PolITIcal aTTacK oN cHINESE FIRmS

Political factors wield decisive influence in excluding Chinese telecom providers from the American market By Lan Xinzhen

PolITIcal aTTacK oN cHINESE FIRmS

Political factors wield decisive influence in excluding Chinese telecom providers from the American market By Lan Xinzhen

Perhaps sattled by a report from the House Permanent Select Committee on Intelligence, claiming that “Huawei and ZTE (Zhongxing Telecommunication Equipment) threaten U.S. national security,” Huawei, the second largest telecomequipment provider in the world, has hastened preliminary steps to get listed. Despite its Beijing-based public and media office’s denial of any IPO preparations, insiders reveal Huawei has been in contact with some international accounting firms and investment banks, and Hong Kong and London are the likely choices.

Some believe Huawei’s IPO plan is designed to improve transparency in a bid to boost its chances of winning major overseas contracts. Among the top five telecom giants, Huawei is the only one yet to go public and is now haunted by the ill will of American politicians who are dead set against the company’s expansion into the United States.

On October 8, the committee unveiled the result of its one-year investigation into Huawei and ZTE, suggesting the American Government not use equipment manufactured by the two companies. On October 14, the U.S. Congress launched a second round of investigations against the Chinese firms.

Huawei and ZTE strongly denied the accusations. Huawei argued the report was aimed at hindering Chinese ICT (information and communication technology) companies from accessing the American market. The report leveled false allegations against Chinese firms and ignored copious factual information provided by Huawei as well as its good track record of network security in the United States and worldwide.

ZTE also said that its own equipment posed no threat to U.S. national security because all equipment it supplied to American operators had been assessed by the U.S. Security Assessment Laboratory, which is supervised by the U.S. Government.

Whether or not the prospective IPO will breathe new life into Huawei’s U.S. plans is uncertain. Disagreements over whether to go public are rife within the company. In November 2011, when the House Permanent Select Committee on Intelligence filed for investigation against Huawei and ZTE, Huawei’s executives and board of directors raised the possibility of an IPO.

Proponents believed an IPO could enhance the company’s transparency and sources of income, while opponents argued an IPO plan would not yield the desired result because ZTE was under investigation despite its status as a listed company.

Political force-out

In 2007 and 2008, Huawei’s two attempts to acquire 3COM, an American network equipment manufacturer, were blocked due to U.S. national security concerns. In 2010, its bids for 2Wire and the mobile network branch of Motorola also failed to obtain approval from the U.S. Government. In 2011, the company backed away from its attempt to purchase 3Leaf, an American server producer.

Since February 2011, when the House Permanent Select Committee on Intelligence began its investigation into Huawei and ZTE, the two companies have cooperated with the committee in an open and transparent manner.

The committee insists that Huawei has been heavily subsidized by the Chinese Government, which is thought to be eager to use it as a Trojan horse to infiltrate the American communications network.

However, as allegations swirled by the U.S. Congress that both companies pose “security threats” to the country, no evidence has yet to be presented. People familiar with the inquiry revealed that those conducting the investigation dug into reports of suspicious activity and visited nearly 1,000 telecom equipment buyers.“We knew certain parts of the government really wanted” evidence of active spying, said one source, who requested anonymity. “We would have found it if it were there.”

A spokesman for Huawei said the company knew little about the review but expected no evidence of espionage to be found.

The United States is more sophisticated in network and telecommunications development than China. If a security threat did exist, the United States would quickly spot it.

“I don’t know where these ‘security threats’ come from,” said Mei Xinyu, a research fellow of the Chinese Academy of International Trade and Economic Cooperation.

“Huawei has an undisclosed level of closeness to the Chinese Government,” according to the report, which points to the background of Ren Zhengfei, the company’s founder, who served in the PLA (People’s Liberation Army) engineering corps in the 1970s in its information technology research unit.

In an open letter responding to the speculation in 2010, Ren’s personal details were published. “Ren, born into a rural family on October 25, 1944, spent his childhood in a small remote town in Guizhou Province. He graduated from Chongqing University of Civil Engineering and Architecture in 1963 and had engaged in the trade of civil engineering since then. In 1974, he began to serve as an engineering construction soldier in the PLA to participate in building the Liaoyang Chemical Fiber United Factory and served successively as a technician, engineer and deputy director, without a military rank. After cuts to the armed forces, he left the army in 1983. Later, he moved to Shenzhen and took up a post at a logistics service base. Unhappy with his job, he set up Huawei in 1987 with just 21,000 yuan, a bit more than $2,500 at the time. Ren has been Huawei’s president since 1988.”

