China's Telecom-Gear Titans Invade U.S.

Spurred by a downturn at home, ZTE and Huawei are challenging Cisco and Nortel for wireless and broadband equipment contracts in the U.S.

For China's high-flying manufacturers of telecom equipment, the U.S. market has always been a no-go zone. The Chinese government wants its companies to go global, but for Huawei Technologies and ZTE, that has meant heading to the developing world.

Customers in Southeast Asia, the Middle East, sub-Saharan Africa, and Latin America have all been receptive to Chinese-made equipment that performs almost as well and costs far less than comparable gear from Cisco (CSCO), Nortel (NT), and Alcatel-Lucent (ALU). And while the Chinese made some forays into Western Europe they stayed clear of the U.S. after an embarrassing legal challenge by Cisco in 2002 cast an unflattering light on Huawei for alleged copying.

That timidity is now starting to fade. Both Huawei and ZTE have been boosting their sales and marketing teams in the U.S. and becoming more aggressive in trying to land deals with American carriers. Huawei last month inked a deal with Cricket Communications, a subsidiary of Nasdaq-listed Leap Wireless International (LEAP), to supply its latest-generation CDMA multiplexing technology to the San Diego wireless carrier.

A Flurry of Deals for ZTE

The agreement, signed July 11, was the second in the past 12 months for Huawei with Leap. On Aug. 15 last year, Huawei announced that it had won a contract to launch 3G networks for Leap's Cricket subsidiaries in Boise, Idaho, Reno, Nev., and Spokane, Wash.

ZTE, headquartered in the southern Chinese city of Shenzhen along with Huawei, is used to playing second fiddle to its larger cross-town rival. But it has scored the highest-profile win to date in the U.S. On July 17, the Chinese company and Sprint Nextel (S) announced an agreement for ZTE to provide the U.S. carrier with an undisclosed amount of wireless broadband, or WiMAX, equipment.

ZTE has made some smaller deals, too, and George Sun, chief executive of ZTE's American subsidiary, says that the company is also in the final stages of negotiations on a deal to provide ZTE cellular phones to an American customer. After years as a U.S. also-ran, "we have successfully penetrated this market," boasts Sun.

Drop in Domestic Demand

Making headway in the U.S. is just the latest sign that the Big Two Chinese telecom equipment makers are now formidable challengers to the big Western equipment makers. After the bursting of the telecom bubble in 2000, the Chinese largely avoided the U.S. and stuck to easier markets. What the Chinese did have in the U.S. was largely research and development facilities. ZTE operates R&D centers in San Diego, Dallas, and New Jersey, and Huawei has them in Dallas and Silicon Valley.

Instead, the two Chinese companies focused on their domestic market as well as elsewhere in the developing world, where competition was less fierce. That strategy worked nicely for a while but last year started to create some problems for ZTE as demand from China's telecom operators fell because of delays in the launch of 3G cellular networks in the country. ZTE, which is traded on the Hong Kong Stock Exchange, suffered a 41% fall in profits last year, to $100 million, on a 7.7% drop in sales, to $3 billion.

Privately held Huawei reported a big drop in earnings, too, with profits falling from $681 million in 2005 to $512 million in 2006, even as sales rose 42%, to $8.5 billion.

Quality Essential for U.S. Acceptance

Hence the need for more business in the U.S.

ZTE's American push dates back to 2005 with the arrival of Sun from corporate headquarters in Shenzhen. The company had just a handful of sales and marketing employees in the U.S. at the time. Since then, Sun, a 38-year-old electrical engineering PhD from the Chinese Academy of Science who has worked for ZTE since 1998, has added several dozen salespeople and opened company offices in Washington, D.C.; Chicago; Kansas City, Mo.; Tampa; and Jacksonville, Fla.

They have helped ZTE reach deals such as one announced last December with ClearTalk Wireless, which operates discount wireless services in nine small cities in California, Idaho, Tennessee, Alabama, and Florida, to sell equipment for 3G voice, data, and multimedia services.

To make real inroads in the U.S. the Chinese will have to establish a reputation for quality, not just low prices. That price advantage is waning anyway as just about all of their Western rivals have now shifted their manufacturing to low-cost locations in Asia. And big telecom operators in the U.S. are accustomed to buying in huge volumes and getting favorable deals from suppliers. "It will take a few more years before these efforts really pay off," says Matt Walker, an analyst with Ovum-RHK, in an e-mail interview.

No Exploding Cell Phones

With headlines in the American media screaming about dangerous, Chinese-made toothpaste, drugs, and pet food, this may not be the best time to be trying to convince U.S. companies or consumers that they should take a chance on a new "Made in China" product. While that's less of a concern when the Chinese are selling to businesses, safety issues come to the forefront if ZTE does start selling its cellular phones to American consumers.

"You have a lot of horror stories [in China] about exploding batteries" in cell phones, says Evan Erlanson, an analyst in Hong Kong with Bear Stearns (BSC). "That is one key concern, the authenticity of the parts in the phone."

Huawei's Charlie Chen, senior vice-president for marketing in the U.S., says that the company is up to the challenge. The roster of Huawei customers in Europe includes such big names as Vodafone (VOD), Telefonica, T-Mobile, and British Telecom. "These companies don't just consider prices," says Chen.

ZTE Discounts Backlash Factor

And John Saboe, vice-president for engineering at Cricket, notes that his company's choice to go with Huawei came only after thorough testing of the Chinese technology. Cricket vetted the Chinese network in sample markets before agreeing to a bigger rollout. "We built over time the confidence level that they could deliver a reliable product," says Saboe.

ZTE's Sun dismisses suggestions that the company will suffer from a backlash against Chinese-made products. "Manufacturing for this company has never been a problem," he says. "The only challenge is to try to understand the U.S. market and its requirements." Besides, he adds, it's not as if ZTE is unique in trying to market Chinese-made telephones to Americans. "Even Motorola (MOT) and Nokia (NOK), most of their handsets are made in China," he says.

The moves by the Chinese in the U.S. are still small. But Erlanson of Bear Stearns is optimistic that the Chinese will make progress in the U.S. The Sprint deal for ZTE could be a real breakthrough. "It's a get-to-know-you introduction to the technology," he says. "They will definitely try to penetrate other markets." Things like wireless broadband represent "virgin territory for telecom equipment makers and there is no established market share. It's an interesting opportunity for these guys to show what they've got."

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