If China’s mobile handset makers could be credited with something, it would be bringing smartphones to the masses. But that does not mean they should be credited with bringing value to shareholders. Consider ZTE, the Chinese telecoms equipment maker. Now the world’s fourth-biggest handset seller by units, it sold 57m mobile phones last year, of which a quarter were smartphones. But the cost to margins of that aggressive smartphone push helped shares fall by a third during the past year, more than twice as much as the broader Hang Seng index. Yet this week, it said it plans to become the world’s third-largest handset maker by 2015. And improve margins.
The problem is that ZTE sits at the low end of the smartphone market and 90 per cent of its handsets are sold through operators such as Vodafone and Sprint. That has done little for unit prices that are already two-fifths less than the average at Nokia – and investors know what is going on over there. During the next five years, average smartphone prices are set to fall, led by price declines at the entry level. Direct rival Huawei might have sold a third more smartphones than ZTE last year but it has no public shareholders to upset over halving profits to achieve that.
Even if ZTE can raise margins slightly this year by selling more in developed countries, investors know that handsets will remain its lowest-margin segment. While these are set to make up a third of revenues in 2012, they will contribute only 8 per cent to net income, JPMorgan estimates. Moreover, its efforts to boost its bottom line will centre more on squeezing the supply chain as it scales up rather than building its brand. A pity, then, that its share price is at the opposite end of the spectrum to its smartphones; trading at a large premium to peers Samsung and Apple of 16 times forward earnings. Without obvious margin improvement on ZTE’s handset segment, it will have a hard time proving to investors that its growing focus on smartphones rings true.