Thoughts on Huawei 2015 – The Juggernaut Continues to Build
In late April I once again attended Huawei’s annual analyst meeting in Shenzen, China. As with my last trip to this event, I approached it with a mix of dread and curiosity – dread because it is a long tiring trip and doing business in China if you are dependent on Google services is at best a delicate juggling act, and curiosity because Huawei is one of the most interesting and poorly understood of the large technology companies in the world, especially here in North America.
I came away with reinforcement of my previous impressions that Huawei is an unapologetically Chinese company. Not a global company that happens to be Chinese, as Lenovo presents itself, but a Chinese company that is intent upon and is making progress toward becoming a major global competitor in multiple arenas where it is not dominant now while continuing to maximize its success in its strong domestic market. A year later, all the programs that were in motion at the end of 2014 are still in operation, and Y/Y results indicate that the overall momentum in areas where Huawei is building its franchise, particularly mobile and enterprise IT, are, If anything, doing even better than promised.
If you dwell on the minutia of the individual products and technologies, particularly in the enterprise IT space where I spend the majority of my time, it is possible to miss the competitive threat Huawei poses to other enterprise IT vendors.[i] Taken as piece parts, most of Huawei’s products are competent but not inspiring. They have good but not breakout server, storage and networking, anchored by solid design (and indeed some interesting tweaks because they are one of the few system vendors who have retained a significant ASIC design capability) and probably a very efficient supply chain. But the details of today’s products are almost a distraction – what is telling at a macro level is the pattern of both past success and future investment, which tells a different story than Huawei’s historical near invisibility in key global markets for enterprise IT.[ii]
Huawei is a $45 B company growing at an annual rate of approximately 20%, and its enterprise IT division, the group that sells servers, storage and data-center networking, grew 27% to approximately $3B in revenue from 2013 – 2014. The target for 2015 is 32%, which would leave Huawei as a $4B enterprise technology supplier, growing more rapidly than any other comparable company or division – the only comparable group would be Cisco’s UCS product group, which is probably growing at 20%+ from a current run rate near $3B. None of its larger competitors are showing anything remotely like this kind of growth rate.
The real weight for my prediction that Huawei will rapidly emerge as a significant global player is not sales, but the strong leading indicator of R&D. Overall, Huawei is spending 14% of revenues on R&D. IBM in its first quarter reported approximately 6.5% and HP weighed in approximately 3.1% for 2014. Even more telling is the internal allocation of R&D. Huawei is using revenues from its profitable carrier networking line of business to overfund its enterprise and mobile business R&D. I didn’t get net equivalent R&D figures for 2014 – 2015, but for last year, the enterprise group got R&D funding that I calculated at an effective rate of 28% of sales.[iii]
While research shows that the impact of R&D investment on share prices is ambiguous[iv], I don’t get the impression that Huawei cares particularly about share price the way many US companies do, and while there are many reasons why a company with superior products may not prosper in the market, my personal observation of several decades of this industry leads me to believe that high R&D investments are indeed correlated with long-term success. While the management at other companies may have plausible excuses why they can get by with stripped down R&D investments, I am skeptical of these explanations. This is an industry that still rewards technological advantage, and even with suboptimal allocation of funds (not necessarily present here) it is hard to see how a net investment of 4 – 9 times the investment of key competitors will not result in some significant advantages.
My key takeaway remains unchanged – Huawei will be moving more aggressively on the global stage over the next several years, presenting both an emerging threat to established vendors in currently “safe” markets and an additional option for enterprise and other IT consumers. Another more speculative prediction is that Huawei is likely to begin making more strategic acquisitions in distribution channels and CSPs to accelerate their market footprint in selected markets.
[i] As have some of their competitors. I have had conversations with competitors who more or less said “we took apart XYZ product, and it was nothing special, so we’re not concerned”.
[ii] Huawei’s intense focus on local markets has been immensely beneficial on multiple levels. Selling into the China market, Huawei enjoys a an advantage over many competitors, and the local market is shortly going to become the largest market in the world, so being positioned as a strong player in the world’s largest and rapidly growing market cannot be construed as a negative. Secondly, when Huawei develops expertise and solutions for large verticals in China, many of them, such as finance, insurance, manufacturing, etc. transfer well to other markets.
[iii] Based on several executive comments about the amount of total R&D going to the different business units. Calculations and any attendant errors are mine – Huawei did not supply a definitive quote, but rather guided in the form of “33% of R&D is going to enterprise business.
[iv] Bernstein Research analyst Toni Sacconaghi