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4 April 2023

Huawei Defies US sanctions with solid 2022 results as R&D hits the roof

Huawei’s sharp profit fall for its 2022 financial year has been wrongly interpreted as evidence that US sanctions are really biting, when the overall results really indicate that the company has weathered the storm in reasonably rude health. The sanctions have for sure had considerable impact, causing Huawei to revise its fundamental strategy in various ways and virtually exit the smartphone business, but it has largely succeeded in realigning its business.

The degree of disruption can be seen from the need to refocus around its own Harmony OS instead of Android and redesign many products to avoid using prohibited components. As Huawei founder Ren Zhengfei pointed out recently in a speech at Nanjing University, Huawei has had to replace over 13,000 imported components with alternatives made in China and redesign more than 4,000 circuit boards to circumvent US sanctions.

Huawei has been rewarded for bold targeting of new sectors with a concomitant commitment of R&D. This helped nudge revenues up by 0.9% over 2022 to CNY642.3bn ($93.3bn), but notably the strongly targeted enterprise business sector was up 30% year-on-year at CNY133.2 bn ($19.4bn), indicating that efforts there are bearing fruit. This included two key target sectors, automotive and cloud computing, both of which were well up, according to the company.

Carrier revenue was flat at CNY284 bn ($41.3bn), indicating that has now been stabilized as the company continues to attract business from nonaligned countries of APAC and Latin America primarily. Only consumer revenues were down, as expected, by 11.9% at CNY214.5 bn ($31.2bn).

Much has been made of Huawei’s sharp 68.7% annual fall in profits over the year to CNY35.6 bn ($5.17bn), but that has to be seen in the context of the restructuring costs and also local factors cited by Huawei, especially the draconian zero Covid strategy with numerous strict lockdowns, which stifled domestic trade and imposed friction on various activities. Huawei also cited rising global commodity prices but shared those in common with non-Chinese competitors. Another one off factor is that Huawei’s 2021 enjoyed a boost from the sale of its Honor smart phone business to a consortium.

The key point then is that relative stabilization has been achieved around the company’s new axis, after the 28% revenue slump in 2021 when the company admitted it was in the midst of an existential crisis. Profits may have been slashed again but are well in the red despite the hike in R&D investment, which now appears to be a gamble that has paid off. The company spent 25% of its 2022 revenue on R&D, up from 22.4% in 2021, mostly on a 6.2% increase in R&D staff to 114,000. This is also well above its competitors, Ericsson spending 18.1% of its revenue on R&D and Nokia 16.0% over the latest periods for which data is available.

Huawei is right to admit that it is not yet completely out of the woods because the transformation of its business along the three dimensions of geography, sector and supply chain, is still ongoing. Almost 25% of its revenues are still from EMEA at a time when some operator customers there remain in the throes of switching to alternative suppliers for 5G RAN equipment in particular.

The tone of executive comments though is rather more upbeat than a year ago. “In 2022, a challenging external environment and non-market factors continued to take a toll on Huawei’s operations,” said Eric Xu, Huawei’s rotating chairman. “In the midst of this storm, we kept racing ahead, doing everything in our power to maintain business continuity and serve our customers. We also went to great lengths to grow the harvest – generating a steady stream of revenue to sustain our survival and lay the groundwork for future development.”

Xu added that “2023 will be crucial to Huawei’s sustainable survival and development. While it’s true that we have considerable pressure ahead of us, we have what it takes to come out the other end.”

This last comment encapsulates optimism that the existential dangers are past and that now it is question of engaging along the revised competitive frontiers.

Xu was even more bullish when talking about the realignment of China’s chip industry, which he contended was being reborn as a result of U.S. sanctions. “I believe China’s semiconductor industry will not sit idly by, but take efforts around self-strengthening and self-reliance,” said Xu during a recent press conference around the annual results release. “For Huawei, we will render our support to all such self-saving, self-strengthening and self-reliance efforts of the Chinese semiconductor industry.”

Huawei was first put on the US Entity List specifying such restrictions in 2019. This included chips for 5G products, but the screw was tightened a year later after the federal administration seemingly realized it could exercise control over the supply chain of cutting edge silicon at the highest processes through ownership of key technology required for the photolithographic etching.

The US administration then introduced broader based chip restrictions in 2022, aiming to deprive Chinese firms of semiconductors for more advanced applications, including those under the banner of AI. But the longer term impact of such restrictions will be to propel Chinese semiconductor technology and establish two global poles that will most likely converge towards parity.