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China's ZTE to post first loss as margins bleed

* ZTE set to unveil first quarterly net loss in 8 years

* Q3 margins seen hitting record lows - analysts

* Earnings may have hit bottom - analysts

HONG KONG, Oct 25 (Reuters) - ZTE Corp, a major Chinese telecommunications equipment manufacturer and the world's No.4 maker of mobile phones, will on Thursday report its first quarterly loss since listing its shares in Hong Kong in 2004, as weak sales have shredded margins to record lows.

Shenzhen-based ZTE, led by Shi Lirong, warned earlier this month that its quarterly loss could be as much as 2 billion yuan ($320 million) - eight times the size of its profit in the first half of the year - triggering a 16 percent drop in its stock price on Oct. 15, a slew of broker downgrades and warnings from Fitch ratings agency.

The slide into the red in July-September - from a 299 million yuan profit a year ago - is the result of a combination of fierce competition, revenue accounting changes, delayed orders in Africa, and chasing market share in Europe through low-margin contracts.

ZTE and its unlisted local rival Huawei Technologies Co Ltd have suffered, too, as telecoms operators slowed spending on networks, and both have been targeted as potential security threats by a U.S. Congress committee. ZTE and Huawei have denied the U.S. committee's allegations.

But this weak quarter could be a turning point, analysts say, as ZTE should benefit from China Mobile Ltd's expected spending next year to develop its 4G network.

``The worst should be over, but the recovery will depend on how the global economy goes, too,'' said Victor Yip, an analyst at UOB Kay Hian.

MARGIN MISERY

On a conference call after the Oct. 14 profit warning, ZTE executives said third-quarter gross margins fell as much as 13 percentage points from a year earlier. Analysts said that would bring margins to a record low of just over 18 percent.

In the first half, gross profit margins had already slipped 2.45 percentage points to below 27 percent, with margins at the telecoms equipment business almost double the 16.6 percent margin at ZTE's consumer devices division, which includes mobiles, tablet PCs and dongles.

``We're always concerned about ZTE's gross margins,'' said Jones Ku, an analyst at Barclays. ``If you look at the (handsets) margin, it's where the major disappointment is coming from. The smartphones margin is probably in the low teens, even lower than in feature phones.''

Telecoms gear contributes about half of ZTE's total sales, while consumer devices make up about a third. The company, which employs more than 80,000 people, generates more than half its revenues outside China.

One analyst at a fund management house that recently sold its ZTE shares, said the firm's debt levels were also a worry.

``We've been looking at ZTE's figures and we don't really like some things we're seeing,'' said the analyst, who was not unauthorised to speak to the media and didn't want to be named. ``Its gearing ratio of 75 percent is worth monitoring.''

UNDER SURVEILLANCE

ZTE, which competes with Ericsson, Alcatel-Lucent SA and Nokia-Siemens in providing equipment to telecom carriers, has been frustrated by project delays in the high-margin African market, while sales in Europe have slowed due to the broad debt crisis there.

Like many in the consumer gadget business, ZTE wants to move up the smartphone value chain with higher-end models like its Grand series, but remains way behind Samsung Electronics Co Ltd and Apple Inc in consumer recognition. ZTE shipped 8 million smartphones in April-June and analysts said executives told them shipments would be around 25 million this year, lower than earlier targets.

The weak results come despite a 370 million yuan gain from the recent sale of a majority stake in ZTE Special Equipment Co (ZTEsec), a business that sells surveillance systems to governments and law enforcement agencies.

An investigation by Reuters earlier this year found that ZTE had sold to Iran's largest telecoms firm a powerful surveillance system capable of monitoring landline, mobile and internet communications. Reuters also reported that ZTE sold or agreed to sell Iran embargoed U.S. computer equipment. The company said later it was curtailing its business in Iran and had stopped looking for new customers there.

ZTE shares have more than halved this year, dropping the firm's market value to below $5 billion. The benchmark Hang Seng stock index has gained almost 18 percent over the same period, while the CSI 300, made up of leading Shanghai and Shenzhen shares, is down 1.7 percent.

ZTE has switched to a stricter way of logging new contract revenues in its home market. It previously signed procurement contracts with carriers' provincial branches, but now also requires agreements with their head offices, increasing the time needed to seal some deals, analysts said.