US authorities investigating whether Huawei violated sanctions against Iran could deliver an unprecedented blow to the global telecom industry by imposing restrictions on the Chinese company. (See US Investigating Huawei for Sanctions Violations – Report.)
The number-one fear is that Huawei Technologies Co. Ltd. will suffer the same penalty as smaller rival ZTE Corp. (Shenzhen: 000063; Hong Kong: 0763). Last week, after it was accused of failing to put its business in order, ZTE was banned from purchasing US-made components for seven years. Its original crime? Violating sanctions against Iran. (See ZTE in Existential Crisis as It Slams 'Unfair' US Ban, Considers 'Judicial Measures'.)
The knock-on effect of that decision has already been dramatic. A report from the Economist indicates that between 80% and 90% of ZTE's products used American components in 2016, according to UBS. With its supply chain in jeopardy, ZTE says its very survival is at stake. Shares in component suppliers such as Acacia, which derives 30% of its revenues from ZTE, have plummeted.
ZTE's customers are also nervously tracking developments. "We use ZTE in Malaysia, Pakistan and Hungary and we are following the situation closely," said Sigve Brekke, the CEO of Norway's Telenor Group (Nasdaq: TELN), when asked about ZTE during a recent earnings call with analysts. "This is something we have been following for the last one and a half years since the first order came out. I cannot comment more than that." (See Telenor's Cost-Cutting Focus Rattles Investors.)
ZTE's main rivals, meanwhile, may be hovering greedily, like carrion crows over a wounded animal. "We come from a strong security background and are trusted from a quality point of view. We have a good chance to succeed in this environment," Nokia Corp. (NYSE: NOK) CFO Kristian Pullola told Light Reading when asked if there was opportunity in ZTE's misfortune. "We will monitor the situation and try to use any opportunity that would present itself in radio, routing or optical." (See Nokia Tumbles on Weak Results, Insists Good 5G Times Lie Ahead.)
While Ericsson CEO Börje Ekholm struck a warier tone during a recent earnings call with analysts, operators are evidently jumpy. "Many customers are asking questions and that is not so strange, but let's refrain from summarizing that yet," he said. (See Ericsson Takes Giant Leap Toward Profitability.)
But if measures against ZTE have caused this much turmoil already, a ban on Huawei could prove even more disruptive. With total revenues of $17.2 billion last year, ZTE remains some distance behind the triumvirate of Huawei, Ericsson and Nokia Corp. (NYSE: NOK), and a marginal presence in some countries. Huawei is today the largest of those industry giants, generating $92.5 billion in sales last year. About $47 billion came from network sales to operators.
For some of the US component makers, a ban on selling gear to Huawei could be devastating. NeoPhotonics Corp. (NYSE: NPTN) looks the most exposed, generating as much as 40% of its revenues from sales to Huawei, according to Michael Genovese, an analyst with MKM Partners. But Oclaro Inc. (Nasdaq: OCLR), Finisar Corp. (Nasdaq: FNSR) and Lumentum Holdings Inc. are also heavily dependent on contracts with Huawei, deriving between a tenth and a fifth of their revenues from the Chinese company.
Genovese, who monitors optical stocks for MKM, also thinks a ban could translate into an even bigger opportunity for the likes of Nokia than restrictions on ZTE alone. "If Huawei were to eventually be cut off from buying US components, which is not our base case assumption, then the market share gain opportunities for Nokia, Ciena and Infinera would become even greater, in our view," he said in a research note this week.
The optical upside for rivals to Huawei and ZTE could be considerable. According to MKM Partners, Huawei is currently the number-one optical systems player in the world, while ZTE occupies the number-three spot. "We think Nokia has a great opportunity to gain share from ZTE in China and outside of China," said Genovese. "Ciena and Infinera will also likely gain some share from ZTE outside of China."
Next page: Rising tension