the Huawei questions

Huawei is a Chinese telecom company.  It makes niftier smartphones than Apple and has 5G technology that’s better than anything US companies can offer.  The company is certainly a competitive threat to US cellphone makers, as well as to manufacturers of telephone equipment worldwide.

The question that arises with a firm like Huawei, also the perennial question raised about dominant US tech companies since WWII, is the degree to which Huawei will act in the national interest of China.  That is, can/will Beijing eavesdrop on conversations or collect/alter data being carried on Huawei networks–maybe even stop them operating, if Beijing so chooses.

The Trump response to Huawei’s technological edge has been two-fold:  to blacklist Huawei, and to aid its US rival, Qualcomm.

Two questions:

1.is this the proper response?   …or is it like Mr. Trump’s invoking national security to price better-performing Asian and European cars to unaffordable levels, forcing citizens to buy US automobiles that three-quarters of the population now shun?

I’m guessing the former.

 

2. does Mr. Trump have a strategy?   Has he thought out the consequences of what he’s doing?

Here my guess is no.  Otherwise, he would have been promoting science education and welcoming skilled foreign scientists, rather than compelling tech firms to relocate their tech hubs to Canada and elsewhere.

(An aside, sort of:  I was recently listening to a podcast which dealt with Mr. Trump’s weak record in real estate by saying that he was rich before he started in the family business and he remained rich after negotiating treacherous waters during the 1980s.  Really?

My read of the president’s career:  he ended (prior to licensing his name and performing in a reality show) with about as much money in real terms as he started with.  So in that highly technical sense what the podcast said is right.  Over the same period, however, a run-of-the-mill real estate developer made, adjusting for risk, four times what Trump did.  A really competent real estate person might have made 10x.  In achieving his result, Mr. Trump was also aided by the public listing, debt refinancing and subsequent bankruptcy declaration of his Atlantic City casinos.  Although Mr. Trump prevailed in the litigation that ensued, as a professional investor I find this an eyebrow-raising episode.

Mr. Trump was “successful” in running a business in the sense that he went fishing during a time when tons of fish were jumping into the boat and he came back with the boat.  Nothing in it …though he was in the area where the most fish were to be had   …and he was soaking wet in a way that suggested he fell out at some point.

I’m also extrapolating from that.)

investment implications?

Throughout my investing career, politics has never made much of a difference.  In fact, to my mind professional investors who based their decisions on reading Washington’s runes simply revealed the poverty of their thought.  I think now is different.  Mr. Trump has exposed the surprising weakness of Congress.  The reality of China as a rival superpower to the US has been made clear.

Unfortunately, Mr. Trump is executing an early twentieth-century strategy to solve a twenty-first century dilemma.  Arguably, but not necessarily, this is a drama where the US is playing the role of post-WWI Britain and China is the 1920s US.  We all know how that worked out. By simultaneously discouraging innovation at home and forcing China to up the pace of its own tech progress, I think the administration is auditioning for the UK part, and thereby potentially doing significant long-term harm to the economy.  Ironically, those hurt most badly will likely be Mr. Trump’s most rabid supporters.  Withdrawal from the Trans Pacific Partnership, for example, is already putting US farms at a disadvantage vs. Australian, Canadian and New Zealand rivals.

What to do?

I’m taking a two-pronged strategy in the US.  I’m looking for companies with worldwide reach and innovative products.  For domestically-oriented companies, I’m taking an approach that might be called, for lack of a better term, “value with a catalyst” (regular readers will likely know that I don’t believe traditional value works any more in the US).  This term usually means a value stock where a turnaround has progressed far enough that the path for the firm to return to health can be identified.  E.g., the stock is trading at 20% of book value in an environment where healthy firms are trading at book.  Only “deep” value investors might be interested.  Then the company recruits a CEO who’s a turnaround expert and the stock begins to trade at 30% of book–this is value with a catalyst.  I’m not so interested in book, though.  I’m looking at price/cash flow.

I’m also looking harder in the Pacific Basin.  I’m even thinking about the EU, although that’s an area where market participants have a thorough value orientation and where lots of local market lore is needed to be successful.  So I find it a bit scary–better said, the rewards not worth the effort.

