Setting the standards

In the struggle to establish global standards for new technologies the Chinese and the Americans are often on opposing sides. Things were different in the late 1990s when Qualcomm’s founder Irwin Jacobs was trying to commercialise CDMA, a wireless technology used by the US military for secure communication.

The MIT-trained Jacobs believed CDMA was a superior way to transmit data digitally but GSM, backed by European giants such as Ericsson and Nokia, was already the dominant format for voice calls.

China came along as the game-changer: Beijing wanted Washington’s support for China’s entry into the WTO and in a quid-pro-quo move the Chinese said they were willing to employ CDMA in their telecoms sector.

This helped Qualcomm to transform from something of a telecom think-tank into a tech powerhouse. Buoyed by a leading position in the Chinese market, the American chipmaker helped write the standards for next-generation mobile services. By the time iPhones had defined the smartphone revolution, wireless devices around the world were reliant on Qualcomm’s chips or its patents.

With the 5G era just around the corner for the telecom sector, the Chinese are no longer considered such a friendly force. Indeed, in a unprecedented step this week, US President Donald Trump called a halt on the biggest tech takeover ever because of Washington’s wariness over China’s 5G ambitions.

What was the deal in question?

During the evolution of 3G in the late 1990s, a flurry of mergers and acquisitions in the tech sector propelled global equities to new highs. Recently there’s been a sense of déjà vu – although the major M&A has this time come from the semiconductor industry.

According to market watcher IC Insights, deals announced by chipmakers – topped by Qualcomm’s $39 billion takeover of NXP – were worth a whopping $107.3 billion in 2015 and $99.8 billion the following year.

Last year looked like being quieter – at just $27.7 billion of business – but the pace picked up when Singapore-headquartered Broadcom made an unsolicited $103 billion bid for Qualcomm in November.

The $70 a share offer would have been the largest tech acquisition ever. Following opposition from Qualcomm management, Broadcom sweetened its bid last month to $82 per share, valuing its target at around $120 billion excluding $25 billion of debt. (Qualcomm’s pre-deal market cap was $75 billion and it was trading at around $93 billion at the start of this week.)

Qualcomm’s management made plain from the outset that it opposed the takeover but Broadcom’s move has been scuppered not by investors but by the intervention of the US government. In a letter to both companies last week, the Committee on Foreign Investment in the US (CFIUS), which oversees cross-border M&A, said it had identified “national security concerns” about the proposed merger.

The takeover bid had dragged on for months but it came to a conclusion this week, following an executive order from President Trump that barred Broadcom from acquiring Qualcomm. It was an unusual step – coming before Qualcomm and Broadcom had even formally agreed to a deal. However, Broadcom formally withdrew its bid on Wednesday.

What’s it got to do with Huawei?

CFIUS warned that the takeover would sap Qualcomm’s capacity to shape worldwide standards for 5G, thus leaving an opening for Chinese firms to promote their own formats. The takeover body name-checked Huawei – the Shenzhen-based powerhouse in telecoms gear, smartphones, cloud computing and cybersecurity – as a threat should Qualcomm be swallowed up by the Singaporean entity.

Trump’s order then warned of “credible evidence” that Broadcom “might take action that threatens to impair the national security of the United States”.

Perhaps that sounded strange to company executives. After all, Trump had praised Broadcom as “one of the really, really great companies” back in November, when the Singapore-based firm announced plans to redomicile in the US in the wake of his tax reforms.

However, just a day after Trump met Broadcom’s boss Hock Tan at the White House, reports of its plan to purchase Qualcomm began to spread in financial media.

CFIUS described Qualcomm as “well-known to and trusted by the US government” but the same standing obviously didn’t apply to Broadcom and the committee was worried that the takeover plan would disrupt Qualcomm’s relationships with the US government, including the Department of Defense.

However, the primary concern seems to have been that Qualcomm could lose ground to Huawei in the race to set new technology standards, especially if the leveraged buyout resulted in cutbacks to Qualcomm’s research and development expenditure. “China would likely compete robustly to fill any void left by Qualcomm as a result of this hostile takeover,” the committee concluded.

