Aug 11, 2010 05:53 PM

Why Huawei Doesn't Get Its Way

(Beijing) - Telecom equipment manufacturer Huawei Technologies rose above the global financial crisis in 2009, posting record net earnings and operating revenues.

Nevertheless, the Shenzhen-based company's attempts to expand globally through overseas acquisitions of foreign electronics companies have continued to fail.

Bids for U.S. broadband network software maker 2Wire as well as Motorola's wireless device unit were recently rejected. In each case, the winning bids in terms of monetary levels were significantly below Huawei's.

The Chinese company – one the world's largest makers of telecom network gear – failed despite its attempt to smooth the way by hiring international law firms and other well-known intermediaries such as Morgan Stanley, Sullivan & Cromwell, Skadden Arps and Arnold & Porter.

Why can't Huawei get what it wants? Analysts cite the U.S. government's position toward the employee-owned company, noting that its government and military-related background is shrouded in mystery. Other factors apparently include the company's complicated ownership structure.

Such misgivings could be dispelled through a public listing, particularly on overseas markets. Such a move, analysts say, could raise Huawei's status by forcing it to undergo stringent capital market supervision and disclose its ownership structure, balance sheets and other information to global investors.

The market might welcome Huawei. It has, after all, been an almost invincible force in recent years on China's domestic market and in many emerging countries. But company officials have shown little enthusiasm for a stock market listing.

Question Marks

A decade has passed since the company created an employee stockholder scheme, including a complex stock ownership and incentive system, to replace what had been a disorganized share structure. The scheme has been adjusted several times, and now Huawei is officially a private company with shares fully owned by employees, and no direct or secret stockholding by government agencies.

Nevertheless, many of Huawei's overseas skeptics still wonder about possible ties to the Chinese military.

One reason is that company President Ren Zhengfei got his career start in the People's Liberation Army. In addition, Huawei worked with China's postal and telecommunications system in the early years of those agencies, which started with deep military relations. Years ago, most Chinese telecom equipment was made for the army.

Recent company reports say 98.5 percent of all stock is held through by an employee stock ownership union, while Ren personally controls less than 1.5 percent of company shares.

A Huawei employee said the company recently released information about its equity structure for the first time in hopes of winning the 2Wire and Motorola bids. It also sought to relieve pressure from regulatory authorities in India, which has blocked imports of Huawei equipment on grounds of national security.

Nevertheless, questions remain over details of the structure of the employee stock ownership union. And it's no secret that China's telecommunication carriers are state-owned monopolies, raising suspicions of government support for Huawei.

These questions factor into Huawei's repeated attempts to close a major acquisition that would strengthen a long-time weak spot: the North American market.

The company tried to buy equipment maker 3Com with U.S.-based Bain Capital in 2007, but the plan was blocked by the U.S. government's Committee on Foreign Investment in the United States. The committee was concerned that technology used by the Pentagon would fall into Huawei's hands.

Huawei also sought to acquire assets from the Canadian firm Nortel, but lost to Sweden's Ericsson. One reason was that Huawei had "blemishes" including charges of intellectual property rights infringement.

Then came the recent failures. The Financial Times newspaper reported the price offered by Huawei for U.S.-based Motorola's wireless device unit was about 10 percent higher than the price offered by Nokia Siemens. But the latter inked the deal for US$ 1.2 billion.

And a British maker of TV set-top boxes named Pace offered US$ 475 million for 2Wire and beat Huawei's higher bid. Directors of 2Wire chose the lower offer out of concern over a possible long delay in closing the deal if Huawei failed to get a nod from the U.S. government.

Going Public?

In an effort to prove a commitment to transparency, Huawei has released annual reports since 2005. But these reports have been criticized for various shortcomings, such as a lack of fixed release dates, year-to-year changes in reporting details, disparities between Chinese and English versions, and incomplete financial statements.

Meanwhile, Huawei officials have agonized over whether to list for more than a decade. Employees say that internal rumors swirled in 1998 and 2004 over possible a IPO, but nothing happened.

Apparently, obstacles to listing have been including difficulties in resolving longstanding issues over sorting out the company's equity structure and affiliates.

Public information says Ren registered Huawei in 1987 with 20,000 yuan in capital as a small switchboard maker. Its early stock ownership model helped the company rapidly expand. By the 1990s, Huawei's sales were almost doubling every year and the rate of return for employee shareholders was as high as 100 percent.

In 2001, the company revamped its stock options and stopped selling stock to new employees. Some shares held by postal and telecom agencies were repurchased by Huawei. Stocks held by existing employees were gradually converted into business performance-related shares. Thus, the greatest returns for employees were no longer dividends but gains tied to added value of company assets.

These are some of the details of a sorting-out process that's continued for about a decade. To date, however, few people are familiar with the specific process and its status.

Equally complex are Huawei's capital structure and its relations with affiliated companies.

The employee stock system was launched in 1995 with 70.05 million yuan in registered capital, according to company reports. Two years later, all stock held by some 2,432 employees in the shareholder union accounted for 61 percent of the company's shares.

Other shareholders at that time were the labor union of the subsidiary Huawei New Technologies Co. Ltd., with about 33 percent, and Huawei New Technologies itself, with 5 percent. The system has continued to operate through company unions with different names.

Nevertheless, even long-time employees admit the system is nearly impossible to understand. The company employs more than 95,000 globally, and more than 60,000 individuals hold as much as 60 percent of the company stock.

An industry veteran close to Huawei said reluctance among company executives for a public listing is based on practical considerations. They worry, he said, that its pace of expansion in emerging markets will be hampered by laws against corrupt practices in Europe and the United States which might be enforced if it goes public.

1 yuan = 14 U.S. cents

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