ZTE Trade Ban Adds to China Malaise

SHENZHEN, CHINA -- This week, a handful of communications components firms were blindsided by the news that the United States Department of Commerce (DOC) announced they are banning U.S. companies from selling components to Chinese tech company ZTE. Some U.S.-based components companies saw their share fall by 5-20% in the threat of losing substantial portions of their revenue.

Here at the Huawei analyst event, the news added to the malaise over an already strained trade relationship between the United States and China. So far, the DOC action has had far more impact than mere rhetoric and threats of tariffs, as the ban puts a crimp on major parts of ZTE's business and trade with partners and had instant ramifications on revenue and market capitalizations.

The shares of chip and components players ranging from Qualcomm (QCOM), Acacia Communications (ACIA), and Oclaro (OCLR), to name several of the companies, were hit broadly this week. While Qualcomm, which is a supplier to ZTE, lost only a few percentage points of value, smaller vendors such as Acacia had more significant hits. Acacia immediately lost 20% of its share value on Monday morning when the news was announced and is down 35% this week.

Wall St. and industry analysts have scrambled to evaluate the impact, which could take on many scenarios, though the consensus seems to be that the issue will be resolved with a settlement in the next year. The move is expected to cost components firms hundreds of millions of dollar in lost revenue.

The DOC has focused on ZTE allegedly selling equipment into Iran and other embargoed countries using chips and components from U.S.-based companies. Although ZTE settled a prior investigation with the U.S. government last year, paying a $900 million fine and dismissing four employees, the DOC apparently feels dissed, saying the company has not followed up with promised adjustments. Commerce Secretary Wilbur Ross told the media this week that "ZTE made false statements to the U.S. Government when they were originally caught and put on the Entity List, made false statements during the reprieve it was given, and made false statements again during its probation.”

In short, the DOC feels like it was misled and has doled out new punishment. That includes a 7-year ban on sales by U.S. companies to ZTE for violating these continuing terms of the sanctions violation case.

Some takeaways:

• U.S. based optical components manufacturers have received the brunt of the puishement. some of those affected include Qualcomm, Oclaro, Finisar (FNSR), and Lumentum (LITE). Oclaro has the most significant share with an estimated 17% of its revenue coming from ZTE, according to Jefferies.
• Some U.S.-based optical systems companies may benefit. Some analysts have pointed out that optical systems companies that compete with ZTE, such as Ciena (CIEN) and Infinera (INFN), may benefit from the ban. Infinera shares have rallied 10% this week.
• Could the ban be short-lived? Even though optical components vendors were hit hard, several analysts have pointed out that most of the industry expects the ban to be short lived, as ZTE scrambles to fix the issue because it is dependent on many U.S.-based suppliers
• Could there be retaliation and would that be bad for Cisco? Jefferies analyst George Notter pointed out in a research note pointed out that when trade tensions between China and the United States escalated in 2012, Cisco's (CSCO) Chinese revenue fell. Overall, the share of Cisco's revenue dependent on China has falled from 7% to 3%.

Overall, the DOC action adds to the general malaise about business between Chinese and American companies, whose supply chains are intricately interlocked. While China is looking boost domestic business, it's clear that companies such as ZTE still have a large reliance on American chips. The increasingly hostile actions and rhetoric and the United States, meanwhile, have raised concerns about trade for American companies.

There are many layers of the ongoing tensions. For example, Qualcomm is still waiting for regulator approval in China for its $44 billion takeover of NXP Semiconductors, which is key to its strategic move into automobile markets. Some experts have speculated that the Chinese is withholding approval of that deal because of escalating tension with the U.S. government.

The ZTE action may be an indication that even though short-term calm has returned to financial impact, the trade tensions appear to be a simmering issue that could have sudden negative repercussions for many technology companies