TELECOMS: Huawei Declares End to Growth at Any Cost

Bottom line: Huawei’s revenue growth for 2017 is likely to drop by more than half from 2016’s rate of 32 percent as it cuts its money-losing businesses, with the biggest slowdown likely to come in its smartphone unit.

Quality over quantity is a growing theme in China these days, as the nation puts aside its previous pursuit of high growth at any cost in exchange for more sustainable expansion in high-quality areas. After starting at the top in Beijing, that theme is trickling down the corporate food chain to telecoms giant Huawei, whose New Year’s message hints that company growth could slow sharply this year.

Or course everything is relative, since Huawei has just announced preliminary results that show its revenue for 2016 jumped an impressive 32 percent to 520 billion yuan, or a whopping $74 billion. To put things in perspective, its biggest global rival Ericsson (Stockholm: ERICb) is seeing its sales contract, and is expected to post about $65 billion in revenue this year.

We’ll try to put all of this in broader context shortly, since Ericsson and Huawei aren’t exactly an apples-to-apples comparison these days. Unlike Huawei, Ericsson is based in a mature market where companies generally seek business opportunities that are profitable. By comparison, Huawei comes from a Chinese market where growth is far and away king above all else, even if that means sacrificing profits. Ericsson’s costs are also much higher, since the company is based in the pricey Swedish market.

All that said, let’s zoom in on Huawei’s year-end message from its rotating CEO, Eric Xu, which was conveniently distributed to the media, meaning the company wants people to know where its priorities will lie in the New Year. The message kicks off with the headline 32 percent revenue growth figure, which is quite impressive for a company of Huawei’s size. (company announcement; English article)

There’s no breakdown within that figure, but it’s probably safe to say a sizable portion — perhaps up to 30 percent — is coming from the company’s newer consumer business, which is anchored by Huawei’s smartphone unit. That unit is growing extremely fast, but also probably isn’t very profitable due to intense competition and a traditional focus on low-end models.

After the headline number, the big theme of Xu’s New Year’s message quickly becomes more staid, focusing on a shift from pursuit of growth at any cost to a more focused pursuit of quality growth. The headline of his speech points out that the company should pursue “sustainable growth”, hinting that a significant portion of its current growth is coming in areas that are only marginally profitable or even loss-making.

Where’s the Profits?

Xu notes that despite the big sales jump, Huawei hasn’t really achieved any increases in operating efficiency or cash flow. That’s certainly not a good sign, since a 32 percent jump in revenue should theoretically lead to greater scale and efficiencies that would ultimately create greater profitability. Xu devotes much of the rest of his message to tempering expectation for Huawei in 2017, in talk that looks quite similar to what’s coming out of Beijing these days about pursuing slower, higher quality growth over growth at any cost.

Xu singles out a few specific areas for the quality-over-quantity shift, including the company’s consumer business and its representative offices that are mostly focused on telecoms networking equipment. That hints that both of those areas are likely to see sharply slower growth in the next year as they focus on profitability under this new directive. Xu ends the message by noting that “A tree can flourish only when it is deeply rooted in the soil,” implying that Huawei’s current roots are somewhat shallow.

We’ll have to wait and see how exactly Huawei executes this new directive. But it’s almost certain we’ll see a sharp slowdown in revenue growth this year. I expect one of the sharpest slowdowns will come in Huawei’s smartphone business, especially in its extremely competitive home China market. We’re seeing that already, as the company recently lost its market-leading position to up-and-coming rival Oppo. I expect we’ll also see Huawei drop out of many of the less profitable developing markets where it sells its core telecoms networking equipment.

A 50 percent drop in the growth rate could easily be the result of all this, and I would predict the company is probably targeting a revenue expansion of 10-15 percent for 2017. That’s certainly quite respectable, especially when one considers that sales for Ericsson and many other peers are currently contracting. Boosting profit margins is the bigger, though perhaps less loudly stated goal. But Huawei’s progress on that front could be slower due to intense competition in both China and other major markets.