GLOBAL WEEKLY REVIEWS

Huawei: Escalation or a deal, but not life on the Entities List

Huawei: Escalation or a deal, but not life on the Entities List

The interventions by ARM and Google illustrate very clearly how very little Huawei’s dilemma has to do with the level of ‘chip inventories’ in its warehouses.  The global technology ecosystem is a web of continuous engagement between firms whose subsystems must function together through continuous change.  Interleaved intellectual property sharing is the lifeblood of this ecosystem.  The Entities List is choking off this lifeblood for Huawei.

What does this mean for Huawei?

  • Huawei cannot continue as a world leading vendor if it remains on the US ‘Entities List’, even if the selective 90-day waivers are repeatedly extended by the US authorities. Huawei needs its close relationships with ARM, Cadence, Synopsys, Google and a hundred other partners if it is to maintain its position in the front rank of global vendors.  These relationships cannot function if Huawei is on the Entities List, irrespective of selective short ‘stays of execution’.  The theoretical ‘self-sufficiency’ of China in technology in five or ten years’ time is irrelevant – Huawei cannot be self sufficient in 2019 or 2020, so its leading status *will* slip if it remains on the list.
  • China will not let Huawei slip from the front rank of global vendors without taking action.
  • . . . so either China will deal with the US that results in removal from the Entities List (as happened with ZTE’s Denied Person status last year) . . .
  • . . . or China will escalate matters – probably through the disruption of US tech supply chains for one or more US firms
  • Either way, the current situation will not persist for long – It will materially improve or it will materially deteriorate, probably within weeks (rather than months)
  • We don’t have a consensus view on the matter within New Street. Whereas our tech team is more optimistic and expects a deal in the next six weeks (here), the telco teams sees a more equal chance of escalation as a next step. We all agree nothing is clear cut and we are in a period of heightened uncertainty.
  • On the bearish side, our arguments are that there are hawkish elements close to the decision making in Washington and in Beijing, who may see advantages in provoking the other side into rash responses. China may see an escalation, or a threat of specific escalation, as necessary to signal the urgency and importance of bringing the US to the table;
  • On the optimistic side, our argument is that both sides can achieve their goals without further escalation. The US does not need to crush Huawei to reset its trade relationships with China, particularly if crushing Huawei involves material harm to its own tech champions.  The President’s concession that “it’s possible that Huawei even would be included in some kind of a trade deal” would align with this reading;

What does this mean for telecoms and tech?

  1. There is no point in trying to work out the impact of ‘life on the Entities List’ for Huawei’s suppliers or its customers in the medium or longer term. Either Huawei will come off the list, or the situation will get much worse.  A continuation of the status quo is not plausible in our view.
  2. For the Chinese carriers, the sanguine share price response would suggest that the market is thinking about this from the perspective of what would be the right thing to do for the telcos rather than what is right for China. In our view this is why the market has underestimated 3G, 4G and now 5G capex, as the carriers do not take these decisions, the Government does. The market is therefore viewing the situation as telco positive as it potentially delays 5G. But from the perspective of the Chinese govt and how it pertains to the telcos there are only two outcomes that are relevant: either Huawei stays on the Entities List or it doesn’t. As we wrote (HERE), implications of either outcome are negative in our view. If Huawei remains on the Entities List there will be an attempt to keep the company afloat for as long as possible. If Huawei loses its overseas business that will not be seen as an opportunity for the Chinese carriers to cut back too. The carriers are likely to be strong-armed into purchasing equipment that may well be defunct in years to come, beyond the point at which it makes commercial sense to keep doing so. Or they may be asked to pay higher unit prices. They may even be required to invest in some sort of “war fund” to support the company. If there is an agreement/de-escalation that involves Huawei coming off the list, then the genie does not just go back into the bottle: China’s priority will be striving for tech independence as rapidly as possible. This likely would also involve a more aggressive capex plan by the MNOs than has previously been envisaged.
    1. For China Tower (and by implication Unicom – see HERE), the outcomes are more binary. If Huawei remains on the Entities List this is fundamentally negative for the towerco; if it comes off the Entities List, fundamentally positive (driven by carrier capex).
    2. For the last 15 years investors have asked whether they “own” China Mobile’s cash pile, currently RMB 349bn (US$ 50bn), or whether it is in some way restricted and unlikely to ever be paid out to shareholders. We may be about to find out, and in our view investors in the company might not like the answer.
  3. Escalation by China may target specific US firms but is likely to hurt sentiment across the board in global tech. An escalation by China is very likely to trigger a further escalation by the US.  However, it is futile to speculate on the scale or mix of these impact (in our view) – the range of scenarios is too great for sensible analysis.
  4. A deal to remove Huawei from the Entities List would calm sentiment to a degree, but markets would have no doubt that tech would remain a key bargaining chip in the wider US-China trade dispute. As Pierre wrote in the note referred to earlier (here), in this scenario “stock markets rally across the board and all names hit in recent days outperform. Ericsson and Nokia give back their relative gains, and the second half recovery is still on”.
  5. Global telcos (ex-China and ex-US) will have a continuing dilemma in doing business with Huawei, either for 4G or 5G. We would expect most to continue to include Huawei in their access networks and handset offerings, at least to a degree.  In many cases this may give network operators a good excuse for slowing the pace of 5G capex.  (We already expect a slow pace in most of Europe, after the excitement of initial launch coverage has passed, so this further slowdown may be hard to detect).

