Huawei – Nowhere to run pt. IV.

Component loophole won’t help the smartphone business.

• US Hardware vendors have found a loophole that will allow them to continue selling silicon-based products to Huawei, but this will not work for software meaning that the outlook for the smartphone business remains dire.
• The loophole in question is called the di minimis rule which provides an exception for companies on the entity list (see here) as long as less than 25% of the technology in the product originates in the USA.
• For silicon chip vendors, this can work well as the vast majority of chip manufacturing in the world takes place in Asia.
• For these sorts of products, it is not difficult to meet this hurdle which has allowed Micron to resume shipping some of its products to Huawei.
• Micron manufactures mostly commodity products meaning that meeting this hurdle is easier but for more advanced products like Intel processors or Qualcomm modems, this will be much harder.
• This because there is a lot more US created IP in these products which will increase the percentage of the technology deemed to have been created in the USA.
• The wires are also full of stories with regard to Intel also resuming shipments to Huawei, which if true, is likely to be the lower-end, less technology-intensive part of its portfolio.
• Hence, I suspect that the sale of CPUs and FPGA’s to Huawei have not been able to resume as a result of the di minimis rule.
• I also suspect that Qualcomm will also be unable to benefit from this exception.
• For smartphones, this is academic because the US hardware that they use is mostly replaceable with non-US product.
• The real problem is Google software and there is no way that this is going to be able to pass the di minimis rule.
• Hence, any smartphone that Huawei attempts to sell outside of China will be carrying its homegrown services to replace the Google ecosystem that it is no longer able to distribute.
• There is no doubt whatsoever that this will be catastrophic for Huawei.
• Even before Google services have been removed, operators are already seeing a 40% decline month on month in orders from their operating companies for Huawei smartphones.
• Even Huawei has admitted as much, as its own estimates strongly imply that it only expects to sell another 20m smartphones outside of China for the rest of 2019 and none at all in 2020.
• RFM calculates that this will lead to a 34% decline in revenues for the consumer business in 2019 and a further 25% decline in 2020.
• This spells financial disaster and unless the US and China do some sort of a deal that includes Huawei, it will be forced to cut vast swathes of its workforce outside of China.
• Huawei has entered the dreaded death spiral where share losses mean poor financial performance, bad press and cost cuts resulting in consumers and distributors beginning to lose confidence.
• This results in further falls in share, confidence falls further and so on.
• The bottom of the spiral in Huawei’s case will be the end of all shipments outside of China and the loss of 50% or more of its entire smartphone business.
• The only company I have ever seen successfully break the spiral was Samsung after the Note 7 disaster (see here) and its dreadful smartphone performance in 2014.
• This means that unless Huawei gets itself back in business very quickly, this is the end of its smartphone business outside of China.
• The potential main beneficiary would be Samsung.
• This is because it has the brand, scale and the presence to ramp up supply and distribution to ensure that there are plenty of Samsung products to meet demand should Huawei fall by the wayside.
• This has not been priced into Samsung’s shares in any way making Samsung a very interesting stock to consider when looking for ways to offset the potential negative implications of a protracted trade war.
• My portfolio is long Samsung Electronics.