics, along with pre- and post-Olympic activities. However, we expect DLD revenues to decline at a three-year (2006-09E) CAGR of 5.3% and ILD revenues to decline at a CAGR of 3.0% over the period.

?? Interconnection Revenues: Compensatory Morsels from the Mobile Dining Table. Due to the China’s current one-way interconnection regime, with fixed-line operators receiving interconnection revenues from mobile operators (but not vice versa), we expect to see continued growth in China Telecom’s interconnection revenues – increasing at a three-year CAGR (2006-09E) of 7.4%.

However, we do not expect these table scraps from China’s burgeoning mobile industry (accounting for only 7.3% of total forecast recurring revenue in 2006) to improve China Telecom’s overall growth prospects. In addition, as mobile-to-mobile calls continue to make up a greater portion of total traffic over China’s mobile networks, we expect China Telecom to benefit less and less from rising mobile traffic.

?? Broadband Trends Positive, but Not Positive Enough. Broadband adoption has been a major growth area for China Telecom over the past few years. We expect total broadband subscribers to increase by 39.7% in 2006 and to continue to grow at a three-year CAGR (2006-09E) of 20.6%. Due to falling broadband ARPU and declining dial-up Internet revenues, we expect that total Internet revenues will grow by only 32.4% in 2006, at a 2006-09E CAGR of 13.7%.

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Forecast 2006 Internet revenues of CNY23.6 billion represent 14.0% of China Telecom’s total 2006E recurring revenue, rising to 20.4% by 2009E.

IPTV Probably Not a Significant Revenue Contributor for the Next Three Years. China Telecom has been experimenting with IPTV as a way to increase broadband uptake and bolster broadband ARPU. However, we remain cautious over the prospects for IPTV in the near term due to regulatory uncertainties. SARFT, China’s broadcasting regulator, has recently become more willing to allow IPTV to grow alongside the digital cable standard that it has been championing. However, SARFT is unlikely to loosen its grasp on content and programming, particularly at the local level. As it stands, China Telecom currently has a handful of IPTV trial networks up and running, the largest of which is in Shanghai. China Telecom operates this network in cooperation with Shanghai Media Group (SMG), a media conglomerate under direct supervision of the Shanghai branch of SARFT.

Extrapolating from the Shanghai Experience. China Telecom’s Shanghai

IPTV trial network currently provides TV applications, including broadcast TV programming, time shifting functionality, and video on demand (VOD) content. China Telecom hopes to provide various value-added services via the IPTV platform in the future, which would not fall under the regulatory control of SARFT. The company expects that its Shanghai trial network will have 50,000 subscribers by the end of 2006. IPTV services are currently provided at CNY60 per month (during the trial period) on top of the average Shanghai broadband ARPU of CNY110 per month (versus the nationwide average of CNY77 per month). The revenue share arrangement with SMG is 60/40, with the larger portion going to the party that acquires the subscriber (in practice, China Telecom acquires most IPTV subscribers). Given these economics (and assuming that 50% of IPTV subscribers are new broadband subscribers), our back-of-the-envelope estimate shows that China Telecom would need to scale its IPTV subscriber base to at least 9.5 million before seeing meaningful (~5%) revenue impact from IPTV. This number is close to one-third of our estimated 2006 year-end broadband subscriber base for China Telecom and would likely be more difficult to achieve than it sounds. A major constraint on ITPV subscriber growth is that China Telecom will need to make separate deals with local media groups across China. There are now only four nationwide IPTV broadcast license holders.

Strong VAS Growth Likely to Slow. China Telecom has recently focused its efforts on expanding its VAS revenues, consisting of traditional VAS such as caller-ID and SMS, on its PAS network, as well as on ICT services provided to SMEs in China. We expect that these revenues will grow 26.6% year on year in 2006. However, with China Telecom’s overall fixed-line subscriber base remaining stagnant, we believe that ICT services will remain a niche business for China Telecom and thus growth will likely slow in subsequent years. We currently assume that China Telecom’s total “Other” revenues (including traditional VAS and ICT revenues) will grow at a three-year 2006-09E CAGR of 10.3%.

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3G Likely to Be Dilutive. While we believe that 3G licensing will likely be a source of near-term upside for China Telecom shares, we expect the implementation of 3G to be a greater challenge than the market is currently anticipating.

Capex Likely to Exceed Expectations. While China Telecom’s stated strategy with respect to 3G is to build primarily in large cities in China’s wealthy coastal regions, we believe that for 3G to succeed as a high-end product, nationwide coverage will be imperative. While there has been some speculation in the market (including public statements by China Mobile CEO Wang Jianzhou) that the MII will require existing mobile operators to share network resources and offer roaming services to subscribers of the new 3G entrants, China Telecom would likely have to pay for these benefits, making this more of a short-term solution. We believe that China Telecom will eventually need to build a nationwide 3G network comparable to China Mobile’s current network in order to remain a viable choice for high-end subscribers. The capex requirement for a nationwide 3G network would likely be many times the amount required for more selective coverage in first-tier cities. The resulting depreciation charges would likely be a drag on China Telecom’s earnings for several years as network utilization rises from low levels.

High-End Competition Challenging. As we noted above, we believe that China Telecom will likely first enter the high end of the mobile market. This would entail taking subscribers from China Mobile (currently the high-end operator of choice), which would require significant handset subsidies as well as attractive tariff plans. China Mobile would likely react aggressively to attempts to poach its most valuable subscribers, as it has in the past when China Unicom introduced CDMA as a high-end product in 2002-03. In fact, we believe that China Mobile has been busy offering handset subsidies to its best subscribers already, as we have observed in our past Off-Road Wireless Surveys. Therefore, we expect that China Telecom may face an even greater challenge than China Unicom encountered with CDMA.

Acquisition of a 2G Network Helpful, but Most Likely Dilutive. If China

Telecom acquired one of China Unicom’s existing 2G networks (not our base case 3G/restructuring scenario), it would definitely help the fixed-line operator establish nationwide coverage more rapidly, but such a transaction would also be dilutive from an EPS standpoint, according to our estimates. If China Telecom were to acquire the CDMA network, it would have to face the same set of problems that have plagued China Unicom since the launch of the network in 2002. China Telecom would still need to rely on handset subsidies for subscriber acquisition/retention while at the same time stepping up marketing efforts to revive the CDMA network’s tarnished brand image. If, on the other hand, China Telecom acquired China Unicom’s GSM network (less likely, in our view), the company would be better positioned, with a sizeable subscriber base, and a mainstream network technology. Even so, we believe that the transaction would be dilutive, as the GSM network would command a higher valuation than China Telecom’s own current trading valuation.

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Figure 35. China Telecom: Financial Summary & Ratios

CHINA TELECOM: Financial Summary & Ratios CAGR YE 31 Dec (CNY mn) 2003A 2004A 2005A 2006E 2007E 2008E 2009E 2010E '06E-'09E Per Share

Reported EPS (CNY) 0.326 0.346 0.345 0.338 0.314 0.289 0.261 0.243 -8.2%—Reported EPS (HKD) 0.307 0.325 0.328 0.330 0.313 0.294 0.266 0.247 -7.0%—Reported EPS (USD) 3.94 4.18 4.21 4.24 4.03 3.77 3.41 3.17 -7.0% Recurring EPS (CNY) 0.222 0.242 0.261 0.277 0.274 0.264 0.247 0.237 -3.7% Recurring EPS (HKD) 0.209 0.227 0.248 0.270 0.273 0.268 0.251 0.241 -2.4% Recurring EPADR (USD) 2.68 2.92 3.19 3.47 3.51 3.45 3.23 3.09 -2.4% DPS (HKD) 0.065 0.065 0.075 0.075 0.077 0.078 0.078 0.078 1.3%

Value (Based on Recurring Items)

EV/Revenue (x) 4.0x 2.9x 2.7x 2.6x 2.6x 2.6x 2.6x 2.6x NM EV/EBITDA (x) 7.7x 5.6x 5.4x 5.1x 5.1x 5.2x 5.3x 5.4x NM EV/EBIT (x) 18.0x 14.1x 13.7x 12.7x 12.8x 13.3x 14.2x 14.8x NM EV/FCF (x) 94.7x 28.3x 24.2x 16.4x 14.2x 13.4x 12.9x 12.2x NM EV/Op FCF (x) 4.4x 3.3x 3.3x 3.2x 3.4x 3.5x 3.7x 3.8x NM P/FCF (x) 74.1x 22.1x 19.0x 12.8x 11.1x 10.5x 10.1x 9.6x NM P/E (x) 19.2x 17.7x 16.2x 14.8x 14.7x 15.0x 16.0x 16.7x NM P/CE (x) 5.6x 4.3x 4.2x 4.1x 4.2x 4.3x 4.5x 4.5x NM Price/ Book 2.5x 2.0x 1.8x 1.6x 1.5x 1.4x 1.3x 1.2x NM

Yield Analysis

FCF Yield (FCFF/EV) 1.1% 3.5% 4.1% 6.1% 7.0% 7.5% 7.7% 8.2% NM Dividend Yield 1.6% 1.6% 1.9% 1.9% 1.9% 1.9% 1.9% 1.9% NM Earnings Yield 5.2% 5.7% 6.2% 6.7% 6.8% 6.7% 6.3% 6.0% NM

Recurring Profit & Loss (Excluding Upfront Connection Fee)

Revenue 110,566 152,754 162,529 169,378 171,332 171,958 170,898 168,852 0.3% EBITDA 57,484 78,542 81,825 86,005 85,803 84,673 82,801 81,599 -1.3% EBIT 24,563 31,372 32,173 34,816 34,434 33,140 31,116 29,774 -3.7% CE 49,722 66,735 70,783 73,567 73,525 72,881 71,672 70,986 -0.9% Pretax Profit 22,790 24,805 27,333 29,314 29,502 28,732 27,092 26,162 -2.6% Net Income 16,801 19,565 21,131 22,378 22,156 21,348 19,988 19,161 -3.7%

Cash Flow

Operating Cash Flow 47,774 60,942 74,888 78,933 77,075 75,007 73,147 72,019 -2.5% Change in Net Working Capital(11,613) (8,886) (9,508) (5,049) (4,677) (4,304) (3,700) (3,077) -9.8% Capex 42,819 56,307 53,864 51,000 45,000 41,000 38,000 35,000 -9.3% Adjusted OpFCF 100,303 134,849 135,689 137,005 130,803 125,673 120,801 116,599 -4.1% Unlevered Free Cash Flow 4,661 15,596 18,200 26,956 31,045 33,015 34,195 36,124 8.3%

Balance Sheet

S/T Debt 46,531 77,818 84,968 60,750 56,250 56,250 56,250 56,250 -2.5% L/T Debt 49,665 72,366 55,777 74,250 68,750 68,750 68,750 68,750 -2.5% Net Debt (Cash) 85,649 136,404 125,332 109,255 88,030 64,059 38,346 10,134 NM Net Debt/ Equity 65.2% 85.7% 69.0% 53.9% 39.7% 26.8% 15.1% 3.8% NM Shareholders Equity 131,272 159,206 181,517 202,650 221,890 239,049 253,977 267,425 7.8% Net Debt / EBITDA 1.5 1.7 1.5 1.3 1.0 0.8 0.5 0.1 NM

Efficiency (Based on Recurring Earnings)

Adjusted ROE (Average) 11.8% 12.6% 12.4% 11.7% 10.4% 9.3% 8.1% 7.3% NM Adjusted ROA (Average) 5.5% 4.8% 5.1% 5.3% 5.2% 4.9% 4.4% 4.1% NM Adjusted ROIC (Average) 6.6% 5.9% 6.2% 6.4% 6.2% 5.8% 5.2% 4.9% NM

Recurring Profitability

EBITDA Margin 52.0% 51.4% 50.3% 50.8% 50.1% 49.2% 48.5% 48.3% NM EBIT Margin 22.2% 20.5% 19.8% 20.6% 20.1% 19.3% 18.2% 17.6% NM Net Profit Margin 15.2% 12.8% 13.0% 13.2% 12.9% 12.4% 11.7% 11.3% NM

Momentum (Apples to Apples) 10 vs. 10 20 vs. 20

Rec. Revenue Growth 9.5% 7.9% 6.4% 4.2% 1.2% 0.4% -0.6% -1.2% NM Rec. EBITDA Growth 13.9% 12.4% 4.2% 5.1% -0.2% -1.3% -2.2% -1.5% NM Rec. Net Income Growth 5.6% -4.8% 8.0% 5.9% -1.0% -3.6% -6.4% -4.1% NM

Momentum (20 provinces)

Rec. Revenue Growth 8.6% 7.9% 6.4% 4.2% 1.2% 0.4% -0.6% -1.2% NM Rec. EBITDA Growth 15.8% 12.4% 4.2% 5.1% -0.2% -1.3% -2.2% -1.5% NM Rec. Net Income Growth 245.3% -4.8% 8.0% 5.9% -1.0% -3.6% -6.4% -4.1% NM

Source: Company Data, Bear Stearns Asia Ltd. estimates.

