The Huawei Saga: Hard To Find A Winner

Huawei has been in the news a lot of late but for all the wrong reasons. There seems to be increased concern about the company posing a national security threat, something that has led the government to take constructive measures against it.

What the U.S. Did

It started with President Trump signing a broad executive order invoking the president’s powers under the Emergency Economic Powers Act that allows the president to regulate commerce in a national emergency. The order directs the Commerce Department along with other government agencies to take steps to see that American firms don’t do business with companies that pose national security risk for the U.S.

This was followed by the Commerce Department including Huawei and its 70 affiliates in the “entity list,” which means that it will not be able to buy U.S. components and technology from anywhere in the world.

By late June, the director of U.S. National Intelligence is now required to produce an assessment of risk to the U.S. and critical infrastructure "from information and communications technology or services designed, developed, manufactured, or supplied by persons owned by, controlled by, or subject to the jurisdiction or direction of a foreign adversary."

While concrete evidence of Huawei’s wrongdoing may not be in the public eye, the company has already been charged in January of attempting to steal T-Mobile trade secrets, while both the company and its CFO have been charged with bank and wire fraud violating U.S. sanctions on Iran.

Meanwhile, China Mobile’s attempt to provide telecom services in the U.S. was voted down unanimously by the FCC, which is also reviewing previously granted approvals to China Unicom and China Telecom.

How Huawei Reacted

Huawei’s reaction was two-fold. On the one side, it maintained that it hadn’t done anything wrong and that it was "ready and willing to engage with the U.S. government and come up with effective measures to ensure product security."

On the other hand, it challenged that "it will do significant economic harm to the American companies with which Huawei does business, affect tens of thousands of American jobs, and disrupt the current collaboration and mutual trust that exist on the global supply chain."

Moreover, U.S. companies and consumers would instead be limited to "inferior yet more expensive alternatives,” especially given its strength in 5G and inclusion in the 5G standard.

Its rotating Chairman Eric Xu told Reuters in a recent interview that "in case of unforeseen events ... we definitely have our contingency plan. What we have prepared has already been used in some of our products in the Chinese market."

Speaking along the same lines, Huawei Chief Security Officer Andy Purdy told Yahoo (NASDAQ:AABA) Finance that there must be risk-mitigation measures. On the other hand, the ban would do more harm to U.S. suppliers because the company would be able to maintain its global operations, if not in exactly the same way since it was already selling devices with competing technology in China.

Huawei’s Thursday statement said that the move was "in no one's interest."

How Chinese Government Sources Reacted

The Chinese government has pointed to U.S. protectionism. Foreign Ministry spokesman Geng Shuang said the U.S. was looking to "deliberately smear" and suppress Chinese companies. "We urge the United States to stop using the excuse of security issues to unreasonably suppress Chinese companies, and provide a fair, just, non-discriminatory environment for Chinese companies carrying out normal investments and operations in the United States,” he said.

He added that the ZTE (HK:0763) case has resulted in some "benefits" because "external pressures have developed into internal drivers" in China.

This could also be another thorn the government is pushing in China’s side as a trade deal seems far from done now.

Impact on Huawei

One obvious fallout is of course increased global scrutiny of Huawei products and technology although most countries don’t have a trade war on their hands, so are likely to take a more pragmatic view.

According to a Huawei executive, the negative impact on Huawei if it isn’t able to source from U.S. players is mainly on the server and network side because they already have their own smartphone components. However, it may have to use a stripped down version of Android, we don’t know how that will work.

A Jeffries analyst has reportedly said that Huawei has been building huge component stocks. While the initial target was to build for 6-9 months, inventories for some components are now expected to last 12 months and others, 24 months.

As far as sales are concerned, Huawei caters to 45 of the 50 leading telecoms in the world. In the U.S., its sales are currently limited to a few small rural telecoms that continue to use its switches and other equipment because they are cheaper even after its relations with the U.S. soured. So it has very low exposure.

Jefferies also says that the sanctions would be a "nightmare for China's 5G.”

Impact on U.S. Players

Huawei spent around $11 billion on U.S. components in 2018, part of which may have been spent on its stockpiling efforts. So the annual impact on U.S. suppliers is likely to not exceed $11 billion.

A large number of those suppliers are chipmakers like Broadcom (NASDAQ:AVGO) , Qualcomm (NASDAQ:QCOM) , Intel (NASDAQ:INTC) , Micron (NASDAQ:MU) , Skyworks (NASDAQ:SWKS) and Integrated Device Technology IDTI.

Alphabet (NASDAQ:GOOGL) licenses Huawei value-added components and services that it gives away to its manufacturing partners, so it will be impacted. And that’s not all. If Huawei has to use a stripped down version of Android, it likely won’t have Maps, Play Store and other software that drive Google’s revenue.

Apple (NASDAQ:AAPL) is likely to see an indirect impact as both the Chinese government and nationalistic Chinese people may boycott its products. More importantly, since most of its supply chain is in China, that government may make serious trouble for Apple that could significantly impact its product sales and revenue.

The Rural Wireless Association, which represents carriers with fewer than 100,000 subscribers, estimates that 25% of its members use Huawei or ZTE equipment, as stated in a Federal Communications Commission filing from December. These small players will be impacted.

Impact on Others

Despite the President’s call to allies, Europe is clearly taking a less targeted approach. Rather than singling out Huawei, they are looking to formulate common security specifications that could be adopted across the EU.

Germany and the Netherlands have already made their intentions clear. The Federation of German Industries (BDI) has said that "Europe needs to maintain its own course… Europe must not be dragged into the trade dispute between China and the United States." It called for the German government and European Commission to continue along its chosen path. "German industry quickly needs legal and planning certainty in 5G expansion," the BDI said.

Conclusion

Given Huawei’s position as a leading provider of telecom equipment and smartphones, any sanctions on the company are bound to have far-reaching implications.

As to the justification for the measures taken, as regards treating the situation as a national emergency, we’ll never know for sure until the government tells us a lot more.

Just because the company has apparently not aided Chinese espionage, there’s no reason to think it won’t in the future, if there’s a scope to do it.

The question then is whether that scope actually exists and if it does, what can be done to mitigate the possible harm.

Huawei said that it is in communication with government agencies, but a solution may not be available soon given the tensions around the trade war.

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