TELECOMS: ZTE to Appeal US Sanctions, Reprieve Unlikely

Bottom line: ZTE will lose its appeal of tough US export sanctions for illegally selling high-tech equipment to Iran, as Washington sends a strong signal that companies engaging in such actions will face stiff punishment.

ZTE to appeal US sanctions

An increasingly frantic ZTE (HKEx: 763; Shenzhen: 000063) is working on several fronts in a bid to stop crippling US sanctions, after Washington determined the company illegally sold equipment to Iran. I used to be a strong supporter of compromise in China’s frequent trade conflicts with the west, and still believe that some form of compromise might be the best solution here.

But at the same time, the frequent tendency by Chinese companies to flout laws and agreements both at home and abroad shows that sometimes harsher measures are the only way to convince these firms to play by the rules. Accordingly, I do expect we could see Washington take a relatively tough stance against ZTE in this case, despite protests from Beijing and the potential for big disruption to the operations of one of China’s largest telecoms equipment makers.

ZTE shares have been suspended for 2 weeks now, after reports first emerged that Washington was prepared to punish the company for violating rules that banned the export of US high-tech equipment to Iran. (previous post) ZTE has just announced it will delay the release of its latest quarterly results and its shares will remain suspended indefinitely. (company announcement)

ZTE has been working hard to try and ease the sanctions, which require it to receive an export license before it can buy any high-tech equipment from regular suppliers like Microsoft (Nasdaq: MSFT) and Oracle (Nasdaq: ORCL). New reports are showing that ZTE spent $5.1 million over the last 4 years to lobby Washington to drop the probe, but it obviously lost that battle.

Now the latest reports say ZTE is preparing to appeal the US ruling, in what would really be its only hope of avoiding the punishment that would cause major disruptions to its supply chain. (English article) Beijing previously voiced its objections to the punishment, implying it was too severe, though no one to date that I’ve seen has actually denied that ZTE illegally sold US-made equipment to Iran.

Room for Leniency

Washington does have some leeway in this instance, since it could allow some exports to continue by granting licenses on a selective basis. The latest reports also indicate that Washington officials and ZTE continue to talk about the issue, again hinting that there might be some room for compromise.

Europe tried a conciliatory approach in a another case several years ago involving Chinese-made solar panels. In that instance, the European Union found that Chinese solar panels received unfair state subsidies and announced punitive tariffs. But then it changed course after some government leaders intervened, and signed a compromise deal that saw Chinese manufacturers agree to voluntarily raise their prices.

But no sooner was the deal signed, then the Chinese companies immediately began looking for ways to undermine the agreement by offering rebates to customers and shipping panels via third countries to hide the fact they were made in China. Likewise, ZTE knew quite well that what it was doing was illegal, but reportedly crafted an elaborate scheme to sell US products to Iran by using various shell companies to hide its actions.

At the end of the day, it’s quite difficult to defend a company that engages in these kinds of actions. Such companies know that what they’re doing is illegal or violates their previous commitments, but are so competitive and profit-driven that they often are willing to take such risks and hope they don’t get caught.

ZTE clearly got caught in this case, and really does deserve to face some punishment, which would send a strong signal to others who might be considering similar violations. The only question left is how severe the punishment should be, and I do suspect that Washington will take a tough approach that could cause some major headaches for ZTE when the company ultimately loses its appeal.

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