I don’t usually like to write about the same company or issue twice in the same week, but it’s hard to ignore a new report that has just come out of Washington saying US telcos shouldn’t do business with China’s top 2 telecoms equipment makers due to security concerns. Of course people who follow the industry will know that I’m referring to a new Congressional report taking aim at Huawei and ZTE (HKEx: 763; Shenzhen: 000063), 2 of the world’s leading telecoms equipment makers and also 2 of China’s high-tech exporting superstars. The report comes just a day after reports emerged that Huawei was considering an offshore IPO in an attempt to diffuse concerns that its equipment can be used for spying by Beijing (previous post).
This new report is the most specific yet detailing security risks posed by equipment from both Huawei and ZTE, saying the biggest risk comes from both companies’ vulnerability to influence by Beijing. (English article; Chinese article) The committee further recommended that the US government block any potential sales by Huawei or ZTE to US telcos, a move that will surely discourage companies like Sprint (NYSE: S) or Verizon (NYSE: VZ) from ordering equipment from the 2 companies.
Both Huawei and ZTE fired back with statements that were unusually strong for companies that prefer to take a low profile stance on this sensitive matter. Huawei used its American spokesman William Plummer, a former US State Department official, to denounce the report’s findings as “baseless”, calling it a “dangerous political distraction”. (English article) Even China’s Foreign Ministry joined with its own more muted protest, saying Chinese telecoms equipment makers respect international market norms, and that the US should dispose of its preconceptions. (Chinese article)
As if the report wasn’t bad enough, another media report disclosed that US networking equipment giant Cisco (Nasdaq: CSCO) has also severed a long-standing relationship to supply its routers and switches to ZTE after the Chinese company constructed a sophisticated telecoms network for the Iranian government. (English article) The US bans its companies from selling such equipment to Iran, whose nuclear energy program it suspects is a front for trying to develop an atomic bomb.
Washington has no power to ban other companies from other countries from selling their products to Iran, but strongly discourages such sales by potentially locking those companies out of the US market. Clearly the loss of Cisco’s products will cause problems for ZTE, since those products are often key components of the networks that ZTE builds for many of its clients.
Now that I’ve recounted all the latest developments, it’s time to give my own assessment of how much of this is political wind and how much is based on real security risks, and also what are the longer term implications for Huawei and ZTE. While some of the tough talk from Washington is obviously political, especially with a major US election only a month away, I do think the security concerns are valid to a certain extent.
The bigger issue isn’t whether Beijing currently uses Huawei and ZTE for electronic snooping, but rather whether it has the potential to do so. In that regard, China has a very poor record for showing that its major companies can operate independently of influence from Beijing, which frequently pressures and orders such firms to disclose information and make strategic decisions they would never make purely based on commercial factors.
Key cases in point are the country’s 3 major telcoms carriers, which frequently block Internet web sites based on orders from Beijing and are believed to willingly disclose information on their users to “assist” in government investigations. While this kind of meddling is of less worrisome for companies that develop natural resources and sell low-tech products like clothing and furniture, the implications are a bit more worrisome for makers of higher tech products like cellphones and telecoms equipment.
Until Beijing can show definitively that it won’t use its influence to meddle in company affairs, the kinds of security concerns now plaguing Huawei and ZTE will continue to persist. As such, look for Huawei and ZTE to remain locked out of the US for at least the next 5 years, and for the 2 companies to quite possible find themselves meeting with growing resistance in other markets that once eagerly purchased their low-cost, relatively high-quality products.
Bottom line: Huawei and ZTE will remain locked out of the US for at least the next 5 years due to security concerns, and could quite possibly see their business drop off in other markets as well.
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