US Senators demand answers from Pentagon for alleged Huawei reprieve

The US Department of Defense has reportedly vetoed plans to further disrupt the Huawei supply chain, seemingly paying attention to the ‘rule of unintended consequence’.

Over the course of the last 18 months, the US Government has effectively been using the economist version of guerrilla warfare to dilute the influence of Huawei and China on the global technology industry. Success has been debatable, though the plan certainly worked on ZTE, and now three US Senators are questioning why the Pentagon has reportedly blocked plans to ramp efforts.

“We write regarding recent public reports that the Defense Department objected to a proposed change to Commerce Department regulations that would have made it more difficult for U.S. companies to sell to Huawei from their overseas facilities,” the Senators wrote.

“Given the national security risks surrounding Huawei’s technology and operations, concerns which resulted in the addition of Huawei and its affiliates to the Department of Commerce’s Entity List in May 2019, we respectfully ask for a member-level briefing on the Department’s rationale for its reported objection.”

Senators Ben Sasse of Nebraska, Tom Cotton of Arkansas and Marco Rubio of Florida, the authors of the letter, are all incredibly vocal leaders of the US aggression towards China. Sasse has been particularly active surrounding the on-going conflict in Hong Kong, while Cotton authored the Bill which would ban US intelligence sharing with Huawei friendlies, and Rubio has attempted to use legislation to extinguish the hope of any exemptions to the Entity List.

The latest twist in this saga concerns efforts from the US Commerce Department to further impact the Huawei supply chain. As it stands, US suppliers can work with other Huawei suppliers, as long as US components do not make up more than 25% of the product. The new rules would see this number reduced to 10%, potentially spelling disaster for the Huawei supply chain.

But it seems the Department of Defense are taking a much wider view of the move than the Department of Commerce. The Pentagon is worried about how this ban would impact sales for US businesses, potential job losses and the sums which can be redirected towards R&D to ensure the US technology industry remains cutting edge.

This is potentially the ‘law of unintended consequence’ in action. Although there is no official confirmation from the Pentagon that it did indeed block the Department of Commerce, the Senators are attempting to bring the saga into the public domain.

What has largely been ignored to date is the impact of the Huawei offensive on the fortunes of US businesses. In the immediate aftermath of Huawei entry onto the Entity List, the share price of several companies was hit hard. Micron Technologies was one such firm, and in a recent earnings call, quarterly revenue were reported down 43% year-on-year. Qualcomm, Xilinx, Skyworks Solutions, Qorvo and Neophotonics are only a few of the companies who have skin in the game.

The US strategy to combat Huawei is seemingly having more of an impact on US firms than it is the intended target. It might seem like an unpopular move to block increased aggression against the Chinese vendor, but it might will be the most logical decision.

There are a couple of points worth considering. Firstly, what impact is the strategy having on US companies. Secondly, what impact is the strategy having on Huawei. And, what are the potential secondary and tertiary consequences of the initial impacts.

Firstly, several US technology companies are suffering due to the ban. Secondly, Huawei is continuing to report year-on-year financial growth, therefore negative impacts are arguably limited. But the most interesting element of this story are the consequences because of the action to date.

In being unable to work with US suppliers, Huawei has been forced to look elsewhere, in most cases to Chinese suppliers, or create its own alternative. HiSilicon, the Huawei-owned semiconductor company, has likely been offered greater importance, while the firm is also creating an in-house alternative to the Android mobile operating system. Where Huawei can’t replicate products on its own, the Chinese ecosystem will benefit.

Not only are revenues being deprived from US suppliers, Huawei is removing reliance on an international supply chain while also driving more R&D funds to Chinese companies. China’s technology industry could be viewed as getting a boost, while the US influence is diluted. Arguably this is only because of US aggression towards Huawei.

This is all a very theoretical argument of course, and the chances of success or failure depend on the ability of Huawei to replicate the performance and efficiency of the US components of its supply chain. But it is a potential outcome which few have seemingly been paying attention to.

Micron expects up-tick after Huawei licence application win

US semiconductor firm Micron Technologies has said it expects a greatly improved 2020 after US authorities granted the firm a licence to trade with its largest customer, Huawei.

