The company announced on May 24 that its wholly-owned subsidiary Ziguang International will acquire 30% of Xinhuasan's shares through cash payment. The source of funding is Ziguang Co., Ltd.'s own capital and bank loans. The company currently plans to apply for a loan of no more than RMB 10 billion or the equivalent in US dollars from the bank.

After the plan was adjusted, cash acquisitions increased profits and reduced valuations brought room. On May 26, 2023, the company plans to acquire 49% of the total shares held by HPE entities through Ziguang International, and plans to raise no more than 12 billion yuan in capital through a fixed increase. The company plans to adjust the above share acquisition plan and decide to terminate the fixed increase after comprehensively considering factors such as the fulfillment obligations of the previous agreement, the financial situation in its own currency, and financing channels. After the plan was adjusted: (1) The acquisition ratio was adjusted from 49% to 30%; (2) the transaction price was US$2.14 billion, about RMB 15.18 billion, which is consistent with the consideration basis for the previous 49% share acquisition; (3) the delivery date is expected to be no later than August 31, 2024, and a grace period ending on October 21, 2024 will apply. We believe that compared to fixed increases, acquisitions made using cash payments will combine assets and increase profits without causing equity dilution, corresponding to a reduction in PE valuation levels.

The remaining 19% of the shares can still be purchased. In addition to this transaction, the company and HPE Cayman also signed a “Follow-up Arrangement Agreement”. The two parties agreed that for HPE Cayman's 19% stake in Xinhua 3:1) Ziguang International will relinquish priority purchasing rights, and HPE Cayman has the right to sell it once to a third party that meets specific conditions. 2) Both parties each grant each other a sale/purchase option, which can be optionally exercised during the 16th to 36th month after the completion of the 30% share transaction in Xinhua 3. 3) The 19% equity transaction price triggered based on the exercise of options corresponds to US$1.36 billion, which is consistent with the 30% equity transaction consideration basis. 4) When Ziguang International exercises the purchase option, it may appoint a third party to purchase 19% of the shares.

National policies encourage mergers, acquisitions and restructuring to grow bigger and stronger, and enhance shareholder returns. In recent years, relevant state departments have continuously introduced relevant policies favorable to mergers, acquisitions and restructuring. In March 2014, the State Council issued “Opinions on Further Optimizing the Market Environment for Mergers and Restructurings of Enterprises”. Subsequently, the Securities Regulatory Commission and other supervisory authorities continuously encouraged enterprises to improve and strengthen listed companies through measures such as revising the “Administrative Measures on Reorganization” and updating relevant supporting regulations. On April 12, 2024, the State Council issued “Certain Opinions of the State Council on Strengthening Supervision and Risk Prevention to Promote High-Quality Development of the Capital Market”, which encourages listed companies to focus on their main business and comprehensively use mergers, acquisitions, restructuring, and equity incentives to improve the quality of development.

As a leading ICT company, Xinhuasan has strong growth and is expected to increase profits significantly after increasing control. Xinhua 3 is the world's leading supplier of cloud computing infrastructure construction and smart application services in the industry. It has a high market share in major ICT infrastructure markets such as switches, servers, routers, and WLAN, and is in a leading position in the domestic market. In 2023, the net profit of Xinhuasan was 3.4 billion yuan, and the net profit of Ziguang Co., Ltd. to mother was 2.03 billion yuan. Considering the completion of this transaction, Ziguang Co., Ltd.'s control over Xinhua 3 will increase from 51% to 81%. Using the 2023 results as a reference, Ziguang's profit will increase by 1.02 billion yuan, or 49%. At the same time, the company maintained an excellent growth rate. In 24-26, the company expects Xinhua's revenue to be 57.3 billion yuan, 67.5 billion yuan, and 80.2 billion yuan, with year-on-year growth rates of 10%, 18%, and 19%, respectively, and net profit of 3.8 billion yuan, 4.6 billion yuan and 5.5 billion yuan, with year-on-year growth rates of 12%, 20%, and 21%, respectively.

