Tightening the Screws
On 11/11/20 we noted that reports out of China had indicated that Huawei (pvt) was planning to sell its Honor (pvt) smartphone brand to a consortium led by the Shenzhen government and Digital China (000034.CH), the largest IT service provider in China. A few days later the actual deal was announced, with a newly formed company Shenzhen Zhixin New Information Technology Co (state) the ultimate owner. That organization was formed by the Shenzhen Smart City Technology Development Group, the majority shareholder, which is wholly-owned by the Shenzhen government, and over 30 agents and dealers of the Honor brand along with a number of investment firms. Digital China, a spin-off of Lenovo (992.HK) was rumored to be part of the consortium but was never disclosed, while China Telecom (601728.CH), which is owned by the state government is said to also have a small stake.
Huawei had developed the Honor brand to broaden its smartphone offerings by adding a new mid/low tier line that would allow Huawei to maintain its stature, and found that the brand was even more successful than it had planned, and represented between 30% and 40% of Huawei’s smartphone shipments in China, and higher percentages outside of the country. As the US continued to tighten restrictions on Huawei’s ability to sell product, eventually extending those restrictions to all suppliers whose products use American made components or are produced using US software, subsidiary Honor found it also was tacitly being included in the ban on its parent, and would likely be unable to procure the components it needed to continue production. Parent Huawei was large enough to withstand the US trade sanctions, albeit not quite as easily as anticipated, but the Honor brand organization saw the handwriting on the wall.
While the actual price of the Honor brand purchase was not disclosed, it was assumed to be ~$15b, which essentially went from the Shenzhen government to Huawei, who then disavowed any connection to the brand. The transaction was meant to separate the Honor brand from Huawei’s inclusion on the US Entities list, and Honor was then able to sign its own deals with US suppliers. Since then Honor has seen its share of the Chinese smartphone market vary between ~5% and 14% and has continued to develop and release 14 new smartphone models this year, shipping ~12m units in the 1st half.
However that success might be nearing an end if a group of 14 House Republicans get their way. The group has requested that the ‘End-User Review Committee” of the Department of Commerce should include the Honor Device Company in the DOC’s Entity list and restrict the flow of US technology and software to the company, as it has done with Huawei and many of its subsidiaries. Citing a 3rd party interview of a former analyst at a Washington DC think tank which suggested that the spin-off was guided by the Chinese Communist Party and revealed “the extent to which nominally private entities, such as Honor, are deeply embedded within a PRC ecosystem that leverages interconnections among the CCP, state-owned banks, local governments, and venture capital for strategic objectives.” The group is requesting a response within two weeks and is requesting a briefing with the committee to “ensure the Administration is moving with enough speed to counter CCP attempts at export control evasion.”
The CEO of Honor responded to the letter at an event launching the company’s first ‘flagship’ smartphone since the spin-off. He emphasized that Honor is now an independent company that is no longer involved with Huawei and said, “We believe that if we keep on doing well in what we do that all these problems can be solved” (see Fig. 1). The new phone is based on the Qualcomm (QCOM) Snapdragon 888 chipset, whose CEO made positive comments about the phone through a pre-recorded message at the event.
While we certainly are not going to pick a side in this heavily political debate, there seems to be little hiding the fact that the Chinese government, whether directed by the CCP or motivated by face-saving, structured the Honor deal to skirt the devastating effects of the US trade ban, but this is something that happens all the time in China. We have seen display companies taken over by state owned entities when they looked like they were heading toward failure and more recently with semiconductor start-ups that faced a lack of experienced management.
The Honor spin-off also had the obvious hope behind it that the economics involved with many US and foreign companies would supersede the fact that it allowed the Chinese government to both bail out Huawei and try to ‘slip one by’ the US. What they did not consider was that politicians in the US love to hang their hats on scapegoats when things are not going their way, and while China is certainly not without its faults, it has become a representation of the antithesis of the American way of life and therefore is a perfect stooge for US political grandstanding.