The conventional wisdom in Washington is that Huawei is an arm of the Chinese state, so de facto, any bid to control the 5G sphere by the Shenzhen firm would compromise the security of US communications.

“If Broadcom acquired Qualcomm, the US military was concerned that within 10 years there would essentially be a dominant player in all of these technologies and that’s Huawei,” a source familiar with CFIUS’s thinking told Reuters.

Is Broadcom close to China?

Much of the CFIUS review was classified, although parts remained available to public view, including mention of “risks associated with Broadcom’s relationships with third party foreign entities and the national security effects of Broadcom’s business intentions with respect to Qualcomm”.

Broadcom was founded by a UCLA professor in 1991, although its recent history was shaped by a $37 billion leveraged buyout by Avago Technologies in 2016. Avago, which was created out of Agilent, a Hewlett-Packard unit acquired by KKR and Silver Lake in 2005, kept Broadcom’s name once the takeover had been completed.

Broadcom’s private equity backers have a rich history of doing deals with Chinese parties. Silver Lake in particular was one of the earliest foreign investors in China’s semiconductor industry. In an interview with 21CN Business Herald in 2010, Silver Lake’s senior partners Eric Chen and Ken Hao said the Silicon Valley fund’s first China deal was a $40 million investment for a 13% stake in Spreadtrum, now a unit of state-backed semiconductor giant Tsinghua Unigroup.

Chen and Hao set up Silver Lake’s head office in Asia in Hong Kong in 2008 and in the same year their company was one of two final bidders that Huawei picked for its handset making unit. 21CN reckoned Huawei didn’t need to raise funds at the time but that the divestment was aimed at finding a foreign partner that could help with its international expansion.

The deal lapsed in the wake of the global credit crunch but Silver Lake was cognisant of Huawei’s potential (its fledging handset business has since become one of the world’s largest). “If we have the chance to work with Huawei’s management, we will certainly treasure the opportunity,” Chen told 21CN.

Wuhan-born Chen stepped away from a day-to-day role at Silver Lake in 2015 and he is now one of the senior members of the Future Forum, a Beijing-based think tank that promotes dialogue between scientists and investors.

But Hao, according to Bloomberg, was the Silver Lake partner who made the original approach to Qualcomm’s executives on Broadcom’s behalf and also the person who brought CEO Hock Tan, a Harvard-trained Malaysian, to the company in 2006.

“Over the past dozen or so years, the two men have helped Silver Lake generate huge returns and turn the Silicon Valley private equity firm into a leading actor in the rapidly consolidating chip industry,” Bloomberg noted.

There is no evidence that either Silver Lake or KKR might choose to broker the sale of portfolio firms such as Broadcom to Chinese entities like Huawei.

Nevertheless CFIUS has made clear that it wasn’t keen on Broadcom’s stated intention to take Qualcomm in “a private equity-style direction”.

“Broadcom has lined up $106 billion of debt financing to support the Qualcomm acquisition, which would be the largest corporate acquisition loan on record,” the US committee noted, concerned that paying down the debt could compromise Qualcomm’s commitment to investment in research.

How is China preparing for 5G?

Neither the Chinese government nor the state-controlled press has made direct mention of the takeover row, despite the reference to Huawei in the CFIUS ruling.

That said, the phrase “getting shot while lying in bed” has been widely used on social media this week to describe Huawei’s position – local slang that refers to situations when someone is unexpectedly or unfortunately ridiculed.

However, the Chinese and the American press both agree that Huawei has become a legitimate challenger to Qualcomm.

“Huawei and Qualcomm have been the duopoly leading the race in setting 5G standards,” a columnist wrote on 21CN this week. “This [the Qualcomm takeover saga] means that the war has escalated to a white-hot state.”

Fifth generation processors will serve as the building blocks for new networks of connected devices over the so-called Internet of Things, as well as underpinning emerging technologies such as self-driving cars and virtual reality streaming.

