Battle lines drawn; Huawei on the offensive

Chinese vendor's strategy focuses on its emerging-market niche

Source: MarketWatch

As the global economic picture darkens, so too does the outlook for Western telecom-equipment vendors. But the economic and industry troubles may spell opportunity for emerging-market rivals such as Huawei Technologies.

Weaker spending from North America and Western Europe has eroded the sales and earnings picture for top players including Ericsson AB and Alcatel-Lucent, as belts are tightened in advance of a possible U.S. recession. Ericsson shares, for example, have lost half their value since a shock profit warning in October.

Against this backdrop, Chinese vendors such as Huawei are on the offensive, ready to capture key markets and perhaps even claim the assets of struggling rivals. The company's strong presence in emerging markets, where network demand is not expected to slow, means it could weather a recession better than its Western rivals.

Among the top Western players, Ericsson AB has had the most trouble of late.
A month after its third-quarter profit warning, the Swedish company cut its sales outlook. When business didn't improve in the fourth-quarter, it was forced to lower its forecast for mobile-equipment spending in 2008 and announce heavy layoffs.

Despite its recent stumble, Ericsson maintains that the long-term outlook for the industry is unchanged. Some observers agree, arguing that sharp increases in data traffic will eventually force operators to add capacity.

But as the U.S. toys with recession, a marked improvement looks increasingly unlikely this year, prompting several analysts to lower their forecasts.

Tim Boddy, of Goldman Sachs, recently cut his view on the sector to cautious from attractive, saying it's more sensitive to the economy than the market thinks. He warned that a slowdown in the U.S. and Europe will translate into lower equipment spending.

Ericsson's failure to launch a cost-cutting plan of the depth now underway at rival Alcatel-Lucent (FR:013000: news, chart, profile) (ALU:alcatel-lucent ALU 6.12, +0.11, +1.8%) has also worried observers, who fear for its operating margin.

Alcatel-Lucent, which didn't manage a profit in 2007, is shedding a fifth of its 80,000 employees by 2009. Top executives have also been jumping ship. CEO Patricia Russo has lost five of her top deputies in the past year, including well-respected former chief operating officer Mike Quigley. Alcatel Lucent shares slumped 55% in 2007.

But it's not just a decline in equipment orders from the West that threatens Ericsson (SE:ERICB: news, chart, profile) (ERIC:ERIC 21.22, +0.77, +3.8%) and Alcatel-Lucent's profitability this year. The rise of China's Huawei Technologies is just as troubling, analysts said.

Huawei to the fore
For many years, Huawei, which is China's largest telecoms network-equipment maker, maintained a low profile. All that changed when it joined forces late last year with private-equity firm Bain Capital Partners in a $2.2 billion bid for 3Com (COMS:
3Com Corporation COMS 3.91, -0.06, -1.5%).

Huawei established its first research and development center in 1995, but only started competing seriously on the international scene in early 2000. Long dismissed as a mere regional player, its strength in emerging markets means it can no longer be ignored.
Ericsson CEO Carl-Henric Svanberg last month said the industry must acknowledge that Huawei has become an established player, and isn't simply looking for a foothold.
Huawei, too, is working to raise its profile.

Although the privately run firm, based just outside of Hong Kong in Shenzhen, is not obliged to declare its financial results, it has started providing some information to support its internationalization. The figures show just how fast it has been growing. In 2006, its global revenue rose 42% to $8.5 billion.

Its international profit has soared, with 65%, or roughly $7.2 billion, of contract revenue generated overseas last year. Recent orders have come from MegaFon and Vimpelcom in Russia, Deutsche Telekom's (DT:deutsche telekom ag DT 19.37, +0.08, +0.4%) T-Mobile in five European countries and Vivo in Brazil. See related story from Barcelona.

And its chief executive, Ren Zhengfei, a former soldier who fashions himself after the larger-than-life Communist leader Mao Zedong, was listed by Time Magazine in 2005 as among its 100 most influential people.

Huawei's home market, meanwhile, is exploding.
China has the world's largest mobile subscription base, at over 520 million, and is on the verge of overtaking the U.S. to become the world's largest broadband-subscriber market. Chinese operators are expected to spend $31 billion on telecom equipment this year.

Huawei: a trigger for consolidation
At home and abroad, Huawei's aggressive pricing, helped by a low-cost manufacturing base, has allowed it to capture market share from bigger rivals, particularly in fast-growing emerging markets.