FCC Bans Subsidies For Huawei, ZTE Kit: Will Others Benefit?

The Federal Communications Commission (“FCC”) has formalized a key proposal issued last year that could further complicate the negotiation process for a consensus relating to the ‘Phase One’ deal between the United States and China. With a unanimous 5-0 verdict, the telecom regulatory authority has prohibited the use of federal subsidies by small and rural carriers to buy equipment from Chinese telecom goods manufacturer Huawei and ZTE (HK:0763) on national security grounds.

This is likely to inflict a severe blow to both the firms and create new business opportunities for other telecom equipment manufacturers like Nokia (HE:NOKIA) Corporation (NYSE:NOK) and Ericsson (BS:ERICAs) (NASDAQ:ERIC) . With the industry on the cusp of a nationwide commercial deployment of 5G technology, it appears poised to witness a major upheaval as the sector demographics are likely to be redrawn.

Seeds of Mistrust

The United States has long suspected Huawei to be an extension of China’s government due to the close ties of its founder with the military. Moreover, the fact that Huawei products are remarkably cheap owing to the huge subsidies by the government to undercut other 5G equipment manufacturers has perennially evoked a feeling of mistrust. Jim Lewis, a cybersecurity expert with the Center for Strategic and International Studies, observed, “… the Chinese government is not paying hundreds of millions of dollars to build another country’s telecom infrastructure because they admire its cuisine.”

Fallouts

In May 2019, the Trump administration signed an executive order to declare national emergency in order to thwart any attempts of cyber espionage. It effectively barred U.S. firms from either buying or selling any telecom equipment to firms like Huawei that are deemed to pose national security risks. The directive triggered a chain of events by first invoking the International Emergency Economic Powers Act, which bestowed the President with the authority to regulate commerce in view of the national emergency, followed by the enforcement action by the Commerce Department.

After the White House passed the order, the U.S. Commerce Department immediately added Huawei along with 70 of its affiliates to the Entity List – a list of entities that are ineligible to receive any item without government approval. Huawei was also charged by the U.S. Justice Department with a 10-count indictment, accusing it of stealing robotic technology from T-Mobile US, Inc. (NASDAQ:TMUS) to test smartphones’ durability. The indictment traced its roots to a civil suit filed by T-Mobile in Seattle District Court in 2014, in which it accused Huawei of stealing trade secrets at the behest of the R&D team based in China. Although the case was settled with a $4.8 million compensation to T-Mobile in 2017, it appeared that the Trump administration would leave no stone unturned to ban Huawei from the country.

A bipartisan group of lawmakers has also released draft legislation to get rid of low-priced telecommunications equipment manufactured by Huawei, ZTE and other Chinese firms by proposing to offer $1 billion to small and rural carriers with less than 2 million subscribers. The move is in sync with the new FCC program dubbed ‘Find it, Fix it, Fund it’ to provide rural telecom carriers adequate funds to self-assess networks and identify ‘suspect equipment’ that could siphon off data. Initially, FCC intends to allow the equipment to stay within the network after being quarantined, but plans to rip and replace it in the long term. With the formalization of the policy to bar the use of U.S. telecommunications subsidies to buy telecom equipment from firms that pose national security threat, FCC has presently sought to form a comprehensive policy to safeguard national interests.

Is the Caution Necessary?

The superfast 5G networks are widely expected to facilitate the transfer of a larger pool of data, making them more vulnerable and prone to cyber theft. 5G is also likely to result in $12.3 trillion of global economic output by 2035 (per data from research firm IHS Markit). Critics contend that countries could go to any extent to gain a greater pie in this trillion-dollar market in order to have a political, economic and technological advantage.

The U.S. government officials are devising ways to better encrypt communications to thwart snooping attempts. In addition to robust communication networks through anti-spying mechanism tools, the Homeland Security Department has launched a supply chain initiative to secure the telecommunications and other key industry sectors. The Pentagon is also reportedly working on ways to segregate vital communications to eliminate the risks from compromised networks.

Road Ahead

With strict government restrictions in place for Chinese telecom equipment manufacturers, several small rural U.S. telecom carriers are considering to tap its rivals Nokia and Ericsson to replace their banned equipment. However, negotiations to switch from low-priced components to pricier alternatives are likely to be fruitful only when the Congress approves the subsidies for the changeover.

Nevertheless, the turn of events has likely offered a golden opportunity to other telecom equipment firms to fill the void and strengthen their position in the market, thereby augmenting top-line growth.

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