Although Micron was not one of the worst impacted firms following the decision from the Government to ban any US company from working with Huawei, the firm’s earnings call in September showed the damage. Revenues for the final reporting quarter of 2019 stood at $4.87 billion, down 43% from the previous year. Being unable to trade with Huawei was a major contributor to this downturn.

During the September earnings call, CEO Sanjay Mehrotra said the situation might get worse, though with the new licences being granted, the team is optimistic once again.

“As previously disclosed, we are continuing to ship some products to Huawei that are not subject to Export Administration Regulations and Entity List restrictions,” Mehrotra said this week.

“We applied for, and recently received, all requested licenses that enable us to provide support for these products, as well as qualify new products for Huawei’s mobile and server businesses.

“Additionally, these licenses allow us to ship previously restricted products that we manufacture in the United States, which represent a very small portion of our sales. However, there are still some products outside of the mobile and server markets that we are unable to sell to Huawei.”

This is major news for Micron. Across the financial period for 2019, sales to Huawei accounted for 12% of total revenues. There are firms who are significantly more dependent on Huawei as a customer, though any accountant will tell you that losing a customer worth 12% of total revenues is a devasting impact to the spreadsheets.

Looking at the financials for the latest earnings call, total revenues stood at $5.1 billion, up 6% sequentially, but down 35% in comparison to the same period of 2019. This is unsurprising considering the situation, though it will get better. Lost revenues will not be recovered immediately, new products need to be qualified with Huawei’s mobile and server businesses prior to contributing to revenue, but that is the only dampener here.

The next three months are traditionally the weakest for Micron throughout the year, though CFO David Zinsner expects recovery to begin in the third quarter of 2020. This is when the renewed relationship with Huawei will start to show on the spreadsheets.

Although the trade conflict between the US and China is still raging on, Micron will be hoping this will be the end of the collateral damage impacted by the US Government. Theoretically, this nightmare is in the rear-view mirror for Micron.

Creating a competitor will only help us – Huawei CEO

In the latest edition of ‘A coffee with Ren’ the Huawei founder graced a wide range of topics from data protection to 6G, but perhaps the most important area was the licensing idea which has been floated.

It is an interesting thought. Huawei founder Ren Zhengfei is prepared to license the technology which has fuelled the vendors drive towards the top of the connectivity ecosystem, to create a competitor. And just any competitor, one from the US, the very country which is driving the misery and headaches in Shenzhen.

For some, actively creating a competitor might be considered somewhat of a risk, but this is not how Ren see things.

“First, we will get a lot of money from the licensing,” said Ren. “That will be like adding firewood to fuel our innovation on new technologies. It will mean that we will have a better chance of maintaining our leading position.

“Second, we will bring in a strong competitor. This will prevent our 190,000 employees from becoming complacent. They’ll know that if they sleep on the job, they might wake up and find they have lost their jobs.

“Sheep become stronger when they are chased by wolves. I don’t worry that a strong competitor will emerge and drag Huawei down. In fact, I would be happy to see that, because this would mean that the world is becoming stronger.”

This might sound like a corporation putting a brave face on an uncomfortable situation, but there is some logic to it.

Ren has suggested the new competitor should probably be a US firm, as Europe already has its own vendors in this space. This presents a very interesting opportunity for Huawei. Presumably, a US vendor would have an excellent opportunity to secure valuable contracts with US telcos. If you have a look at the vendors activities in their own domestic markets, they are generally very successful.

Should this presumption prove accurate, Huawei won’t be making money directly from the US market, but through license fees, it will secure indirect revenue. The more successful this company is, the more revenue Huawei can realise through licensing.

The US is an incredibly large and lucrative market for network infrastructure vendors and Huawei has been almost non-existent to date. It might have secured contracts with some of the regional telcos, but these are not the riches which are promised in the ‘Land of the Free’. Huawei will be making money somewhere it has never really made money before. Suddenly, the licensing plan starts to look like an understated but clever move.

The technology will be licensed to the exclusive partner on fair, reasonable and non-discriminatory (FRAND) terms, with the team offering everything associated to 5G. That means software source codes, hardware designs, production technologies, as well as network planning and optimization and testing solutions, as well as chip design technology.

