August 8, 2020

Dear Subscribers,

I am in the middle of a move to Asia, but MTN Consulting's research schedule is unaffected. Last month we published three reports - a quarterly review of the telecom sector, and two company assessments (Huawei, and Jio) - and we have several slated for release this month. This newsletter gives a preview of two upcoming reports, with some analyst takes on the turbulent world of telecom. China once again plays a big role.

Please feel free to send along questions or suggestions.

Best regards,
Matt Walker
Chief Analyst
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US crackdown on Chinese mobile apps to hit TikTok and WeChat; next step could affect their use of US technology

This week the Trump White House issued separate Executive Orders banning US companies and people from transacting with either ByteDance, TikTok's current parent company, or the WeChat messaging service run by Chinese webscale giant Tencent. In effect these orders ban TikTok and WeChat from operating in the US, at least once the order takes effect on September 20.

Note that this is 6 days after the May supply chain restrictions on Huawei are due to take effect. September is going to be a turbulent month for US-China relations and the broader tech industry.

Chinese ownership at issue

The orders are concerned with data security and censorship stemming from the Chinese ownership of WeChat and TikTok. As they are phrased, the orders affect WeChat directly but TikTok indirectly through a restriction on its current parent company, ByteDance. Hence, TikTok may get a reprieve if it is sold off to a US company like Microsoft.

TikTok has been in the news for months and a frequent target of China hawks, and discerning parents. It's a catchy app, loved by millions. But it is also an incredibly invasive app configured to learn everything it can about your device and the network to which it is connected. And it's owned by a Chinese company, ByteDance, no matter what legal games are played to make it appear otherwise.

WeChat is a messaging platform, or THE messaging platform of choice in China, widely used for much more than staying in touch - mobile payments, for instance. It's not a household name among most Americans but overseas Chinese use it widely. WeChat and Weixin, the domestic brand of the same platform, had a combined 1.2 billion active users as of March 2020.

The last year of debates around Huawei have reminded us all that the Chinese government has incredible powers to do what it wants with Chinese companies, especially if a national security rationale can be contrived. There is a solid rationale for restricting these companies' operations in the US, or any other country not willing to give its network secrets away to China, and the US is not the first to make this decision. India similarly banned both apps last month, along with dozens of others.

Beyond network security, there is the issue of content censorship. An American teenager went viral on TikTok several months ago by cleverly inserting views about Xinjiang into a makeup tutorial, after she claims she had been censored for discussing the subject directly. Meanwhile, WeChat's censorship of content on its platform, even private conversations, has been common knowledge for many years.

Implications of EO on networks

The ink is barely dry on these EOs and there is much online debate about the implications and legality of the move. They are probably legal, based upon citation to the International Emergency Economic Powers Act and the National Emergencies Act, and despite First Amendment concerns. In my opinion this issue might have been better handled by the FCC, which could have conducted a public investigation, and then established general principles to apply to the next TikTok or WeChat. But the Trump White House is not big on process, always eager to push the boundaries of what it is allowed to do, and there's an election coming up.

So the question becomes, what's next? Let's assume the orders go into effect, even if they need some clarification down the road. It's not clear how much they affect Tencent's broader operations, for instance, including its many investments in affiliate companies in the gaming and video sectors. That will be ironed out, eventually.

What's interesting to me is what may happen in the network arena. I suspect the next step will be to target how these companies build their networks. Just as the US government can restrict Huawei from accessing US-origin technology, it can do the same for Tencent and TikTok, and the many other cloud/tech players in China attempting to spread their wings globally, many with a US presence.
Tencent's data center footprint
Tencent's data center footprint 1Q20
Hammering down on network design

Tencent, Alibaba, Xiaomi, and several other Chinese tech companies build large data centers using, at least in part, US-origin technology. Many of the firms are building global operations, and some have infrastructure in the US. If the US has security concerns about their scope of operations, ownership, and intentions, then it may limit the companies' access to certain US-origin technology. In fact, we predicted this would happen in a Commentary published in June. While the EO doesn't clearly reference this aspect, it seems inevitable that some arm of the US (yes, even under a President Biden) will restrict the Chinese cloud players' access to US tech. That would affect Tencent in a big way, as it has data centers spread across the globe and spent nearly $5B in capex in 2019.

