Accelerated expansion of user base is priced in
   
We think Dr. Peng can continue to generate robust cash flow due to faster user baseexpansion, even though ARPU will decrease due to intensified competition. However,we think this has been largely priced in. Investors' main focus is on how the companycan leverage its network and user base to penetrate into value-added content services,where it still lacks visibility, in our view.
   
User base expansion accelerated, while ARPU declined
   
Dr. Peng gained 3m users for its broadband access service in Q1-Q316 compared with2m for all of 2015. The user increase drove Q1-Q316 revenue to rise 15.24% YoY andQ316 revenue to rise 11% YoY, basically in line with expectations. We think this ismainly because the company changed its strategy to focus more on user baseexpansion due to a new market environment and rolled out a series of promotionalmeasures (eg, collaborating with local TV companies to acquire new users). However,as most of the promotional measures focused on price, its ARPU decreased, to a certainextent, affecting gross margin. Nevertheless, Q316 net profit attributable to the parentrose 13% YoY due to its successful control over selling expenses.
   
Lack of visibility remains in value-added content services
   
The company is attempting to boost ARPU through paid value-added content deliveredthrough its Domy set-top boxes. We think there is a certain synergy between itsstrategy to expand into value-added content services and its network and user base.However, we think more visibility is still needed because: 1) Dr. Peng does not haveexperience in content-related business; 2) China's paid content market is still maturing;and 3) the user base of Domy set-top boxes and smart TV is still small.
   
Valuation: Slightly lifting PT to Rmb23.5; downgrading to Neutral
   
We maintain our revenue and earnings estimates but are lifting our DCF-based PTslightly to Rmb23.5, mainly due to a lower risk-free rate, which has led to a decrease inWACC (to 8.3% from 8.5%). We are downgrading our rating to Neutral from Buy, aswe think upside is limited until there is better visibility in its value-added contentservices.