Qualcomm has profited from ownership of patents that served as the foundation for 3G and 4G technology. It also owns more 5G patents than any other company. But the race is on with firms like Huawei to control the intellectual property that underpins years of innovation in the 5G format.

Huawei’s trump card in the struggle is the sales potential of the Chinese market. The country’s three state-controlled telecom carriers reported a total of 1.4 billion mobile phone users in December and Huawei has invested $600 million in 5G research since 2009, a company spokesman told the New York Times, with an additional $800 million committed for this year.

The tech powerhouse isn’t battling alone. A research paper by the Ministry of Industry and Information Technology (MIIT) last year suggested that the three telecom carriers would spend a total of Rmb2.8 trillion ($410 billion) themselves on building 5G networks between 2020 and 2030.

Testing has already been carried out on trial networks but the MIIT’s plan is to roll out large-scale commercialisation of 5G technologies within two years.

“China, which used to lag behind in the development of cutting-edge technologies, is now poised to take the lead in this much-anticipated industry,” Xinhua proclaimed this month. (Indeed, a MIIT official told state broadcaster CCTV this week that state planners have already started working on 6G standards.)

The Chinese are also making their case at international bodies such as 3GPP, or the Third Generation Partnership Project, which has a strong say in setting wireless standards. The number of Chinese representatives serving as chair or vice chair of subgroups at the 3GPP was 10 last year, up from eight in 2013, the New York Times noted this week.

“Chinese companies, including Huawei, have increased their engagement in 5G standardisation working groups as part of their efforts to build out a 5G technology,” CFIUS also highlighted in its report, further noting that Huawei was boosting its R&D spending despite owning a number of industry-leading patents already.

These efforts have been causing wider concern in Washington. According to Axios, a US news website, the National Security Council is already proposing a plan that a centralised, nationwide 5G network should be up-and-running within three years. Security officials have also proposed that the best option is for the government to pay for the build-out of the network in the US and then rent it out to carriers like AT&T.

Trust is thin on the ground…

Huawei has always been a concern for US legislators. A 2012 Congressional report warned that the Chinese government could use the firm’s networking equipment to spy on Americans and in January the mood was still suspicious enough for AT&T to back out of another agreement to sell Huawei’s flagship handsets in the US (see WiC394).

The reception that Qualcomm gets in China has been becoming frostier too.

In 2015 it was on the receiving end of a $975 million fine by the government for antitrust behaviour. Since then it has agreed to lower its prices to Chinese customers and promised to shift more of its high-tech manufacturing to local partners. Last August the New York Times questioned whether such concessions meant that Qualcomm was working against the interest of its home country (see WiC377), because of its dependence on revenues from the Chinese market.

In fact, Qualcomm is in an unenviable position, with government and defence contracts in America but the majority of its sales from China.

Qualcomm bosses know that Beijing’s policymakers can make things very difficult for them in their most important market, while the Broadcom case suggests that the Trump administration regards the company as an integral part of its ‘America First’ ethos.

It’s a difficult balancing act. “We see ourselves as part of the China semiconductor system,” Cristiano Amon, Qualcomm President told Reuters at an event in Beijing in January. “It’s very clear that 5G is important to the United States of America. It’s important for China.”

As the race to get ahead in 5G moves forward, a former board member of Qualcomm may recall the very different circumstances of a previous era.

Brent Scowcroft, a former National Security Advisor to Presidents Ford and Bush), had already earned Chinese approval after making a secret visit to Beijing in July 1989 to repair Sino-US relations. Later in his career he spent a lengthy period as a director at Qualcomm, going back to the Chinese capital on another crucial mission.

In 2000, Scowcroft and Irwin Jacobs (Qualcomm’s boss at the time) sat down with then Chinese Premier Zhu Rongji. And following the meeting China Unicom announced it would build a CDMA network for 10 million of its customers using Qualcomm’s technology.

No such figure and no similar deal looks to be on the horizon as the 5G era begins. That means that the transition to the new standard could be one of the most politically-charged periods in telecoms history – and that Huawei’s name is likely to crop up again and again in the international news.

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