In building out their clouds, much of the technology the Chinese players use is produced locally. That's not the case for chips, though. Even though they have been building their self-design capabilities for several years, Chinese webscale players continue to buy most high-end chips directly from US suppliers. And even for their self-designed chips, for production the Chinese option SMIC is not the solution. Alibaba’s Pintouge chip unit has been relying largely on Taiwan-based TSMC, while Baidu has partnered with Samsung.

Tencent is also working on chip self-design, but at a much earlier stage. It relies even more heavily than Alibaba and Baidu on US companies for building out its network, including AMD, Intel, Nvidia, and Qualcomm. It also uses Acacia and (Finland-based) Nokia for data center interconnect optical transport. These vendors will be affected by the EOs eventually, and should expect to lose some sales. We should also expect the Chinese government to keep up the pressure on SMIC to mature production capacity, and expect the subsidies to keep flowing.

One other inevitability, in my opinion, is a crackdown on Zoom. It's amazing to me that it hasn't happened yet. The logic of limiting Zoom's US access is essentially the same as for WeChat and TikTok: Chinese ownership, requires disclosure of private device and network information to function, and at least some history of censorship.

Stay tuned.

*Note: MTN Consulting will publish a Playbook covering Tencent in mid-August.
Preliminary 2Q20 vendor share: Telecom network infrastructure sales sink outside China

China's top-down rush to deploy 5G as fast as possible kept total revenues stable in 2Q20 for the telecom vendor segment. With 75% of vendors reporting (based on revenues), telco network infrastructure (telco NI) vendor revenues were flat YoY in 2Q20. That's based on 68 vendors' earnings results, including the big 3 (Huawei, Ericsson and Nokia).

Huawei was an anomaly this quarter. Its claimed revenues (unaudited, presented in short press release format, as usual) surged 16% from 2Q19 in the telco segment, to approximately $12.9B. Ericsson, which has pushed hard for a presence in Chinese 5G networks, also grew revenues in 2Q20, up 1% YoY to $5.6B. By contrast, Nokia's telco NI revenues dropped 14% YoY in 2Q20 to $4.6B as its choice to de-emphasize China hit the top line. However, Nokia's earnings were improved: operating profit was +170M Euros in 2Q20, from -76M Euros in 1Q20, or -57M Euros in the year earlier period of 2Q19. Hardly a blockbuster quarter, but impressive in light of the revenue dropoff.

Full steam ahead in China 5G

Of the 11 Chinese vendors we cover in our telco NI research, only 1 (Huawei) has actually reported 2Q20 results. However, Huawei's surge - from a 7% drop in 1Q20 to 16% growth in 2Q - is consistent with other data out of China.

Based on MIIT data, China had a total of 130,000 5G enabled base stations at year-end 2019, added 68K in 1Q20 and another 212K in 2Q20. That means about 75% of the newly built (or upgraded) 5G base stations in 1H20 were completed in the second quarter. You would expect vendors' revenues to also be weighted more heavily towards the second quarter, as was the case with Huawei. Another datapoint, from Ericsson: China spiked from 4% of Ericsson's corporate revenues in 1Q20 to 9% in 2Q20.

As the other Chinese vendors report, notably ZTE and China Comservice, it will become more clear just how reasonable Huawei's claimed 2Q surge was. Both these vendors report detailed financials to stock exchanges and stand to benefit from the Chinese 5G buildouts.

Not to disbelieve Huawei's claims, as it clearly is the leading player in China and network spending is on a tear there, for now. But analysts should question and validate vendors' claims, not just take them at face value. Huawei is currently in the middle of a political and trade war between two large countries. China has a lot at stake in being able to claim leadership in 5G - and Huawei does not want to look like it's fading away for fear that overseas telco clients will move even faster away from it into the arms of Nokia, Ericsson, Samsung, NEC, Fujitsu, Cisco and others.

