TEXT-Fitch: China hi-tech exporters baffled by alleged security risks

(The following statement was released by the rating agency)

Oct 10 - The decision by the US House Intelligence Committee to label Huawei andZTE as threats to US national security - largely on the premise of potential Chinesestate influence - underlines once again the difficulties facing the Chinese telecom equipmentmakers as they seek to expand across major developed markets.

Exposure to the US is quite small for both companies, at less than 5% of totalrevenues, so the potential loss of US revenue is unlikely to affect theiroperations significantly. Yet a more meaningful impact could arise if morecountries decide to avoid the Chinese manufacturers over alleged nationalsecurity concerns.

Earlier this year, the Australian government decided to exclude Huawei fromparticipating in building the country's national broadband network (NBN) due toconcerns that it could impinge on national security, despite assurances to thecontrary.

ZTE responded to the US congressional committee report by emphasizing itsindependence from state influence, the integrity of its vendor-neutral networksecurity systems, and how the value of various telecom equipment components ZTEpurchases from US companies is significant compared with the revenue it derivesfrom the US. The company also expressed disappointment that the two Chineseequipment makers had alone been singled out, and how the report failed toconsider Western telecom equipment vendors and their Chinese joint-venturemanufacturing partners in its assessment, given that the vast majority oftelecom equipment in place in the US is in fact manufactured in China.

ZTE is 31%-owned by Zhongxingxin Telecommunications Equipment Co., Ltd, which inturn is 51%-owned by two stated-owned entities. The ownership structure ofHuawei is not in the public domain as the company remains a private concern.Nevertheless, according to various media reports, most of its shares are ownedby the company's employees - including its founding shareholder, Ren Zhengfei.

National security concerns are understandably an important consideration whendeploying mobile or fixed-line networks. In January, India's Department ofTelecommunications warned of potential security issues not just with the Chinesemanufacturers, but also with vendors from the US, Europe and Japan, and henceemphasised the need for India to become more self-sufficient in telecoms networktechnology.

Margins for the Chinese telecom equipment manufacturers are under pressure,partly because they typically need to offer significant discounts in order towin strategic orders from large network operators in developed markets. Theextent of the discount required is only likely to be greater for those marketswhere supposed security concerns weigh against the Chinese exporters. This isdespite Fitch's view that the Chinese technology is highly competitive andoffers significant cost-savings.

In February, Fitch downgraded ZTE to 'BB?' from 'BB+' due to deterioratingcredit metrics - including thin margins and negative free cash flow. This wasafter the company's push to gain market share in Europe and North America hadled to a fall in operating profitability in 2011.

((Bangalore Ratings Team, Hotline: +91 80 41355898, Bhanu.priya@thomsonreuters.com,Group id: BangaloreRatings@thomsonreuters.com,Reuters Messaging: Bhanu.Priya.reuters.com@reuters.net))