Talking Point, Telecoms

A connection problem

Huawei faces another setback in the US where it’s viewed as a security risk

A connection problem

For Huawei the ‘American dream’ is proving more of a nightmare...

Back in September 2007 Israeli aircraft flew undetected into Syrian airspace to bomb an alleged nuclear facility being built by the North Koreans.

Unsurprisingly, the Israelis haven’t explained how they managed it. But the speculation is that Syrian radar might have been disabled through a hidden backdoor in one of its microprocessor chips, in which a preprogrammed code blocked equipment from working properly. A flick of the “kill switch”, as it is called by the technology geeks, and Syria’s defensive shield turned off for the night.

How might the failings of Syrian radar systems be relevant to Chinese companies? Because some American congressmen fear that Chinese vendors might be tempted to wire kill switches into the US telecommunications sector. And that is giving firms like Huawei, China’s leading telecom equipment maker, plenty of commercial headaches.

Huawei claims its products are now deployed in over 100 countries, helping to connect a third of the world’s population via telephony. But this week it was forced to relinquish patents that it had purchased from a Californian technology start-up, adding to another problem: its sales efforts in the US have had far from a smooth ride…

There has been disappointment in its American M&A before?

Yes, Huawei was blocked from acquiring 3Com in 2008, when a joint bid with Bain Capital was scuppered by government concerns that routers, switches and network cards made by 3Com and used by US military could be at risk of sabotage and snooping.

Huawei is also said to have failed in bids last year to acquire the wireless network division of Motorola as well as 2Wire, an American maker of broadband internet software. Analysts say that Motorola and 2Wire were told that Washington was likely to block any deals. Also last year, Huawei ran into sustained opposition to its efforts to supply Sprint Nextel with networking equipment. And now the refusal by CFIUS (the Committee on Foreign Investment in the US) to allow it to keep patents it had purchased from 3Leaf – these involved technology that binds operating systems together.

It was all too much for the Global Times, which rolled out a fiery editorial ridiculing the case. This was another attempt to stymie Huawei’s growth in the US, the newspaper said. “It seems that the only transactions the US is not concerned about are China’s purchases of US bonds,” it concluded.

What concerns the Americans most?

The most common complaint is that Huawei is associated with the People’s Liberation Army (its founder, Ren Zhengfei, was formerly director of a PLA research institute).

Huawei refutes such claims, insisting it is 100% employee-owned. Indeed on the FAQ section of its website it even states “the Chinese government and the PLA do not hold shares in Huawei, nor do they control the company in any form.”

But that doesn’t seem to have prevented ongoing speculation on its ownership structure, or its relationship with the military. Indeed, in a letter last year to US Commerce Secretary Gary Locke, a group of US lawmakers went further still, accusing Huawei of having ties with the Taliban, and the Iranian Revolutionary Guard too.

“Unfounded innuendo” was the Huawei response.

But it’s not just the company’s acquisition agenda in the US that is being curtailed – sales contracts are being hit too. Although Huawei has won deals to supply telecom companies like Cox Communications, bigger contracts have tended to be much more elusive.

Last October five US senators wrote to the Chairman of the Federal Communications Commission arguing against the sale of Chinese equipment to US telecoms firms. Previously, agencies like the Pentagon had expressed concern that many of its defence contractors relied on commercial suppliers for chips, many of which are now fabricated overseas. But the letter from senators widened the scope again: “When telecommunications carriers purchase equipment from Huawei, the result is that US communications will travel over switches, routers and other equipment that was manufactured and designed in China and may be remotely accessed and programmed from that country, and the CFIUS process cannot protect against it.”

What about the Chinese reaction to that 3Leaf ruling?

“Of course, we all know that Huawei is a genuine private enterprise,” Xiang Songzuo, Deputy Director of the Institute of International Currency at Renmin University, told CCTV, going on to describe the speculation on Huawei’s military links as “trumped up”.

Nor did Xiang see much room for maneouvre ahead. “The United States is now very clear. If your industry is associated with military technology, and if your business is a state-owned enterprise, then the acquisition is basically rejected on grounds of national security.”

Ye Hailin, another CCTV commentator, agreed. “Where once the US was a beacon of an open economy, now it has become ‘a shining city upon a hill’ of protectionism,” he lamented.

Weibo comments – the Chinese Twitter-equivalent (see WiC95) –tend to have been more scathing still, often accusing the US telecom equipment makers of running scared of Huawei. “The IT industry is the only industry US companies still dominate, so it has to protect it,” trumpeted one irate contributor. “China’s low-cost strategy with its all-devouring and all-destroying momentum makes Europeans and Americans fearful.”

