ZTE falls to new low on profit warning, US probe

PUBLISHED : Tuesday, 17 July, 2012, 12:00am
UPDATED : Tuesday, 17 July, 2012, 12:00am


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ZTE, China's second-largest telecommunications equipment manufacturer, saw its shares take a beating yesterday after the company warned of a sharp fall in first-half net profit and news emerged that it was under investigation by the United States government.

Shares of the Shenzhen-based ZTE tumbled 16.32 per cent to close at a new low of HK$10.46, the stock's steepest drop since finishing at HK$4.91 on October 27, 2008.

In early trading yesterday, the shares came down as much as 17.4 per cent to reach HK$10.32. The outlook appears grim for ZTE based on what Bernstein Research described as the company's 'deteriorating fundamentals', and potential harsh penalties that the US could impose if the Chinese company was found guilty of selling banned technologies to Iran.

Several brokerage houses - including Jefferies, JP Morgan, CLSA and Credit Suisse - have downgraded their respective ratings for ZTE, which is the world's fifth-biggest supplier of telecoms equipment.

ZTE warned in a call with analysts on Friday that its net profit for the first half might decline 60 to 80 per cent, in the range of 154 million yuan (HK$181.26 million) to 308 million yuan, compared with the same period last year.

That forecast was due to lower investment income, foreign exchange losses and the postponement of tenders for network contracts by mainland telecoms network operators.

In a report yesterday, Bernstein Research senior analyst Pierre Ferragu said 'ZTE destroyed a lot of its earnings power last year', when the company tried to increase sales in its core telecoms equipment business 'with aggressive pricing' to undercut larger rivals.

Bernstein kept unchanged ZTE's 'underperform' rating - the equivalent of sell - and lowered the stock's target price to HK$9 from the previous HK$15.

ZTE vowed last month to boost its profits by ratcheting up sales of smartphones with higher margins to about 26 million to 28 million units this year, up from 15 million last year. That was enough for CCB International Securities to keep its 'outperform', or buy, rating for ZTE.

But Bernstein Research said gains from the smartphone business were unlikely, because of competition in the domestic and international markets against privately held Huawei Technologies, its larger cross-town rival in Shenzhen and the world's No 2 telecoms equipment supplier.

'We expect ZTE to barely break even in smartphones in 2015, while Huawei would reach about 6 per cent operating margins,' Ferragu said.

Both Chinese companies, however, could face a backlash in the US, the world's leading telecoms market, after news broke last week that both the US Federal Bureau of Investigation and Commerce Department had initiated investigations into ZTE over its American subsidiary's alleged sale of banned technologies to Iran.

'I suspect that this will reinforce the belief [by certain US government authorities] that Huawei and ZTE cannot be trusted,' said Jeffrey Carr, chief executive at US cyber-security consultancy Taia Global.

'Huawei will experience a parallel negative impact by association even though that [alleged Iran deal] involved ZTE.'

With a range of longstanding economic, scientific and military sanctions against Iran, Washington can impose stiff fines and penalties to those found guilty of violating its embargo.

The US investigations of ZTE stem from a Reuters report in March, which said the company sold a powerful surveillance system worth US$130.6 million to Iran last year.