Time to Take Notice of ZTE

Situation Overview ZTE is the largest publicly traded telecommunications equipment manufacturer from China. The company manufactures and supplies a broad range of wireless and fixed network equipment, having sold systems to service providers in China as well as international markets. In the wireless realm, its portfolio spans infrastructure and devices based on GSM/UMTS, Personal Handyphone System (PHS), WiMAX, and CDMA technologies.
On March 25 and 26, 2009, the company held its Fifth Annual Analyst Conference in Shenzhen, PRC. Despite weak global economic conditions, ZTE delivered strong results, expanding further into international markets while strengthening its overall position in China. ZTE top line revenues grew over 27% to nearly RMB 44.3 billion in 2008, up RMB 9.5 billion from the 2007 level of RMB 34.8 billion (see Figure 1). Profits before income taxes also grew, expanding from RMB 1.7 billion to RMB 2.3 billion for a slightly faster 31% rate of growth.

This rate of expansion ranks ZTE, once again, as the fastest growing, in terms of total revenues, among publicly traded major telecommunications manufacturers in percentage growth terms. The company was also the fastest growing in 2007. As for its wireless business, sales of infrastructure, handsets, software and services, and other wireless related items amounted to some 38.5% of total revenues. The segment grew from $2.1 billion in 2007 to approximately $2.5 billion in 2008. Over the last five years, ZTE’s wireless business has more than doubled. ZTE’s wireless business growth, at approximately 20%, was slower than the top line growth of 27%, though it still well outpaced the industry as a whole.
Within the wireless business segment, sales of infrastructure elements comprised the largest portion. At 65% of the total, wireless infrastructure amounted to approximately $1.65 billion in sales. According to ZTE, the composition of these infrastructure sales were 33%, 45% GSM/UMTS, and 22% other technologies. ZTE’s GSM/UMTS growth has been significant, with transceiver shipments amounting to 550,000 in 2008 for a growth rate of nearly 100% from 2007 levels. This growth is being supported by major investments in R&D, including the recent construction of a 900 million (RMB 6 billion) 3G and LTE lab in Xian.
On the CDMA front, ZTE’s experience now comprises 120 operators in some 60 countries across the globe. It has also deployed over 70 EV-DO networks. It has delivered in excess of 130,000 base stations. The remainder of its wireless infrastructure business is comprised of GSM, UMTS and WiMAX sales. On the GSM and UMTS front, the company is serving over 200 million subscribers in 60 operator networks. In WiMAX, the company’s technology has been deployed in 26 countries and by over 35 operators.
Going forward, the magnitude of overall wireless infrastructure sales as well as its composition should evolve further as ZTE’s deliveries of 3G TD-SCDMA and UMTS base stations in China as well as overseas build further momentum.

Future Outlook
Time to take notice: Opportunities ahead In IDC’s view, it is time for the wireless infrastructure industry to start paying closer attention to ZTE. Its trajectory outpaces the industry and is paving the way for a much more significant presence in the years to come. The company is already well positioned in 2009. Amidst what will be one of the most challenging economic environments ever faced by the wireless industry, ZTE has started the year strong with critical wins in the initial round of 3G contract awards in China. The company was the top contract winner overall and among the top two awardees in each of the operator tenders (see Figure 2). The company is now effectively the number one supplier of TD-SCDMA equipment. Its move to the top in China’s 3G market is particularly well timed given the country, as it did during the Asian currency crisis in the late 1990’s, will be an important anchor for the regional wireless infrastructure opportunity in the next few years.