Should Honor be restricted? If Huawei is then Honor should but that begs the question as to why Huawei was put on the list in the first place. Ostensibly it was because the US suspected that backdoors in Huawei’s telecom equipment was allowing the Chinese government to monitor US government communication, and then mushroomed into a more ‘…we can’t let them win…’ in the semiconductor space. As we have said in the past, rather than winning by doing as much damage to your competitor as possible, perhaps winning by being more creative and innovative than your competitor is a better strategy. It works for Apple (AAPL), but maybe we are just drifting toward the unicorns and rainbows view.
Huawei had developed the Honor brand to broaden its smartphone offerings by adding a new mid/low tier line that would allow Huawei to maintain its stature, and found that the brand was even more successful than it had planned, and represented between 30% and 40% of Huawei’s smartphone shipments in China, and higher percentages outside of the country. As the US continued to tighten restrictions on Huawei’s ability to sell product, eventually extending those restrictions to all suppliers whose products use American made components or are produced using US software, subsidiary Honor found it also was tacitly being included in the ban on its parent, and would likely be unable to procure the components it needed to continue production. Parent Huawei was large enough to withstand the US trade sanctions, albeit not quite as easily as anticipated, but the Honor brand organization saw the handwriting on the wall.
While the actual price of the Honor brand purchase was not disclosed, it was assumed to be ~$15b, which essentially went from the Shenzhen government to Huawei, who then disavowed any connection to the brand. The transaction was meant to separate the Honor brand from Huawei’s inclusion on the US Entities list, and Honor was then able to sign its own deals with US suppliers. Since then Honor has seen its share of the Chinese smartphone market vary between ~5% and 14% and has continued to develop and release 14 new smartphone models this year, shipping ~12m units in the 1st half.
However that success might be nearing an end if a group of 14 House Republicans get their way. The group has requested that the ‘End-User Review Committee” of the Department of Commerce should include the Honor Device Company in the DOC’s Entity list and restrict the flow of US technology and software to the company, as it has done with Huawei and many of its subsidiaries. Citing a 3rd party interview of a former analyst at a Washington DC think tank which suggested that the spin-off was guided by the Chinese Communist Party and revealed “the extent to which nominally private entities, such as Honor, are deeply embedded within a PRC ecosystem that leverages interconnections among the CCP, state-owned banks, local governments, and venture capital for strategic objectives.” The group is requesting a response within two weeks and is requesting a briefing with the committee to “ensure the Administration is moving with enough speed to counter CCP attempts at export control evasion.”
The CEO of Honor responded to the letter at an event launching the company’s first ‘flagship’ smartphone since the spin-off. He emphasized that Honor is now an independent company that is no longer involved with Huawei and said, “We believe that if we keep on doing well in what we do that all these problems can be solved” (see Fig. 1). The new phone is based on the Qualcomm (QCOM) Snapdragon 888 chipset, whose CEO made positive comments about the phone through a pre-recorded message at the event.
While we certainly are not going to pick a side in this heavily political debate, there seems to be little hiding the fact that the Chinese government, whether directed by the CCP or motivated by face-saving, structured the Honor deal to skirt the devastating effects of the US trade ban, but this is something that happens all the time in China. We have seen display companies taken over by state owned entities when they looked like they were heading toward failure and more recently with semiconductor start-ups that faced a lack of experienced management.
The Honor spin-off also had the obvious hope behind it that the economics involved with many US and foreign companies would supersede the fact that it allowed the Chinese government to both bail out Huawei and try to ‘slip one by’ the US. What they did not consider was that politicians in the US love to hang their hats on scapegoats when things are not going their way, and while China is certainly not without its faults, it has become a representation of the antithesis of the American way of life and therefore is a perfect stooge for US political grandstanding.
Should Honor be restricted? If Huawei is then Honor should but that begs the question as to why Huawei was put on the list in the first place. Ostensibly it was because the US suspected that backdoors in Huawei’s telecom equipment was allowing the Chinese government to monitor US government communication, and then mushroomed into a more ‘…we can’t let them win…’ in the semiconductor space. As we have said in the past, rather than winning by doing as much damage to your competitor as possible, perhaps winning by being more creative and innovative than your competitor is a better strategy. It works for Apple (AAPL), but maybe we are just drifting toward the unicorns and rainbows view.
Figure 1 - Rainbow Unicorns - Source: theunicornlife.com Figure 2 - Trade War Cartoon - Source: Kevin Kallaugher
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