Market ex-Huawei fell 6% in 2Q20, as GDP stats worsen

Taking Huawei out of the picture, telco NI revenues for the other 67 vendors declined by over 6% in 2Q20, much worse than the previous two quarters.

Lockdowns due to COVID's spread were clearly a factor. Not so much on supply chains, as fewer vendors claim disruptions this quarter than last. Most vendors have already crafted and implemented safety measures that allow work to continue despite the pandemic. But COVID's effect on economic growth, even with government intervention, has been catastrophic.

GDP in the US fell 9.5% from 1Q20 to 2Q20, which works out to an annualized decline of 32.9%. Personal spending in the US was down a steeper 34.6%. This is the "sharpest downturn since the 1940s", per Bloomberg. Europe wasn't spared. GDP in euro zone economies declined 12.1% in 2Q20 (from 1Q20), with Spain hit the hardest. Even with massive government stimulus and efforts to curtail employment erosion, household budgets for discretionary services like telecommunications have been hit. Telcos feel this directly, and need to adjust their spending budgets.

Who's up, who's down

In addition to Huawei and Ericsson, several other vendors have recorded sizable revenue growth in the telco NI segment.

Intel stands out with its 44% YoY growth in telco NI sales, as it sells directly to telcos more and more, in addition to behind the scenes sales to base station and server manufacturers. Fujitsu's 39% YoY growth in sales are also due to rising 5G deployments. That's mainly in Japan so far, but not for long: Fujitsu was selected as a radio supplier by DISH recently for its new 5G rollout. Smaller vendors Wiwynn, Casa Systems, and Inseego each also saw telco NI revenues grow by over 30% in 2Q20, due to telco server sales, an acquisition (of NetComm), and Verizon 5G hotspots, respectively.

On the flip side, Samsung saw the biggest drop in 2Q20 (-43% YoY) as Korea's early 5G spending tapered off. Indian vendors Sterlite and Tejas also dipped, down 38% and 53% YoY, respectively. These three all rely too heavily on government support in their home markets and need to diversify. Extreme Networks and Nexans also saw declines worse than -30%. Extreme says its wins are in the future as 5G services scale, while Nexans notes that lockdowns limited the pace of new fiber builds.

Telco-webscale collaboration

The big three cloud providers - AWS, Azure, and GCP - continue to ramp up their efforts to sell into the telco market. Cash-strapped telcos are increasingly eager to work with them, for a mix of workload shifts, joint development of services and sales partnerships. Early deals seemed more aimed at workload shifts where the telco is essentially avoiding the expense of building out cloud and development capabilities by relying on the webscale partner. Recent deals are more in the nature of service partnerships, involving joint development and customization aimed at specific target verticals. For instance:

  • Verizon is using AWS Wavelength to “launch a mobile edge compute service — integrating our 5G Edge platform with Wavelength to allow developers to build new categories of applications and network cloud experiences"
  • Orange and GCP will build next-generation data analytics and machine-learning platform, as well as integrate the AI capabilities of Google to improve Orange’s cybersecurity efforts.
  • Microsoft Azure will support UAE-based Etisalat with Azure solutions, including Multi-access Edge Computing (MEC) and Network Edge Computing (NEC), enabling new types of applications related to smart cities, autonomous systems, gaming, AR/VR, IoT, and vision computing solutions.
There are complexities to this collaboration which we won't explore in this brief newsletter. The salient question is whether webscale operators should be considered as "vendors" selling software and services to telcos, and hence included in our market share study. This is something we are currently reviewing carefully. The working assumption is that these partnerships supplement telcos' internal service development and sales capabilities, rather than their network infrastructure, but that is not an absolute - especially after Microsoft's acquisitions of Affirmed and Metaswitch. We will explore this issue in upcoming research.

*Note: MTN Consulting will publish the 2Q20 version of its "Telecom's biggest vendors" report in early September, 2020.
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