The committee, armed with such background information, argued, “Analysts in the field hold different views. For example, some of them take Ren as the director of the PLA Information Engineering University, which they believe maintains close links with the PLA GSD (General Staff Department). For this reason, Ren may be still in touch with the Chinese military.”

Top leaders at Huawei consider such speculation ridiculous. Since China opened up to the world over 30 years ago, hordes of ex-servicemen and government officials have resigned from their posts to begin new careers. If these conjectures are true, does it mean all the Chinese entrepreneurs maintain close ties with the Chinese Government?

The committee added, “Huawei can’t provide detailed information to explain how the Chinese Government normally regulates, controls and supervises it.”

Top Telecom equipment makers, 2011 ($bn)

“It mirrors the Cold War mentality in the U.S. Congress. Such a mentality will not only affect Chinese firms, but also severely undermine the commercial environment in the United States,” said Mei.

On October 9, Shen Danyang, spokesman of the Ministry of Commerce, announced that the ministry “strongly opposes” the U.S. report, one based on “subjective guesswork”and “false evidence,” as it uses national security as an excuse for blocking Chinese companies from fair competition in the U.S. market.

Shen said the move by the U.S. side violated its long-held free market principles and would undermine investment and cooperation between the two countries’ companies.

“We hope the United States could make concrete efforts to create a just and fair market environment for companies from both sides and promote the sound development of bilateral economic and trade ties,” Shen said.

Motives

For Huawei and ZTE, security concerns over their products have been the largest stumbling block on the path of their American expansion. To tackle the situation, Huawei hired a former American official as its chief security officer, and hoped to win trust through an overseas listing, but to no avail.

Shi Yinhong, a professor at the School of International Studies at Renmin University of China, says Chinese enterprises have been suffering from a lack of trust by the U.S. Government, especially when they try to invest in sensitive areas, a reflection of American concerns over a rising China.

“The U.S. Government is sensitive to Chinese investment in fields which it believes may pose a potential threat to U.S. national security, like energy and telecommunications. The obstacle Huawei and ZTE now face might have been expected because the United States has never lowered its guard against Chinese firms wanting to access its hi-tech sector,” said Shi.

Jiang Yong, Director of the Economic Security Research Center at the China Institutes of Contemporary International Relations, believes trade protectionism is masquerading as a defense of national security.

“The United States has a long practice of setting up trade barriers against Chinese enterprises. This latest move can be taken as its prolonging protectionist measures adopted after the financial crisis. Now, the targets are Huawei and ZTE, both of which have developed by leaps and bounds in the international market,” said Jiang.

Political factors aside, Jiang believes Cisco, a Huawei rival, may be the real impediment facing Huawei and ZTE. According to industry statistics, the growth of the global telecommunication market was a mere 12.2 percent in 2011, far less than the 31-percent growth rate registered in 2010. It is widely believed that the euro-zone sovereign debt crisis, coupled with uncertainties of an economic recovery, will lead to further declines in growth. Under such circumstances, Huawei and ZTE, whose products are more competitively priced, are more appealing to customers. According to Cisco’s 2011 financial report, the company saw a drop in its gross profit. Price competition from its Chinese rivals is one factor behind its slackening performance.

Closely connected with the U.S. Government and military, Cisco is an active lobbying group. It is unlikely to sit by and watch its largest rival possibly make inroads in a market it currently dominates.

A jousting with no winner

Nobody knows whether the report published by the U.S. Congress will trigger a telecommunications trade war between China and the United States.

In 2011, the United States took up $1.3 billion, or 4 percent of Huawei’s total revenue, and $30 million of ZTE’s. Huawei is second only to Ericsson in the manufacturing of routers, switches and other telecom equipment, and ZTE ranks fifth. In contrast, 16 percent of Cisco’s revenue comes from the Pacific Rim and China, and for Cisco, China is also the second fastest-growing market in the region after Japan. Currently, China accounts for 30 percent of Cisco’s overall profits, while the United States makes up 45 percent. If a trade war breaks out, Cisco would have far more at stake than Huawei.

