If any doubts remained, Huawei Technologies Co. Ltd.’s recent contract wins with BT Group plc (NYSE: BT; London: BTA) demonstrate that the Chinese vendors are now a major force in the telecom equipment industry. Until now, North American and European vendors have largely dominated the global market. Barriers to entry such as intellectual property rights, access to capital, or language skills have prevented Asian manufacturers from winning much business outside their home markets.
The last five years, however, have witnessed the emergence of three Chinese vendors – Huawei, UTStarcom Inc. (Nasdaq: UTSI), and ZTE Corp. (Shenzhen: 000063; Hong Kong: 0763) – that have accumulated sufficient technical expertise and critical mass in their domestic market to compete with established incumbent vendors abroad. While China's vendors have typically had initial success in the developing countries of Asia and Africa, increasingly they are looking to compete on Western vendors' home turf.
Of the three Chinese vendors, Huawei appears to have the most robust profit margins, while ZTE has the strongest balance sheet, following its recent share sale. UTStarcom has the lowest margins (due to product mix) and the weakest balance sheet. The generally high profitability of Chinese equipment vendors versus their Western peers mainly reflects low labor costs. These were as little as 14 percent of sales for ZTE in 2004, compared to 33 percent for Alcatel (NYSE: ALA; Paris: CGEP:PA). This cost advantage is likely to be eroded over time as Chinese vendors increase their sales and marketing (S&M) staff in high-cost countries and Western vendors increase their research and development (R&D) personnel in countries where labor is cheaper. Additionally, we see higher IP royalty payments knocking about 5 percent off Chinese profit margins in the medium term.
Based on our analysis, Huawei appears well positioned to take market share in developed regions, particularly in DSLAMs, routers, and optical networking. ZTE appears less well placed to take share in Western markets but has strong potential in developing countries, particularly in wireless networking. UTStarcom's product portfolio is much more focused than its Chinese peers. While we believe that while UTStarcom has a relatively strong position in IP DSLAMs, the company may struggle to expand its non-China business.
Although we are skeptical the Chinese will make many inroads into Western 3G mobile networks, a significant opportunity remains for them in 2G and 3G mobile infrastructure in emerging countries. ZTE and particularly Huawei seem well positioned to capitalize on this, although we note that many of their wireless contracts to date have been for fixed-wireless access systems, rather than true mobile solutions.
Arguably, fixed-line networking presents a greater opportunity for the Chinese vendors in Europe and North America. They should continue to take share in standardized products such as DSLAMs, where pricing is a major factor in the purchasing decision. We also believe next-generation networks (such as BT's 21CN) provide an opportunity for the Chinese (particularly Huawei), as the complexity of these projects demand the large engineering resources that Chinese vendors can make available to customize solutions and troubleshoot problems. This will give them an advantage over Western vendors with thinner resources.
—From the Light Reading Insider report, "China’s Big Three Vendors Take On the World," by Contributing Analyst James Crawshaw