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Figure 36. China Telecom: Summary of Assumptions

** '99—'02 represents 4 provinces, '03 represents 10 provinces and '04E-'09E represents 20 provinces CAGR (%)

YE 31 Dec 2003A 2004A 2005A 2006E 2007E 2008E '06E-'09E '06E-'11E Subscriber Assumptions

Lines in Service (mn) 118.1 186.7 210.1 222.5 228.9 230.4 1.0% -0.2% Avg. LIS (mn) 107.4 173.8 198.4 216.3 225.7 229.6 2.1% 0.7% Residential Lines 79,415 113,100 118,000 121,273 123,120 122,582 -0.2% -1.1% —Growth (%)* 9.9% 4.6% 4.3% 2.8% 1.5% -0.4% NM NM Corporate Lines 13,615 19,000 20,900 22,144 22,842 23,073 1.7% 1.4% —Growth (%)* 9.3% 7.4% 10.0% 6.0% 3.2% 1.0% NM NM Public Telephones 6,715 12,400 14,100 15,583 16,218 16,525 2.5% 2.0% —Growth (%)* 39.9% 28.9% 13.7% 10.5% 4.1% 1.9% NM NM PAS Subscribers 18,346 42,200 57,100 63,532 66,700 68,236 2.8% 0.4% —Growth (%)* 153.4% 65.1% 35.3% 11.3% 5.0% 2.3% NM NM Broadband Subscribers (DSL / FTTH) 5,630 13,840 21,020 29,375 37,534 44,765 20.6% 17.4% —Growth (%) 200.4% 90.7% 51.9% 39.7% 27.8% 19.3% NM NM

Traffic

Local MOU / User / month (ex Dial-up) 228 206 189 162 146 136 -7.4% -5.9% Total Market Traffic: Local Minutes (bn) (ex Dial Up) 294.2 429.2 449.4 420.0 395.0 375.0 -5.5% -5.3% DLD Minutes (Outgoing) (bn) 53.8 82.0 93.8 94.7 95.5 96.0 0.2% -0.6% ILD Minutes (Outgoing) (mn) 1.6 1.7 1.7 1.7 1.6 1.8 3.9% 2.9%

China Telecom Minutes / Nationwide Minutes (%)

DLD Minutes* 38.8% 44.0% 42.4% 37.7% 34.1% 31.3% NM NM ILD Minutes * 50.2% 51.9% 46.0% 42.0% 40.0% 36.0% NM NM

Tariffs

Local (ex Dial-up Usage) 0.12 0.12 0.11 0.11 0.10 0.10 -2.0% -2.0% DLD (Blended) 0.37 0.32 0.28 0.27 0.26 0.25 -5.4% -5.3% ILD (Blended) 2.33 2.29 1.99 1.79 1.65 1.53 -6.7% -6.0% Leased Line: Tariffs (E1 / Mo) 30,443 24,515 22,612 20,351 18,315 16,484 -10.0% -10.0% Managed Data: 64Kb (CNY / Mo) 2,424 1,946 1,739 1,555 1,390 1,242 -10.6% -10.6%

Operating Costs (%) of Recurring Revenue

Network Operations and Support 20.6% 18.1% 18.7% 17.3% 17.3% 17.3% NM NM SG&A 11.0% 12.6% 12.2% 12.3% 12.3% 12.2% NM NM Personnel 13.8% 15.2% 15.4% 15.8% 16.2% 16.8% NM NM Net Interconnection Expense -3.2% -4.3% -4.5% -4.7% -5.0% -5.4% NM NM

—Interconnection Revenue 5.8% 7.0% 7.9% 8.5% 9.1% 9.8% NM NM —Interconnection Expense 2.6% 2.7% 3.4% 3.8% 4.1% 4.4% NM NM Depreciation 29.8% 30.9% 30.5% 30.2% 30.0% 30.0% NM NM

Capex

Capex (CNY mn) 42,819 56,307 53,864 51,000 45,000 41,000 -9.3% -8.9% Capex as % of Recurring Revenue 38.7% 36.9% 33.1% 30.1% 26.3% 23.8% NM NM

Source: Company Data, Bear Stearns Asia Ltd. estimates.

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China GrenTech Corp.

(GRRF-$16.55)

CHINA GRENTECH CRP -ADR-REDH

High: 19.00 ADR Low: 8.55 GRRF 3/30/06 to 12/4/06 Last: 15.65 USD

18

14

10

Value Play on China 3G Theme. We believe China GrenTech

Millions 6.77

3.39(GRRF) is the most undervalued and fastest-growing company in

Dec Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov

our telco equipment universe. We estimate US$ revenue growth Source: FactSet Research Systems Inc. at 21% in 2006, vs. 9.9% growth for ZTE and consensus

Stock Rating estimates of 20% growth for Comba. In 2007, we expect GRRF Outperform to grow revenues by 58%, driven by 3G spending, base station RF modules, and market consolidation.

Sector Rating

Market Overweight ?? Expecting Wireless Coverage Capex to Rise 16% in 2007 Following a Lackluster 2006. In 2006, we believe that China's Target Price wireless coverage equipment industry revenue was relatively flat US$20 at CNY7.62 billion (US$957 million) due to pricing pressure on Valuation Method GSM equipment and weak China Unicom CDMA spending. In

Forward P/E multiple

2007 we expect coverage equipment revenue to reach CNY8.66 52-Week Range billion (US$1,110 million).

US$8.21-US$22.50

GAAP EPS EPADS ?? Margin Stabilization: Copper, Sales Mix. Gross margin fell

2005: US$1.09

2006E: US$0.84 by 640 bps (to 48%) in 2006E due to high cable prices, but 2007E: US$1.24 declining copper prices in June-December 2006 are allowing for Note: Employee stock options are inmaterial to margin stabilization. Margins for GRRF's other products earnings estimates declined gradually in 2006 due to pricing pressure but we expect P/E 3G equipment sales to slow GRRF's rate of margin erosion in

2006E: 19.6x 2007-08. 2007E: 13.3x

Dividend

2007E P/E OF 13.3x, US$2.31 IN NET CASH/SHARE. While

$0.0

we have reduced 2007 estimates on lower margin assumptions,

Yield

0.0% we maintain our year-end 2007 target price of US$20, which implies an 2007E P/E of 16.1x. We view GRRF as the most

Com. Shares (mil)

625 (ADS: 25mn) direct play on China's 3G network spending. GRRF is also attractive relative to its peers, ZTE (28.0x 2007E P/E) and

Equity Market Capitalization (mil)

US$414 Comba (15.7x 2007E P/E, based on consensus).

Book Value per Share

US$7.52

Risks to our price target and investment outlook include weaker-Est. 3-Yr EPS Growth Rate than-expected telecom capex in China and competitive risks.

24.4%

Exchange Rate

US$ = CNY7.96

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We consider China GrenTech to be the most attractively valued Asian telecom equipment stock in our coverage universe. It also offers pure-play exposure to the key theme that we expect to drive the sector over the next 12 months: China 3G licensing and network buildout. The company’s other growth driver, wireless base transceiver station (BTS) RF modules, will also become a significant revenue contributor in 2007 and should allow GrenTech to sustain a healthy growth rate even after 3G-related wireless coverage spending slows down (expected in 2009).

Figure 37. GrenTech—Quarterly Results Summary (CNY mn unless otherwise stated)

Reported Results Full-Year Ests. Q3 05A Q4 05A Q1 06A Q2 06A Q3 06A Q4 06E 2006E 2007E

Revenue 156.0 378.1 14.8 180.0 187.7 460.3 842.8 1,329.3 Gross Profit 80.1 203.6 8.0 89.5 89.1 216.3 402.8 582.5

Gross Margin (%) 51.3% 53.9% 54.1% 49.7% 47.4% 47.0% 47.8% 43.8%

Research & Development(7.5)(10.4)(8.4)(8.3)(13.9)(20.0)(50.6)(77.1) Sales & Distribution(26.0)(22.9)(24.1)(26.6)(25.9)(32.9)(109.6)(152.9) General & Administrative(10.4)(11.8)(11.1)(11.0)(11.4)(17.1)(50.6)(66.5) Operating Income /(loss) 36.3 158.5(35.6) 43.6 37.9 146.2 192.1 286.1

Operating Margin (%) 23.3% 41.9% -240.8% 24.2% 20.2% 31.8% 22.8% 21.5%

Net Income / (loss) 17.4 155.3(35.7) 39.4 30.7 125.3 159.8 241.9

Net Margin (%) 11.1% 41.1% -241.5% 21.9% 16.4% 27.2% 19.0% 18.2%

Dil. EPS (ord. sh., CNY) 0.03 0.31(0.07) 0.06 0.05 0.20 0.27 0.39 Dil. EPADS (US$) $0.11 $0.96($0.22) $0.20 $0.16 $0.64 $0.84 $1.24

Source: Company data, Bear Stearns Asia Ltd. estimates.

From a growth and profitability standpoint, 2006 was a tough year for all listed Chinese telecom equipment companies due to a slowdown in domestic CDMA and PAS spending (although PAS indoor coverage spending was strong), continued pricing pressure on legacy GSM equipment, rising commodity prices, and a working capital crunch at China Unicom. Although overall wireless capex was strong in 2006, we believe that a slowdown at China Unicom and pricing pressure at China Mobile caused a decline in wireless coverage revenues in 2006, meaning that vendors were forced to compete for market share in order to grow. From GrenTech’s perspective, we expect an improvement in most of these dynamics in 2007 for the following reasons:

Strong wireless capex: We expect overall wireless capex growth of 16% in 2007.

New technologies, less price pressure: We expect WCDMA, TD SCDMA, and CDMA 2000 EV DO products to alleviate the pricing pressure that has weighed down sales and margins for GSM, PAS, and CDMA2000 1xRTT products for the past three years.

China Mobile centralized procurement a mixed positive: China Mobile will apply its centralized procurement policy to wireless coverage equipment for the first time in 2007. While centralized procurement entails competitive bidding and pricing pressure, it will also give GrenTech an opportunity to gain market share at the No.1 operator. Furthermore, centralized procurement will eliminate the most price competitive vendors in the market – the small, regionally specific

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vendors. It is also worthy of note that GrenTech’s working capital burden will likely decline if China Mobile rises as a proportion of overall revenue, as China Mobile’s payments terms are much more vendor-friendly than China Unicom’s. GrenTech estimates that more than 50% of its receivables, for example, are related to China Unicom, even though it makes up only around 40%-45% of sales in a given quarter.

Copper prices less of a factor in 2007: Due to copper’s rise from US$2.20/pound in late December 2005 to a high of US$3.99/pound in mid-May 2006, GrenTech experienced rising coaxial cable costs, one of the main reasons for an estimated 640bps decline in gross margins in 2006. Copper has since stabilized at around US$3.20, leading to a decline in coaxial cable prices.

R&D investment paying off as RF Modules and 3G products begin to ship in 2007: We expect 3G products to make up 50% or more of GrenTech’s 2007E wireless coverage revenues and for BTS RF modules to rise from less than 2% of 2006 sales to an estimated 13% in 2007E. We believe that GrenTech may begin to see some operating leverage due to the fact that much of the company’s 2005 and 2006 R&D expenditures were related to products that were not yet commercial, leading to a rise in R&D costs, relative to revenue. R&D could potentially fall in relation to revenue as GrenTech realizes the benefits of its historical spending.

Wireless Coverage Segment (94.8% of 2006E Revenue): Revenue Assumptions and Market Environment. We believe that wireless coverage capex rose only marginally in CNY terms (rising by 3% in US$ terms) in 2006, totaling CNY7.62 billion versus CNY7.60 billion in 2005. While China Mobile and the fixed-line operators increased their spending by more than this amount (we estimate an 8% rise at China Mobile and a 45% rise at the fixed-line operators), the decline in China Unicom’s CDMA capex more than offset a rise in its GSM coverage spending. GrenTech was more affected by the China Unicom shortfall than Comba Telecom Systems (2342.HK-HIK$3.60; Not Rated) due to the fact that 42% of GrenTech’s 2006E revenue will be attributable to China Unicom, while Comba will only source an estimated 22% of 2006E revenue from China Unicom (based on consensus revenue estimates from Thomson). Still, GrenTech was able to increase its market share in a flat market, growing 2006E revenue by 17.7% in CNY terms (21% in U.S. dollar terms) due to rising PAS coverage spending by the wireline operators and market share gains at China Mobile. By comparison, consensus expectations imply 2006E revenue growth of 20.5% for Comba (in US dollar terms).

In 2007, we expect China’s wireless coverage capex to rise by 13.7% in CNY terms (16% in US dollar terms), tracking the expected rise in wireless capex. This large jump in coverage capex will be driven by 3G network buildouts, expected to begin in second-quarter 2007. We believe that operators have been delaying some of their indoor coverage spending due to uncertainty over which technologies would be adopted. When 3G licenses are issued (expected in first quarter 2007), the technology decision will be clear and a great deal of pent-up demand will be released. Key sources of spending will be: 1) upgrades of existing indoor coverage to be 3G-compliant; 2) greenfield builds by new market entrants; and 3) resumed spending by China Unicom’s parentco, which will begin upgrading its CDMA 1xRTT indoor

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coverage systems to EV DO Rev. A in our base case 3G scenario. Our wireless coverage capex market assumptions are as follows:

Figure 38. China Wireless Coverage Capex in Absolute Terms and Relative to Total Wireless Capex

12,000 250,000 12.0% 225,000 Wrls Capex (inc PAS) Wrls Coverage Capex % of Total Wrls Capex 11.0%

9,962

10,000 10.0% 200,000

8,663

6,000 5,320 125,000 6.6% 6.7% 6.0% 6.5%

100,000 5.0%

5.2%

4,000 CAPEX (CNY mn) 4.0% 75,000 3.0% 50,000

WIRELESS COVERAGE CAPEX (CNY mn) 2,000 2.0% 25,000 1.0%

— 0.0%

2003A 2004A 2005A 2006E 2007E 2008E 2003A 2004A 2005A 2006E 2007E 2008E

Source: MII, Bear Stearns Asia Ltd. estimates.

