Even With New Deal, ZTE Is Damaged Goods

Security and reputational concerns surrounding ZTE hard to dispel
By Fan Yu, Epoch Times
June 9, 2018 Updated: June 10, 2018

NEWS ANALYSIS

The Trump administration reached a deal with Chinese telecom equipment maker ZTE Corp. to lift a ban preventing the company from purchasing U.S. equipment in exchange for a hefty fine.

While the deal allows ZTE to resume production and avoid going out of business in the near term, it’s not entirely out of the woods. ZTE faces stiff headwinds from unconvinced U.S. lawmakers and a damaged commercial reputation that make it difficult for the company to return to its former prominence.

Under the deal, announced by U.S. Commerce Secretary Wilbur Ross, ZTE must pay $1 billion in penalties and put another $400 million in an escrow account to cover future indiscretions. In addition, the company has to replace its board of directors and top management within 30 days, and submit to oversight from a U.S.-selected compliance team. The company will also incur a new, 10-year ban on purchases of U.S. telecom equipment if it is suspected of future violations.

ZTE initially pleaded guilty in March 2017 to violating U.S. trade embargoes by purchasing U.S. components, installing them in its telecom hardware, and illegally selling that equipment to Iran. Despite paying $1.2 billion settlement in that case, the company again ran afoul of regulators in April 2018, when it was caught violating sanctions on Iran and North Korea.

This second violation—which occurred in the midst of crucial trade talks between the United States and China—elicited a ban on procurement of U.S. supplies that were crucial to ZTE’s manufacturing. This caused ZTE to halt production entirely, leaving the fate of the company and its 75,000 employees in the balance and thrusting the company’s future to the forefront of U.S.-China bilateral trade negotiations.

Difficult Road Ahead

The power the United States is able to exert over foreign companies—even those located in countries that do not impose U.S. sanctions—is remarkable and underscores the importance of the U.S. dollar in global trade and U.S. semiconductor components which underpin the entire global telecom industry.

“We still retain the power to shut them down again,” Ross said during a June 7 interview with CNBC.

Financially, ZTE appears to be able to withstand the new fine. As of March 31, it had 26.9 billion yuan (US$4.2 billion) of cash and short-term securities on its balance sheet.

But even with the component sales being lifted, it would be difficult for ZTE to return to its former prominence. As of the end of first quarter 2018, ZTE had an 11 percent smartphone market share in the United States, good for fourth place behind Apple, Samsung, and LG, according to Counterpoint Research.

ZTE became the first Chinese state-owned telecom company to go public in 1997. But even before recent sanctions, its status as a global leader in smartphone sales had been slipping. Since being named the world’s No. 4 smartphone maker in 2012, its global share has been eclipsed by domestic Chinese rivals, including Huawei, Xiaomi, and upstarts Oppo and Vivo.

As of today, ZTE’s smartphone shipments have completely halted, and it could take months for ZTE to ramp up production and ship phones again. In addition, employees will be left in the lurch while fearing furloughs and wage cuts as the company replaces its senior management.

It also faces concerns in getting new contracts, especially from businesses and governments outside of China, where its reputation has been tattered.

“When telecom companies buy infrastructure equipment, they need to feel assured that the company will be around in a few years to maintain that equipment,” Dan Wang, a technology analyst at Gavekal Dragonomics, told the Financial Times in a June 8 report.

“The fate of ZTE has taken many twists and turns, and that increases uncertainty for buyers.”

The price of ZTE’s bonds due in January 2020 crashed to 93.78 on June 8 from more than 101 as recently as mid-April.

Major Security Concerns

Despite a new deal, prominent members of the U.S. Congress—from both parties—remain unconvinced that ZTE should be granted a reprieve.

The concerns don’t stop at violations of sanctions.

ZTE, like its domestic rival Huawei, poses national security threats. Chinese telecom equipment makers are believed to have built-in “backdoor” access allowing the Chinese Communist Party (CCP) the ability to inject malware into the systems in order to spy on and hack against American business and government. The concerns have become acute as China has become a rival to America on the global stage in technological and military capabilities.

Earlier this year, The Epoch Times reported that U.S. military bases stopped selling phones manufactured by Chinese equipment makers. “Huawei and ZTE devices may pose an unacceptable risk to [Department of Defense] personnel, information and mission,” said Pentagon spokesman Major Dave Eastburn in April.

Several U.S. senators announced on June 7 plans to introduce a new bill to restore sanctions on ZTE. “Huawei and ZTE pose a serious threat to America’s national security. These companies have direct links to the Chinese government and Communist Party,” said Sen. Marco Rubio (R-Fla.). “Their products and services are used for espionage and intellectual property theft, and they have been putting the American people and economy at risk without consequence for far too long.”

Among the risks of intellectual property theft is the global technological race for dominance in 5G mobile network technology. The CCP’s latest Five-Year Plan mandates a broad commercial launch of 5G networks in China by 2020, and both ZTE and Huawei are integral players in China’s ability to reach that milestone.

China is currently the global leader in 5G readiness, followed by South Korea, according to an April study by CTIA, a trade association representing the U.S. wireless industry, which argues for greater government involvement in promoting U.S. R&D into 5G wireless technologies.

An internal Trump administration memo dating back to the beginning of 2018, obtained by Axios, outlines the administration’s own concerns around the build-out of a 5G mobile network and, specifically, competition from China. In the memo, certain National Security Council officials argued for a plan in which the U.S. government leads the deployment of the network and leases bandwidth to major mobile carriers.