Telecom Death Spiral Continues with ZTE's Steep Profit Drop

Sluggish telecom operator infrastructure spending, mobile device price wars and roadblocks in several western markets have all combined to cause China’s ZTE to report an 85% drop in profits (year over year) in the latest quarter that ended in June. Net earnings for the first half dropped 68 per cent  to Rmb245m, in line with a warning issued last month. That’s the steepest drop in net profits since the Hong Kong listed company went public six years ago!

The drop follows a series of weak results announcements by other leading  telecom equipment vendors. Huawei, ZTE’s larger Chinese rival, reported a 22  per cent slide in first-half operating profits.  Alcatel-Lucent and NSN have been losing money and laying off employees for years, while LM Ericsson recently reported net income down 63 per cent to SKr1.2bn ($172m), compared with a year ago.

ZTE blamed delayed orders from telecom operators and foreign exchange losses  because of the euro crisis for the weak performance, but some analysts say the  company faces much broader problems. China’s three telecoms carriers spent only a third of their projected  full-year capital expenditure during the first half, according to BOCI Research. Analysts do not expect a significant increase before the end of the year that could translate into new orders for ZTE, especially since Chinese operators are  not expected to receive licences for fourth-generation mobile services until  2014.

These are not ZTE’s only woes. The company, alongside Huawei, is being  investigated in the EU for allegedly receiving unfair subsidies from the Chinese  government. In the US, it is under investigation by the Department of Commerce and the FBI for allegedly selling equipment to Iran in violation of trade  sanctions. But unlike privately owned Huawei, ZTE is  predominantly owned by Chinese state entities despite its Hong Kong stock  exchange listing.

“The authorities in both the US and the EU appear to protect their own  players in the industry,” said Mr Ku. “That will make it very challenging for  ZTE to make inroads in the US market, much like it has been for Huawei.”

According to excerpts of an affidavit posted online by The Smoking Gun website last month, Ashley Yablon, a Texas-based lawyer working for ZTE, told the FBI that company executives discussed lying to the US government and  destroying evidence. ZTE on Wednesday declined to comment on the investigations.  As a result of the probe, Jon Christensen, a former Republican Congressman, terminated his lobbying for ZTE last month. A group of US lawmakers has also  called for a Treasury investigation against the Chinese company.

And mobile phone sales aren’t contributing to the bottom line! ZTE is the world’s fourth-largest handset vendor by shipments, but the ultra-competitive and price sensitive handset/mobile device business is depressing its profit margins.

“We still expect only low single-digit growth in global telecom capex next  year, and everyone is competing by price, so things will continue to be tough  for the industry,” said Jones Ku, an analyst with Barclays Capital.

More info at:  http://www.ft.com/intl/cms/s/0/c09c2db4-ec46-11e1-81f4-00144feab49a.html#axzz24NrVpW9v


From ZTE’s latest financial report:

Overview of the global telecommunications industry in the first half of 2012

Investment in equipment in the global telecommunications industry slackened during the first half of 2012. Regional differences remained as emerging markets such as Latin America, Middle East and Asia Pacific continued to enjoy faster investment growth. With the gradual phase-out of 2G networks and the further optimisation and upgrades of 3G networks, commercial deployment of 4G networks has commenced in many countries around the world. In the meantime, global broadband construction continued to be boosted by policy support for and financial commitments to the national broadband strategy in various countries. Smart terminals continued to account for an increasing share of the market, in line with growing popular demand for the product driven by the rapid development of Mobile Internet and the growing variety of mobile applications.

Operating results of the ZTE Group for the first half of 2012

During the first half of 2012, the Group achieved relatively fast growth in overall revenue courtesy to efforts to explore market niches and enhance its market position through initiatives in the perfection and innovation of product technologies, as competition in global telecommunications industry became more rational. Terminals remained on track for fast growth, while telecommunications software systems, services and other products sustained existing growth rates. Nevertheless, the Group’s net profit declined in comparison the same period last year, reflecting reduced investment income, exchange losses, postponement of network contract tenders of certain domestic carriers and lower gross profit margin. For the first six months of 2012, the Group reported operating revenue of RMB42.642 billion, representing a year-on-year growth of 15.21%. Net profit attributable to the shareholders of the parent company amounted to RMB245 million, decreasing by 68.17% as compared to the same period last year. Earnings per share amounted to RMB0.07 per share.