In our view, the key drivers of GrenTech’s wireless coverage business in the “rising tide” environment expected for 2007 are market consolidation; product quality/technological competitiveness; and international sales. Market consolidation will accelerate in 2007 for several reasons, most importantly China Mobile’s centralized procurement policy and higher demands on working capital entailed by the spending increase and the expected speed of deployment. China Mobile is now the market’s most diversified operator with regard to coverage equipment sourcing, with the three listed coverage equipment vendors (GrenTech, Comba, and Telestone [TSTC.US-$6.28; Not Rated]) accounting for only 39% of China Mobile’s estimated 2006 wireless coverage spending (versus 30% in 2005). GrenTech estimates that there are currently 50 coverage vendors selling to China Mobile, but that this will fall to 20-25 in 2007 following the institution of centralized procurement in late December 2006. This may cause the top three to four vendors’ market share to rise from approximately 35% of wireless coverage spending at present to an estimated 40% in 2007 (GrenTech estimates 50%+), and may also afford the top players a chance to acquire small regional competitors at depressed valuations – or to potentially poach their sales staff. GrenTech’s ability to win bids with China Mobile between now and the end of the month will be a key determinant of its China Mobile market share and revenue growth for the next two year, in our opinion. Product quality will also be a more important issue as the 3G era begins, and GrenTech should be at an advantage to most of its competitors in this regard. We believe that product reputation and R&D capabilities (as much of the R&D involved in wireless coverage involves fast, reliable product customization) will become a key driver of market share in 2007. International sales will provide an added boost in 2007 as GrenTech piggybacks on ZTE’s and Huawei’s sales of wireless systems to rapidly growing emerging wireless markets including Indonesia, Philippines and other parts of ASEAN and South Asia. We expect international sales to contribute around 3% of GrenTech’s 2007E revenue growth.

Revenue and Margin Outlook for RF Module Business (3.9% of 2006E Revenues). GrenTech’s RF Module sales to BTS OEMs are expected to first broach the US$1 million mark in fourth-quarter 2006 and will likely accelerate sharply

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throughout 2007 as GrenTech progresses through the lengthy product approval process with more vendors and more products. ZTE is now the main customer, but GrenTech plans to realize a small amount of revenue from Huawei in the fourth quarter. We expect Huawei and ZTE to be GrenTech’s biggest customers in 2007, being the first to grant GrenTech qualified supplier status and to begin sampling and testing the company’s products. However, GrenTech also has a solid relationship with Siemens, particularly for TD SCDMA products and will likely also begin recognizing revenue from Alcatel and Nortel by the end of 2007.

The technology mix of GrenTech’s 2006 RF product sales is weighted toward GSM, with CDMA being the next largest revenue contributor. In 2007, the company believes that GSM will remain the largest contributor at slightly more than half of RF Module revenues, with TD SCDMA, WCDMA and CDMA products each being roughly equal as a proportion of revenues. We believe that sales mix guidance will change if 3G licenses are issued early in the year, with higher-margin TD SCDMA and WCDMA products rising as a proportion of sales.

In terms of profitability, RF module gross margins are lower than the company’s overall margin, but operating margins are quite similar to those of coverage equipment. This is due to the fact that RF modules have much lower sales and distribution costs (vis-à-vis wireless coverage equipment) once the product approval process has been completed. We view rising RF module sales as a very positive trend for GrenTech. Not only is the RF module business less competitive, with higher barriers to entry than the wireless coverage business, it is also potentially larger in size and imposes much less of a working capital burden than the wireless coverage business, with a payment cycle of less than 180 days.

Figure 39. GrenTech Revenue Mix, Gross Profit, and Gross Margin Trend

1,800

1000 80% 1,600 Wireless Access & Other Gross Profit (CNY) (LHS) GPM(%) RHS

900

70%

60.9%

1,400 RF Modules 800 57.3%

47.8%

1,000

500 40% 800

REVENUE (CNY mn) 400

30% 600 300 20% 400 200 200 10% 100

0 0 0% 2003A 2004A 2005A 2006E 2007E 2008E 2003A 2004A 2005A 2006E 2007E 2008E

Source: Company Data, Bear Stearns Asia Ltd. estimates.

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Coaxial Cable Pricing Is Falling. While the sudden rise in coaxial cable pricing (caused by an equally sudden 80% rise in copper prices) during second-quarter 2006 depressed gross margins in the third quarter of 2006, we believe that the worst is behind us and that GrenTech’s margins on resold coaxial cable (used in the company’s wireless coverage installations) will stabilize or perhaps rise in 2007. Coaxial cable comprises an estimated 13% of 2006 revenues. GrenTech believes that its cable pricing has fallen by about 20% from the levels seen in May and June of 2006, which is roughly in line with the trend in copper pricing during that time. Note, however, that the copper/cable pricing relationship is not 1:1, as copper comprises only an estimated 25% of coaxial cable vendors’ cost of sales.

In the charts below, we show a breakdown of GrenTech’s gross margins on different products, first disaggregating the profitability of products and services encompassed by the wireless coverage segment, and then comparing profitability between segments. These charts show that, despite the faster-than-expected decline in gross margins in 2006, most of this was due to a halving of cable margins. We expect a continued gradual downtrend in wireless coverage hardware margins, but for the decline to slow somewhat in 2007 and 2008 as more revenues are expected to come from 3G products. In 2006, hardware margins were depressed by a rapid increase in low-margin PAS and GSM products as a proportion of sales.

Figure 40. GrenTech Gross Margin Breakdown: Wireless Coverage Products and Wireless Coverage versus Other Segments

100% 100%

Wrls Covg Hardware Cable Wrls Covg Equip & Svc RF Modules

90% 90%

Other resold parts Services Wrls Access & Other

80% 80% 70% 70% 60% 60%

50% 50% 40% 40% 30% 30% 20% 20% 10% 10%

0% 0%

2003A 2004A 2005A 2006E 2007E 2008E 2003A 2004A 2005A 2006E 2007E 2008E

Source: Company Data, Bear Stearns Asia Ltd. estimates.

Company Guidance Is Conservative: Why We Are More Optimistic. GrenTech is guiding for 30% revenue growth in 2007, which we view as conservative. The company also expects 10%-15% of 2007 revenues to come from RF modules and is not expecting international sales to increase as a proportion of sales. Margin guidance is as follows: 40%-45% gross margins for wireless coverage equipment; 30%-40% margins for RF products; no change in ratio of opex:sales. A quick back-of-the-envelope analysis of these numbers shows that this implies overall revenues of around CNY1.1 billion (US$140 million) and, taking the midpoint of RF module revenue guidance, RF module revenue of CNY137 million (compared to an estimated

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33 million in 2006). In other words, GrenTech expects about 12%-13% of its revenue growth to come from RF modules and only 17%-18% to come from wireless coverage, in line with its 2006 performance. We are significantly above guidance on the point of revenue growth, mainly because we expect faster growth from the wireless coverage business due to the twin positives of higher wireless spending and continued market share gains, especially at China Mobile. We also expect RF modules to grow more rapidly than guidance, which is also partly due to our more optimistic outlook on 3G timing and related demand for TD SCDMA and WCDMA BTS components.

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Figure 41. GRENTECH Financial Summary & Ratios

CHINA GRENTECH: FINANCIAL SUMMARY AND R 0.0651724 CAGR

2004A 2005A 2006E 2007E 2008E 2009E 2010E '06E-'09E PER ADS DATA (US$)

EPADS (Basic) 0.93 1.17 0.86 1.24 1.48 1.63 1.65 23.8% EPADS (Diluted) 0.86 1.09 0.84 1.24 1.48 1.63 1.65 24.4% FCF per ADS 1.14(0.95) 0.04 0.00 0.62 1.11 1.46 NM Cash Earnings per ADS 0.94 1.20 1.02 1.53 1.87 2.07 2.12 26.6% Book Value per ADS 2.11 3.09 7.52 8.53 10.17 11.80 13.45 16.2% Net Cash per Dil. ADS(0.20)(1.22) 2.31 2.21 2.84 3.96 5.44 19.6% Assumed F/X Rate (CNY/USD) (avg) 8.28 8.19 7.96 7.80 7.65 7.65 7.65 -1.3%

VALUE

EV / Revenue 5.3 4.1 3.4 2.1 1.6 1.5 1.4 NM EV / EBITDA 13.7 12.2 12.8 8.2 6.5 5.9 5.8 NM Price / Sales 6.0 4.7 3.9 2.4 1.9 1.7 1.6 NM Price / Book 9.8 6.7 2.3 1.9 1.6 1.4 1.2 NM P/E (Diluted) 19.2 15.1 19.6 13.3 11.2 10.2 10.0 NM P/E (ex net cash per share) 19.4 16.2 16.8 11.6 9.3 7.7 6.7 NM

PROFITABILITY

Gross Margin % 57.3% 54.2% 47.8% 43.8% 42.0% 41.6% 40.7% NM EBITDA Margin % 38.7% 33.8% 26.8% 25.8% 24.9% 25.2% 24.3% NM Operating Margin % 36.6% 31.4% 22.8% 21.5% 20.5% 20.6% 19.7% NM Net Income Margin % 25.3% 25.0% 19.0% 18.2% 16.5% 16.6% 15.9% NM

YIELD

FCF Yield 5.5% -4.6% 0.2% 0.0% 3.8% 6.7% 8.8% NM Earnings Yield 4.2% 5.3% 4.9% 7.5% 8.9% 9.8% 10.0% NM

BALANCE SHEET (US$ mn)

Net Debt / (Cash) 4.0 24.3(55.0)(55.2)(71.0)(99.0)(136.0) NM Current Assets 122.5 143.1 227.8 294.7 363.3 410.9 467.1 21.7% Total Assets 151.0 180.2 298.8 400.0 487.5 540.4 598.9 21.8% Current Liabilities 80.1 90.2 117.5 183.7 229.2 240.7 257.1 27.0% Total Liabilities 100.7 110.6 117.5 183.7 229.2 240.7 257.1 27.0% Minority Interest 2.7 2.2 2.8 3.2 4.0 4.8 5.6 19.9% Book Value of Equity 42.1 61.9 178.6 213.1 254.3 294.9 336.2 18.2%

RETURNS

ROA% 12.9% 13.2% 8.4% 8.9% 8.3% 7.9% 7.2% NM ROE% 47.2% 42.1% 16.7% 15.8% 15.8% 14.8% 13.1% NM ROIC% 27.5% 28.2% 17.5% 20.4% 19.8% 19.4% 18.7% NM

MOMENTUM (in US$ terms)

Revenue Growth % 57.0% 27.8% 21.0% 60.9% 31.2% 9.6% 5.6% NM EBITDA Growth % 35.8% 11.6% -4.1% 55.3% 26.3% 10.8% 1.8% NM Operating Profit Growth % 33.4% 9.7% -12.2% 51.9% 25.0% 10.1% 1.1% NM EPADS Growth % -10.3% 26.5% -22.7% 46.7% 19.0% 10.2% 1.5% NM

Source: Company Data, Bear Stearns Asia Ltd. estimates.

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Figure 42. GRENTECH Summary of Driving Assumptions

CAGR/bps 2002A 2003A 2004A 2005A 2006E 2007E 2008E 2009E '06E-'09E

Revenue Assumptions

Revenue Growth by Product Segment

Wireless Coverage NA 5.5% 51.4% 28.1% 16.8% 38.0% 20.0% 5.0% 20.2% RF-Modules NA NA 457.6% -33.1% 50.0% 536.4% 71.4% 25.0% 138.9% Wireless Access NA 1196.5% -91.8% 270.0% 300.0% 50.0% 50.0% 25.0% 41.2% Total Revenue Growth 215.1% 14.2% 57.0% 26.4% 17.7% 57.7% 28.6% 9.6% 30.5%

Revenue Contribution by Product Segment

Wireless Coverage 105.8% 97.8% 94.3% 95.5% 94.8% 82.9% 77.4% 74.1% (2,067 bps) RF-Modules 0.0% 1.6% 5.8% 3.1% 3.9% 15.8% 21.1% 24.0% 2,010 bps Wireless Access 0.3% 3.4% 0.2% 0.5% 1.8% 1.7% 1.9% 2.2% 47 bps Settlement discounts -6.1% -2.8% -0.2% 1.0% -0.5% -0.4% -0.4% -0.4% 10 bps

Total 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0%(0 bps)

Margin & Expense Assumptions

Blended Gross Margin% 59.8% 60.9% 57.3% 54.2% 47.8% 43.8% 42.0% 41.6% (620 bps) Opex as % of Sales 15.4% 17.8% 20.7% 22.8% 25.0% 22.3% 21.5% 21.0% (400 bps) Research and development 2.4% 3.4% 2.9% 4.3% 6.0% 5.8% 5.5% 5.5%(50 bps) Sales and distribution 6.0% 7.8% 12.5% 12.8% 13.0% 11.5% 11.0% 10.5% (250 bps) General and administrative 6.9% 6.6% 5.3% 5.7% 6.0% 5.0% 5.0% 5.0% (100 bps) Operating margin % 44.4% 43.1% 36.6% 31.4% 22.8% 21.5% 20.5% 20.6% (220 bps) Depreciation / Sales % NA 1.6% 2.1% 2.4% 4.0% 4.3% 4.4% 4.6% 59 bps

Exchange Rate Assumptions

Assumed F/X Rate (CNY/USD) (avg) 8.28 8.28 8.28 8.19 7.96 7.80 7.65 7.65 -1.3%

Seasonality and Quarterly Profitability Assumptions

Q1 05A Q2 05A Q3 05A Q4 05A Q1 06A Q2 06A Q3 06A Q4 06E

% of FY Revenue in Quarter 1.2% 24.3% 21.8% 52.8% 1.8% 21.4% 22.3% 54.6%

Gross Margin % 53.2% 57.6% 51.3% 53.9% 54.1% 49.7% 47.4% 47.0% Operating Margin % -372.7% 35.1% 23.3% 41.9% -240.8% 24.2% 20.2% 31.8% Net Margin % -401.4% 22.7% 11.1% 41.1% -241.5% 21.9% 16.4% 27.2%

GRRF: Quarterly Revenue Seasonality Trends

100.0

Q3 03A Q4 03A Q1 04A Q2 04A Q3 04A Q4 04A Q1 05A Q2 05A Q3 05A Q4 05A Q1 06A Q2 06A Q3 06A Q4 06E

Source: Company Data, Bear Stearns Asia Ltd. estimates.

