Trump's Known Unknowns Cloud Technology Hardware Valuations

(Bloomberg Gadfly) -- The ground is shaking. After the U.S. slapped ZTE Corp. with a seven-year ban on component purchases from American suppliers, no one knows how to value China’s technology hardware companies any more. 

The latest casualty is Huawei Technologies Co. 

The Justice Department is investigating whether Huawei violated U.S. sanctions related to Iran, the Wall Street Journal reported Wednesday. It’s another slap for the network-equipment and smartphone giant, which was already facing bond investors jittery over rising Treasury yields and intensifying U.S.-China trade tensions.

Huawei has been holding a roadshow for new dollar and euro debt. Earlier this week, even before the Journal article was published, the company had to drop the planned dollar portion. Now, it’s been forced to postpone the euro bond sale too.

At any other time, Huawei’s debt offerings would be gobbled up. Ebitda hit $10.7 billion last year, a 26 percent increase from the previous 12 months. Meanwhile, as of the end of 2017, the company was sitting on $26.9 billion of cash with only $6.1 billion of liabilities.

Huawei got a mere 6.5 percent of its sales from the Americas last year. But U.S. revenue isn't the point. President Donald Trump has finally found a way to halt China’s technological advance. By banning supplies of a few key components, the U.S. can hobble China Inc.’s ability to build functional smartphones, or internet networks. Investors can’t dismiss the possibility that Huawei will slide from riches to junk status one day with just a wave of Trump’s pen. Rising Treasury yields add interest-rate risk to these political hazards.

Meanwhile, fund managers on the mainland are trying to figure out what to do with their ZTE stock, which has been halted from trading in Shenzhen since April 17. Many funds piled in last year, as the company was seen as a major beneficiary of China’s push to develop 5G wireless networks.

First Seafront Management Ltd. has been the most aggressive in writing down holdings, cutting the value of its shares to 22.82 yuan apiece, or 27 percent below the last traded price. At least 30 fund managers have lowered their net asset values because of ZTE, according to Chinese media reports.

Companies related to ZTE – suppliers or peers – are suffering too. Smartphone maker Lenovo Group Ltd. is now at risk of being removed from Hong Kong's benchmark Hang Seng Index.

It’s not just Chinese companies that are affected. In the U.S., shares of Acacia Communications Inc., which counts ZTE as a key customer, have plunged 30 percent. The Philadelphia Stock Exchange Semiconductor Index is down 6.6 percent. 

With China vowing to develop its own core semiconductor technology at all costs, there’s also evidence that this Trump-induced frenzy is distorting capital allocation.

Gree Electric Appliances Inc. is the latest to jump on the chip bandwagon. Shares of the air-conditioner maker slumped more than 9 percent in Shenzhen on Thursday, wiping out $4.2 billion of market value, after it declined to pay a dividend for the first time in a decade. The reason? The company, which posted a 45 percent increase in 2017 net income to 22.4 billion yuan ($3.5 billion), said it planned to spend more on R&D to develop, among other things, integrated circuits.

To be fair to Gree, China’s booming private funds are chasing a few hot industries and stocks: Chipmakers are still a scarcity and command much higher valuations than white goods.

Analysts may argue that sanctions are just a bargaining chip for Trump in his trade negotiations with China. But these threats are already having real effects, causing billions of dollars to be lost and diverted. It will take a brave investor to predict values in such an unstable environment.

Shuli Ren is a Bloomberg Gadfly columnist covering Asian markets. She previously wrote on markets for Barron's, following a career as an investment banker, and is a CFA charterholder.

©2018 Bloomberg L.P.

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