ZTE: Yet Another Probe as Profit Tumbles 中兴通讯又遭调查
Embattled telecoms equipment maker ZTE (HKEx: 763; Shenzhen: 000063) is probably starting to feel like an ailing hospital patient, following word that it’s coming under yet another investigation in what seems like a never-ending stream of probes by western governments. The recent investigations and other setbacks in both North America and Europe are taking a growing toll on ZTE’s bottom line, with the company warning that its profit dropped sharply in the second quarter and may have even disappeared completely.
Let’s look first at the latest investigation, which has the US Federal Bureau of Investigation, better known as the FBI, probing ZTE for potentially illegal sales of US computer equipment to Iran. (English article) According to a media report, the US-made equipment at the center of the investigation was part of an earlier sale of a powerful surveillance system by ZTE to Iran’s largest telco.
The US has been discouraging other companies from doing business with Iran as it tries to isolate the country economically due to concerns about its nuclear program. As part of that effort, Washington has made the export of high-tech US equipment to Iran illegal, and it appears the FBI is investigating whether any US law was violated by the inclusion of US-manufactured equipment in ZTE’s surveillance system that it built for Iran.
This investigation is just the latest directed at ZTE and Chinese rival Huawei, which have been subject to various probes by the US and other western governments over concerns that their telecoms networking equipment could be used for spying by Beijing. The pair are also being investigated by the European Union over claims that they receive unfair government subsidies from Beijing.
If this latest FBI investigation wasn’t bad enough, ZTE itself also warned late last week that its profit tumbled in the first half of the year, as it blamed factors like slowing investment income and narrowing profit margins for the sharp drop. (company announcement) The company only said that its first-half profit would be down 60-80 from a year earlier, without providing more specifics.
But based on my own calculations using its previously released first-quarter data, the company’s second quarter profit tumbled about 90 percent, marking a sharp reversal from its 19 percent profit growth in the first quarter. Based on its profit forecast, the company could even report no profit at all in the second quarter if its final figures come in at the bottom end of its forecast.
ZTE’s profit growth had already been slowing sharply, but this sudden and steep drop is clearly an alarming development. Investors dumped ZTE stock the day after all the bad news came out, with the company’s Hong Kong-listed shares dropping 16 percent while its Shenzhen-listed shares fell 10 percent.
The share reaction is probably slightly exaggerated and I suspect the company’s rapid profit erosion is at least partly due to one-time factors like currency movements and investment income rather than solely due to deteriorating business. Still, the broader trends certainly don’t look good for ZTE over the mid-term, as it’s unlikely to get much new business for its networking equipment unit from the US or Western Europe until government probes in those 2 lucrative markets end.
In the meantime, the company’s recent push into the low-end smartphone space will continue to erode profits, as it sells those phones at low margins in a bid to gain market share. With all that turbulence in the air, look for ZTE’s profits to remain at depressed levels for at least the next year, with the very real possibility that it could even sink into the red before its situation starts to stabilize and improve.
Bottom line: A US government probe and a profit warning by ZTE reflect an ongoing state of crisis at the company, whose situation is likely to remain depressed for the next year or longer.
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