ZTE’s market momentum is further enhanced by the $15 billion credit line facility recently made available to the company in a five-year framework agreement with the China Development Bank. At a time when credit markets are extremely tight, ZTE will have the ability to provide select customers with access to critical financing. The funds are earmarked to support ZTE’s overseas project financing and credit needs.
Overall, the rising ZTE presence can be attributed to several factors, which will also be critical to maintaining its present rate of growth and market momentum. These include technology, geography and professional services.
■ Technology: There is no denying that ZTE has been winning contracts as a result of a strong cost position. However, growth can not be sustained without delivering reliable and effective technology. To this end, R&D should remain a priority with ZTE continuing to commit in excess of 10% of its revenues to these efforts. Additionally, ZTE’s SDR approach to base stations, comprising its ZXSDR series base station product line, results in a competitive product line that is consistent with growing operator requirements. While IDC defines the SDR concept differently, the overall platform and distributed base station approach, coupled with low power consumption and small form factor of the ZXSDR make it a credible choice in today’s highly competitive base station market. The ZXSDR is also complemented by a broad portfolio of products that allows ZTE to offer networking solutions, rather than just individual products. Another important component of the firm’s technology base is the growth in its GSM/UMTS business. Between 2007 and 2008, GSM transceiver shipments grew in excess of 100% to approximately 550,000 transceivers. This places the company in approximately the 4th to 5th position in that important segment. Finally, ZTE has captured the number one position in TD-SCDMA. While the TD-SCDMA will have little relevance for the rest of the world, it will provide a sizeable opportunity for 2009 and 2010 in the Chinese market as the 3G infrastructure is built out.
■ Geography: ZTE has established operations in key emerging markets across the globe. While it has yet to truly make its presence felt in the more evolved markets of North America and Western Europe, 2009 finds the company in the opportune position of being established in countries that are likely to exhibit growth despite the economic turmoil enveloping the world today. Most obvious among these opportunities is China. The country is already demonstrating the benefits of a fiscal stimulus package that includes provisions for accelerated investments in telecommunications infrastructure. Emerging markets are the growth engine of the mobile infrastructure industry.
■ Professional services: Over the last three years, ZTE’s professional services business has more than doubled. Between 2007 and 2008, it grew 74%, from $269 million to $468 million. This was a pace more than three times faster than the company’s overall revenue growth. It is also a trend consistent with ZTE’s peers, who similarly see their professional services revenues grow faster than the overall infrastructure business. As mobile operators focus on marketing and the development of applications and services, they increasingly look to their technology partners to provide operational and support services. ZTE’s efforts to build its professional service capabilities has been critical to enabling growth in recent years.

Challenges ahead ZTE faces a number of challenges, including those that only become greater the more the company continues to succeed. Some of these major challenges include the reality of its current scale of operations, the enhanced marketing efforts required by its growing footprint and presence, and the enduring need to further internationalize and manage the growth of its operations.
■ Build scale: While ZTE’s growth ranks it the fastest growing among publicly traded telecommunications equipment vendors, the scale of its wireless infrastructure business remains smaller than its global competitors. Scale increasingly matters, especially in wireless infrastructure where it helps to deliver lower cost, innovation and market reach. In the coming years it will be critical for ZTE to maintain its growth levels in order to achieve economies of scale consistent with the global top tier of mobile infrastructure vendors. Success, such as in China’s initial round of 3G contracts, point to the positive momentum the company possesses. It will be critical that ZTE replicate this success outside of China and deliver global scale in terms of both products and services.
■ Enhance marketing: As ZTE’s market reach and exposure continue to expand, greater emphasis and effort must be placed in positioning the firm’s products, capabilities and brand. Developing a coherent green strategy will, for example, help to build the firm’s international credibility while at the same time delivering products and services that will resonate with customers. Enhanced product marketing efforts will also mean that awareness of ZTE’s capabilities and technological competency go “beyond China”. Another critical step will be ZTE seeking to better understand its customer’s customer. This will enable the company to better adapt technology solutions to real world consumer requirements as well as to provide an overarching vision for mobility in general. Ultimately, ZTE must continue to get closer and closer to the mobile consumer themselves.
■ Internationalize and manage growth: It goes without saying that while China will be important fuel for the mobile infrastructure market in the short term, building further momentum in other countries will be critical for ZTE. This applies to both 2G and 3G. While 2G will remain significant, it will be the 3G market that will exhibit robust growth in the coming years. Additionally, managing an expanding base of employees and operations will create another challenge to the company. Systems and processes to manage a fast growing organization effectively will be essential and is especially the case given the typically higher costs associated with doing business outside of China, higher costs that could place further pressure on ZTE’s modest margins.