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ZTE Corp.

(763.HK-$38.70)

ZTE CORP

High: 37.50 'H'CNY1 Low: 21.50 B04KP8 12/1/05 to 12/4/06 Last: 36.35 HKD

36 China’s 3G Proxy, But How Much Upside Remains?

32

28 While 3G will be a positive earnings contributor, we believe that

24 ZTE is already pricing in a very optimistic China 3G capex (and

Millions 6.50

3.25 market share) scenario. Moreover, we see several potential Dec Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov downside risks for the company, hence our November 21 Source: FactSet Research Systems Inc. downgrade of ZTE to Peer Perform from Outperform.

Stock Rating

China Wireless Revenues 11%/19% of 2006E/2007E

Peer Perform

Revenues. While ZTE will be a beneficiary of China’s 3G license issuance, we believe there is a large disconnect between

Sector Rating the stock’s recent reaction to positive 3G newsflow (e.g., TD

Market Overweight

SCDMA commercial trials and official statements supporting the Target Price domestic 3G standard) and its true exposure to domestic wireless HK$31 revenues.

Valuation Method

Forward P/E multiple ?? International Growth Trajectory Flattening Out.

52-Week Range International revenues are expected to grow 29% in 2007 HK$21.80-HK$42.50 compared with 52% in 2006E and 83% in 2005. Apart from the higher base effect, we see constraints on the growth prospects for

GAAP EPS

handsets and wireless infrastructure, which have been the key 2005: CNY1.342 drivers of international growth for the company over the past

2006E: CNY0.864

2007E: CNY1.384 three years. Note: Employee stock options are inmaterial to

earnings estimates ?? Persistent Margin Pressure. While ZTE has managed to grow P/E revenue at a 10.5% CAGR in 2003-06E, earnings have fallen 2006E: 45.8x during this time due to pricing pressure, deteriorating product 2007E: 28.0x mix, and overheads associated with international expansion. Dividend While we expect some margin recovery in 2007, it is too early to

HK$0.24

predict a return to ZTE’s historical 8%+ operating margin levels.

Yield

0.6%

Expensive Relative to Comparables at 28x 2007E Earnings.

Com. Shares (mil) Our year-end 2007 HK$31.00 target price implies a 2007E P/E

960

of 22.5x, compared with a 2007-10E EPS CAGR of 9.2%. Our

Equity Market Capitalization (mil)

five-year DCF analysis arrives at a hypothetical fair value of

US$4,775

HK$31.50, assuming a 9% WACC, 10% public market discount,

Book Value per Share

and a 10x exit EBITDA multiple.

HK$11.04

Est. 3-Yr EPS Growth Rate

35% Risks to our target price and investment outlook include margin pressure from higher levels of competition in the Chinese

Exchange Rate

US$ = CNY7.96 telecom equipment sector.

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Pricing in a Great Deal of Upside Already. As China’s largest listed telecom infrastructure vendor, we believe that ZTE has benefited from its proxy status as an increasing amount of newsflow and analysis has emerged regarding the progress of commercial TD SCDMA trials, and as Chinese officials voice increasing support for the domestic 3G standard. We view the 35% rise in ZTE’s share price over the past five weeks as a product of strong liquidity and investor appetite for “China-theme” stocks, but more specifically to the telecom equipment vendor, and the perceived lifting of the TD SCDMA overhang, thought to be the primary obstacle to 3G licensing in China. At this point, however, we believe that risk:reward is biased to the downside for several reasons, including: 1) high valuation versus growth; 2) remaining uncertainties surrounding the timing and extent of China 3G spending; 3) slowing international sales growth; 4) lack of FCF visibility; and 5) the risk of further capital raising in the Chinese telecom equipment sector. (Please also refer to our xxx November 21st note, “3G Momentum Positive for Sentiment, but Valuations Getting Stretched.”)

Consensus Estimates Pricing in an Optimistic Growth and Profitability Scenario. We expect consensus estimates, already quite optimistic on fourth-quarter 2006 earnings, to decline further as we approach year-end 2006. Even in the event that TD SCDMA and/or WCDMA licenses are granted within the next three to six months, consensus estimates are already factoring in a dramatic 2007 earnings recovery for ZTE. IBES consensus estimates currently imply 2007 revenue growth of 28% and EPS growth of 57% against an already optimistic 2006 earnings base. We find it difficult to understand why the analyst community is forecasting a sharp increase in ZTE’s 2007E net margin (from 3.7% in 2006E [our estimate] to 5.5% in 2007E [IBES consensus estimate]), but we note that ZTE looks relatively expensive even on these assumptions, at a consensus 2007E P/E of 21.6x. We are 19% and 18% below 2006E and 2007E IBES consensus EPS estimates, respectively.

At High End of Historical P/E and P/B Trading Bands. We note that ZTE is trading at the high end of its historical P/E and P/B trading bands (see Figure 43). In the past, we have based our ZTE target price on a PEG ratio (forward P/E versus three-year EPS CAGR) of 1.0. Based on our estimates, ZTE’s current 2007E PEG ratio is 2.9. ZTE is also currently at the high end of its historical trading range of 15x-25x forward earnings, trading at a 2007E P/E of 28x. ZTE is also trading at 3.5x 2006E P/B, which seems high compared with its normalized ROE of 11%-13% and historical trading range of 2.0x-3.5x forward P/B.

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Figure 43. ZTE Historical P/E and P/B Trading Ranges

ZTE Prospective P/E Bands ZTE Prospective P/B Bands

HKD HKD30

2.5x

20.0x

0 0

Jan 03 Apr 03 Jul 03 Oct 03 Jan 04 Apr 04 Jul 04 Oct 04 Jan 05 Apr 05 Jul 05 Oct 05 Jan 06 Apr 06 Jul 06 Oct 06 Jan 03 Apr 03 Jul 03 Oct 03 Jan 04 Apr 04 Jul 04 Oct 04 Jan 05 Apr 05 Jul 05 Oct 05 Jan 06 Apr 06 Jul 06 Oct 06

Source: Company Data, Bear Stearns Asia Ltd. estimates.

Lack of FCF Visibility, Working Capital Requirements Could Constrain Future Cash Flow. ZTE has experienced negative FCF for the past two years due to rising net working capital, likely related to its overseas expansion and long overseas payment cycles. While we assume that FCF becomes positive in 2007 and that working capital becomes less of a drag on overall FCF in future periods, this might be generous given that most of the company’s future growth will likely come from domestic and international wireless projects, both of which have notoriously long payment terms. With more conservative working capital assumptions, our DCF-based hypothetical fair value would be even lower than in our base case.

Revenue Issues: When Will 3G Revenue Actually Hit the P&L? We expect ZTE to increase its wireless infrastructure market share following 3G license issuance due to factors including: 3G technology transition (WCDMA/TD SCDMA/EV DO Rev. A); operator tax inducements; and ZTE’s close relationships with the fixed-line operators. However, we also note that final recognition of a good portion of the revenue related to expected 2007 capex could be delayed into 2008, potentially leading to: 1) a 2007 revenue disappointment; and 2) an increase in 2007 working capital. Delayed revenue recognition could result from lack of operator final acceptance, particularly in the case of new wireless market entrants, which would be unlikely to launch full 3G commercial services before first-quarter 2008, by our estimates.

Will International Sales Slow in 2007? We currently estimate that ZTE’s international revenue growth will slow from 52% year-on-year growth in 2006 (following 83% growth in 2005) to 29% in 2007. We believe that ZTE’s growth in its core Asia (ex-China) markets may be slowing due to competitive pressures, political factors (particularly in India), and, in some cases, slowing capex following two very strong years. Meanwhile, Africa and “other” geographies (primarily Latam, Middle East, and Eastern Europe) have gathered momentum in the past 12 months. Much of ZTE’s international growth in 2006 has thus far been attributable to lower-margin products such as handsets and broadband access equipment. We estimate that international handset sales grew by 93% in 2006, rising to 25% of estimated international sales. Figure 44 illustrates trends in ZTE’s domestic:international

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revenue split as well as sales momentum in different geographies. ZTE does not specifically disclose the composition of international revenues, but we believe that in 2006 wireless infrastructure will be the biggest revenue contributor, accounting for around 40% of international sales, with handsets being the second largest sales contributor.

Figure 44. ZTE Revenue Composition: International Revenue Trends

Revenues: Domestic Vs. International International Revenue by Geography

20,000 5,000

China International Asia (ex China) Africa Others

4,000 15,000

3,000

CNY mn 10,000

2,000

5,000

1,000 0 -

1H 03 2H 03 1H 04 2H 04 1H 05 2H 05 1H 06 2H 06E 1H 07E 2H 07E 1H 03 2H 03 1H 04 2H 04 1H 05 2H 05 1H 06 2H 06E 1H 07E 2H 07E

Source: Company Data, Bear Stearns Asia Ltd. estimates.

Potential Capital Raising in the Sector Could Eclipse ZTE’s Proxy Status. Based on past statements by ZTE’s domestic telecom equipment rivals, we believe that China’s 3G licensing could be a catalyst for further capital raising in the Chinese telecom equipment sector. A key candidate that has previously considered coming to market is Huawei, ZTE’s larger domestic competitor. We believe that possible further capital raisings could place downward pressure on ZTE’s valuation as stronger and larger comparable companies emerge to compete for investor attention and capital. A Huawei listing, for example, could lead to a reweighting or even removal of ZTE from key indices, causing a potential technical sell-off.

Potential Dilution from Planned Options Issuance. Although the final structure of ZTE’s “A-Share Incentive Scheme” has not yet been formally approved, it is quite likely that investors in ZTE Corp. will be exposed to 5% dilution upon the company’s issuance of A-share linked options to employees at a strike price of CNY30.80 (equivalent to a price of about HK$30.30 for the H-Share), allowing employees who receive the options to purchase an aggregate of up to 47.98 million new A-shares. While options exercise will not occur until October 2008 (options will be “unlocked” or distributed to employees in years three to five of the options plan), we will likely have to begin factoring in the prospective EPS dilution associated with the plan once it receives final authorization from the China Securities Regulatory Commission (CSRC), which has been delayed from the original November 16 deadline.

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What Likely Upside from China 3G Spending?

ZTE has less exposure to China’s wireless spending than is generally believed. We estimate that 35% of ZTE’s revenue will be derived from wireless infrastructure in 2006, but that just 11% of total 2006 revenue will be attributable to the domestic wireless market. Domestic wireless revenues have declined in importance in the past two years due to weak CDMA and PAS spending, combined with ZTE’s peripheral position in the domestic GSM infrastructure market. ZTE’s wireless revenue growth slowed considerably in 2005 (1.6% growth) and 2006 (estimated growth of -8.8%) due to the downtrend in domestic CDMA and PAS spending. In 2007, we expect domestic wireless revenue to grow 120% year on year (following -46% growth in 2006E) and for international wireless sales to grow by 30% (following 35% growth in 2006E). Our key assumptions regarding ZTE’s potential domestic 3G revenues are as follows:

China wireless infrastructure revenue: Rising to CNY5.8 billion in 2007E, equivalent to 19% of ZTE’s total revenues. 3G (WCDMA and TD SCDMA) revenues estimated at CNY3.4 billion in 2007, rising to CNY6.0 billion in 2008E and CNY8.0 billion in 2009E.

Implied China 3G market share: Our ZTE 3G estimates imply that ZTE’s domestic wireless infrastructure equipment market share (calculated on the basis of equipment vendor revenue rather than capex, and excluding PAS) rises from 2.8% in 2006E to 6.8% in 2007E, and 8.2% in 2008E. 3G market share drives all of the increase, as GSM and CDMA revenues are assumed to be virtually flat.