 

 

 

Huawei: troubles getting business in the US

Huawei has become a leading supplier of telecom infrastructure equipment around the globe over the past decade.   Its formula for success?   …providing state-of-the-art products at low prices.  Despite these attractions, Huawei has been unable to make much headway in the US.  Like virtually all mainland companies, it has close connections with the Beijing government and the ruling Communist Party–in Huawei’s case, through the military.  But that relationship has little direct connection with its inability to gain traction here.

The US government opposes Huawei’s attempt to penetrate the US market for two reasons:

–It’s a form of protectionism for domestic industry.  Whoever appears to be the most threatening economic rival of the US at a given time simultaneously becomes the focus for denial of market share or market presence domestically.  It doesn’t hurt at all that this activity plays very well with the voters at home.

In 1987, for example, when Japan was the competitor most feared by Americans, Fujitsu tried to buy a controlling interest in Fairchild Semiconductor.  Although operating on American soil, Fairchild was not an American-owned company.  It was a subsidiary of the French oilfield services giant, Schlumberger.  Nevertheless, Washington opposed the sale on the grounds that foreign ownership of Fairchild was a threat to national security.  Fujitsu withdrew its offer.

In 1989, Mitsubishi Estate wanted to buy 100% of Rockefeller Center for an astronomical price (it subsequently defaulted on the mortgage loan it took out to finance the deal).  This, despite the fact that the Rockefeller Center buildings were old and needed substantial refurbishing.  In addition, the Center’s tenants were about to decamp en masse for lower rents in newer buildings elsewhere midtown Manhattan, as their long-term leases in Rockefeller Center ran out in the following couple of years.  Luckily for Mitsubishi Estate, it was saved from larger disaster by a firestorm of protest that arose in government circles about Japan “buying up America.”  This forced Mitsubishi Estate to cut back the amount it was buying–thereby allowing many Americans to participate in the subsequent financial failure as well.

Today’s economic foe is China, and Washington is dishing out the same treatment.

In 2005, China National Offshore Oil bid for the US integrated oil company, Unocal.  It’s object?  …Unocal’s extensive hydrocarbon holdings in Asia.  Again, a firestorm of protest from Washington, which forced CNOOC to drop its bid.  Unocal was ultimately acquired by Chevron for about a billion dollars less than CNOOC had offered.

Late last year, Huawei appeared to have won a multi-billion dollar portion of an infrastructure contract with Sprint.  But, according to the Wall Street Journal, the then Secretary of Commerce, Gary Locke called the CEO of Sprint.  When Dan Hesse hung up the phone, Huawei was out of the bidding.

A recent Financial Times article analyzing Huawei’s problems closes with a reference to a small rural broadband contract Huawei won from Northeast Wireless in Maine.  The FT says the win came despite a call by the FBI on the Northeast Wireless management, apparently in an attempt to pressure them not to select the Chinese equipment supplier.

So far, this sounds like standard jingoistic fare–politicians wrap themselves in the flag, but act against the country’s long-term economic interests to score points with voters at home and keep domestic corporate contributors to their campaign coffers happy.

–There’s a second reason for government opposition to Huawei that makes its case unique, however.  It’s the issue of cyber warfare.  The worry is that China may secretly embed in Huawei equipment the capability to monitor or disrupt the flow of communications through it.

We already know there have been sophisticated cyber attacks on government and corporate computer systems in the US, emanating from the military in China.  Although it’s a somewhat different issue, the Stuxnet computer worm that has attacked Iranian nuclear installations is generally believed to have been born in US and Israeli government cyberlabs.   So the idea that a government would prevail on a telecom equipment provider in its country to secretly place disruptive or monitoring capability in its products is not that far-fetched.

Although the threat may be framed in military terms–suppose China wants to invade the US?–the much more substantial worry, in my opinion, is corporate espionage through the possible undetected monitoring of corporate communications.

There’s no way to know whether Huawei is doing this now or would ever attempt to do so.  But this uncertainty seems to me to guarantee that the road to success in selling telecom infrastructure in the US for Huawei will continue to be long and hard.