In summary, we have entered a dangerous period, with unpredictable outcomes, some of which could be very negative.  We are not in steady state – China will not let Huawei be choked by the US without a reaction – so a steady state analysis is not useful.

As analysts, it is important for us to recognise the limitations of analysis, and highlight these limitations to investors.

 

Could Vodafone Be AT&T’s Next Big Deal?

AT&T would tell you that they have created value over the last 20 years by doing deals.  We aren’t sure they have created value over the last 20 years, but if they have, it certainly isn’t through operating prowess.  So, sure…let’s say they have a special competence in acquiring things.

AT&T closed the Time Warner deal in June 2018, after a longer than expected fight.  We are coming up on the one-year anniversary, which means we are probably a year or so away from them looking for their next deal.

Finding deals is getting harder for AT&T as they swell in size and as their multiple swoons relative to assets they might like to buy.  They are hobbled by an enormous dividend and a core business that has been declining.  Whatever they buy has to be cheap.  Very cheap.  AT&T is trading at less than 10x earnings and FCF.

So, could Vodafone be next?

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Infrastructure Deal Bonanza: What It Means For Towers Globally

Nearly $20BN of telecom infrastructure changed hands this week through two large deals: Cellnex acquired all of Xavier Niel’s towers in Europe, and a consortium of private equity funds acquired Zayo in the US.  In this weekly review, we discuss the implications of these deals on the communications infrastructure landscape globally, and why they support our stance that SBAC is the most compelling opportunity within towers.

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What happens to Sprint if the deal is blocked?

The deal review doesn’t seem to be going Sprint’s way. The agencies could still approve the deal as it has been proposed. If they don’t, the companies could offer an alternative structure that passes muster. We offered thoughts on workable alternatives in a report we wrote two weeks ago (LINK). T-Mobile may prefer to walk away than accept the alternatives we suggested. It is worth considering what happens to Sprint if they end up in this situation. Continue reading “What happens to Sprint if the deal is blocked?”

Positively becalmed: Checking the pulse on European Telecoms

In December last year, we upgraded the European telecoms sector (LINK) to a more positive stance and four months on we revisit that call. While the market has been on fire since – up 16% largely backed by a change of view at the Federal Reserve helping reverse cyclicals’ underperformance in Q4 – the European telecoms sector is only up 1%. So, although the sector hasn’t done as well as the wider market in the last four months, let’s be grateful for small mercies – at least the European telecoms sector isn’t down – having seen declines of 12%, 4% and 8% in 2016, 2017 and 2018 respectively. We might be only 4 months into the year, but we already see this as a reversal of a historic trend.

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Cable’s Broadband Growth Set to Accelerate in The US

In our last weekly comment on the broadband market we sketched a decade-away view of a single connectivity market with whatever remains of today’s wireless and wired companies competing for the entire market. We argued that cable is best positioned for the fight given that they are attacking a market that is twice the size of the one they are defending, and they have time and infrastructure advantages. This week we focus on more proximate trends in the run up to the first set of results in what we believe will be a strong year for Cable broadband growth and for Cable equities. Continue reading “Cable’s Broadband Growth Set to Accelerate in The US”

T-Mobile / Sprint: Regulators And Investors May Be Making The Same Mistake

If the DOJ or state attorneys general really are preparing to sue to block the deal, we think they would be making a mistake. They would be missing the fact that the distribution of capacity across market participants could have a far bigger impact on competition and pricing than the number of participants. Prices are likely to increase if the deal is blocked, particularly for low income customers. Prices are more likely to stay low or head lower if the deal is approved.

Investors and some of the market participants appear to be making the same mistake. Verizon and AT&T are better off if the deal is blocked. These companies would face tougher competition if the deal is approved. In fact, it could be devastating for them. Verizon and AT&T should be fighting approval viciously (and perhaps they are, quietly).

We lay out the argument in this iteration of the Global Weekly review.

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Creative Disruption

It has been a long time since a single presentation has created as much of a stir among global telecom investors as Hiroshi Mikitani’s, the founder and CEO of Rakuten, on the entry strategy of the Japanese e-commerce leader into the mobile industry at MWC this year. Following a deluge of client interest, we have carried out a deep dive into what Rakuten is doing (HERE).  What we found out has the potential to be scary for the incumbent Japanese mobile operators, but may be rather less of a fright for the rest of the global industry.

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5G & Wireless Capacity

We have written three reports that have expanded on the theme of 5G and its impact on wireless capacity in the US in the past couple of weeks.  In this Global Weekly Review, we highlight our expectations for how the C-Band and other sources of 5G spectrum may transform the wireless, cable, and tower industries.

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Spanish Unicorns

It’s been a busy week for coverage at New Street, having initiated on five companies across the telco, media and tech space: Softbank (Japan), Chorus (New Zealand), MultiChoice (South Africa) and MASMOVIL and Euskaltel in Spain.

We aim to have something different to say on all the names but in the case of Spain it’s more a case of pointing out the obvious whilst reassuring investors that recent fears are overdone.
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