The international market

During the reporting period, the Group reported operating revenue of RMB21.757 billion from the international market, accounting for 51.02% of the Group’s overall operating revenue and representing a year-on-year growth of 6.20%. With a strong focus on populous nations and mainstream global carriers, the Group consolidated its market shares in emerging markets, while winning recognition in its work to enhance cooperation with mainstream global carriers on different products. As well as reinforcing its operation in current mainstream products, the Group was vigorously planning for new strategic niches.

http://wwwen.zte.com.cn/en/about/investor_relations/announcement/201208/P020120822628655583372.pdf

Closing Comment:

It’s been over three years since the “great recession” officially ended (at least in the U.S.). And 12 long years since the dotcom/fiber optic networking bubbles burst. Yet the recovery in sales and earnings for telecom equipment companies are still extremely depressed with little if any growth (especially in bottom line/net earnings). Layoffs continue unabated at most of the large networking gear makers (Alcatel Lucent to layoff 5,000 more employees starting in September 2012).  

There are also few if any network equipment start-ups being funded and many of those that got seed money in the last few years are folding as they can’t obtain additional capital/investments.  Network infrastructure has become a dirty word for VCs and Angel investors who were badly burned by previous investments in that space 10 or 12 years ago (e.g. ultra long haul, photonic (all optical) switching, multi purpose provisioning platforms (AKA “God boxes”), metro optical & resilient packet rings, terabit routers, free space optics, WiMAX, and many, many more technologies that never were commercially successful.

It has certainly been a very long nuclear winter.  More like a decade of frozen tundra for telecom gear makers, component and most semiconductor companies exclusively focused on this still depressed market segment.

When will the recovery come?  I was asked that question during an IEEE Globecom 2002 Business Applications Session on Optical Networks. Almost 10 years later, there is no recovery in site. Does anyone have a guess when the telecom infrastructure industry will see sunny days again?

References:

http://community.comsoc.org/blogs/alanweissberger/weak-global-econcomy-slow-business-china-has-negative-impact-alcatel-lucent-an

http://www.reuters.com/article/2012/07/16/us-zte-shares-idUSBRE86F00E20120716

http://community.comsoc.org/blogs/alanweissberger/huawei-gaining-ericsson-leadership-network-infrastructure-equipment-sales

 

0 thoughts on “Telecom Death Spiral Continues with ZTE's Steep Profit Drop

  1. Well written and thoughtful analysis, Alan. As much I would like it to change, I suspect this “nuclear winter” for telecom vendors is the new normal.

    In the rural markets, in the U.S. at least, there is so much uncertainty that rural operators are cutting back on expenses wherever they can and even slowing investment in infrastructure until there is more clarity. The way the rules are being configured, there isn’t much visibility beyond a year.

    That sort of uncertainty ripples through the vendor community, unfortunately.

    On the flip side, the long-term prognosis has to be good for fiber to the home (and fiber to everything else) vendors. The infrastructure has got to be upgraded over the long-term. How long can 60 year old copper last? And we are still early in the fiber transition, as there is still at least 75 to 80% that needs upgrading in the U.S. to FTTH.

    Perhaps the work Google is doing will help drive other carriers to speed up their FTTH plans. Or, maybe it will take community groups like B4RN to drive fiber deeper:

    http://www.viodi.tv/2012/08/21/fiber-by-the-community/

    1. Thanks Ken. I’m hoping the IEEE members belonging to the ComSocSCV Discussion Group will offer some pockets of opportunity within telecom infrastructure, e.g. equipment business. We’ve heard enough about the move to manage networks & services (Ericsson, Alcatel-Lucent & NSN), but that’s not the core strength of equipment companies.

  2. Excellent write-up Alan. Your analysis unfortunately is very true. For someone like me, having seen the glory days of the Telecom sector, this is very difficult to come to grips with. SDN has the potential to lift the Telecom equipment vendors, but the verdict is not in yet.

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