TELECOMS: ZTE Plays Contrite as US Sanctions Loom

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Bottom line: The US should penalize ZTE for violating trade restrictions against Iran, but should moderate the severity to acknowledge that Chinese firms are improving their adherence to global laws and standards.

ZTE assists with US probe

Two days after exploding into the headlines, US sanctions against ZTE (HKEx: 763; Shenzhen: 000063) continue to ripple through the news as the Chinese telecoms equipment maker faces major disruptions to its supply chain. Washington has determined that ZTE sold equipment from US companies to Iran in violation of export restrictions against the country at the height of an international dispute about its nuclear development program.

As a result of its finding, which comes after a 4-year investigation, all of ZTE’s US suppliers, including the likes of Microsoft (NYSE:MSFT) and Oracle (Nasdaq: ORCL), must now apply for export licenses before they can sell to ZTE. Media reports have indicated that Washington is likely to deny such license requests, as punishment to ZTE for violating the trade restrictions.

China’s foreign ministry and now its commerce regulator have both responded to the US move in usual fashion, with the latter saying it was “resolutely opposed” to the action. ZTE itself has been more contrite, and now is urging its US suppliers to apply for export licenses that technically could allow it to still receive critical goods from Microsoft, Oracle and others.

We’ll take a closer look at specifics behind these latest developments shortly, but first I have to inject my own personal observation of the fact that no one in China is actually disputing the validity of the US claims. That would certainly seem to imply that ZTE did indeed sell the goods to Iran in violation of US trade restrictions, and it does seem clear from the reports that ZTE was aware of that fact.

So it does seem only fair that ZTE should have to pay a penalty for violating US law, which even China should acknowledge. Surely if ZTE violated China’s laws, then Beijing would want to punish the company. That said, the next question is what kind of punishment is most appropriate?

We’ll return to that question shortly but first let’s look at the latest headlines, including ZTE’s first official response to the US action. ZTE doesn’t try to claim it’s innocent, but instead says that as a Hong Kong- and China-listed company, it needs to observe global conventions and laws. (Chinese article) ZTE adds that it will continue to cooperate with the US probe, and remains in communication with Washington.

A separate report says that ZTE has urged its suppliers to apply for export licenses, and quotes an unnamed company official protesting that the punishment is too tough. (English article) Meantime, China’s Commerce Ministry said in a statement the move would affect the operation of Chinese companies, and that Beijing will continue negotiating with Washington on the issue.

No Dispute Over Guilt

All of that said, we really do need to return to the issue of what happened here, and what kind of punishment is appropriate. Since no one seems to be disputing the US allegations, it’s probably fair to assume that they are partly or completely true. So the point of dispute is whether ZTE deserves such severe punishment, which could have a huge impact on its business.

In fact, this kind of behavior is quite typical for Chinese companies. The European Union is now conducting a similar probe into Chinese solar panel makers who tried to circumvent similar sanctions related to an anti-dumping case.

At the same time, many companies like ZTE and crosstown rival Huawei are making honest efforts to behave more by global norms, and the US should take that fact into account. Excessively harsh punishment in this case could actually be counterproductive, since it could push companies like ZTE back into some of their older bad habits.

At the end of the day Washington has given itself some space for flexibility since it didn’t ban the sale of all US goods to ZTE outright. Accordingly, perhaps the negotiations with Beijing and ZTE will result in a middle-ground that sees Washington ban the export of some US goods to the company, but not all exports.

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