Our 3G revenue assumptions imply that ZTE’s domestic 3G market share (again, based on equipment revenues rather than operator capex) reaches 11% in 2007E, 19% in 2008E, and 26% in 2009E. We believe that our assumptions factor in sufficient upside from the issuance of both WCDMA and TD SCDMA licenses, as well as the fact that ZTE will likely be the No.1 or No.2 vendor of TD SCDMA infrastructure.

Figure 45. ZTE Revenue Composition: Wireless and Overall

Wireless Infra Revenues by Technology Revenue Composition (%)

9,000 100% PAS CDMA GSM WCDMA 90% 8,000

80%

7,000

70%

6,000

60%

CNY mn 5,000 50%

4,000 40% 30%

3,000

20%

2,000

10%

1,000

0%

- 1H 03 2H 03 1H 04 2H 04 1H 05 2H 05 1H 06 2H 06E 1H 07E 2H 07E

1H 03 2H 03 1H 04 2H 04 1H 05 2H 05 1H 06 2H 06E 1H 07E 2H 07E Wrls Infra FL Data/Opt Hsets Others

Source: Company Data, Bear Stearns Asia Ltd. estimates.

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Gross Margin Downtrend May Persist. ZTE’s gross margin declined from 44% in first-half 2005 to 32% in first-half 2006 and 29.5% in third-quarter 2006. ZTE’s gross margin outlook will be determined by a changing product mix, as detailed in Figure 46. We believe that a rise in the proportion of higher-margin wireless infrastructure revenue could likely be offset by the fact that a large proportion of revenue will continue to be derived from lower-margin segments including handsets and the diverse “telecommunications software systems, services & other products” segment. We also expect margin declines in the data/optical and fixed-line segments. The “others” segment has grown faster than originally expected in 2006, with much of this growth coming from applications including: set-top boxes for IPTV; IPTV platforms; modems; and intelligent networks for mobile operators. Finally, we note the risk of continued margin pressure in the domestic wireless business due to: 1) the launch of 3G, which may result in intense price competition in the first stages of buildout as vendors scrabble for market share; and 2) China Mobile’s centralized procurement policy, which appears to be creating intense pricing pressure on vendors.

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Page

Figure 46. ZTE Revenue and Profitability Breakdown and Assumptions

Revenue by Source 10,179 11,041 10,303 11,273 10,491 12,547 21,220 21,576 23,038 31,007 36,611 40,413 40,433 40,735 21% 12%

Wireless Communications 4,498 4,289 4,698 4,233 3,513 4,628 8,786 8,931 8,142 12,946 16,401 19,251 19,306 19,553 33% 19% Wireline Switch & Access 1,306 1,293 721 2,032 1,075 1,829 2,599 2,753 2,904 2,904 2,904 2,962 3,021 3,082 1% 1% Optical & Data Communications 1,151 1,185 1,491 1,862 1,710 2,256 2,335 3,353 3,967 4,826 5,635 5,848 5,812 5,742 14% 8% Handsets 2,604 3,411 2,215 2,118 2,134 2,600 6,015 4,333 4,734 5,877 6,169 6,414 6,161 5,970 11% 5% CHINA Telecommunications Software & Others 622 863 1,178 1,028 2,058 1,234 1,485 2,206 3,291 4,455 5,502 5,938 6,133 6,388 22% 14%

Revenue Breakdown (%) 100% 100% 100% 100% 100% 100% 100% 100.0% 100% 100% 100% 100% 100% 100% NM NM

Wireless Communications 44% 39% 46% 38% 33% 37% 41% 41% 35% 42% 45% 48% 48% 48% 1,229 bps 1,266 bps TELECOM Wireline Switch & Access 13% 12% 7% 18% 10% 15% 12% 13% 13% 9% 8% 7% 7% 8% (528) bps (504) bps Optical & Data Communications 11% 11% 14% 17% 16% 18% 11% 16% 17% 16% 15% 14% 14% 14% (275) bps (312) bps Handsets 26% 31% 21% 19% 20% 21% 28% 20% 21% 19% 17% 16% 15% 15% (468) bps (589) bps Telecommunications Software & Others 6% 8% 11% 9% 20% 10% 7% 10% 14% 14% 15% 15% 15% 16% 41 bps 140 bps

Gross Profit by Source 3,735 3,671 3,782 3,693 3,667 4,149 13,814 14,102 15,222 10,329 12,220 13,668 13,719 13,871 -4% -2%

SERVICES Wireless Communications 1,756 2,057 2,180 1,729 1,542 2,037 4,973 5,022 4,564 5,567 6,888 8,085 8,108 8,212 21% 12% Wireline Switch & Access 725 768 356 1,136 391 823 1,106 1,261 1,690 1,162 1,162 1,185 1,208 1,233 -11% -6% Optical & Data Communications 318 249 385 271 481 451 1,769 2,698 3,035 1,206 1,409 1,462 1,453 1,436 -22% -14% Handsets 567 162 342 416 592 468 5,286 3,575 3,675 1,058 1,110 1,154 1,109 1,075 -32% -22% Telecommunications Software & Others 370 435 519 141 662 370 680 1,547 2,259 1,336 1,651 1,781 1,840 1,916 -8% -3%

& Gross Profit Breakdown (%) 100% 100% 100% 100% 100% 100% 100% 100% 100% 100% 100% 100% 100% 100% NM NM

EQUIPMENT: Wireless Communications 47% 56% 58% 47% 42% 49% 36% 35.6% 30% 54% 56% 59% 59% 59% 2,917 bps 2,922 bps Wireline Switch & Access 19% 21% 9% 31% 11% 20% 8% 8.9% 11% 11% 10% 9% 9% 9% (243) bps (222) bps Optical & Data Communications 9% 7% 10% 7% 13% 11% 13% 19.1% 20% 12% 12% 11% 11% 10% (924) bps (959) bps Handsets 15% 4% 9% 11% 16% 11% 38% 25.4% 24% 10% 9% 8% 8% 8% (1,569) bps (1,639) bps Telecommunications Software & Others 10% 12% 14% 4% 18% 9% 5% 11.0% 15% 13% 14% 13% 13% 14% (181) bps (103) bps

Gross Margin Assumptions (%) 36.7% 33.3% 36.7% 32.8% 35.0% 33.1% 34.9% 34.6% 33.9% 33.3% 33.4% 33.8% 33.9% 34.1% (10) bps 13 bps

Wireless Communications 39.0% 48.0% 46.4% 40.8% 43.9% 44.0% 43.4% 43.8% 43.9% 43.0% 42.0% 42.0% 42.0% 42.0% (195) bps (195) bps ’T

Wireline Switch & Access 55.6% 59.4% 49.3% 55.9% 36.4% 45.0% 57.5% 54.2% 41.8% 40.0% 40.0% 40.0% 40.0% 40.0% (180) bps (180) bps

WAS

Optical & Data Communications 27.6% 21.0% 25.8% 14.5% 28.1% 20.0% 24.3% 19.5% 23.5% 25.0% 25.0% 25.0% 25.0% 25.0% 150 bps 150 bps Handsets 21.8% 4.7% 15.4% 19.7% 27.7% 18.0% 12.1% 17.5% 22.4% 18.0% 18.0% 18.0% 18.0% 18.0% (438) bps (438) bps THE Telecommunications Software & Others 59.5% 50.4% 44.0% 13.7% 32.2% 30.0% 54.2% 29.9% 31.4% 30.0% 30.0% 30.0% 30.0% 30.0% (135) bps (135) bps

Source: Company Data, Bear Stearns Asia Ltd. estimates.

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Some Operating Margin Recovery in 2007 after International Expansion in 2006. ZTE’s first-half 2006 operating margin fell to 4.8% (from 8.6% in first-half 2005) and deteriorated further to 0.9% in third-quarter 2006 (versus 1.8% in third-quarter 2005). According to management, the operating margin compression experienced in 2006 will revert in 2007, and thereafter. In 2006 opex/sales rose as a result of ZTE’s aggressive international expansion, which caused growth in contracts and overheads to temporarily exceed revenue growth. While we expect ZTE’s opex/sales to decline to 27% in 2007 from 28.3% in 2006E, we do not see an immediate return to the 25%-26% levels experienced in 2003-05.

Figure 47. ZTE Revenue and Profitability Breakdown and Assumptions

ZTE Revenue & Gross Margin ZTE Margin Trends

25,000 45.0% 55.0%

REV (CNY mn) (LHS) GPM (%) (RHS) 50.0% GPM (%) OPM (%) NPM (%) 20,000 40.0% 45.0% 36.7% 36.7% 36.7% 36.7%

40.0% 34.5% 35.0% 35.0% 33.8% 33.3% 32.8% 35.0% 33.1%

34.5% 35.0% 32.1% 33.8% 35.0% 15,000 33.3% 32.8% 33.1% 35.0% 32.1% 30.0% 25.0% 10,000 30.0% 20.0% 14.2%

15.0% 9.6% 10.2% 8.6%

5,000 25.0% 6.7% 6.9% 6.2% 6.9% 10.0% 4.8% 5.5%

5.0%

- 20.0% 0.0%

1H 03 2H 03 1H 04 2H 04 1H 05 2H 05 1H 06 2H 06E 1H 07E 2H 07E 1H 03 2H 03 1H 04 2H 04 1H 05 2H 05 1H 06 2H 06E 1H 07E 2H 07E

Source: Company Data, Bear Stearns Asia Ltd. estimates.

Valuation: DCF and Other Measures. Our year-end 2007 target price of HK$31.00 implies a 2007E P/E of 22.5x and a forward P/B of 2.8x, in the middle of ZTE’s historical trading range. Our five-year DCF analysis returns a hypothetical fair value of HK$31.50, assuming a WACC of 9% and an exit EBITDA multiple of 10x.

BEAR STEARNS ASIA LTD. Page 85

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Figure 48. ZTE DCF Analysis and FCF Composition

(CNY mm) 8,000

EBIT * (1-t) D&A NWC Capex FCF 6,000

4,000 2,000 -(2,000)

(4,000)

2002A 2003A 2004A 2005A 2006E 2007E 2008E 2009E

Weighted Average Cost of Capital DCF Valuation

Risk Free Rate 2.9% PV of First 5 Years FCF 6,054 Market Risk Premium 8.0% Terminal EBITDA 4,169 Beta 0.96 Terminal Value 24,861 Cost of Equity 10.6% Total Enterprise Value (CNY mn) 30,914 Cost of Debt 6.5% Net Debt (2006E)(3,450) Statutory Tax Rate 33.0% Equity Value 34,364 After-Tax Cost of Debt 4.36% Equity / Total Capitalization 70.0% Raw DCF Equity Value/Share (CNY) 35.81 Debt / Total Capitalization 30.0% Raw DCF Equity Value/Share (HKD) 35.00 WACC 9.0% Hypothetical DCF-based Fair Value/Share 31.50 Discount to DCF 10.0% Terminal Value Assumptions Implied Perpetual Growth Rate -0.63% Terminal Value % of DCF Valuation 72.3%

Source: Company Data, Bear Stearns Asia Ltd. estimates.

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Asian Equity Research

BEAR STEARNS

Figure 49. ZTE Financial Summary and Key Financial Ratios

CAGR 2002A 2003A 2004A 2005A 2006E 2007E 2008E 2009E '06E-'09E '07E-'10E

Per Share Data

- Basic EPS (HKD) 0.826 1.207 1.475 1.275 0.845 1.380 1.767 2.183 37.2% 9.6% Diluted EPS (CNY) 0.878 1.284 1.326 1.342 0.864 1.384 1.738 2.147 35.4% 9.2%—Diluted EPS (HKD) 0.825 1.206 1.246 1.275 0.845 1.380 1.767 2.183 37.2% 9.6%—DPS (HKD) 0.13 0.23 0.23 0.24 0.24 0.34 0.39 0.48 25.2% 6.8%—BVPS (HKD) 4.32 5.40 9.03 10.15 11.04 12.39 14.06 15.85 12.8% 7.2%—CEPS (HKD) 1.12 1.63 1.63 1.80 1.30 2.08 2.65 3.26 35.9% 10.8%—FCF (HKD) 1.37 0.23 1.00(1.06)(0.46) 1.19 1.06 1.46 -247.0% 14.2% Shares Outstanding (mn) 801 801 960 960 960 960 960 960 0.0% 0.0% Exchange Rate Assumption (CNY/US 8.28 8.28 8.28 8.19 7.96 7.80 7.65 7.65 -1.3% -0.4% Exchange Rate Assumption (USD/HK 7.80 7.79 7.79 7.78 7.78 7.78 7.78 7.78 0.0% 0.0%

Value

P/E (x) 46.9 32.1 31.1 30.4 45.8 28.0 21.9 17.7 NM NM P/B (x) 9.0 7.2 4.3 3.8 3.5 3.1 2.8 2.4 NM NM P/CE (x) 34.7 23.8 23.7 21.6 29.8 18.6 14.6 11.9 NM NM P/FCF (x) 28.2 171.8 38.9(36.5)(84.2) 32.6 36.5 26.5 NM NM P/ Revenue (x) 3.7 2.3 1.9 1.8 1.7 1.3 1.1 1.0 NM NM EV/EBITDA (x) 27.1 18.9 16.2 14.9 19.9 13.1 11.0 9.2 NM NM EV/Revenue (x) 3.2 2.0 1.6 1.6 1.5 1.1 0.9 0.9 NM NM

