China's ZTE Expects $1B Loss This Year After US Sanctions

China's ZTE has forecast a loss of up to $1 billion for 2018 after US sanctions, which included a temporary ban on ZTE's purchase of US-made components, tore into its business earlier this year.

The network equipment maker, which competes against Ericsson AB (Nasdaq: ERIC), Huawei Technologies Co. Ltd. and Nokia Corp. (NYSE: NOK), has issued guidance for a net loss of between 6.2 billion and 7.2 billion Chinese yuan (between $890 million and $1 billion). Last year, it reported a net profit of about RMB4.6 billion ($660 million). (See ZTE Back in the Game, Seeking Trust & 5G Deals.)

While ZTE Corp. (Shenzhen: 000063; Hong Kong: 0763) did not issue sales guidance, it also reported a 23% fall in revenues for the first nine months of the year, to around RMB58.8 billion ($8.5 billion). It has racked up a net loss of about RMB7.3 billion ($1.1 billion) for that period, compared with a net profit of roughly RMB3.9 billion ($490 million) for the first nine months of 2017.

However, the company may at last have turned a corner, managing a small net profit of RMB564 million ($71 million) for the recent third quarter.

US authorities have penalized ZTE for selling gear featuring US-made components to both Iran and North Korea, in breach of sanctions against those countries. The Chinese equipment maker was hit with a $900 million fine in 2017 when the affair originally came to light. It bounced back from that setback after promising to make organizational changes and discipline the staff responsible for breaching sanctions.

But earlier this year the US accused ZTE of lying about the steps it had taken to improve corporate governance. Because most of ZTE's products rely on US components, the subsequent ban on equipment sales to the company forced it to cease business operations for several weeks. (See ZTE in Existential Crisis as It Slams 'Unfair' US Ban, Considers 'Judicial Measures'.)

Under a deal brokered by the Department of Justice, and unpopular with US hardliners, ZTE was eventually allowed to resume dealings with US component makers if it agreed to pay another fine of $1 billion, replace its senior management team and board of directors, and be more strictly monitored by US authorities.

The company blamed its downbeat full-year forecast on the latest fine and its suspension of business activities while the US components ban was in force.

But it also claimed its business is now "rapidly recovering with the negotiation and signing of new orders and the further implementation of existing orders."

"Meanwhile, the company has resumed normal operations in R&D, production and logistics," the company said in its earnings statement. "Specifically, its production and purchasing capabilities have been back on track, and its R&D progress has kept pace with the target [set] at the beginning of the year. Also, ZTE has fully restored its customer services."

ZTE said it had invested about RMB8.5 billion ($1.1 billion) in R&D over the first nine months of the year, down from about RMB9.2 billion ($1.2 billion) in the same period of 2017.

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The company's difficulties have come against the backdrop of growing hostility between the US and China. Accusing the Chinese of intellectual property theft and unfair trade practices, President Donald Trump's administration has imposed tariffs on Chinese imports worth billions of dollars annually, and China has retaliated with its own trade restrictions. (See Trump Admin Reboots $50B China Tech Tariffs.)

In the telecom sector, both ZTE and bigger Chinese rival Huawei have been unable to sell equipment and services to the main US telcos since 2012, when a US government report labeled the two vendors a potential security threat because of their perceived ties to the Chinese government.

Concern about China's use of technology to spy on the US was highlighted with the recent publication of a Bloomberg report alleging that Chinese authorities managed to install tiny chips in servers that were eventually deployed in the networks of major US companies and government organizations. (See Chinese Hardware Hack Threatens US Tech Supply Chain – Bloomberg and Huawei, ZTE Charm Offensive Just Got Harder.)

ZTE's difficulties this year appear to have triggered a loss of business for the company, as customers affected by the components ban turned to other network vendors. Having struck a major network deal with ZTE at the end of 2017, Italy's Wind Tre, for example, recently held ZTE partly responsible for customer losses and a sales decline, after the US components ban delayed work on the ZTE project. The setback led Wind Tre to introduce Ericsson as a secondary supplier. (See ZTE ban and Iliad entry blow Wind Tre of course.)

Along with Huawei, ZTE was recently banned from selling 5G equipment in Australia due to apparent security concerns, and both companies are now being scrutinized in other parts of the world as a potential security threat. (See US Senators Urge Canada to Ban Huawei – Report, Australia Excludes Huawei, ZTE From 5G Rollouts. Huawei Poses Security Threat, Says UK Watchdog and Could Japan Also Bar Huawei, ZTE?)

Service providers outside China may be wary of doing business with ZTE given its recent problems and failure to make amends in 2017 after the first US fine. Until ZTE is back in a healthier financial position, it may struggle to attract new customers amid worry about its long-term prospects.

Nevertheless, ZTE claimed in its latest earnings report to have "deepened the negotiations with major global operators to constantly obtain new orders."

— Iain Morris, International Editor, Light Reading