ZTE slammed, New Oriental exonerated

ZTE's massive third quarter loss marks the beginning of a downward spiral that could end with a reorganization.

PUBLISHED : Monday, 15 October, 2012, 11:20am
UPDATED : Monday, 15 October, 2012, 11:27am

There's bad news and good news coming from two Chinese sector leaders, with embattled telecoms equipment maker ZTE (0763.HK; Shenzhen: 000063) leading the downbeat headlines while education services specialist New Oriental (NYSE: EDU) brings some much needed relief to beaten-down US-listed Chinese stocks. The bad news for ZTE never seems to end, and now we're starting to see the impact of all the negative developments on this former high-flyer which has just announced it will post a massive loss in the third quarter.

Meantime, New Oriental has quietly issued its own announcement implying an investigation by the US securities regulator into some of its accounting practices has cleared it of any wrongdoing, in what would be welcome news for a sector of US-listed Chinese firms that has been dogged by an accounting credibility crisis for more than a year.

Let's take a look first at the ZTE news, which came in a rare weekend announcement that the company will post a whopping loss of around two billion yuan, or nearly $320 million, for the three months through September, wiping out its entire profit for the first half of the year. I've been following ZTE for quite a while, and this is the first loss I can recall for a company that had previously boasted steady revenue and profit growth for much of the last decade before it started to stumble last year.

ZTE blamed the huge reversal of fortune partly on plunging profit margins, most likely due to the company's aggressive drive to quickly build up its smartphones business. It also blamed the loss of business from the controversial Iranian market. The Iranian government had previously hired ZTE to built a sophisticated telecoms network, but now that business has stalled amid a US investigation into whether ZTE violated any US laws by including US-made equipment in that network. The US bans its companies from selling anything to Iran, amid its suspicion the country is trying to develop a nuclear weapon.

Compounding its woes, ZTE and crosstown rival Huawei have just been barred from selling their networking equipment products into the US due to security concerns, and Canada and some European markets may soon take similar actions. If I were a contrarian, I would say that ZTE shares could look like a good bargain after a coming sell-off that is likely to see them hit a new three-year low. But I suspect that more bad news is still going to come for this company, which could ultimately be forced into a major restructuring or sale of its problematic telecoms equipment business.

Meantime, the news coming from New Oriental is much better, with the company saying the US securities regulator has "no objections" to the accounting treatment that New Oriental was using for some of its subsidiaries. New Oriental had previously disclosed it was being investigated by the US Securities and Exchange Commission, though it didn't know the exact reason. Based on the questions it was being asked, it speculated the issue was related to its accounting treatment of some of its subsidiaries.

This announcement seems quite low-key, as disclosure of the apparent exoneration from the SEC was included almost as an afterthought to another announcement from the company about an unrelated stock exchange filing. But I suspect we'll see a nice rally in New Oriental shares when its stock starts trading on Monday in New York; and from a broader perspective, this apparent exoneration will be welcome news in helping to dispel some of the lingering investor doubts over the questionable accounting practices of some overseas-listed Chinese firms.

Bottom line: ZTE's massive third quarter loss marks the beginning of a downward spiral that could end with a reorganization.


The opinions expressed in this article are the author's own. To read more commentaries from Doug Young, click on