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FBI’s Wanted List Sends Chinese Tech to First From Worst

IBM Servers
Public, private, and management data wires lead to servers on one of the cloud racks inside pod two of International Business Machines Corp.'s (IBM) Softlayer data center in Dallas, Texas, U.S. Photographer: Ben Torres/Bloomberg

Investors in Chinese technology shares can thank the U.S. Justice Department for turning their unprofitable bets into the stock market’s biggest winners.

The benchmark gauge of mainland technology companies has rallied 5.5 percent since May 19, when the U.S. indicted five Chinese officials and put them on the Federal Bureau of Investigation’s most-wanted list for cyber crimes. After the move, China excluded Microsoft Corp.’s Windows 8 from a state purchasing order, asked banks to switch from International Business Machines Corp. servers to a local brand and said it will vet technology firms for national-security breaches.

Speculation that the dispute will give China’s technology companies an advantage over U.S. rivals has turned the CSI 300 Information Technology Index into the best performer among 10 industry groups from the worst. Lenovo Group Ltd., which agreed to buy IBM’s low-end server unit in January, jumped 9.9 percent in a seven-day rally through yesterday, its longest winning streak since 2003, while Yonyou Software Co. surged 28 percent.

“The government is encouraging the usage of hardware and software products made by domestic producers, which provides a long-term boost to the industry,” said Wang Weijun, a strategist at Zheshang Securities Co. in Shanghai. “National information security is a big thematic play for investors.”

The Bloomberg China-US Equity Index gained 0.6 percent to 102.75 in New York yesterday, the highest since March 7. Qihoo 360 Technology Co. was the best performer, rising 5.7 percent to $95.14 after the Internet company said it expects second-quarter revenue to be in a range from $300 million to $305 million. The average estimate among 11 analysts surveyed by Bloomberg was $279 million.

Stock Rebound

The CSI technology gauge climbed 0.3 percent at 9:45 a.m. local time, while the Shanghai Composite Index rose 0.2 percent.

The U.S. indictment triggered a rally in the China technology gauge from its lowest level in 10 months. It had tumbled 22 percent from last year’s peak in October amid concern valuations had climbed too high relative to earnings prospects.

The Justice Department accused five Chinese military officials of hacking computers of American companies, including U.S. Steel Corp. and Alcoa Inc., to steal trade secrets. President Barack Obama’s administration took action because of “concerns over government-sponsored, cyber-enabled theft,” White House spokesman Jay Carney said on May 19. China has denied any hacking.

IBM Switch

Chinese agencies, including the central bank and the ministry of finance, are asking banks to remove IBM servers and replace them with a local brand as part of a trial program, according to four people familiar with the matter, who asked not to be identified because the review hasn’t been made public.

“IBM is not aware of any Chinese government policy recommending against the use of IBM servers within the country’s banking industry,” Jeff Cross, a spokesman for IBM, said in an e-mailed statement.

China is issuing rules because Internet and information safety are important parts of its security, Qin Gang, a spokesman for the Foreign Ministry, said in Beijing.

Microsoft said it was “surprised” to learn that the China Central Government Procurement Center excluded its Windows 8 operating system from a purchase of energy-efficient computers. The official Xinhua News Agency called it “a move to ensure computer security.”

U.S. Review

While rising tension between the two countries over national security issues is spurring investor enthusiasm for Chinese technology companies, any positive impact on earnings will take time to materialize, said Wang Zheng, the chief investment officer at Jingxi Investment Management Co.

Inspur Group Ltd., whose Hong Kong-listed unit gained 20 percent in the past two days, unveiled on May 27 an “IBM to Inspur” initiative aimed at taking the U.S. company’s market share in China. The U.S. government has yet to approve Lenovo’s plan to buy IBM’s low-end server unit for $2.3 billion. That transaction faces regulatory scrutiny, including a U.S. national security review.

China’s push to replace “foreign technology with domestic products will be a gradual and partial process, and you cannot count on earnings growth to catch up with stock-price gains quickly,” Wang said by phone from Shanghai.

Valuations in the industry have declined from this year’s peak. The CSI technology gauge trades at 28 times reported earnings, compared with around 35 times in February, according to data compiled by Bloomberg. Lenovo is valued at 16 times earnings, versus a five-year average multiple of 21.

Major Player

“Lenovo will benefit because it is the major player in China,” said Pauline Dan, who helps manage $153 billion as the Hong Kong-based head of greater China equities at Pictet Asset. Aside from the spying dispute, the company stands to gain from growing demand for computing power within China, she said.

The domestic industry may get a longer-term boost as President Xi Jinping seeks to increase the role of services in the world’s second-largest economy, while reducing the country’s reliance on the credit-driven construction that propelled growth in the past decade.

China’s cabinet, which approved a plan in May 2012 to bolster seven strategic industries including technology, said last August the government will increase Internet access and build faster wireless networks. Forrester Research Inc. estimates purchases of information-technology products in China will rise 11 percent this year to $125 billion.

The country’s replacement of overseas technology with locally made products is “inevitable” as disputes with the U.S. escalate, Fu Jian, an industry analyst at Ping An Securities Co., wrote in a May 27 report. The brokerage’s recommendations included Shenzhen Kingdom Sci-Tech Co., a maker of security software that surged 75 percent this year and has a market value of $1.1 billion.

The technology gap between overseas companies and Chinese brands “has closed up a lot,” Erwin Sanft, the head of China and Hong Kong equity research at Standard Chartered Plc, said by phone in Hong Kong. “There is scope to switch sourcing more to local vendors.”

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