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ZTE Leans on Credit Crutch

Ray Le Maistre
8/29/2006

ZTE Corp. (Shenzhen: 000063; Hong Kong: 0763) is applying for nearly $2.6 billion in new credit facilities to shore up its balance sheet and keep its expansion plans on course following a dramatic 46 percent fall in first-half profits, according to documents filed with the Hong Kong Stock Exchange.

The Chinese vendor, which issued a first-half profit warning in early July, reported net income of 373.5 million renminbi (US$46.9 million) for the six months to June 30, down nearly 46 percent year-on-year. The EPS (earnings per share) was RMB0.39, compared with the RMB0.72 reported in the first half of 2005. (See ZTE Warns on Profits.)

A sizeable chunk of that profit came from government subsidies, which accounted for RMB211.9 million ($26.6 million) in the first half of the year. While such income was a welcome boost, questions have been raised about the ongoing levels of subsidies -- including tax refunds and government grants –- that ZTE will receive. The subsidy issue, plus the ongoing battle against chief rival Huawei Technologies Co. Ltd. and increasing competitive pressures abroad as well as at home, have caused concerns for ZTE's investors. (See Pressure Piles on Huawei, ZTE.)

While the latest numbers hardly affected the vendor's stock, as a profit warning had already been issued, the share price has fallen notably in recent months. Despite climbing HK$1.60 today to HK$27.35 (US$3.52), it's down nearly 17 percent from the HK$32.80 (US$4.22) price achieved in early April. Today's closing price, though, is also a considerable improvement from June's low of HK$21.80 (US$2.80).

While profits were down, first-half revenues were up slightly, by about 1.8 percent, to RMB10.49 billion ($1.32 billion), thanks to a ramp in sales outside Asia/Pacific, as Table 1 shows.

Table 1: Geographic Mix of ZTE Revenues

RM = renminbi H1 2006 Revenues As a % of total H1 2005 revenues H1 2005 as a % of total
People's Republic of China (PRC) RM6.53 billion 62.20% RM7.2 billion 69.50%
Asia (excluding PRC) RM1.75 billion 16.70% RM1.99 billion 19.30%
Africa RM1.42 billion 13.50% RM1.04 billion 10.10%
Others RM798 million 7.60% RM115 million 1.10%
Total RM10.49 billion 100% RM10.3 billion 100%
Source: ZTE




International revenues (all revenues outside China) were up nearly 26 percent to RMB3.96 billion ($497 million), and the company continues to invest in its global operations, including a foray into North America, where, it says, it has been making a push with its CDMA infrastructure and handsets, broadband access, and fixed-line terminal products. "Business relationships have been established with carriers," states the vendor in its filing. (See ZTE, Telus Sign and Huawei, ZTE Ramp Up IP Access.)

However, domestic revenues were down year-on-year in a period when, according to numbers from China's Ministry of Information Industry (MII) cited by ZTE, telecom capital expenditure in the country was up by more than 9 percent to RMB84.87 billion ($10.66 billion).

ZTE says the domestic slump is due primarily to a shift in carrier spending ahead of the award of 3G licenses, which could come any time in the next 18 months. Ahead of their investments in 3G networks, China's mobile operators have scaled back spending on legacy technologies such as CDMA and PHS, which have generated significant sales for ZTE in the past.

There are expectations, though, that the imminent green light for 3G network builds from the Chinese government will spark a major wave of new capital investment, and that ZTE will be among the beneficiaries. The company says it has products suitable for all three potential 3G network types -- WCDMA, CDMA EVDO, and China's own flavor of 3G, TD-SCDMA.

In terms of product lines, both the wireless equipment and handset business units noted sales reductions in the first half of this year, but that was offset by increases in wireline, optical and data, and, most notably, software, services, and other products (including fixed-line terminals and modems), which increased nearly 75 percent year-on-year, as Table 2 shows.

Table 2: ZTE Revenues & Costs by Product Line
RM = renminbi H1 Revenues % change over 2005 H1 Costs % change over 2005 Gross profit margin
Wireless equipment RM3.51 billion -25.20% RM1.94 billion -20.40% 44.40%
Wireline equipment RM1.07 billion 49.20% RM683 million 81.10% 36%
Optical and data equipment RM1.71 billion 14.70% RM1.22 billion 24.80% 28.10%
Handsets RM2.13 billion -3.60% RM1.59 billion -19.90% 25.20%
Software, services, and other products RM2.06 billion 74.60% RM1.39 billion 114.80% 31.80%
Total RM10.49 billion 1.80% RM6.83 billion 6.30% 34.50%
Source: ZTE




That table also shows why profits shrank despite slightly higher revenues. ZTE's costs increased by 6.3 percent in the first half of the year to RMB6.83 billion ($858 million), sending the vendor's gross margin for the period down to 34.5 percent from 36.7 percent a year earlier.

But there's no letup in ZTE's international expansion and R&D plans, which are seen by management as key to securing the vendor's place as a major player in the next-generation networks market.

And to help fund that vision, the company's board has approved plans to apply for loans and credit facilities worth $2.58 billion -- RMB15.35 billion ($1.93 billion) from eight Chinese banks and a further $650 million credit from another three Chinese financial institutions -- during the second half of the year to "provide strong financial coverage for the company’s business development."

ZTE needs those facilities to ensure it doesn't come unstuck, as its balance sheet shows some unhealthy trends. Cash reserves dropped to just short of RMB3 billion ($377 million) at June 30, down from RMB5.57 billion ($700 million) at the end of 2005, while moneys owed, recognized under the "bills receivables" and "trade receivables" lines, shot up to RMB6.34 billion ($797 million) from RMB4.68 billion ($588 million) at the end of 2005.

In addition, the company's inventories rose in value to RMB2.87 billion ($360 million) from RMB2.52 billion ($316 million) in the same period.

— Ray Le Maistre, International News Editor, Light Reading

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digits
digits
12/5/2012 | 3:42:54 AM
re: ZTE Leans on Credit Crutch
Thanks to a friendly reader, a few corrections have been made from the original article, most notably in table 2, where I had originally referred to the gross profit margin line as operating profit margin.
The other correction is in reference to the balance sheet, where I had referred only to bills receivables but *not* trade receivables when mentioning the level of moneys owed.

For anyone wanting to know which banks ZTE is applying to for its credit facilities, the document filed with the Hong Kong exchange is at

http://www.hkex.com.hk/listedc...

Ray Le Maistre
larytet
larytet
12/5/2012 | 3:42:53 AM
re: ZTE Leans on Credit Crutch
any connection with UTSI ?
digits
digits
12/5/2012 | 3:42:53 AM
re: ZTE Leans on Credit Crutch
What are the prospects for ZTE in N America? Is there a gap for a price competitive CDMA infrastructure and handset vendor?

And what about broadband access? That looks like a very tough market to break into -- even Huawei, which has made inroads in Europe, has failed to make an impact there.
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