ZTE Faces Challenges Amid Declining Telecom Investment in China

Telecom equipment giant ZTE sees revenue decline, raising concerns

Overview of Recent Performance

• ZTE’s revenue fell for the first time last year since 2018, driven by decreased 5G investments from Chinese carriers.
• While ZTE’s AI and enterprise divisions show potential, decreasing profit margins and possible new U.S. sanctions could hinder growth.

ZTE Corp. (0763.HK; 000063.SZ) faced devastating sanctions from the U.S. in 2018, nearly leading the telecom giant to collapse. The company paid a historic $1.4 billion fine and restructured its leadership to regain access to the market. Since then, ZTE has been on a long recovery path, aiming to reduce reliance on U.S. suppliers, enhance its domestic market presence, and diversify its product offerings beyond telecom equipment.

By 2022, ZTE had apparently begun to recover, with annual revenues surpassing pre-sanction figures from 2017. However, the company’s latest financial report for 2024 reveals a more complicated landscape. Slowing revenue growth, narrowing profit margins, and ongoing geopolitical tensions are raising questions about the sustainability of its recovery amid a fragmented global tech market.

Revenue Decline and Market Context

ZTE’s 2024 report released last Friday indicates a worrying trend: annual revenue decreased by 2.38% year-over-year, totaling 121.3 billion yuan ($16.7 billion). This marks the company’s first decline since the 21% drop following U.S. sanctions in 2018. The five-year recovery ended with a peak growth of 13% in 2021, dropping to 7% in 2022 and 1% in 2023. Meanwhile, last year’s net income contracted by 9.7%, contrasting earlier modest gains.

Quarterly data shows that while ZTE experienced revenue growth in the first two quarters of 2024, the second half saw increasing revenue declines, culminating in a 10% drop in the fourth quarter to 31.3 billion yuan.

This downturn stands in stark contrast to rival Huawei, which, despite facing stricter U.S. sanctions, has rebounded by developing alternative suppliers and entering new markets such as intelligent driving. ZTE has made similar moves, yet the outcomes have been less favorable.

The financial report disappointed investors, leading to a 12.5% decline in ZTE’s stock listed in Hong Kong the day after the announcement. As of Monday’s close, the stock mirrored levels last seen just before the 2018 sanctions.

Sector Trends and Challenges

The slowdown in ZTE’s performance coincides with a broader decline in China’s telecommunications sector. Following years of heavy investment in 5G infrastructure, the nation’s three major state-run carriers—China Mobile, China Telecom, and China Unicom—collectively reduced capital spending by 5.4% in 2024, marking the first annual decline since 2018, as reported by the state-affiliated publication, Communication Weekly.

This cutback severely impacted ZTE’s core business. Revenue from its carrier network segment, which contributes over half of total sales, sank by 15% year-over-year in 2024. Similar challenges were noted for other telecom software firms like Comba (2342.HK) and AsiaInfo (1675.HK; 688225.SH).

Diversification Strategies

Since the 2018 sanctions, ZTE’s revenue composition has shifted significantly. Revenue from U.S. and European markets fell to 15% of the total in 2024, down from 25% in 2017, according to its latest report.

Though expectations were high for ZTE to focus more on emerging markets favorable to Chinese investments, actual progress has been slow. For instance, Africa contributed only 5.3% to total revenue in 2024, a slight increase from 3.5% in 2017. The slow growth is attributed to tough competition from Huawei, which has a strong foothold in these regions amid their growing 5G infrastructure needs.

As a result, ZTE has primarily concentrated efforts at home, and the domestic market now accounts for 68% of revenue, up from 57% in 2017. The company is also expanding its product portfolio within China.

Efforts include a focus on government and corporate segments, which encompass servers and enterprise software. This sector grew by an impressive 37% last year, now accounting for 15.3% of revenue, rising from 9% in 2017. ZTE’s consumer electronics, like smartphones and tablets, expanded by 16%, though its share of revenue has dropped from 32% in 2017 to 27% in 2024.

ZTE’s 2024 report highlights the growth potential within its government and corporate segments, citing high demand for AI servers and software services during the ongoing AI boom. Additionally, support from government initiatives like “East Data, West Computing” aims to bolster data center infrastructure across China. However, ZTE faces competition from established firms, such as Lenovo (0992.HK) and foreign players like Dell (DELL.US).

The company has acted swiftly to capitalize on AI opportunities, launching AiCube, a system that integrates AI training and inference. This system aims to enhance various computing tasks and expedite AI implementation for clients.

Nonetheless, entering this space also comes with its own difficulties. The government and corporate sector has significantly thinner margins than the telecoms division, partly due to high costs associated with AI servers and infrastructure. ZTE’s gross profit margin for this segment was merely 15% last year, in stark contrast to the 51% margin for telecoms equipment. This disparity contributed to the overall decline in net income.

Investors should also consider geopolitical risks as ZTE ventures into these new sectors. The dependency on AI chips from U.S. suppliers like Nvidia or using domestic chips developed with U.S. technology introduces vulnerabilities, especially given the unpredictability of U.S. export conditions. While China can import certain lower-tier Nvidia chips despite current regulations, uncertainties linger.

The potential for new U.S. restrictions looms large amid escalating tensions with China under President Donald Trump. ZTE’s past supply chain woes illustrate the risks, though recent efforts to diversify procurement may mitigate future issues. Although the company hasn’t fully disclosed its strategic responses, media reports suggest increased reliance on domestic chip suppliers. In its 2024 report, Chairman Li Zixue confirmed ZTE’s commitment to developing independent technologies, with R&D expenditures doubling from around 10% of revenue pre-sanctions to 20% last year.

Looking Ahead

In the immediate future, ZTE’s primary challenge lies in adapting to the decline in telecommunications equipment spending in China. With the main 5G infrastructure largely in place, domestic carriers are tightening budgets. The company’s success will hinge on its ability to ramp up investments in emerging areas like AI infrastructure and enterprise solutions, while also broadening its footprint in less Western-centric markets.