Private equity’s avid interest in Huawei Technologies Co. Ltd.’s handset business is based on Huawei’s opportunities for significant growth and as a means to further investment in China, analysts said last week.

Huawei has a chance to profit from domestic Chinese wireless growth and from an international trend among network operators to brand as their own handsets purchased from Huawei and similar vendors.

Five private equity firms currently are in talks with Huawei after each bid about $2 billion apiece for an approximately 50% stake in the company, according to news reports that Huawei has confirmed.

The swiftness and level of private equity’s interest in Huawei and its growth opportunities has drawn unflattering parallels with Motorola Inc.’s six-month search for a financial partner and a new handset CEO, which so far has not met with success.

But the two companies are distinctly different animals, according to Bonny Joy, analyst at Strategy Analytics.

In fact, Huawei’s attraction of private equity investment is part of a trend among aggressive Chinese handset vendors, Joy said.

“They’re not trying to build the next Apple,” Joy said of private equity’s interest in Huawei. “They’re taking advantage of medium-term opportunities. Huawei itself is chasing money to make more money.”

Huawei’s handset division – just a slice of its overall operations, which include a massive global presence in network infrastructure – is growing rapidly, according to Strategy Analytics data.

In 2007, Huawei shipped about 20 million handsets, a 60% increase over 2006, Joy said. The vast majority of that growth was in sales to operators such as Vodafone Group plc, which puts its own brand on the devices. (About 60% of Huawei’s gain was in CDMA handsets, 40% in W-CDMA and GSM.) Huawei probably sells about 10% of its handsets under its own brand. The company’s strongest markets are China, India and Latin America, according to Strategy Analytics data.

Private equity can help the company scale up to profit from two distinct, medium-term opportunities, Joy said.

One of Huawei’s two major opportunities is growth in the domestic Chinese market, particularly in various 3G standards just blessed by the Chinese government, including W-CDMA and TD-SCDMA.

In TD-SCDMA, for instance, Strategy Analytics projects the sale of 2 million units this year, a volume that is projected to grow to 52 million units in five years. Global brands such as Nokia Corp. undoubtedly will address the domestic Chinese market as well, but local vendors have an early advantage, Joy said.

Internationally, operator demand also will grow for low- and mid-tier handsets from original design manufacturers such as Huawei that they can brand as their own.

In 2007, approximately 4% of the 1.15 billion handsets sold globally (about 46 million units) were operator branded, according to Strategy Analytics data. By 2011, that slice will double to 8% of projected annual handset sales of 1.45 billion, which translates to about 116 million units.

Geoff Blaber, analyst at CCS Insights, agreed that those two opportunities have attracted Huawei’s private equity suitors.

“Investment in Huawei not only offers growth opportunities in an under-penetrated Chinese market but also in high-margin, mature markets,” said Blaber. “Operators are increasingly looking to reduce costs and lower the premiums they pay for handsets from tier-one brands. This puts Huawei in a very strong position going forward if it can scale the business sufficiently.”

“Given that it’s becoming increasingly difficult to compete with the scale of Nokia,” Blaber added, “the cost advantages available to the Chinese vendors makes them very attractive to investors.”

According to data from Forward Concepts, Huawei’s growth between 2006 and 2007 propelled it from No. 25 in global rankings two years ago to No. 19 last year. Private equity investment should provide the means for Huawei to continue its growth, according to Will Strauss, principal at Forward Concepts.

And there’s bigger game afoot for private equity – a stake in Huawei represents a foot in the door for further investment in China.

“The fact is, private equity has an interest in mainland China and very little of that has happened in the past,” Strauss said. “This is a door that just opened for them.”

Huawei’s stated interest in building market presence in the U.S. – it signed a modest deal with MetroPCS Communications Inc. last year – is natural because the U.S. is the top market for handset revenue, Joy said, but building a brand here would be expensive. The analyst saw no connection between U.S.-based private equity’s interest in Huawei and the vendor’s opportunities in the U.S.

Huawei and other Chinese vendors with rapid growth – a group that includes Haier, ZTE Corp., Amoi-Xia and Lenovo – face several hurdles to realizing their opportunities, according to Joy.

One is that with shipments largely dependent on operator deals, these companies see a lot of volatility in quarterly shipments and thus they struggle with inventory management, Joy said. Also, operating profit margins for Chinese handset vendors overall are tiny – 1% and decreasing, according to Joy. Because many of these largely ODM efforts rely on identical chipsets from MediaTek, they also have difficulty in presenting operators with a unique product, sufficiently differentiated from their fellow Chinese rivals. That tends to make these companies’ handset businesses a somewhat commoditized, volume play.

Despite these apparent hurdles, however, a private equity deal with Huawei is “a very attractive proposition,” Blaber said, especially given the size of the stake being offered. And in the “hugely competitive” low-tier handset market, Huawei has a track record for cost efficiency. With its Vodafone deal – 3G handsets for 21 countries over five years, according to Forward Concepts – Huawei established that its products can compete in an operator portfolio that includes the world’s top brands, the CCS Insights analyst said.

Source:RCR News