If you believe in historical precedents, the trade war with China should have ended last week.
The Commerce Department announced Wednesday it would require all U.S. companies doing business with Huawei and its affiliates to get a special license. It’s a nuclear bomb.
The White House expects China to surrender.
Huawei is a font of Chinese national pride. By most accounts, it currently makes the best telecommunications gear, with a clear lead in 5G development.
Its systems, thanks to close integration with American semiconductor firms, are more advanced than competitors from Nokia and Eriksson. Plus, they are cheaper.
Global telecos, ever eager for competitive advantages, have been lining up to buy Huawei’s switches and network components.
And the stakes are high. Very often, investors assume fifth-generation wireless is about smartphones and download speeds between 10x and 1,000x faster than 4G.
That is short-sighted.
5G is about the future of connected things. Higher-capacity networks with lower latency — the time it takes between initiating an action and it actually happening — will open up all sorts of new technologies.
Connected and self-driving cars, remote robotic surgery, smart cites and factories are only the beginning of what is possible.
The company that wins the 5G race is going to reap untold riches.
The Trump administration wants to make sure Huawei is not even in the running.
Related post: Why 5G networks will be a game-changer
The directive from the Commerce Department effectively bans the sale of semiconductors from U.S. firms. This kneecaps Huawei in the worst possible way.
There is no easy way for the company to build 5G products without that intellectual property.
Huawei depends on Qualcomm (QCOM) to make its smartphones. Building out 5G infrastructure will be impossible without the field gate programmable array (FGPA) intellectual property that Xilinx (XLNX) and Intel (INTC) are developing.
FPGA is ideal for 5G because it allows the integrated circuit to be programmed after it is manufactured. Software-defined hardware is key to building flexible base stations and towers.
The Commerce Department claims the ban is a matter of national security. It points to longstanding concerns Huawei is merely a front for the Chinese government. Making the company ground zero for 5G, therefore, is tantamount to building-in a spy network.
And there is some precedent for concern …
The Chinese government pledged in 2006 to build the African Union headquarters in Addis Ababa, Ethiopia. The $200 million project, completed in 2012, featured a state-of-the-art computer and networking system supplied by Huawei.
Le Monde Afrique reported in 2018 that, for two hours every night, African Union servers began transferring data back to Shanghai … 5,000 miles away. The breach was discovered by chance, according to a BBC story, when a scientist working late one evening discovered unusual server activity.
Huawei claimed no wrongdoing. However, the firm has close ties to the Chinese state government. Ren Zhengfei, its 74-year-old founder, began his career as military technologist in the People’s Liberation Army.
Ren has become a symbol of Chinese entrepreneurial spirit. He started Huawei in 1987 with an investment of only $5,000. The company began modestly. As a reseller of telecommunication switches. Early employees worked, ate and lived in a small Hong Kong office. Today, the Shenzhen firm is the largest telecommunication firm in the world, with $108.5 billion in sales.
According the corporate website, the firm has 180,000 employees in 170 countries and has built 1,500 telco networks, connecting one-third of the world’s population.
Now Washington wants to make it the first victim of the Sino-American trade war.
Related post: Huawei casts Apple from the fold in China
This is an important escalation. Attempts to kill Huawei will not sit well with Chinese political leaders. They have made it a vital part of longer-term plans to move the country from a supplier of inexpensive electronics to a technology leader in artificial intelligence, robotics, self-driving cars and aerospace.
In the technology space, there is plenty of gloom. Huawei is a major customer for U.S. technology companies.
For example, Quartz reported in 2016 that China imported $160 billion worth of semiconductors, making the tiny bits of silicon even more valuable to its economy than oil.
One company that seems to have anticipated the trade war escalation is Cisco Systems (CSCO). It’s also a logical beneficiary of a weaker Huawei.
Executives told CNBC they have mitigated the effects of the move to 25% tariffs on many Chinese goods by moving part of the supply chain to other countries.
The global maker of teleco equipment has been transitioning to network services like security. The company has fiscal 2018 sales of $49.3 billion, a 2.7% increase year over year.
Shares trade at 16.5x forward earnings, for a market capitalization of $251 billion.
Longer-term investors should consider buying a pullback to the low $50s.
Best wishes,
Jon D. Markman
P.S. The trade war turns one year old in July. Cisco could do very well no matter how long it lasts, or who wins. Meanwhile, other 5G pioneers and other “connected” companies are growing like gangbusters, many without the big exposure to the Chinese market. Get invested in them before they truly start to surge. Click here to learn more.
