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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 and ZTE as threats to US national security - largely on the premise of potential Chinese state influence - underlines once again the difficulties facing the Chinese telecom equipment makers as they seek to expand across major developed markets.

Exposure to the US is quite small for both companies, at less than 5% of total revenues, so the potential loss of US revenue is unlikely to affect their operations significantly. Yet a more meaningful impact could arise if more countries decide to avoid the Chinese manufacturers over alleged national security concerns.

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

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

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

National security concerns are understandably an important consideration when deploying mobile or fixed-line networks. In January, India's Department of Telecommunications warned of potential security issues not just with the Chinese manufacturers, but also with vendors from the US, Europe and Japan, and hence emphasised the need for India to become more self-sufficient in telecoms network technology.

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

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

((Bangalore Ratings Team, Hotline: +91 80 4135 5898, Bhanu.priya@thomsonreuters.com, Group id: BangaloreRatings@thomsonreuters.com, Reuters Messaging: Bhanu.Priya.reuters.com@reuters.net))