Yield

Earnings 2.1% 3.1% 3.8% 3.3% 2.2% 3.6% 4.6% 5.6% 346 bps 207 bps Dividend 0.3% 0.6% 0.6% 0.6% 0.6% 0.9% 1.0% 1.2% 61 bps 35 bps FCF (FCFF/EV) 3.4% 0.6% 2.9% -3.1% -1.3% 3.3% 2.9% 4.0% 531 bps 300 bps

Profitability

Gross Margin 35.9% 34.1% 34.9% 34.6% 33.9% 33.3% 33.4% 33.8% (10) bps 62 bps EBITDA Margin 11.8% 10.7% 10.0% 10.7% 7.5% 8.5% 8.6% 9.3% 173 bps 138 bps Operating Margin 9.5% 8.6% 8.2% 8.3% 5.6% 6.3% 6.3% 6.7% 115 bps 55 bps Net Margin 6.5% 6.0% 6.0% 6.0% 3.6% 4.3% 4.6% 5.1% 150 bps 81 bps

Efficiency*

ROE 20.9% 24.8% 18.4% 13.2% 7.9% 11.7% 13.2% 14.6% 674 bps 140 bps ROA 6.7% 7.2% 6.8% 5.9% 3.5% 4.9% 5.3% 5.9% 236 bps 55 bps ROIC 14.3% 17.2% 14.1% 10.9% 6.5% 9.7% 11.4% 12.7% 622 bps 179 bps

Leverage

Net Debt / Equity -42.1% -39.9% -65.8% -39.0% -31.8% -33.7% -33.1% -34.3% NM NM Total Debt / Total Cap 25.1% 27.4% 13.6% 12.0% 14.2% 9.1% 8.3% 7.1% (716) bps (300) bps EBIT Coverage (x) 8.37 8.54 12.34 10.15 6.01 6.62 9.09 11.96 NM NM Factored Rec'bles (Non-recourse) —- 692 724 804 1,115 1,317 1,454 NM NM Net Debt (inc. FR) / Equity** -42.1% -39.9% -58.3% -31.9% -24.4% -24.3% -23.2% -24.6% NM NM Total Debt (inc. FR) / Total Cap** 25.1% 27.4% 18.8% 17.2% 19.4% 16.3% 16.0% 14.8% NM NM

Momentum

Revenue 14.4% 57.8% 24.6% 1.7% 6.8% 34.6% 18.1% 10.4% NM NM Gross Profit 17.4% 50.1% 27.5% 0.9% 4.6% 32.2% 18.3% 11.9% NM NM Net Income 70.0% 46.1% 23.7% 1.2% -35.6% 60.1% 25.6% 23.5% NM NM Diluted EPS (HK$) 66.0% 46.1% 3.3% 2.3% -33.7% 63.3% 28.1% 23.5% NM NM

Summary Financials (CNY mn)

Revenue 10,796 17,036 21,220 21,576 23,038 31,007 36,611 40,413 20.6% 5.5% Gross Profit 3,872 5,810 7,407 7,474 7,815 10,329 12,220 13,668 20.5% 5.8% Operating Profit 1,024 1,462 1,732 1,786 1,288 1,957 2,307 2,724 28.4% 7.2% EBITDA 1,271 1,821 2,127 2,312 1,733 2,632 3,138 3,739 29.2% 8.7% Depreciation 247 359 395 526 446 675 831 1,015 31.6% 12.5% Net Profit 704 1,028 1,273 1,288 829 1,328 1,668 2,060 35.4% 9.2% Cash & Cash Equivalents 2,784 3,573 7,509 5,397 5,250 5,218 5,590 6,271 6.1% 8.0% Short-term Debt 201 978 422 636 540 480 480 456 -5.5% -2.0% Long-term Debt 1,032 759 1,025 768 1,260 720 720 684 -18.4% -2.0% Cash Earnings 951 1,387 1,668 1,814 1,275 2,003 2,499 3,075 34.1% 10.4% Shareholders Equity 3,683 4,600 9,217 10,251 10,840 11,928 13,264 14,957 11.3% 6.8% Dividend 111 200 240 240 240 332 367 453 23.6% 6.4% FCFF 1,170 192 1,016(1,070)(452) 1,143 1,002 1,378 -245.1% 13.7%

Source: Company Data, Bear Stearns Asia Ltd. estimates.

BEAR STEARNS ASIA LTD. Page 87

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BEAR STEARNS

Addendum

Important Disclosures

China Mobile (HK) (941.HK)

China Mobile (HK) (941.HK)

90 BSC Recommendation History since October 5, 2003 for:

Analyst: Evan

80 Erlanson China Mobile (HK) (941.HK)—Hong Kong Dollar

Date Stock Price Rating Target / Horizon

70

(UP)**Analyst: Evan Erlanson

60 UP

PP 11-Mar-05 24.95 PEER PERFORM —

50

07-Jul-05 28.40 UNDERPERFORM —

40

13-Jul-05 28.10 UNDERPERFORM 23 / 2005

30 06-Jan-06 38.45 UNDERPERFORM 29.7 / 2006

20 19-Jul-06 44.15 UNDERPERFORM 33.5 / 2006

10 28-Sep-06 55.10 UNDERPERFORM 44.1 / 2007

Nov-03 Feb-04 May-04 Aug-04 Nov-04 Feb-05 May-05 Aug-05 Nov-05 Feb-06 May-06 Aug-06 Nov-06

Rating & target data valid through December 4, 2006. 13-Nov-06 65.55 UNDERPERFORM 49 / 2007 Source: FactSet Research Systems, Inc.; Bear, Stearns Equity Research Ratings Key: OP—OutPerform; PP—PeerPerform; UP—UnderPerform; NR—Not Rated

Stock Price Target YE'03 Target YE'05 Target YE'06 Target YE'07

China Mobile ADR (CHL)

China Mobile ADR (CHL)

60 BSC Recommendation History since November 30, 2003 for:

Analyst: Evan

55 Erlanson China Mobile ADR (CHL)—U.S. Dollar

50 Date Stock Price Rating Target / Horizon

45**Analyst: Evan Erlanson

40(UP)

PP UP 11-Mar-05 16.06 PEER PERFORM —

35 07-Jul-05 18.39 UNDERPERFORM —

30 13-Jul-05 18.23 UNDERPERFORM 14.8 / 2005

25 06-Jan-06 24.96 UNDERPERFORM 19.09 / 2006

20 19-Jul-06 28.45 UNDERPERFORM 21.5 / 2006

15 28-Sep-06 35.25 UNDERPERFORM 28.4 / 2007

10 13-Nov-06 42.33 UNDERPERFORM 31.5 / 2007

Nov-03 Feb-04 May-04 Aug-04 Nov-04 Feb-05 May-05 Aug-05 Nov-05 Feb-06 May-06 Aug-06 Nov-06

Rating & target data valid through December 4, 2006. Source: FactSet Research Systems, Inc.; Bear, Stearns Equity Research Ratings Key: OP—OutPerform; PP—PeerPerform; UP—UnderPerform; NR—Not Rated

Stock Price Target YE'05 Target YE'06 Target YE'07

China Unicom Ltd. (762.HK)

China Unicom Ltd. (762.HK)

20 BSC Recommendation History since November 30, 2003 for:

Analyst: Evan

18 Erlanson China Unicom Ltd. (762.HK)—Hong Kong Dollar

Date Stock Price Rating Target / Horizon

16

(OP)**Analyst: Evan Erlanson

14 PP

OP 19-Mar-04 8.65 PEER PERFORM —

12 08-Mar-05 7.10 OUTPERFORM 8.2 / 2005

10 09-Jan-06 6.85 OUTPERFORM 8.2 / 2006 28-Sep-06 7.59 OUTPERFORM 8.8 / 2007

8

6

4

Nov-03 Feb-04 May-04 Aug-04 Nov-04 Feb-05 May-05 Aug-05 Nov-05 Feb-06 May-06 Aug-06 Nov-06

Rating & target data valid through December 4, 2006. Source: FactSet Research Systems, Inc.; Bear, Stearns Equity Research Ratings Key: OP—OutPerform; PP—PeerPerform; UP—UnderPerform; NR—Not Rated

Stock Price Target YE'04 Target YE'05 Target YE'06 Target YE'07

‘

Asian Equity Research

BEAR STEARNS

China Unicom Ltd. ADR (CHU)

China Unicom Ltd. ADR (CHU)

20 BSC Recommendation History since November 30, 2003 for:

Analyst: Evan

Erlanson China Unicom Ltd. ADR (CHU)—U.S. Dollar

18

Date Stock Price Rating Target / Horizon

16

(OP) PP**Analyst: Evan Erlanson

OP

14 04-Jun-04 29.36 OUTPERFORM 38 / 2004 31-Mar-05 34.85 OUTPERFORM 38 / 2005

12

07-Jul-05 36.13 PEER PERFORM 31 / 2005

10 31-Mar-06 35.00 PEER PERFORM 30.85 / 2006 13-Nov-06 43.69 PEER PERFORM 39.8 / 2007

8

6

Nov-03 Feb-04 May-04 Aug-04 Nov-04 Feb-05 May-05 Aug-05 Nov-05 Feb-06 May-06 Aug-06 Nov-06

Rating & target data valid through December 4, 2006. Source: FactSet Research Systems, Inc.; Bear, Stearns Equity Research Ratings Key: OP—OutPerform; PP—PeerPerform; UP—UnderPerform; NR—Not Rated

Stock Price Target YE'04 Target YE'05 Target YE'06 Target YE'07

China Telecom Corp. (728.HK)

China Telecom Corp. (728.HK) BSC Recommendation History since October 10, 2003 for:

Analyst:

6.5 Evan China Telecom Corp. (728.HK)—Hong Kong Dollar

Erlanson

6 Date Stock Price Rating Target / Horizon 5.5**Analyst: Evan Erlanson

5(PP) OP 04-Jun-04 2.33 OUTPERFORM 3 / 2004

PP

4.5 31-Mar-05 2.65 OUTPERFORM 3 / 2005

4 07-Jul-05 2.80 PEER PERFORM 2.4 / 2005 21-Mar-06 2.78 PEER PERFORM 2.4 / 2006

3.5

20-Oct-06 2.89 PEER PERFORM 2.8 / 2007

3 13-Nov-06 3.41 PEER PERFORM 3.1 / 2007

2.5

2

Nov-03 Feb-04 May-04 Aug-04 Nov-04 Feb-05 May-05 Aug-05 Nov-05 Feb-06 May-06 Aug-06 Nov-06

Rating & target data valid through December 5, 2006. Source: FactSet Research Systems, Inc.; Bear, Stearns Equity Research

Stock PriceRatings Key: OP—OutPerform; PP—PeerPerform; UP—UnderPerform; NR—Not Rated Target YE'03 Target YE'04 Target YE'05 Target YE'06 Target YE'07

China Telecom ADR (CHA)

China Telecom ADR (CHA)

60 BSC Recommendation History since November 30, 2003 for:

Analyst: Evan

55 Erlanson China Telecom ADR (CHA)—U.S. Dollar

50 Date Stock Price Rating Target / Horizon

(PP)

PP**Analyst: Evan Erlanson

45 OP

04-Jun-04 29.36 OUTPERFORM 38 / 2004

40 31-Mar-05 34.85 OUTPERFORM 38 / 2005

35 07-Jul-05 36.13 PEER PERFORM 31 / 2005 31-Mar-06 35.00 PEER PERFORM 30.85 / 2006

30

13-Nov-06 43.69 PEER PERFORM 39.8 / 2007 25

20

Nov-03 Feb-04 May-04 Aug-04 Nov-04 Feb-05 May-05 Aug-05 Nov-05 Feb-06 May-06 Aug-06 Nov-06

Rating & target data valid through December 4, 2006. Source: FactSet Research Systems, Inc.; Bear, Stearns Equity Research Ratings Key: OP—OutPerform; PP—PeerPerform; UP—UnderPerform; NR—Not Rated

Stock Price Target YE'04 Target YE'05 Target YE'06 Target YE'07

Asian Equity Research

BEAR STEARNS

China GrenTech (GRRF)

China GrenTech (GRRF) BSC Recommendation History since March 31, 2006 for: China GrenTech (GRRF) – U.S. Dollar

27

Analyst:

Evan Date Stock Price Rating Target / Horizon

Erlanson

OP**Analyst: Evan Erlanson

22

r 09-May-06 16.20 OUTPERFORM 19.8 / 2006

lla

o 03-Nov-06 13.59 OUTPERFORM 20 / 2007

. D

.S 17

U

12

7

Mar-06 Jun-06 Sep-06

Rating & target data valid through December 5, 2006. Source: FactSet Research Systems, Inc.; Bear, Stearns Equity Research Ratings Key: OP—OutPerform; PP—PeerPerform; UP—UnderPerform; NR—Not Rated

Stock Price Target YE'06 Target YE'07

ZTE Corp. (H Shares) (763.HK)

ZTE Corp. (H Shares) (763.HK) BSC Recommendation History since February 18, 2005 for:

50

Analyst:

Evan ZTE Corp. (H Shares) (763.HK)—Hong Kong Dollar

45 Erlanson

PP

Date Stock Price Rating Target / Horizon

40 OP

**Analyst: Evan Erlanson

35 23-Feb-05 27.25 OUTPERFORM 30 / 2005

30 18-Nov-05 22.50 OUTPERFORM 30 / 2006 21-Jul-06 23.35 OUTPERFORM 28 / 2006

25 21-Nov-06 36.05 PEER PERFORM 31 / 2007 20 15

10

Feb-05 May-05 Aug-05 Nov-05 Feb-06 May-06 Aug-06 Nov-06

Rating & target data valid through November 21, 2006. Source: FactSet Research Systems, Inc.; Bear, Stearns Equity Research RatingsStock Price Key: OP—OutPerform; Target YE'05 PP—PeerPerform; Target UP -YE'06 UnderPerform; Target YE'07 NR—Not Rated

Addendum

Important Disclosures

China GrenTech[GRRF]: Within the past twelve months, Bear, Stearns & Co. Inc. or one of its affiliates has performed, or is performing, investment banking services for which it has received a fee from this company.

