Huawei – Nowhere to run pt. XXVI

The UK hardens its stance still further.

• A new bill passing through the UK parliament that bans the installation of Huawei equipment from September 2021 has caused some consternation but makes sense given the long-term restrictions and Huawei’s inability to procure components.
• The UK has been taking an increasingly tough stance on Huawei firstly because there are genuine security questions that need to be answered but also as an expression of its displeasure at Beijing’s slowness to prevent the spread of SARS-Cov2 to the rest of the world.
• This displeasure will increase still further in the high likelihood that the bill passes parliament which stipulates that no installations of new Huawei equipment may occur after September 2021 and that all of its equipment needs to be phased out by 2027.
• The telecom sector is obviously annoyed at this sudden change, but I think that this reaction is a little naïve given the outlook that Huawei is currently facing and the requirement to remove the equipment by 2027.
• In anticipation of Huawei having supply problems, some operators have stockpiled a lot of Huawei equipment to deploy, but this equipment is not worthless and could be sold on the second-hand market.
• If we assume that most telecom equipment has a useful life of 10 years, then any equipment that is installed now will have to be removed before the end of its useful life and the operators would already have been well aware of this.
• Equipment that is installed now will have to be removed after 6 years of its useful life meaning a write-down of 40% of its value on the operator’s balance sheet.
• However, if the operator were to sell the brand-new equipment to an operator in a country where Huawei is not banned, then the operator might expect to realise 75% of the price that it paid.
• Hence, selling the equipment second hand could end up being a better economic proposition rather than deploying it and having to replace it before it reaches the end of its useful life.
• Furthermore, Huawei is at significant risk of being unable to source the semiconductors that it needs to make its base stations (see here) meaning that deploying Huawei equipment now is a far riskier proposition than it was a year ago.
• With these limitations, it has also become clear that Huawei is going to give priority to the domestic market and so operators in the UK and elsewhere will find themselves quickly at the back of the queue.
• Hence, I don’t think that it makes a lot of sense to continue with Huawei equipment anyway as there is an economic case to sell the new equipment on the second-hand market and use another vendor.
• This is pretty much what British Telecom has done with Nokia which will now have to step up its execution both in terms of bringing its 5G solution into line and getting the equipment to BT more quickly.
• The main beneficiaries here are Ericsson, Nokia and Samsung.
• Ericsson’s valuation already reflects a strong recovery while Nokia’s does not as the company has just taken on new management where there is a lot of clearing up to do.
• I am comfortable that this is a realistic proposition and assuming that Nokia wins 1/3 of the business that Huawei relinquishes, I am looking for €6 on the shares.
• I am a comfortable holder.