Furthermore, the report has tarnished the image of the business environment in the United States. In the eyes of Chinese people, the United States is a leader in the free economy. However, its protectionist actions following the financial crisis have been disappointing.

The biggest worry for Huawei and ZTE is not losing the U.S. market but the possibility of U.S. allies following suit.

Canada and the UK announced on October 12 their own investigations into Huawei- and ZTE-made telecom products. With Huawei’s presence in countries like Canada, the UK, Germany, France and Australia, any domino effect could have a devastating impact on the company.

Headquartered in Shenzhen, south China’s Guangdong Province, Huawei is a privately owned enterprise. In its infancy, Huawei invited IBM to help build its core operating departments, such as R&D, product development, its supply chain and financial management, for which IBM sent over 200 consultants. Huawei’s success is largely attributed to its ties with IBM.

On October 9, the Chinese Ministry of Foreign Affairs declared the establishment of its Department of International Economy. One major function of the new department is to settle emerging international economic disputes interwoven with complicated political issues, which may prove helpful to Huawei and ZTE.

Staying with U.S. plan

“Huawei is a diversified business group. We are trying to open the U.S. market by satisfying customers in different fields. We are fully aware of the political obstacles we are facing. One thing is certain: The independence and integrity of Huawei and the quality and security of the solutions it provides are illustrated by its cooperation with more than 500 telecom operators in 140 countries,” Huawei’s Beijing-based public and media office said in a statement it presented toBeijing Reviewon October 12.

The statement said Huawei is committed to providing American customers with innovative products and services and becoming a long-term investor in the United States. Since expanding its business into North America in 2001, Huawei has purchased $30 billion worth of products and services from over 280 American suppliers, which has contributed significantly to local employment. Any intervention and obstruction to free competition will hurt the entire industry chain.

“We had hoped to ensure that the investigation would be fact-based and objective in its review of our business activities and the global issue of cyber security. Over the past 11 months, Huawei has cooperated with the committee in an open and transparent manner, and engaged in good faith interaction: Our top management team carried out multiple rounds of face-to-face communication with the committee members in Washington D.C., Hong Kong and Shenzhen. We opened our R&D area, training center and manufacturing center to the committee and offered a wealth of documentation, including the list of members of the board of directors and the supervisory board over the past 10 years, and the annual sales data since our establishment in 1987. We also made the list of our shareholding employees, the shares they hold, as well as information about our funding resources and financial operations available to the committee,” said the statement.

“We adopted a transparent approach in providing this information to ensure the results are fact-based and unbiased, hoping the committee’s objective review of our business can clarify any misperception of Huawei,” the statement added.

Introspection needed

R&D LAB: An engineer handles equipment at Huawei’s headquarters in Shenzhen on June 3, 2010

Chen Yongdong, an associate professor and independent scholar in information management, e-commerce and new media, suggests that since the U.S. Government believes the Chinese Government has much bearing on Huawei and ZTE, their normal commercial activities are under constant surveillance.

However, concerns over alleged “security threats,” which have been amplified by the U.S. Government, might cost the United States to lose business opportunities and profits.

Chen believes the Chinese Government should use the Huawei case as an opportunity for reflection. China is the most open telecommunications market in the world, where protectionism barely exists. Almost all telecom firms try to make a fortune here, with some having achieved great success. China treats enterprises of different nationalities equally without discrimination.

In stark contrast to Chinese enterprises struggling in the U.S. market, American telecom firms, represented by Cisco, are sailing by smoothly in China. A handful of foreign companies, like Cisco, Intel, Microsoft, Motorola, IBM, HP and Apple, have swallowed a large share of the Chinese market. Cisco-manufactured telecom equipment has been widely used by households and by the government in the fields like education and commerce. But in the United States, Chinese equipment will likely be barred from government use.

If China were to treat American firms the same way, it would be impossible for Cisco to enter China’s IT telecommunications equipment market. It is worth asking why the United States—a country that regularly extols the virtues of global free trade—behaves the way it does toward Chinese firms.

“When we open up to countries with ulterior motives and our generosity is met with scrutiny and obstruction, should we also enhance our own national security awareness?” asks Chen.