China GrenTech[GRRF]: Within the past twelve months, Bear, Stearns & Co. Inc. or one of its affiliates was the manager or co-manager of a public offering of securities for this company.

China GrenTech[GRRF]: Bear, Stearns & Co. Inc. is a market maker in this company's equity securities.

China Telecom Corp.[728.HK]: Bear, Stearns & Co. Inc. or one of its affiliates holds one percent (1.0%) or more of this company's common equity securities outstanding.

For important disclosure information regarding the companies in this report, please contact your registered representative at 1-888-473-3819, or write to Sandra Pallante, Equity Research Compliance, Bear, Stearns & Co. Inc., 383 Madison Avenue, New York, NY 10179.

Ratings for Stocks (vs. analyst coverage)

Outperform (O) — Stock is projected to outperform analyst’s industry coverage universe over the next 12 months. Peer Perform (P) — Stock is projected to perform approximately in line with analyst’s industry coverage universe over the next 12 months.

Underperform (U) — Stock is projected to underperform analyst’s industry coverage universe over the next 12 months.

Ratings for Sectors (vs. regional broader market index)

Market Overweight (MO) — Expect the industry to perform better than the primary market index for the region (S&P 500 in the U.S.) over the next 12 months.

Market Weight (MW) — Expect the industry to perform approximately in line with the primary market index for the region (S&P 500 in the U.S.) over the next 12 months.

Market Underweight (MU) — Expect the industry to underperform the primary market index for the region (S&P 500 in the U.S.) over the next 12 months.

Evan Erlanson, Asian Telecom Services: China Mobile (HK), China Mobile ADR, China Telecom ADR, China Telecom Corp., China Unicom Ltd., China Unicom Ltd. ADR, Hutchison Telecom, Hutchison Telecom ADR, KDDI CORP., KT CORP, KT CORP ADR, KT Freetel, LG Telecom, NTT DoCoMo Inc., NTT DoCoMo ADR, PCCW LTD ADR, PCCW LTD., SK Telecom, SK Telecom ADR, Sina Corp., SmarTone Communications, Tom Online Inc., Tom Online Inc. ADR

Evan Erlanson, Asian Telecom Equipment: China GrenTech, NEC Corp ADR, NEC Corp., UTStarcom Inc., ZTE Corp. (H Shares)

Bear, Stearns & Co. Inc. Ratings Distribution as of September 30, 2006:

Percentage of BSC universe with this rating / Percentage of these companies which were BSC investment banking clients in the last 12 months.

Outperform (Buy): 43.3 / 4.6 Peer Perform (Neutral): 47.7 / 3.3 Underperform (Sell): 9.1 / 0.0

For individual coverage industry data, please contact your account executive or visit www.bearstearns.com.

Addendum

Important Disclosures

Analyst Certification

The Research Analyst(s) who prepared the research report hereby certify that the views expressed in this research report accurately reflect the analyst(s) personal views about the subject companies and their securities. The Research Analyst(s) also certify that the Analyst(s) have not been, are not, and will not be receiving direct or indirect compensation for expressing the specific recommendation(s) or view(s) in this report.

Evan Erlanson

The costs and expenses of Equity Research, including the compensation of the analyst(s) that prepared this report, are paid out of the Firm’s total revenues, a portion of which is generated through investment banking activities.

This report has been prepared in accordance with the Firm's conflict management policies. Bear Stearns is unconditionally committed to the integrity, objectivity, and independence of its research. Bear Stearns research analysts and personnel report to the Director of Research and are not subject to the direct or indirect supervision or control of any other Firm department (or members of such department).

This publication and any recommendation contained herein speak only as of the date hereof and are subject to change without notice. Bear Stearns and its affiliated companies and employees shall have no obligation to update or amend any information or opinion contained herein, and the frequency of subsequent publications, if any, remain in the discretion of the author and the Firm.

Price targets, risks, and valuation methods, where appropriate, may be found on the first page of each company profile.

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Exhibit E

IDC

Analyze the Future

M A R K E T AN A L Y S I S

W o r l d w i d e P r o j e c t o r 2 0 0 7 – 2 0 1 0 F o r e c a s t a n d A n a l ys i s

Tom Mainelli

I D C O P I N I O N

The projector market experienced slowing growth in 2005 as the year-over-year growth rate dropped from more than 54% in 2004 to 7.5%. The market appears to be rebounding quite well and was on track to resume double-digit growth rates by the end of 2006. As technology continues to improve and prices continue to drop, IDC predicts continued solid growth in 2007 and into the later years of the forecast. We expect the home theater (HT) segment of the market to drive a portion of this growth in the coming years. While the segment has taken off somewhat more slowly than originally expected, the continued rollout of more affordable 720p projectors and — over time — well-priced 1080p units should spur interest in this exciting part of the market. Specific market developments we expect during the forecast period include:

Total worldwide projector unit shipments will reach 9.6 million units by 2010, representing a 19.5% compound annual growth rate (CAGR) from 2005 to 2010.

Despite healthy growth in shipments, declining average selling prices (ASPs) will result in a revenue CAGR of only 0.9% during that same time period.

The sub-3.0lb category will grow from 4.9% of the market in 2005 to 9.3% in 2010, while the 5.0–9.9lb market will decline from 54.8% to 36.9% during that same time. Meanwhile the 3.0–4.9lb segment will grow to dominate the market, moving from 31.4% in 2005 to 50.5% in 2010.

The United States and Western Europe owned the lion's share of the market in 2005, holding 37.8% and 26.8%, respectively. IDC predicts that by 2010, the United States will cede share to both Western Europe and a hard-charging Asia/Pacific market (led by China), dropping to 30.2%, while Western Europe grows to 28.2% and Asia/Pacific reaches 29.2%.

Home theater projectors will grow from about 8.5% of the market in 2005 to more than 21% by 2010.

Projector vendors face a potentially harmful standards battle in the near term as HDMI and DisplayPort technologies seek to become the dominant digital interface.

Filing Information: January 2007, IDC #205028, Volume: 1, Tab: Markets Displays and Projectors: Market Analysis

Global Headquarters: 5 Speen Street Framingham, MA 01701 USA P.508.872.8200 F.508.935.4015 www.idc.com

T A B L E O F C O N T E N T S

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In This Study 1

Methodology 1 Executive Summary 2

Situation Overview 2

Vendor Market Shares 3

Future Outlook 6

Forecast and Assumptions 6

Market Context 44

Essential Guidance 45 Learn More 45

Related Research 45 Definitions 45

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L I S T O F T A B L E S

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1 Key Forecast Assumptions for the Worldwide Projector Market, 2007–2010 7

2 Worldwide Projector Shipments, ASP, and Revenue by Region, 2005–2010 11

3 Worldwide Projector Shipments, ASP, and Revenue by Form Factor, 2005–2010 15

4 U.S. Projector Shipments, ASP, and Revenue by Form Factor, 2005–2010 19

5 Western Europe Projector Shipments, ASP, and Revenue by Form Factor, 2005–2010 21

6 Japan Projector Shipments, ASP, and Revenue by Form Factor, 2005–2010 23

7 Asia/Pacific Projector Shipments, ASP, and Revenue by Form Factor, 2005–2010 25

8 Rest of World Projector Shipments, ASP, and Revenue by Form Factor, 2005–2010 27

9 Worldwide and U.S. Projector Shipments by Channel, 2005–2010 29

10 Worldwide and U.S. Projector Shipments by Type, 2005–2010 32

11 Worldwide and U.S. Projector Shipments by Technology Type, 2005–2010 34

12 Worldwide Projector Shipments by Resolution, 2005–2010 36

13 Worldwide Projector Shipments by Aspect Ratio, 2005–2010 38

14 Worldwide Projector Shipments by Lumen Count, 2005–2010 39

15 Worldwide Projector Shipments by Interface, 2005–2010 41

16 Worldwide Notebook and Projector Shipments and Projector-to–Notebook PC Attach Ratio by Region, 2005–2010 43

17 Worldwide Projector Shipments, 2005–2010: Comparison of 2005 and 2006 Forecasts 44

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L I S T O F F I G U R E S

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1 Worldwide Projector Shipment Share by Vendor, 2005 3

2 Worldwide Projector Shipment Share by Vendor, 1H06 4

3 U.S. Projector Shipment Share by Vendor, 2005 5

4 U.S. Projector Shipment Share by Vendor, 1H06 6

5 Worldwide Projector Shipments by Region, 2005–2010 14

6 Worldwide Projector Revenue by Region, 2005–2010 14

7 Worldwide Projector Shipments by Form Factor, 2005–2010 17

8 Worldwide Projector Revenue by Form Factor, 2005–2010 18

9 Worldwide Projector Shipment Share by Channel, 2005–2010 31

10 Worldwide Projector Shipment Share by Type, 2005–2010 33

11 Worldwide Projector Shipment Share by Technology Type, 2005–2010 35

12 Worldwide Projector Shipment Share by Resolution, 2005–2010 37

13 Worldwide Projector Shipment Share by Lumen Count, 2005–2010 40

14 Worldwide Projector Shipment Share by Interface, 2005–2010 42

15 Worldwide Projector Shipments, 2005–2010: Comparison of 2005 and 2006 Forecasts 44

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I N T H I S S T U D Y

This study reviews the worldwide landscape of front digital projectors, providing current and forecast market sizing on a worldwide and regional scale. We examine specific areas such as technology, form factor, purchase channel, resolution, brightness, and consumer/enterprise outlook in order to better demonstrate where this growing market is headed. We also provide vendor share findings on the worldwide and U.S. levels.

M e t h o d o l o g y

This document is the result of IDC's ongoing research on digital front projectors. We used both primary and secondary sources in its development. Primary sources included surveys of vendors and component suppliers, and secondary sources consisted of publicly accessible financial information (for example, the 10K and annual reports of projector vendors, as well as in-depth meetings and discussions with these vendors). In addition, IDC reviewed our internal forecasts that size IT spending, gross domestic product (GDP) growth, and the growth of notebooks, all of which have dotted-line relationships to the growth of the projector market.

Note: All numbers in this document may not be exact due to rounding.

Scope

This document reviews the digital projector market in the United States, Western Europe, Japan, Asia/Pacific, and the rest of the world (ROW). We provide worldwide projector unit shipment and value forecasts. The document includes 2005 and 1H06 estimates of actual shipment figures for the U.S. and worldwide markets. We generated forecasts for 2007–2010 and calculated compound annual growth rates for 2005–2010. IDC reserves the right to adjust historical data if better and more granular information is later supplied by vendors.

Weight Classes

We classify the worldwide projector market into five primary weight classes: Sub-3.0lb 3.0–4.9lb 5.0–9.9lb 10.0–39.9lb 40.0lb+

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E x e c u t i v e S u m m a r y

The worldwide projector market experienced a dramatic slowdown in growth last year, dropping from a phenomenal 54% year-over-year rate in 2004 to a tame 7.5% by the end of 2005. The industry has rebounded quite nicely in 2006 and is on track to experience a growth rate of 21.1% for the full year. We predict solid growth continuing throughout our forecast period, with worldwide shipments reaching 9.6 million units by 2010, generating a CAGR of 19.5%. A majority of these units will continue to be multimedia projectors that appear largely in business and educational settings. However, home theater–specific projectors will make up a larger portion of the market over time, growing from about 9% in 2005 to 21% in 2010.

XGA has overtaken SVGA as the market-leading resolution, and we expect it to grow from 46.8% in 2005 to 68.4% in 2007, after which it will begin to decline as adoption of WXGA, SXGA, and HDTV (1080p) resolutions grows. However, we expect XGA to remain the dominant resolution throughout our forecast period.

The most dominant projector size will also shift during the forecast period. In 2005, 5.0–9.9lb projectors owned 54.8% of the market, but by the end of 2010, that number will drop to 36.9%. Rising to dominance will be the 3.0–4.9lb category, which will grow from 31.4% in 2005 to 50.5% in 2010.

As projectors become smaller, a growing percentage of them will also get brighter. In 2005, the most popular brightness level was 1,501–2,000 lumens, with 29.8% of the market. By the end of 2006, projectors offering brightness levels of 2,001–2,500 lumens will move to the front, grabbing about 31.4% of the market. That number will grow to about 40.1% of the market by 2010.

