ZTE H1 Profits Up, but Sales Stuck in a Rut

Ray Le Maistre
8/27/2019

ZTE today rolled out some headline-grabbing financial numbers for the first half of the year, reporting a 13.1% increase in revenues compared with the same period a year ago and a net profit that compared very favorably to a gut-wrenching loss for the first six months of 2018.

While there's no arguing that those are numbers to shout about, a peak under the financial hood shows there's some way to go before the Chinese vendor can stop popping the anxiety pills.

First, a look at the margins. ZTE's operating profit for the first half of 2019 came in at 2.34 billion Chinese yuan (US$327 million), compared with a near RMB1.75 billion ($244 million) operating loss for the same period a year earlier. Reported net profit hit RMB1.47 billion ($205 million), compared with an eye-watering RMB7.82 billion ($1.09 billion) net loss a year earlier. The vendor has also announced that it expects its third quarter, which closes at the end of September, also to generate net profits (but it hasn't provided a sales forecast).

That all seems like an amazing turnaround and in many ways it is -- you could say it's against all odds, given how vendors from China have been demonized during the past year or so (sometimes rightly so). It's especially amazing given the parlous state in which ZTE found itself during the first half of 2018. Back then, following revelations that the Chinese vendor had failed to comply with trade agreements, a ban on US component sales to the Chinese vendor forced it to temporarily close its factories and nearly put the company out of business: Hence its net loss of more than $1 billion for the first six months of last year.

ZTE was ultimately given another chance by the US authorities (once it had paid another monster fine and appointed a new board): It cut its costs significantly and worked its way back into profitable trading territory while at the same time investing in home-grown components to reduce its future reliance on US goods (more on that later).

But its revenues have not recovered in line with its margins. Sure, it's first-half revenues are up by 13.1% to RMB44.6 billion ($6.23 billion), but that percentage gain hides the real story.

As previously reported by Light Reading, ZTE's quarterly sales had declined year-on-year for four consecutive quarters up to and including the first quarter of this year, showing how much its run-ins with the US authorities had dented the vendor.

The quarter most affected by the US ban was the second quarter of 2018, so it's no surprise to see a year-on-year improvement in the first half of this year.

However, a quick calculation shows that ZTE's second-quarter revenues amounted to just RMB22.4 billion ($3.13 billion) -- almost double what it managed in the same (disastrous) period a year earlier, but not much of an improvement over the first quarter's RMB22.2 billion ($3.1 billion).

Essentially, ZTE's sales are, for the moment at least, flatlining.

That has to be a worry for the vendor. It hasn't managed to diversify its business in the same way as Huawei, its much bigger fellow Chinese telecoms vendor that is about eight times as big in terms of revenues and which has developed a massive global market for its smartphones.

Instead, ZTE is still heavily reliant on its carrier networks unit, generates less than 17% of its sales from smartphones (its Consumer Business), and still generates more than 60% of its total revenues from its domestic market, as these tables of first half 2019 financials show.

Table 1: ZTE H1 2019 Revenues by Business Unit

H1 2019 As a % of revenues
Revenues in RMB 44.6 billion 100%
-- of which Carriers' Networks 32.5 billion 72.82%
-- of which Government and Corporate Business 4.7 billion 10.54%
-- of which Consumer Business 7.4 billion 10.64%
Source: ZTE

Table 2: ZTE H1 2019 Revenues by Geography

H1 2019 As a % of revenues
Revenues in RMB 44.6 billion 100%
-- of which People's Republic of China 27.4 billion 61.47%
-- of which Asia not inc. China 7.8 billion 17.50%
-- of which Africa 2.7 billion 6.09%
-- of which Europe, Americas and Oceania 6.7 billion 14.94%
Source: ZTE

Current macroeconomic factors will not be playing into ZTE's hands either, even if a trade deal between the US and China is forthcoming.

ZTE's saving grace right now is that it is at least generating profits. What it will need to show in the coming quarters is that it can improve its business outside of China and beyond its network hardware and software business. If it can't, the vendor could be in danger of becoming almost completely reliant on China's three major network operators for life support, and news that 5G network sharing is set to feature in the country will not be doing its prospects any good.

The company, though, is doing all it can to future-proof itself by focusing (like the rest of the industry) on developing 5G-relevant products and also by developing as many home-grown hardware and software components as it can, so it can reduce its reliance on the US should anything… crop up.

ZTE notes in its earnings press release (which is devoid of financial detail):

    Committed to building its core competitiveness in independent innovation in the 5G era, ZTE has been focusing on basic operating systems, distributed databases, core chipsets and other fields. The new-generation 5G wireless system chipsets and transport switching network chipset have entered the stage of product introduction. The company has completed the design and mass production of the 7nm chipsets, and embarked on the R&D of the 5nm chipsets. Meanwhile, ZTE will collaborate closely with partners on the R&D of new technologies to accelerate the chipset R&D progress in the fields of leading process techniques, advanced packaging, core IP, new material applications and etc. [sic]

    "The company's self-developed operating system has been applied in various key industries, including telecommunications, high-speed rail, electricity, industry and automotive.

It is also securing as many 5G-related patents as possible, noting in its press release: "By June 30, 2019, ZTE had applied more than 74,000 patents with over 36,000 global patents granted and over 3,700 5G patents. ZTE is a major participant and contributor to global 5G technology research and standard development. As of June 15, ZTE had declared 1,424 families of 5G Standard Essential Patents (SEP) to ETSI, ranking top 3 in the world, based on IPlytics's statistic."

And it's keen to be seen as a 5G networks player, up there with its key rivals Huawei, Ericsson and Nokia: ZTE says it has signed 25 commercial 5G contracts with customers in China, Europe, Asia-Pacific, the Middle East and other major 5G markets.

If it can avoid any international legal, political and trade hairballs and grow its business outside of China between now and the end of 2020, ZTE could find itself with a long-term future of interest to network operators around the world. If not, it might find itself relegated to playing the role of regional actor, albeit with the largest single market in the world providing its script.

— Ray Le Maistre, Editor-in-Chief, Light Reading

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