ZTE Comeback Stumbles on China Telecoms Spending Slowdown

ZTE Corporation (0763.HK; 000063.SZ), a leading global provider of integrated information and communication technology solutions, has faced a setback in its recovery efforts following the U.S. sanctions in 2018. The company's latest financial report for 2024 reveals a sobering milestone: ZTE's annual revenue dropped 2.38% year-over-year to 121.3 billion yuan ($16.7 billion), marking its first decline since U.S. sanctions caused its revenue to tumble by 21% in 2018. This reversal ends a five-year recovery streak that peaked at 13% growth in 2021 before decelerating to 7% in 2022 and just 1% in 2023. Meantime, its net income last year also slipped into contraction, falling 9.7%, contrasting with marginal gains in earlier years.

ZTE's slowdown coincides with a broader downturn in China's telecommunications sector. After years of aggressive investment in 5G infrastructure, the country's three major state-owned carriers — China Mobile, China Telecom, and China Unicom — collectively cut their capital spending by 5.4% in 2024, the first annual drop since 2018, according to Communication Weekly, a state-affiliated industry publication. The pullback hit ZTE's core business hard. Revenue from its carrier network segment — which covers telecoms equipment and accounts for over half of its sales — sank 15% year-over-year in 2024. Others reporting similar difficulties last year include China-focused telecoms software makers Comba (2342.HK) and AsiaInfo (1675.HK; 688225.SH).

ZTE's geographic revenue mix has shifted dramatically since the U.S. sanctions of 2018. Revenue from U.S. and European markets dropped to 15% of its total in 2024, down from 25% in 2017, according to its latest report. Despite expectations that ZTE might pivot strongly toward emerging markets, progress has been limited. Africa, for example, contributed just 5.3% to overall revenue in 2024, marginally up from 3.5% in 2017. The slow expansion reflects the challenge of competing with Huawei's established dominance in these regions, even as those countries accelerate their build-out of 5G infrastructure. Instead, ZTE has primarily looked inward and redirected its focus to its home China market, which now accounts for 68% of revenue, up from 57% in 2017.

ZTE's pivot towards AI and enterprise businesses has shown promising revenue growth, with the government and corporate business segment growing by an impressive 37% in 2024, accounting for 15.3% of revenue. This segment's growth was driven by increased participation in sectors such as internet, finance, and power, as well as the company's increased R&D investment in products like servers, storage, data center switches, and other data center products. However, the profit margins in these new areas might be lower compared to the company's core telecoms equipment business. While the report highlights the growth potential of the AI and enterprise businesses, it does not provide specific profit margin data for these segments, making it challenging to assess the profitability of these new areas accurately.

Moreover, the potential for new U.S. sanctions could pose challenges to ZTE's recovery and expansion into these new areas. The company's reliance on U.S. technology and components has been a significant vulnerability in the past, and any new sanctions could disrupt its supply chain and hinder its growth prospects. Additionally, the persistent tensions between Beijing and Washington could further complicate ZTE's efforts to expand its business in the global market.

In conclusion, while ZTE's pivot towards AI and enterprise businesses has shown promising revenue growth, the profitability of these new areas remains uncertain. The potential for new U.S. sanctions also poses risks to the company's recovery and expansion into these new markets. As ZTE continues to navigate the complex global technology landscape, it must address the challenges posed by the slowdown in China's telecommunications sector and the potential for new U.S. sanctions to ensure the sustainability of its recovery.