We usually try to focus on the fundamental development of 5G ecosystem, and stay away from macro or politics. However 5G is inevitably turning more into a geopolitical issue since both US and China view it as a game that neither can afford losing. The series of Huawei related news this week proved the point.
What happened with Huawei this week? - Suppliers cut off
President Trump on Wednesday declared a national emergency over threats against US technology, and issued an executive order to block transactions that "pose an unacceptable risk to the national security of the United States."
Shortly after the executive order, the US Department of Commerce announced it was adding Huawei and 70 affiliates to the "entity list", which bans Huawei from buying any components or services from US companies without US government approval.
What is the impact? - 5G development delayed
The short-term supply disruption is unavoidable. Huawei has 92 core suppliers and 33 of them are US companies, including the largest semiconductor and component companies like Intel, Qualcomm and Broadcom. Being put on the "Entity list" makes it extremely difficult, if not impossible, for Huawei to purchase required component from these companies. For the 33 companies, Huawei's revenue contribution ranging from single digit to as high as 40%.
The market responded swiftly, the PHLX Semiconductor Index dropped 4% in the two days following the announcement. Optical products providers NeoPhotonics, Lumentum dropped 33% and 19% in the same period.
Huawei, being the most important networking equipment provider, has the largest market share in most of the regions outside of US, and is leading the 5G development. The move by the US will likely delay the 5G development meaningfully if the issue can't be resolved in the near term.
Can it be resolved similar to ZTE last year? - Not likely
The Commerce Department put a similar ban on ZTE last year, which was lifted two months later after ZTE agreed to pay a fine of $1 billion, overhaul the senior management team and bring on board an US monitoring team. We don’t believe the Huawei case can be resolved in a similar fashion.
Huawei is widely viewed as one of the greatest domestic company in China, and the founder Zhengfei Ren is arguably the greatest entrepreneur of all time in China. Overhauling the management team and putting a US monitoring team in Huawei are equivalent to firing Jeff Bezos and letting a team of Communist supervising all activities in Amazon, a scenario we don’t believe acceptable to China.
On the other hand, President Trump has declared National Emergency over the threat of Huawei, which leaves little wiggle room to scale back the restriction without meaningful concession from Huawei.
How can it be resolved then? - Depends on the Trade War negotiation
There is no question that the Huawei issue is part of the broader trade war negotiation between US and China. When and How the Huawei issue can be resolved largely depends on the progress of trade negotiation, and particularly what does President Trump want to achieve by pressuring Huawei. We don’t have a good answer but we can think of two possible scenarios.
Scenario one: President Trump wants to have a trade deal with China before 2020 election, so he can claim a win. Huawei is being used as a leverage against China in the negotiation, a "nuclear threat" that is not available to China. In this case, we believe both parties will make compromises and US will scale back the restrictions in exchange for some concession from Huawei in the next 12 months.
Scenario two: President Trump views Huawei and Chinese 5G development as a strategic threat that has to be stopped at all cost, and does not care much about having a trade deal before 2020 election. We expect the US will keep the restriction on Huawei for an extended period under this scenario.
What is the long term impact? - Further acceleration of Chinese domestic semiconductor supply chain
China has been developing the domestic semiconductor supply chain over the past few years, and has made some early success. The CEO of HiSilicon, Huawei's semiconductor unit, said they have been preparing for such US ban scenario, and they do have a plan B.
We believe the latest development will further accelerate the process of building domestic semiconductor supply chain in China. How successful they can be is an open question for now, but there is no question that China will try at all cost, and we believe the long term risk of established semiconductor companies will go up meaningfully as it happens.
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