The operation of Ziguang Co., Ltd. is developing steadily. The company's revenue in 2023 was 77.308 billion yuan, +4.39% year on year, net profit to mother was 2.03 billion yuan, -2.54% year on year, net profit after deducting net profit of 1,675 billion yuan, -4.80% year on year. Q1 revenue in 2024 was 17.06 billion yuan, +2.89% year on year, net profit to mother was 414 million yuan, -5.76% year on year, net profit after deduction of 343 million yuan, +1.75% year on year.

By business, the company's IT service revenue in 2023 was 51.5 billion yuan, +10% YoY, gross profit margin 25.6%, YoY -2PCT; IT distribution revenue was 29.1 billion yuan, -10% YoY, gross profit margin 6.4%, YoY -0.4PCT. Looking at subsidiary companies, in 2023, Xinhua 3's revenue was 51.9 billion yuan, +4% year on year, net profit of 3.4 billion yuan, and -9% year on year (2024Q1 Xinhua 3 revenue 121 yuan, net profit +14 million yuan, net profit +8% year over year); Ziguang Digital's revenue was 22.8 billion yuan, +3% year on year, net profit of 240 million yuan, -2.5% year on year; Ziguang Software's revenue was 3.5 billion yuan, +12% year on year, net profit decreased 80 million yuan; Ziguang Cloud's revenue was 1.5 billion yuan, year-on-year loss.

The three independent brands in the international business of Xinhua have expanded rapidly, and domestic operators have performed well. In 2023, the business of the three domestic enterprises of Xinhua progressed steadily, achieving revenue of 39.868 billion yuan, or +1.86% over the same period last year. The domestic operator business showed a strong momentum of development, with revenue reaching 9.869 billion yuan, +11.75% over the same period last year. The overall sales scale of the international business continued to expand, with revenue reaching 2.02 billion yuan, +19.70% year over year; revenue from H3C brand products and services was 1.41 billion yuan, +62.04% year over year.

The comprehensive layout of AIGC has outstanding comprehensive strength. In 2023, the company ranked second in the Chinese Ethernet switch, enterprise network switch, data center switch, and campus switch market with a market share of 32.9%, 34.2%, 28.4%, and 36.8% respectively; China's GPU server market share was 19.7%, ranking second in the market; China's UTM firewall market share was 20.4%; and China's hyperconverged market share was 18.8%, ranking second. The company officially launched the “AIGC Open Strategy” in 2023, and built a full-link, end-to-end software and hardware solution from data governance, model training, and inference deployment to applications. We believe that with the rapid development of AI, the company is expected to benefit as a comprehensive leader.

Increased termination benefits and the like affect current expenses in 2023. In 2023, the company's sales expenses were 4.3 billion yuan, +1% year on year; management expenses were 1.4 billion yuan, +44% year over year (mainly due to the increase in retirement benefits of the subsidiary Xinhua 3 in '23), financial expenses were 800 million yuan, +22% year over year, and R&D expenses were 5.6 billion yuan, +6.5% year over year.

Profit forecasting and investment advice. We believe that Ziguang Co., Ltd.'s acquisition of 30% of the shares of Xinhua 3 through cash payments and increased control over Xinhua 3 will hopefully fully stimulate the development potential of Xinhua 3 and continue to expand its business layout. At the same time, it will also bring significant profit growth and room for growth to Ziguang Co., Ltd. Since this transaction has not yet been completed, based on prudential principles, we expect Ziguang's revenue for 2024-2026 to be 86.484 billion yuan, 98.077 billion yuan, and 111,459 billion yuan, respectively, and net profit to mother of 2,512 billion yuan, 2,979 billion yuan, and 3.523 billion yuan, EPS of 0.88 yuan, 1.04 yuan, and 1.23 yuan respectively. Referring to comparable company valuations, the 2024 PE range is 30-35 times, corresponding to a reasonable value range of 26.35 yuan - 30.74 yuan, and a rating of “superior to the market” is given.

Risk warning. Technology and product development risks; macroeconomic environment change risks; operational risks; human resources risks.