Fitch Place ZTE's Debt Ratings on Negative Watch

Published on: 15th Oct 2012

Fitch Ratings has placed China-based ZTE's Long-Term Foreign- and Local-Currency Issuer Default Ratings (IDR) of 'BB-' on Rating Watch Negative (RWN).

­The RWN follows the company's preliminary results announcement for Q312 which were significantly worse than Fitch's expectations and which place into doubt the company's ability to improve profitability and cash flow to maintain credit metrics consistent with a 'BB' category rating.

The RWN will be resolved following release of the full Q312 results, discussions with management and further analysis of the company's ability to improve financial performance in 2013 and 2014.

The company announced a preliminary loss of CNY1.65bn-CNY1.75bn for the nine months to 30 September 2012 (prior year period: profit of CNY1.07bn). According to the preliminary announcement, Q312 revenue declined 13% from a year ago due to centralisation of procurement at Chinese carriers leading to slower domestic orders and also due to delays in international projects. Similarly, Q312 gross margin declined by 13 percentage points reflecting recognition of a number of low-profitability contracts in Europe, Asia and China. Thus, gross margins for the nine months to 30 September 2012 are lower than the prior year period, despite increasing revenue.

The company is also facing high-profile political difficulties in the US, although this market currently represents just 5% of ZTE's turnover. The US House Intelligence Committee has labelled ZTE and the larger Huawei as threats to US national security - largely on the premise of potential Chinese state influence. The company is also cooperating with an investigation by the US Department of Justice concerning deals with Iran.

ZTE responded to the US congressional committee report by emphasising its independence from state influence, the integrity of its vendor-neutral network security systems, and how the value of various telecom equipment components ZTE purchases from US companies is significant compared with the revenue it derives from the US. The company also expressed disappointment that the two Chinese equipment makers had been singled out, and how the report failed to consider Western telecom equipment vendors and their Chinese joint-venture manufacturing partners in its assessment, given that the vast majority of telecom equipment in place in the US is in fact manufactured in China.

Margins for the Chinese telecom equipment manufacturers are under pressure, partly because they typically need to offer significant discounts to win strategic orders from large network operators in developed markets. The extent of the discount required is only likely to be greater for those markets where supposed security concerns weigh against the Chinese exporters. This is despite Fitch's view that the Chinese technology is highly competitive and offers significant cost savings.

 

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