ZTE Bounces Back On Bumpy Recovery
Embattled smartphone and telecoms equipment maker ZTE (HKEx: 763; Shenzhen: 000063) is all over the headlines today, led by word that the company has strongly bounced back into the black after a major restructuring to cut costs and realign its businesses. ZTE also announced aggressive sales targets this year for its fast-growing smartphone business, which it hopes will offset much slower growth for its older networking equipment unit. But the upbeat news was partly offset by word that the US is launching a new probe into ZTE and several other smartphone makers, after a US company filed a patent infringement complaint.
I doubt the US investigation will have a major impact on ZTE, which is vying with a number of Chinese rivals for a piece of the lucrative but highly competitive global smartphone market. And while these latest numbers do indeed look promising, I’m still far from convinced that all the cost cutting and organizational changes will help ZTE return to long term profitability. That’s because at the end of the day, long-term growth and profits depend on good products, and I’m not sure if ZTE’s smartphones and networking equipment have found the right formula yet to compete in the fiercely competitive marketplace.
While the longer term still looks cloudy, the shorter term certainly looks much better for ZTE, which said it expects to post a profit of 1.2 billion yuan to 1.5 billion yuan ($200-$250 million) for 2013, versus a loss of 2.8 billion yuan in 2012. (company announcement) That would be a sharp improvement for the company that posted a net loss of 666 million yuan in the first 9 months of the year, which included extraordinary items. It’s not clear if the latest full-year figure also includes those extraordinary items, but either way the result looks like a huge improvement for the company.
ZTE attributed the turnaround to improved efficiencies following its year-long restructuring, which included the recent formation of separate enterprise and mobile device units to reflect its new focus on those 2 areas. (previous post) As part of its new consumer and enterprise focus, ZTE said it is aiming to boost its smartphone sales by about 50 percent this year to more than 60 million units versus the 40 million-plus sold in 2013. ZTE’s newly named smartphone head Zeng Xuezhong said his company aims to become the world’s third largest smartphone seller by 2016, and that it will see the biggest growth this year in its home China market.
While all that news looked upbeat and bullish, ZTE did get a bit of bad news with word that the US International Trade Commission (ITC) is opening an investigation into the company for patent infringement. The investigation came after US company Pragmatus Mobile complained of the infringement in December, accusing ZTE, Nokia (Helsinki: NOK1V), Sony (Tokyo: 6753) and Samsung (Seoul: 005930) of all illegally using its intellectual property. (English article; Chinese article) As I’ve said above, I doubt this complaint will become a major issue for ZTE, which may incur some slightly higher costs as it tries to settle the matter privately.
Instead, the bigger issue for ZTE will be finding a road to sustainable profits, which means making products that can compete with global rivals. The company is quite reliant on low-cost manufacturing for its networking equipment business — a competitive advantage that will be hard to maintain over the long term as China’s living standards continue to rise. Meantime, its smartphone brand is largely unknown outside China, even though it sells big volumes of phones through partnerships with local carriers in many major western markets. That doesn’t sound like a formula for success to me, and we’ll have to see some major shifts in both of those equations before I’ll become convinced of ZTE’s long-term growth potential.
Bottom line: ZTE’s recent restructuring will help the company’s profits over the short term, but it needs to improve its products and brand awareness to maintain long-term growth.
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