Huawei – Window dressing

Huawei puts a brave face on it.

• Huawei reported 2021 FY results that highlighted just how badly the company has been hit by US sanctions despite an effort to dress up the figures
• 2021 revenues / net income was RMB636.8bn (-28.6% YoY) / RMB113.7bn (+76% YoY) which was flattered by an RMB60.8bn gain from the sale of the Honor smartphone business to a series of state-backed Chinese investors.
• Excluding this and adjusting for tax, net income from continuing operations was around RMB57.1bn representing a fall of 11.6% YoY.
• To be completely fair to Huawei and assuming that these figures are a reasonable representation of reality, Huawei has executed extremely well in the face of great adversity.
• Its carrier business, which sells infrastructure to operators and companies fell by just 7% YoY despite being effectively removed from a large number of its Western clients.
• Hence, most of the pain was felt in the consumer business where revenues fell by 49.6% and are likely to continue falling heavily as Huawei is unable to produce 5G devices.
• Its current flagship device is 4G only and does not feature Google services meaning that it will be unattractive to consumers either at home (5G) in China or abroad (Google).
• It can still produce 5G infrastructure and here it is pushing hard in private networks where 5G is expected to be more relevant than in previous generations.
• This is likely to continue in 2022 with its chairman admitting that this year is likely to be even more difficult than 2021.
• This is why Huawei has expanded its offering and makes many more devices such as printers than it did before the sanctions hit.
• I suspect that the war in Ukraine and China’s lack of condemnation of Russia could turn Western clients even more against Huawei than they were in 2021.
• It is much simpler to justify higher prices to one’s customers and shareholders meaning that Huawei’s competitive edge of low cost outside of Chia and emerging markets is becoming less effective.
• This moves the ball even more into Nokia and Ericsson’s court where Ericsson’s corporate governance skeleton has once again jumped out of the closet and is doing a tap dance on the company’s already battered reputation.
• There is also now a fully-fledged shareholder revolt in progress where even Norges Bank has said that it will vote against the AGM resolution to absolve current management from blame for the lapses that led to the probability that the company sent money to ISIS (see here).
• Thanks to the differential weight of votes in the A and B share distribution, the resolution is likely to pass but this will leave a bad taste in the mouth of its economic owners and customers.
• This creates a good opportunity for Nokia to gain further market share as its corporate governance has been first-rate for over 20 years.
• I think that the recent report (see here) that Nokia has deliberately enabled Russian state surveillance of its enemies despite pulling out of the country is misleading.
• All of the equipment that Nokia, Ericsson and Huawei sell has to be able to interface with the lawful intercept equipment of law enforcement for the prevention of crime in every country in which they operate.
• The reality is that Nokia equipment will interface with Russian state intercepts when its customer, the Russian operator is compelled to comply.
• What Nokia has not done (and what is implied) is sell the intercept equipment itself and, given the share price reaction, this is clearly a storm in a teacup.
• Hence, I think that Nokia’s reputation will not suffer as a result of this meaning that doing business with Nokia carries by far the lowest reputational risk.
• I continue to think that Nokia will gain more market share from Huawei which may accelerate as a result of the situation in Ukraine.
• Nokia is no longer the obvious value play that it was when Pekka Lundmark took over, but I remain very comfortable with my position in the shares until at least €6.
• Things are almost certain to get worse for Huawei in 2022 but I expect that it will continue to make the best of an awful situation.