ZTE comeback stumbles on China telecoms spending slowdown

The telecoms equipment seller's revenue began declining in the second half of last year, and fell 10% in the fourth quarter

Key Takeaways:

• ZTE's revenue dropped for first time last year since 2018 as its core business slumped with reduced 5G spending by Chinese wireless carriers
• The telecoms equipment maker's AI and enterprise businesses show promise, but lower margins and the potential for new U.S. sanctions could pose challenges

Crippling U.S. sanctions on ZTE Corp. (0763.HK; 000063.SZ) in 2018 brought the Chinese telecoms giant to the brink of collapse, forcing it to pay a historic $1.4 billion penalty and overhaul its leadership to secure relief. Since then, the company has embarked on a grueling recovery path, pivoting to lower its reliance on U.S. suppliers, strengthen its position in the domestic market, and broaden its product portfolio beyond telecoms equipment.

By 2022, ZTE appeared to turn a corner as its annual revenue finally rebounded to surpass pre-sanctions levels in 2017, signaling a tentative comeback. But the company's latest financial report for 2024 paints a more complex picture. Decelerating revenue growth, compressed profit margins, and persistent tensions between Beijing and Washington are casting shadows over the sustainability of its recovery in an increasingly fractured global technology landscape.

The company's 2024 report, released last Friday, reveals a sobering milestone: ZTE's annual revenue dropped 2.38% year-over-year to 121.3 billion yuan ($16.7 billion), marking its first decline since U.S. sanctions caused its revenue to tumble by 21% in 2018. This reversal ends a five-year recovery streak that peaked at 13% growth in 2021 before decelerating to 7% in 2022 and just 1% in 2023. Meantime, its net income last year also slipped into contraction, falling 9.7%, contrasting with marginal gains in earlier years.

On a quarterly basis, ZTE reported year-on-year revenue gains in the first two quarters of 2024, only to slip into accelerating revenue contraction in the second half of the year. Those declines culminated with a 10% drop in the fourth quarter to 31.3 billion yuan.

The slowdown contrasts sharply with crosstown rival Huawei, which was hit with even harsher U.S. sanctions but has bounced back more strongly by developing alternative non-U.S. suppliers and moving into new areas like intelligent driving. ZTE has made similar efforts, which we'll detail shortly, though the results have been more limited.

Investors weren't too impressed with ZTE's latest report, with its Hong Kong-listed stock tumbling 12.5% the day after the announcement. At its Monday close, the stock is now roughly where it stood just before the original U.S. sanctions in 2018.

ZTE's slowdown coincides with a broader downturn in China's telecommunications sector. After years of aggressive investment in 5G infrastructure, the country's three major state-owned carriers — China Mobile, China Telecom, and China Unicom — collectively cut their capital spending by 5.4% in 2024, the first annual drop since 2018, according to Communication Weekly, a state-affiliated industry publication.

The pullback hit ZTE's core business hard. Revenue from its carrier network segment — which covers telecoms equipment and accounts for over half of its sales — sank 15% year-over-year in 2024. Others reporting similar difficulties last year include China-focused telecoms software makers Comba (2342.HK) and AsiaInfo (1675.HK; 688225.SH).

Diversification effort

ZTE's geographic revenue mix has shifted dramatically since the U.S. sanctions of 2018. Revenue from U.S. and European markets dropped to 15% of its total in 2024, down from 25% in 2017, according to its latest report.

Despite expectations that ZTE might pivot strongly toward emerging markets friendlier to Chinese investment, progress has been limited. Africa, for example, contributed just 5.3% to overall revenue in 2024, marginally up from 3.5% in 2017. The slow expansion reflects the challenge of competing with Huawei's established dominance in these regions, even as those countries accelerate their build-out of 5G infrastructure.

Instead, ZTE has primarily looked inward and redirected its focus to its home China market, which now accounts for 68% of revenue, up from 57% in 2017. The company's efforts to diversify its product portfolio are also focused on China.

Those efforts are centered on its government and corporate business segment, which includes servers and enterprise software. This segment grew by an impressive 37% last year, accounting for 15.3% of revenue, up from 9% in 2017. The company's consumer electronics, including smartphones and tablets, grew 16%, but its 27% share of revenue remains below its 2017 level of 32%.

In its 2024 report, ZTE emphasizes the growth potential of its government and corporate business, pointing to surging demand for AI servers and software services amid the AI boom. It also highlights government support through policies like "East Data, West Computing," a national initiative to expand data center infrastructure across China. But even in these areas, the company must compete with far more established giants, led by hometown rival Lenovo (0992.HK), as well as foreign rivals like Dell (DELL.US).

Capitalizing on AI opportunities, ZTE moved quickly to tap into the momentum created by DeepSeek, whose recent breakthrough success has sparked nationwide demand for AI infrastructure. Last month, ZTE introduced AiCube, a hardware system that combines AI training and inference functions, aiming to support various computing scenarios and speed up AI deployment for its clients.

However, expanding into this business also presents challenges. The company's government and corporate segment operates on notably thinner margins than the telecoms equipment business, partly due to the high component costs of AI servers and related infrastructure. ZTE's 2024 report reveals the segment's gross profit margin was just 15% last year, significantly lower than the 51% margin for its traditional telecoms equipment business. This margin difference was a key factor in the company's reduced net income for the year.

Beyond operational challenges, investors might also want to weigh geopolitical risks as ZTE expands into these new sectors.

The AI server business illustrates such vulnerabilities, since such systems depend heavily on AI chips from U.S. suppliers like Nvidia or domestic chips made with U.S. technology. Though China can still import certain lower-tier Nvidia chips under current rules, the unpredictable nature of U.S. export controls creates ongoing uncertainty for this business line.

Another pressing concern is the potential for ZTE to fall victim to new U.S. restrictions, given rising tensions with China under the new administration of President Donald Trump. While ZTE's recent supply chain diversification efforts may help avoid a repeat of its 2018 crisis, challenges remain.

Though ZTE has not fully disclosed its mitigation strategies, Chinese media reports indicate the company has increased procurement from domestic chip suppliers. In ZTE's 2024 annual report, Chairman Li Zixue emphasized the company's commitment to developing independent core technologies. This focus is reflected in ZTE's R&D spending, which has doubled from around 10% of revenue pre-sanctions to 20% last year.

In the near term, ZTE's biggest challenge probably lies not in potential sanctions but in navigating the slowdown in China's telecoms equipment spending. With China's 5G networks mostly built and domestic carriers tightening budgets, the company's success will depend on how quickly it can scale up new growth areas like AI infrastructure and enterprise solutions, while expanding its presence in non-Western markets.