In 2005, DLP technology continued its attack on the market-leading share of LCD technology. In 2005, DLP claimed about 45.9%, while LCD dropped to about 54%. IDC expects DLP to continue to make inroads, particularly as home theater projectors gain more traction. By 2008, DLP will overtake LCD in terms of market share leadership, and by 2010, it will hold a comfortable leadership position of 53.8% to LCD's 45.9%. Despite Sony's success with its SXRD line, LCoS technology will continue to be a sub-1% player in the market.

Finally, in 2005, the United States continued to maintain its leadership role in terms of shipments. However, both Western Europe and Asia/Pacific will chip away at the U.S. market share over the next few years. By 2010, the regions will reach near parity, with the United States maintaining a slight lead with 30.2% of units shipped, Western Europe with 28.2%, and Asia/Pacific at 29.2%.

S I T U AT I O N O V E R V I E W

The once phenomenal growth rate of the worldwide projector market slowed dramatically in 2005 but picked up steam again this year. IDC expects worldwide shipments to reach 4.79 million units by the end of 2006, for a year-over-year growth rate of 21.1%.

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V e n d o r M a r k e t S h a r e s

Figure 1 displays the worldwide market shares of the top 10 projector vendors for 2005. Epson continued its global domination of the market by grabbing 15.6% of the worldwide total, an increase from 15.1% in 2004. At the close of 2005, InFocus maintained its distant-second status with 9.8% of the market, a drop from 10.5% in 2005. NEC and Sanyo maintained their third- and fourth-place positions in 2005, while BenQ entered the top 5 (up from number 7 in 2004) with 6.7% of the market. Sony grabbed the number 6 spot with 6.5%, followed by Hitachi with 5.7%, Toshiba with 5.4%, Dell with 5.1%, and Optoma with 5%.

F I G U R E 1

W o r l d w i d e P r o j e c t o r S h i p m e n t S h a r e b y V e n d o r , 2 0 0 5

Epson 15.6 InFocus 9.8 NEC 9.5 Sanyo 6.7 BenQ 6.7 Sony 6.5 Hitachi 5.7 Toshiba 5.4 Dell 5.1 Optoma 5.0

Other 24.0

0 5 10 15 20 25 (%)

Source: IDC, 2006

©2007 IDC #205028 3

The changes were more dramatic in the first half of 2006, as Figure 2 shows. Although Epson built upon its leadership position to grab 15.9% of the market, NEC moved into the number 2 spot with a 9.5% share. BenQ continued to grow its shipments, snagging a healthy 8.1% of the market. Financially troubled InFocus slipped badly in 2006, falling from number 2 to number 4 with 7.4% of the market. Sanyo rounded out the top 5 with 6.7% of the market. Sony slipped into the sixth-place position with 6.4%, followed by Hitachi with 6.2%, Optoma with 6.1%, Toshiba with 5.1%, and Dell with 4.7%.

F I G U R E 2

W o r l d w i d e P r o j e c t o r S h i p m e n t S h a r e b y V e n d o r , 1 H 0 6

Epson 15.9 NEC 9.5 BenQ 8.1 InFocus 7.4 Sanyo 6.7 Sony 6.4 Hitachi 6.2 Optoma 6.1 Toshiba 5.1 Dell 4.7

Other 23.9

0 5 10 15 20 25 (%)

Source: IDC, 2006

We take a look at the U.S. market in 2005 in Figure 3. InFocus continued to maintain a dominant position with 16.6% of the market, followed by worldwide leader Epson with 11.2%. Dell grabbed a robust 8.4% of the market to seal the number 3 spot, followed by NEC with 6.3% and Hitachi with 6.1%. Numbers 6–10 were Optoma with 5.5%, Sony with 4.8%, Sharp at 4.6%, Toshiba with 4.3%, and BenQ with 4.2%.

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F I G U R E 3

U . S . P r o j e c t o r S h i p m e n t S h a r e b y V e n d o r , 2 0 0 5

InFocus 16.6 Epson 11.2 Dell 8.4 NEC 6.3 Hitachi 6.1 Optoma 5.5 Sony 4.8 Sharp 4.6 Toshiba 4.3 BenQ 4.2

Other 28.0

0 5 10 15 20 25 30 (%)

Source: IDC, 2006

Figure 4 illustrates some of the dramatic changes occurring in the U.S. market by the first half of 2006. Here Epson has wrestled away the lead position from InFocus, snagging 14.7% of the market compared with the latter's diminished 11.3%. Dell slipped a bit as well, dropping to 7.7%, but it maintained its third-place position. Hitachi moved up into the fourth-place spot with 7.2% share, while a surging Optoma grabbed the fifth-place spot with 7%. Rounding out the U.S. top 10 were NEC with 6.4%, Sony with 5.1%, Sharp with 4.6%, BenQ with 4.4%, and Mitsubishi with 3.6%.

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F I G U R E 4

U . S . P r o j e c t o r S h i p m e n t S h a r e b y V e n d o r , 1 H 0 6

Epson 14.7 InFocus 11.3 Dell 7.7 Hitachi 7.2 Optoma 7.0 NEC 6.4 Sony 5.1 Sharp 4.6 BenQ 4.4 Mitsubishi 3.6

Other 28.0

0 5 10 15 20 25 30 (%)

Source: IDC, 2006

F U T U R E O U T L O O K

F o r e c a s t a n d A s s u m p t i o n s

Table 1 lists the key assumptions used to generate the forecast.

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T A B L E 1

K e y F o r e c a s t A s s u m p t i o n s f o r t h e W o r l d w i d e P r o j e c t o r M a r k e t , 2 0 0 7 – 2 0 1 0

Accelerator/

Inhibitor/ Certainty of Market Force IDC Assumption Impact Neutral Assumption

Macroeconomics

Economy Worldwide and regional Low. The economy — in its economic growth will be lower in stability but lower growth — 2007 compared with 2006. The is now a net neutral influence United States will fall below 3%, on IT spending. It does seem Western Europe will be under able to withstand oil shocks

2%, and Latin America, Eastern and terrorism. ?Europe, and Asia/Pacific outside ??of Japan will all drop. While Japan is expected by Consensus Economics to grow 2.2%, IDC analysts in Japan believe the country will beat expectations.

Oil prices Oil prices will stay between $60 Moderate. The new higher and $80 a barrel, unless there is oil prices — up 100% in two a significant cooling of the U.S. years — seem to have been economy. For the early part of internalized by the market. A 2007, oil prices might be at the sudden upward spike would lower end of the band as the affect GDP growth, and ?United States is expected to hence IT&C spending. A ??have a mild winter. The higher spike downward, however, prices are the result of demand would have a lesser short-and, to some extent, the fall of term effect. the dollar over the last several years.

Profits In 2007, profit growth will be far Moderate. Company profits less than 2006's estimated 19%, should still be high enough to according to the Consensus fund IT&C initiatives that ?Economics October 2006 poll — either cut costs elsewhere or ??in fact, at 4%. Profits will be drive increased revenue. lower, but not that low.

Profit expectations We expect no major surprises, Low. This affects business either up or down, overall. Oil- confidence, which affects dependent and housing-related IT&C investment. industries in the United States ?? ?will feel a crunch, but the market has already taken that into account.

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T A B L E 1

K e y F o r e c a s t A s s u m p t i o n s f o r t h e W o r l d w i d e P r o j e c t o r M a r k e t , 2 0 0 7 – 2 0 1 0

Accelerator/

Inhibitor/ Certainty of Market Force IDC Assumption Impact Neutral Assumption

Iraq The conflict in Iraq will continue Low. There is little reason to be messy throughout 2007, for economic uncertainty creating political disruptions and over Iraq to impact IT&C affecting midterm elections in the spending.

United States, but the chance for economic disruptions in minimal.

For now, there will be no activities or initiatives sufficient to affect IT&C market forecasts.

Technology/service developments

Convergence Convergence is a complex Moderate. Convergence will phenomenon working at many drive new competitive levels — convergence of the dynamics, offer new telephone network and the applications and functions to Internet, of communications and customers, and strain the IT technologies, of consumer and legal and regulatory enterprise technologies, and systems. It will also drive even of storage, routing, and increased IT&C spending. processing in the datacenter. Of these, perhaps the most overarching is the convergence ?of voice, video, and data ??communications. This convergence is a permanent phenomenon and will pick up pace as the decade wears on.

One measure: by 2009, IDC expects 1.5 billon users on the Internet and 3 billion users of the phone network, with 2.5 billion mobile users. The overlap will be significant.

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T A B L E 1

K e y F o r e c a s t A s s u m p t i o n s f o r t h e W o r l d w i d e P r o j e c t o r M a r k e t , 2 0 0 7 – 2 0 1 0

Accelerator/

Inhibitor/ Certainty of Market Force IDC Assumption Impact Neutral Assumption

Product competition As the price of LCDs, plasmas, Moderate. Although they are and RPTVs continues to fall, an exciting extension of the projector vendors face projector market, home increasingly difficult sales theater–oriented units have situations. Projectors may offer a been slow to make a true sharp, giant-sized image, but volume impact. While we ?? ?they continue to be relatively expect home theater to difficult to display at retail, and become a larger part of the they can be difficult to set up well mix in coming years, it will at home. remain a relatively niche product overall.

Purchase criteria Brand importance in purchase High. Market leader Epson decisions continues to erode in won't likely experience much light of performance increases share erosion. However, ?? ?and ASP declines across the second-tier brands are not board. automatic "repurchases."

Channel challenges Direct and online projector sales Moderate. Commoditized will increase at the expense of performance and high local retailers and AV dealers. reliability appear in nearly all brands, so buyers feel less ?? ?need for face-to-face buying guidance and are more comfortable buying online.

Market characteristics

Hardware Hardware markets continue to Low. Hardware spending, defy gravity and remained about 40% of total IT positive in 2006. About the same spending, drives spending as performance is expected in 2007, well in software and with pockets of both growth and services. decline. IT hardware spending (including network equipment sold to carriers and enterprises) growth in 2007 with be 6–7%.

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T A B L E 1

K e y F o r e c a s t A s s u m p t i o n s f o r t h e W o r l d w i d e P r o j e c t o r M a r k e t , 2 0 0 7 – 2 0 1 0

Accelerator/

Inhibitor/ Certainty of Market Force IDC Assumption Impact Neutral Assumption

Consumption

Saturation Markets that seem saturated Low. There will be a general

(e.g., PC shipments in the United increase in the amount of States), can be "unsaturated" by research and marketing new price thresholds or new devoted to segmentation; functionality (DVD playback) that there will also be potential spurs faster replacement or organization disruption as brings new users into the market vendors realign to better (e.g., seniors). Thus while all approach these segments. markets have a fixed number of potential adopters (people or companies), there is usually a price, feature, or solution that can drive additional spending.

Also with IT generally less than 3% of an enterprise's expenses (or a country's GDP), there is tremendous opportunity to turn internal spending on staff or business processes into external spending on IT&C products and services. Market "saturation" will be a moving target that varies by submarket but in almost all cases can be countered.

Buying sentiment IT&C buyers have switched from If buyer sentiment remains neutral to optimistic, as high, then spending could evidenced by IDC's 2006 beat forecasts.

FutureScan surveys. There seems to be no irrational sentiment against IT&C, as there was several years ago.

Legend: very low, low, moderate, high, very high

Source: IDC, 2006

In Table 2, we look at the worldwide projector shipments by region. While the United States continued to lead the world in unit shipments in 2005, we continue to believe that Western Europe and Asia/Pacific will eat away at the U.S. market share. In 2005, shipment levels to the United States reached nearly 1.5 million units, representing approximately 37.8% of the worldwide market. By 2010, the United States will see shipments of 2.9 million units, accounting for about 30.2% of the market and a 14.3% CAGR.

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T A B L E 2

W o r l d w i d e P r o j e c t o r S h i p m e n t s , A S P , a n d R e v e n u e b y R e g i o n , 2 0 0 5 – 2 0 1 0

2005–2010 2005 2006 2007 2008 2009 2010 CAGR (%)

United States Shipments (000) 1,495 1,787 2,054 2,276 2,572 2,910 14.3 Growth (%) NA 19.6 14.9 10.8 13.0 13.1 ASP ($000) 1,068 886 765 632 541 484 -14.6 Growth (%) NA -17.1 -13.6 -17.4 -14.4 -10.5 Revenue ($M) 1,597 1,583 1,572 1,438 1,392 1,409 -2.5 Growth (%) NA -0.8 -0.7 -8.5 -3.2 1.2

Western Europe Shipments (000) 1,060 1,303 1,554 1,892 2,263 2,720 20.7 Growth (%) NA 22.9 19.3 21.7 19.6 20.2 ASP ($000) 1,296 1,076 876 724 628 563 -15.4 Growth (%) NA -17.0 -18.6 -17.4 -13.2 -10.3 Revenue ($M) 1,374 1,402 1,362 1,369 1,422 1,532 2.2 Growth (%) NA 2.1 -2.8 0.5 3.8 7.7 Japan Shipments (000) 308 326 350 395 436 474 9.0 Growth (%) NA 5.6 7.5 12.7 10.4 8.9 ASP ($000) 2,349 1,783 1,535 1,215 1,043 862 -18.2 Growth (%) NA -24.1 -13.9 -20.8 -14.2 -17.4 Revenue ($M) 725 581 537 480 455 409 -10.8 Growth (%) NA -19.9 -7.4 -10.7 -5.3 -10.0

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T A B L E 2