Although the company which undertakes this license will go toe-to-toe with Huawei on a technology basis, it will also have to prove it can support customers in the same way.

One of the reasons Huawei has been a success in recent years isn’t simply down to the technology. CTOs and network executives have noted to us that the support offered to customers post-sale sets the vendor apart, while the team is more open than most to consider customisable solutions to meet the unique demands of each vendor. This attention to detail is one of the reasons Huawei is perhaps considered the leader in the market.

Overall, this is of course a way to ease the tension between the White House and Huawei. We suspect this will not have much of an impact on the overarching trade-war between the two global super-powers, however that is of little concern to Huawei. This is a commercial organisation. It matters little if there is political conflict overhead, just as long as the company is not drawn into the saga.

The big question which remains is whether this will appease the aggression of the US.

The attraction of gaining more traction in the network infrastructure space might well be a tempting offer to disperse the aggression. The US is a company which wants to control the 5G ecosystem after all, as does pretty much every country. This is perhaps one of the contributors to the tension between the US and China.

As Ren pointed out during the coffee session, the saga does need to be resolved before more powerful technologies are being discussed in wider society.

“5G is not that amazing; its power is exaggerated by politicians,” said Ren. “AI will have an even brighter future. I hope we will not be added to the Entity List again in the AI era.”

Huawei is not the biggest and best software company around (just yet) therefore we cannot see the company taking a lead in the AI-era. It’s heritage and excellence primarily lie in the hardware, however it is a risk should the tension continue to remain at a stalemate between the two global superpowers.

Skyworks financials reveal the cost of working with Huawei

Mobile chip maker Skyworks solutions has released its financial results for the third quarter of 2019, with a $127 million hole in comparison to the same period of 2018.

In most circumstances, a 16% drop in revenues for a three-month period would send the office into meltdown. Executives and shareholders will of course not be thrilled, but this downturn was expected by pretty much everyone involved; this is the cost of doing business with Huawei.

As you can see from the table below, there are certainly some numbers which will cause a persistent twitch.

Q3 2019 Q2 2018
Net revenue $767 million $894.3 million
Gross profit $312.5 million $442.7 million
Net income $144.1 million $286.5 million
Earnings per share (Basic) $0.83 $1.58

What is worth noting is that there are factors contributing to this downturn outside the Huawei saga. Semiconductor sales across the world are in a trough currently, the Semiconductor Industry Association (SIA) unveiled quarterly figures earlier this week, with the global smartphone shipments impacting financials everywhere.

Perhaps due to a lack of innovation in the smartphone arena or consumers afraid of purchasing new devices with a new ‘G’ on the horizon, shipments have declined. History suggests this is cycler, though the depressed states of affairs can also be contributed to Huawei business.

Skyworks solutions is one of those businesses which is in a somewhat difficult position. There might a brief reprieve for those working with Huawei, though the damage has clearly been done.

In entering Huawei onto the Entity List, effectively banning any US company from working with the Chinese vendor, President Trump released a wave of collateral damage. Skyworks was not one of the worst effected, though as you can see there clearly is friendly fire from the White House.

During last years Annual Report, Skyworks told investors Huawei was one of three firms which accounted for more than 10% of annual revenues. With a third of generated revenues being attributed to three companies, this is not the healthiest position, but in the smartphone segment it is largely unavoidable; there aren’t than many manufacturers after all.

Interestingly enough, while the firm did beat market expectations, this does not seem to have diluted fears from investors.

The management team has greenlit a 16% increase of dividend payments, while there is hope it might be able to continue work with Huawei, but investors are seemingly voting with their feet. At the time of writing, share price declined by almost 7.4% in overnight trading.

This is not a firm which will cease to exist because of these negative events, however it is wounded right now. Huawei is a massive customer for the team and an account which was only getting more profitable as Huawei grew its global smartphone market share. This is not the beginning of the end, but it doesn’t make for the most comfortable reading.

Industry quietly lobbies against Trump’s anti-globalisation agenda

Slowing down the progress made by Huawei on the global stage might be a win for the White House, but US firms are not seeing the benefits as some are reportedly lobbying against the infamous ban.

