Growth drive may have hurt ZTE's profit

PUBLISHED : Monday, 26 March, 2012, 12:00am
UPDATED : Monday, 26 March, 2012, 12:00am


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Mainland telecommunications equipment maker ZTE established itself as a bona fide powerhouse in the rapidly growing market for smartphones last year, with an aggressive expansion programme that drove its international sales.

Shenzhen-based ZTE, China's second largest maker of telecoms equipment, was ranked fifth by market research firm Gartner among the world's largest suppliers of internet-ready smartphones last year, overtaking the better-known BlackBerry maker Research In Motion, Taiwan-based HTC, and Motorola Mobility.

That singular achievement, however, may have fallen short in helping Hong Kong-listed ZTE boost its profitability.

A senior analyst at Bernstein Research in Britain, Pierre Ferragu, said the mainland firm was predicted to show 'disappointing numbers' when its 2011 financial results are announced after the market closes on Thursday.

'We expect the company to report a second half in line with expectations in terms of top line [revenue], but well below consensus in profitability,' Ferragu said. Bernstein Research estimated that ZTE's overall net profit last year reached 2.69 billion yuan (HK$3.29 billion), down from 3.25 billion yuan in 2010. Forecast revenue was 86.91 billion yuan, up from 70.26 billion yuan.

'We believe ZTE continued to ramp up smartphone sales in the second half of 2011 to reach 14 million units at year-end, but with no contribution to operating margins,' Ferragu said. The company 'suffered strong pressure on prices and margins' in total telecommunications equipment sales, 'as it continued to try and gain market share in international markets with limited success'.

In the first half, ZTE saw its net profit decrease 12.42 per cent to 768.52 million yuan, from 877.49 million yuan a year earlier, due to lower profit margins, a change in product structure and pending software value-added tax refund subsidies. Revenue rose 21.55 per cent from 30.73 billion yuan to 37.35 billion yuan.

In a filing with the Hong Kong stock exchange, ZTE chairman Hou Weigui said the company took 'an aggressive approach' to gain access and compete effectively in the so-called smart terminals market segment, which included 3G smartphones and data cards attached to laptop computers to access wireless broadband networks.

The company shipped 60 million terminal products, including five million smart devices, in the first six months. That marked a 400 per cent year-on-year increase in its smart terminal sales, especially on the mainland and in North America, South America and Europe.

The gross profit margin for those products, however, declined to 19.6 per cent from 22.7 per cent a year earlier, and Ferragu pointed out that ZTE 'had to sell telecommunication equipment below production costs in order to maintain growth'.

Despite that strategy, industry leader Ericsson of Sweden and privately held Huawei Technologies, China's biggest telecommunications equipment maker, outgrew ZTE last year and Ferragu said it could not sustain recent growth and gain meaningful share from Ericsson, Huawei, Nokia-Siemens Networks and Alcatel-Lucent 'without meaningfully altering its profitability'.

Bernstein Research estimated that Ericsson last year had a 43 per cent share of the global wireless equipment market, which includes mobile base stations and towers, wireless network planning tools, and mobile phones. Nokia-Siemens had a 21 per cent share, Huawei 18 per cent, Alcatel-Lucent 11 per cent, and ZTE 7 per cent.

With more than 40 per cent of ZTE's total business coming from mainland operators China Mobile, China Unicom and China Telecom, ZTE 'remains highly leveraged to Chinese equipment spending, which we expect to be down in 2012', Ferragu said.

Fitch Ratings last month downgraded ZTE's long-term foreign- and local-currency issuer default ratings from BB+ to BB-. The outlook of the ratings is stable.

'The downgrade reflects a downward trend of ZTE's credit metrics, as the company focuses on increasing handset shipments through an aggressive marketing push,' said Kevin Chang, director of Fitch's Asia-Pacific telecommunications, media and technology team. Fitch may consider a further negative rating action if ZTE reports this week that its operating ebitda (earnings before interest, taxes, depreciation and amortisation), fell below US$600 million.

ZTE's share price was down 1.67 per cent last Friday to finish at HK$20.55.