But hadn’t Huawei been on a charm offensive in the US?

Last autumn it teamed up with Amerilink Telecom Corp for a joint bid to serve as an equipment provider to Sprint Nextel, the US carrier. Under the proposed deal Amerilink would have purchased equipment directly from Huawei that it would then have integrated into Sprint’s network.

Amerilink may have also provided some heavy-duty assistance in the Washington corridors of power. It was founded by William Owens, vice chairman of the Joint Chiefs of Staff under President Clinton and a former CEO of Nortel Networks Corp, and also welcomed former Democrat congressional leader Dick Gephardt and former World Bank governor James Wolfensohn as directors.

But these efforts don’t look like they have paid off. On the Sprint Nextel supplier deal, both Huawei and its Chinese rival ZTE were dropped from competition with Alcatel-Lucent, Ericsson and Samsung, even though they are said to have submitted lower bids. And now Huawei is being forced to divest the 3Leaf patents purchased last year.

In fact, regulators seem to have been caught unawares on the 3Leaf transaction. Huawei actually acquired patents from 3Leaf last May, but the deal only came to light when CFIUS officials read about it via information provided by one of 3Leaf’s founders on LinkedIn, a social networking site.

That then led to some fairly tense exchanges, with Huawei saying it did not think it needed to file for a review in the first place as it was not buying the company outright, just a few of its patents, and taking on some of its staff. The deal was a small one at $2 million.

Once the review process began, the Huawei executives then pushed for it to go all the way up to the US president’s desk. This is unusual. Standard practice is for companies to withdraw applications if they get an indication that the committee will not recommend a deal.

Huawei refused, adding to the rancour surrounding the case. Only at the last minute did it back down. “This was a difficult decision, however we have decided to accept the recommendation of CFIUS to withdraw our application to acquire specific assets of 3Leaf,” the company said. “The significant impact and attention that this transaction has caused were not what we intended.”

The Europeans have some concerns too?

It’s not just in the US that Huawei has run into regulatory concerns. The European Union has also been investigating the company (and ZTE too), although the substance of the complaint was shaped more in terms of competition rules than fears about telecommunication security.

Option, a Belgian manufacturer of wireless network cards (which connect computers to Internet networks) has seen most of its share of the EU data card market disappear in the last four years. It blamed unfair competition, citing information including a Huawei agreement with China Development Bank in 2009 in which it was given access to a $30 billion credit line (Huawei revenues that year were $22 billion).

“Such fund-raising cannot be achieved on the open market,” the submission stipulated, with the implication that the financial resources are being used to support cut-price tendering. Huawei and ZTE now control 90% of EU wireless card sales, according to reports.

In fact, Option has now dropped its case in exchange for a Huawei agreement to license its own software. Now the EU Commission is dropping its investigation too, but not before some of its preliminary findings outlining the “massive” credit lines available to the Chinese telecom firms were leaked.

Potential for tit-for-tat ahead?

China’s Ministry of Commerce was restrained in expressing its own disappointment on the 3Leaf case, saying that it regarded Huawei’s proposals to have been a “normal commercial move based on its own development needs and market economy rules”.

But the timing of the spat is still awkward, as the Chinese have just announced the creation of a security review panel of their own, comprised of officials from the NDRC and the Ministry of Commerce.

Policymakers say the new body is similar in set up to CFIUS or the Foreign Investment Review Board in Australia. “China is following international practice. Many nations have already adopted such an approval process. It will help China to further open up and improve policy transparency,” a Ministry of Commerce spokesman told the People’s Daily. Some analysts have expressed concern at the breadth of the new panel’s terms of reference: national security is being defined not just for matters of defence but also in agriculture, energy, transport and technology too.

As for Huawei, it hasn’t given up on its US prospects. It posted a 2,000 word open letter on its website this morning in which deputy chairman Ken Hu writes that any claims that Huawei has ties to the military or receives financial support from the Chinese government are “falsehoods”, but also that they “have had a significant and negative impact on business activity”.

In an unexpected move he asked the US government to investigate Huawei to end “unsubstantiated suspicions” it posed a threat to national security, promising that it would “cooperate transparently” with all government agencies in a US investigation. Hu even quotes Abraham Lincoln: “Character is like a tree and reputation like its shadow.” Rumours have been the “shadow of Huawei”, he claims.

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