In a televised interview this morning, Huawei Founder Ren Zhengfei suggested sales forecasts will be negatively hit by the firms debut onto the US ‘Entity List’, taking two years to get back onto the 2018 trajectory. For the White House, this might be vindication of its aggressive anti-Huawei agenda, but not everyone is happy about how events are unfolding.

According to Reuters, US semiconductor firms are quietly lobbying the US Department of Commerce in an attempt to limit the negative impact of the ban. Let’s no forget that while the White House might seem against globalisation trends right now, the success of these firms is largely based on the idea of free-trade and capitalising on the rapid evolution of international markets.

The issue which these firms face is one of commercial loss and gain. Huawei is one of the industry’s biggest consumers of semiconductor products, with the firm rumoured to spend roughly $20 billion a year on such products. When you look at the impact on some firms, you can see why the semiconductor industry is getting a bit twitchy.

Last week, Broadcom lowered its sales forecast for the year by $2 billion, pointing towards one of its customers being caught up in an international trade-war. Although Broadcom has not explicitly stated how much of the total revenues are attributable to Huawei, firms are only compelled to do so when it is more than 10% of the total, the numbers would suggest it is not far off that percentage.

And Broadcom is not alone on relying on Huawei as a customer. Qorvo depends on Huawei for 11% of its total revenues, while Lumentum has said Huawei accounted for 18% of all shipments during the last quarter. As a result, Lumentum’s sales forecast is now $30-35 million less for the year. Xilinx is another chipmaker which has been impacted by the ban on selling components to Huawei, and there are others as well including Intel and Qualcomm.

As a result, numerous lobbying efforts are reportedly being held behind closed doors to mitigate the impact. This might be exemptions or the creation of loopholes, but the friendly-fire is quite notable in this segment.

What is worth noting is that there are other lobby efforts going on also. Google is rumoured to be in active conversations, suggesting its operating system Android should be exempt from the ban on the grounds of national security. Google is arguing that should it be banned from working with Huawei, it would not be able to provide timely security updates which could make the devices vulnerable to hacking and data breaches.

However, there is a commercial angle to all of these arguments which might gain more traction in the minds of the government puppeteers.

At Google, the firm has a dominant position in the OS market. Huawei’s alternative OS might not be able to dislodge this position, but it does have a significant domestic market to drive user adoption. If a suitable alternative to Android emerges from the Chinese telco flagbearer, it would not be unimaginable to see mass adoption in the Chinese market. Once it has domestic domination, it would not be unusual to see international expansion to the China-friendly nations. This would potentially erode Google’s influence on the world.

In the semiconductor space, the risk is of the emergence of a homegrown Chinese-semiconductor industry.

This is not to say China does not already have a presence in the semiconductor space but forcing Huawei away from the US could be the catalyst the slumbering sector needs. Companies like Shenzhen Fastprint Circuit Technologies and Jiangsu Changjiang Electronics Technologies have been making financial gains in recent months, both in terms of revenues and share price, while Huawei’s HiSilicon has also been ramping up.

The US is dominant in the semiconductor market and will probably continue to be. There is a gap in competence for core technologies in the Chinese segments to eclipse this position, though the risk is erosion of profits. The more competitors there are on the market, the lesser the market share for US firms. This assumption might well be exaggerated when you consider the preference of Chinese firms for a homegrown supply chain.

For the semiconductor industry, this should be seen as a red-flag. The Semiconductor Industry Association (SIA) has already suggested the industry is in a bit of a slump at the moment, with sales for April down 14.6% year-on-year. The SIA does have international members, though its biggest role is to represent the interests of US manufacturers. The last thing these firms need right now is more bad news when the market is already dampening.

The result of this friendly-fire is conversations behind closed-doors. The Trump administration is seemingly trying to dilute the influence of China on the rest of the world, though it appears to be having the same impact on some US firms. We’ve said this before, but the result of this trade-war seems to be nothing by a net-loss globally right now; no-one is winning, and it seems to be a matter of damage limitation.

What the White House should be wary of is whether this anti-China agenda is starting to look like a personal vendetta for the President. If there is notable damage to US firms as well as Chinese, the White House must question whether the current strategy is the most effective.

Is ‘Make America Great Again’ is the motto of the White House, it would be useful for the rest of us to understand how much friendly-fire will be tolerated in the quest to destroy the Silk Road.