Huawei's search for growth

Staff Writer
21 May 2008

Hold the front page! Bain Capital and Huawei have called off their bid for 3Com.

The only surprise of that episode was that those unlikely partners persisted so long. Just as the Chinese government would never allow Cisco to run network security for the PLA, the Americans had no intention of letting Huawei near the Pentagon. Distrust across the Pacific runs as deep as the sub sea cables Huawei is now building.

Yet Huawei's determined pursuit of 3Com tells a story in itself.

Narrow telco gear market

H3C, 3Com's China subsidiary in which Huawei was once a partner, sold US$1.14 billion in equipment to Chinese businesses in its first full year. It's believed to be the only profitable division in 3Com, which not so long ago was Cisco's prime competitor in the networking space.

Privately-held Huawei does not disclose any financial details, other than its raw sales figure, which last year topped $16 billion. We know that the vast bulk of that came from carrier customers.

But the telecom gear market is a narrow one dominated by a handful of big buyers with an uncertain outlook. Once past the spike in demand for 3.5G-4G and NGN gear, demand will plateau, so it makes sense to broaden the customer and product base.

We can't know much more about Huawei's business, but cross-town rival ZTE, listed on the Shenzhen and Hong Kong exchanges, has just released its annual results. It's worth comparing ZTE's numbers with those of two of its largest competitors-Swedish-based telecom vendor Ericsson and US IP networker Cisco.

Both ZTE and Huawei are closer to a traditional telco gear-maker like Ericsson than a data and IP vendor like Cisco, but Cisco is a useful benchmark because it has a strong enterprise business.

ZTE last year posted a gross profit of 11.4bn yuan on sales of 34.8 billion (US$4.94 billion). Revenue was up a whopping 49.8% but apparently at the expense of margins; the gross margin fell to 32.7%, down from 66.2% in 2006 and 64.9% in '05.

Showing the strains
In raw sales Cisco is roughly seven times the size of ZTE. Over the second half of last year it recorded a handsome 64.5% margin on $19.39 billion sales. Until last year ZTE was seeing similar kinds of fat margins-not bad for a company that is supposed to be a price predator.

But one difference is geographical. Cisco derives 55% of revenue from its home market. But like Huawei, most of ZTE's sales came from abroad-as you'd expect from price-competitive firms focused on emerging markets.

Ericsson's business is more evenly dispersed geographically, but its P&L is showing the strains of flattening demand for wireless networking gear. Revenues were flat in Q4 and grew 4% for the full year. Gross margin shrank two points to 39.3%-although still seven points above ZTE.

But the big differentiator between the three is in services. Services delivered 16.3% of Cisco's sales in 2007 (up 21%), and 22.8% of Ericsson's (up 16%).

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