The second-largest maker of telecoms gear in China is scrambling to get off a U.S. export blacklist that threatens to dry up supplies of critical components.
“The investigations are still in progress, and may result in criminal and civil liabilities under U.S. laws,” ZTE Corp. said on April 6, when it released its earnings figures for 2015.
U.S. authorities have been investigating ZTE since 2012 over allegations it sold software and equipment containing components made in the United States to Iran through shell companies to get around U.S. trade sanctions, people close to ZTE said.
The U.S. Commerce Department said on March 7 that American manufacturers are banned from selling components to ZTE, and foreign manufacturers will be prohibited from selling products containing a significant amount of U.S.-made parts to the firm.
ZTE and three subsidiaries—ZTE Kangxun Telecommunications Ltd., Beijing 8-Star International Co., and Iran-based ZTE Parsian—were hit by the rules.
The company won a temporary reprieve after a series of talks with U.S. officials, and some supplies are being allowed until June 30, a ZTE employee who asked to remain anonymous said.
ZTE delayed the release of its 2015 financials by almost two weeks to assess the impact of the export restrictions, the company said. Net profits rose 22 percent last year to 3.2 billion yuan, the firm said, although it fell short of a January projection of 3.8 billion yuan, according to a filing to the Shenzhen stock exchange on April 6.
Total revenue crossed the 100 billion mark for the first time, a 23 percent increase from 2014, but short of a January forecast by 600 million yuan.
The tough export restrictions are a major setback for the telecoms equipment and smartphone maker, which relies heavily on imported parts. Exports from the United States account for up to 15 percent of its total supplies, Nomura Securities International Inc. said.
The company had enough components in stock to support production for the next six months, a telecom industry analyst in Hong Kong said.
“Without government support, ZTE can do almost nothing about the ban,” an industry insider said. “ZTE is nervous … If the ban is extended, it may kill the company in half a year.”
China’s Ministry of Commerce issued a statement on March 8 that said it opposed the U.S. sanctions. Foreign Minister Wang Yi told the media on the same day that “this approach will only hurt others without necessarily benefiting oneself.”
ZTE’s shares resumed trading in Shenzhen and Hong Kong on April 7 after a month-long suspension.
Changes at the Top
On April 5, ZTE announced what it said was “a routine change of executives.” Zhao Xianming, the firm's chief technology officer, took over as CEO from Shi Lirong, who has run the company since 2010. Zhao was also named the firm’s chairman, replacing ZTE’s 75-year-old founder Hou Weigui, who retired in late March.
Two executive vice presidents, Tian Wenguo and Qiu Weizhao, also stepped down.
Changes to the old guard may be linked to the export restrictions, several people close to the company said. ZTE did not respond to Caixin’s questions on the matter.
U.S. trade regulators softened their position on March 24, allowing ZTE and ZTE Kangxun to make purchases from their U.S. suppliers until the middle of the year, the source from ZTE said. The company must renegotiate once this deadline passes, the source said.
Some of the company’s U.S. suppliers resumed sending components to factories in the southern city of Shenzhen, where the firm is headquartered, the person said, and the first shipment arrived on March 28.
ZTE’s assembly lines have continued to roll out products without any disruption so far, the source said. But U.S. trade authorities could revoke the temporary permission after June 30. “No one can predict what factors may affect their decision,” he said.
The episode has served as a wake-up call for domestic tech companies that are dependent on imports for key components, analysts said.
“In the information and communications technology sector, Chinese companies are unable to wholly rely on self-production,” said one analyst in Hong Kong. “China still lags behind in key areas, such as the production of computer chips, storage devices, electronic devices used in telecom towers, and other advanced materials.”
Caught Off Guard
U.S. trade regulators started probing ZTE’s business dealings with Iran four years ago, several people close to the firm said. “Officials visited ZTE’s offices in the United States in 2012, checked the computers, and copied many files,” one source said.
U.S. commerce officials met with company representatives to discuss ZTE’s ties with Iran about three years ago, another person familiar with the matter said.
Despite this, the restrictions from U.S. authorities still took ZTE by surprise. “According to suppliers, ZTE placed many orders to buy components a few days before the ban hit, indicating the company was caught off guard,” the analyst in Hong Kong said.
If the temporary reprieve comes to an end, ZTE may face catastrophic losses, several analysts said, because a shortage of components will affect all production lines from smartphones to base stations and other network equipment.
“ZTE will have to adjust to a supply shock and its market share may shrink quickly due to production halts,” an analyst said.
U.S. semiconductor companies, such as Qualcomm Inc., Xilinx Inc. and Altera Corp., account for 10 percent to 15 percent of ZTE’s total component supplies, said Huang Leping, a telecoms analyst at Nomura.
“It will be very difficult for ZTE to find alternative suppliers” for chips it buys from Xilinx and Altera, said Huang.
ZTE produces about 3.4 percent of the mobile phone handsets sold globally and has a 10 percent stake in the international telecom network equipment market, data from Nomura showed.
If the United States continues with the tough restrictions, the manufacturing of all of ZTE’s telecom network equipment—its largest business segment—will be crippled, said an expert from China Telecom, the country’s third-largest wireless carrier by number of users.
ZTE may have to redesign its products to replace the components with older versions that it has in stock, said the China Telecom expert, who asked not to be named. This would affect quality and raise production costs, he said.
Many of the company’s recent smartphone models may also have to go out of production because they use Qualcomm chips, said an employee of supply chain service provider Eternal Asia Supply Chain Management Ltd.
The U.S. Commerce Department said in a statement that based on data from 2011, ZTE can find alternative suppliers for about 30 percent of the components it needs.
A Wake-Up Call
The ban also threatens ZTE’s long-term growth plans. The restrictions are likely to weaken ZTE’s bid to build a 4G network at home with China Telecom and China Unicom, said Liu Zhicheng, an analyst at BOC International, the brokerage arm of Bank of China.
China Unicom, the country’s second-largest wireless carrier by number of subscribers, may drop ZTE from its 4G equipment suppliers’ list if the ban continues, the telecoms giant’s chairman, Wang Xiaochu, said.
ZTE’s suppliers in the United States, including Oclaro Inc., Lumentum Holdings Inc., and Fabrinet Inc., have seen their share prices drop sharply since the ban was announced. Optical and laser components provider Oclaro said its third quarter sales will suffer because ZTE was a major customer, buying almost one-tenth of its products.
The bigger risk to U.S. chip makers and suppliers is that the Chinese vendor may take more of its business in-house. ZTE is reassessing its vast supply chain to find ways to reduce its reliance on U.S. component suppliers, a ZTE employee said.
It may invest more on research and development in key components, the employee said. “I think the Chinese government will also increase its supports to R&D efforts among domestic high-tech firms,” he said.
Rewritten by Han Wei.