Huawei – Nowhere to run

The USA does Samsung a massive favour.

• The importance of the digital ecosystem is laid bare as the loss of the Google ecosystem is very likely to cost Huawei all of its smartphone shipments outside of China (50% of total in Q4 18 Counterpoint Research).
• In response to the executive order that was issued on Wednesday, Google has suspended its business with Huawei meaning that all future Huawei smartphones will be unable to offer users the Google services that they demand.
• Huawei will not lose access to Android itself which is open source but Android devices outside of China must offer access to Google services in order to have any prospect of being sold.
• This is because device purchasing is now almost entirely driven by the ecosystem with an Android device purchase representing a desire to live one’s Digital Life with Google.
• This will also cause difficulties for Huawei in 5G as Qualcomm’s recent crushing defeat of Apple is strong evidence that, at the moment, Qualcomm has the only viable 5G smartphone modem (see here).
• This is all in compliance with an executive order which placed Huawei on the entity list meaning that any US company shipping product, software or services to Huawei will need a licence from the commerce department.
• Google and Qualcomm must now decide whether to apply for a licence and there is no indication as to whether or not they would be successful.
• The immediate impact will be negligible as any phone that has already been launched will be unaffected and Huawei has already launched its main devices for 2019.
• Furthermore, Huawei claims that it has enough stocks of US components to last 3 months giving it a window to arrive at a solution.
• For hardware components, there are plenty of options although some will not be as good as their US counterparts, but for the Google ecosystem and 5G, Huawei is in real trouble.
• This is not an exact repeat of the blockade that virtually put ZTE out of business as there is an avenue by which sales can continue but it represents a very serious problem.
• I think that the USA has no particular desire to put Huawei out of business, but it does want to have what it considers to be a fair trade deal with China and companies that are dependent on USA technology are a simple way to gain bargaining leverage.
• Huawei’s roots are in the Chinese military and as most large Chinese companies have fairly close ties to the government, I see this as merely a negotiating tactic.
• Hence, I think that when a trade deal is done either Huawei will be removed from the list or it will become a very simple matter to obtain a licence.
• The real potential beneficiary here is Samsung.
• In the last 2 years, Huawei has put real pressure on its handset business by substantially eroding its volume advantage.
• This advantage, which just 2 years ago was 2 devices shipped for every 1 from Huawei, allowed Samsung to earn margins of 12-14% on smartphones despite selling a commoditised product.
• This advantage is now down to 1.2 to 1 and Samsung’s handset margins have taken a substantial hit as a result.
• Samsung is no longer meaningfully present in China meaning that Huawei falling away would remove by far its biggest competitor.
• Hence, this would herald both a market share jump and a return of the volume advantage that allowed it to make such a good return.
• This has not been priced into the shares in any way making Samsung a very interesting stock to consider when looking for ways to offset the potential negative implications of a protracted trade war.