Analyst: Chinese Face Spy Scandal Fallout

A report suggesting that the Chinese military has hacked into German government computers could have a negative impact on the prospects in Western markets of Chinese equipment vendors Huawei Technologies Co. Ltd. and ZTE Corp. (Shenzhen: 000063; Hong Kong: 0763), believes an analyst at Dresdner Kleinwort .

German news magazine Der Spiegel reported recently that computers in the German chancellery and the foreign, economic, and research ministries had been infected with Chinese spyware software, and German officials say they believe the hackers were linked to China's People's Liberation Army. (See China's Premier 'Gravely Concerned' by Hack on Germany and China to Use Computer Viruses as Cyberwarfare First Strike.)

The incident overshadowed German Chancellor Angela Merkel's state visit last week to Chinese Premier Wen Jiabao.

But the ramifications could go far beyond international relations and even damage Chinese companies' prospects for IT and telecom contracts in the West, believes Dresdner Kleinwort analyst Per Lindberg.

"The ability of Huawei and ZTE to participate in, let alone win, telecom infrastructure tenders in the Western hemisphere may have lessened considerably following last week's shock report," writes Lindberg in a research note issued Monday. "It could trigger a return to national security clearance when it comes to procurement of telecom networks," he adds.

But Heavy Reading chief analyst Graham Finnie is cautious about the potential impact on the likes of Huawei and ZTE. He says the effect on Chinese vendors will depend on whether this incident is a "flash in the pan" or turns into something bigger.

"There has always been an issue in the U.S. that these companies have links with the Chinese government. But it hasn't been quite so much of an issue in Europe," says Finnie. "This is another stick that people can use to beat the Chinese suppliers with."

"It clearly would not be in either company's interest to be seen to be working for the Chinese government," he adds.

Both Huawei and ZTE have been gaining ground with Tier 1 contract wins in Europe and the U.S. this year. Huawei notably won HSDPA contracts with Vodafone España S.A. and Telecom Italia Mobile SpA (Milan: TIM). (See Huawei Wins in Germany, Huawei Wins Vodafone Deal, KPN Picks Huawei, Alltel Uses Huawei Card, Huawei Wins at TIM, ZTE Wins Sprint WiMax Deal, ZTE Wins 3G Deal, and Huawei Gets Vodafone Award.)

But Dresdner says the spyware incident in Germany threatens to slow that momentum. "It could stifle China's telecom export push, trigger urgent replacement of 'unwanted' equipment, and put an end to price dumping tactics," writes Lindberg in his research note.

— Michelle Donegan, European Editor, Light Reading