5G and the winners of American 'state capitalism'

One key area that President Trump has identified as part of its attempt to “Make America Great Again” is to double down on its overall dominance in technology by expanding its lead and quickly playing catch-up in segments where it might lag, like next-generation 5G telecommunications infrastructure, which is currently being rolled out around the world.

To be sure, the White House made 5G an early target. In March 2018, the Trump administration, less than 14 months in office at the time, blocked the US$117 billion acquisition by the then Singapore-based, San Jose-run communications chipmaker Broadcom of rival chipmaker Qualcomm, citing national security concerns. Broadcom makes broadband chips used in WiFi equipment including smartphones that need WiFi access, while Qualcomm makes 4G or 5G baseband chips used to access cellular networks. Trump said the merger was scuttled on concerns that Broadcom’s takeover of Qualcomm would erode America’s lead in mobile communications technology, particularly 5G, and give China the upper hand. Broadcom, which is headed by Penang-born CEO Tan Hock Eng, has since relocated its headquarters to the US.

Yet, it is one thing to help nurture your homegrown “national champions” like, say, tech behemoth and iPhone maker Apple Inc, or e-commerce leader Amazon.com, but quite another to “adopt” foreign tech companies, the way the Trump administration has identified two European firms as targets that it believes will help preserve, protect and defend Western dominance in the communications sector against the controversial Chinese equipment maker Huawei.

America’s grouses against Huawei are well known. For one thing, the Trump administration believes the Shenzhen-based firm, which claims to be the largest employee-owned company in China, has ties to the People’s Liberation Army. For another, Huawei equipment has long been suspected of being used to covertly spy on Western interests and gather data through the backdoor that it ultimately shares with the Chinese intelligence apparatus. Huawei has said it does not spy for any government, but US officials say they have evidence that Huawei has backdoor access to mobile-phone networks around the world that it has helped build, mainly by drastically undercutting Western rivals on pricing. Moreover, the secretive Chinese tech enterprise has been a key beneficiary of stolen critical intellectual property and patents belonging to Western companies. Huawei has also blatantly defied global sanctions against rogue regimes like Iran, North Korea, Venezuela and Cuba, selling them equipment that no manufacturer would dare to. (Huawei’s chief financial officer Meng Wanzhou, daughter of its founder Ren Zhengfei, is currently awaiting extradition from Canada to the US on charges that she broke sanctions and laundered money to sell equipment to Iran.)

America Inc?

On Feb 7, US Attorney General William Barr, who once worked for the largest US telco Verizon Communications as general counsel, or in-house lawyer, recommended that the US and its allies, presumably the EU, the UK and Japan, “invest” in either Swedish telecoms equipment firm Ericsson or Finland’s telco gear maker Nokia.

“As a dictatorship, China can marshal an all-nation approach — the government, its companies, its academia, acting together as one,” the AG said. No American company sells telecoms gear in direct competition with Huawei, Nokia or Ericsson. Lucent, the last US player, merged with France’s Alcatel, which later sold itself to Nokia. Barr argued that the US should consider taking a controlling stake in European telecoms equipment makers to “blunt” Huawei’s “drive to domination”. Buying one or both the firms would allow the US to control, fund and strengthen an America-friendly telecoms equipment maker so that the “Western bloc” — America and its developed-world allies — do not need the likes of Huawei for critical communications infrastructure or technology.

The potential adoption of such “state capitalism” would send a strong signal that the US believes it is a more effective model to create globally competitive tech companies, says Edison Lee, telecoms analyst for Jefferies & Co in Hong Kong. But will it work? Lee says he doubts it. “There is no guarantee that Nokia’s or Ericsson’s tech will significantly improve as a result of ownership by US interests,” he argues. “Even if the US government pours in capital to fund their R&D, there is no guarantee they can catch up.” Nokia and Ericsson have fallen behind Huawei for many reasons, Lee notes. Among them: Huawei’s engineers in China cost a fraction of those at Ericsson and Nokia. Moreover, many of those engineers likely work 50% more hours than those at European companies and receive military-style training, he says.

So, will America pick Nokia or Ericsson, or might the Trump administration be tempted to seek assistance from another, smaller telecoms equipment player — Samsung Electronics, the South Korean tech giant which, unlike Nokia and Ericsson, not only designs and sells equipment but also actually manufactures them, apart from making many of the essential components that go in the gear, like key chips?

Nokia is more likely to be acquired than Ericsson, which has a much more concentrated shareholding structure, with top shareholders all Swedish entities, says the Jefferies analyst. Ericsson is Sweden’s pride and, as such, he does not see why Stockholm would be interested in selling it to the American government for the express purpose of defending Western interests — unless, of course, local shareholders receive a huge premium, which is unlikely.

Nokia is a different story altogether. Once the world’s largest cellular handset maker with a market share of close to 40% at its peak, it declined after Apple introduced the iPhone, the world’s first smartphone or multi-purpose communications device. “Nokia has lost a lot of ground in recent years, after its unsuccessful merger with Alcatel-Lucent, and appears weak,” says Pierre Ferragu, a telecoms equipment analyst with New Street Research in New York. The current iteration of Nokia is, in fact, a combination of four companies — Nokia and telecoms firms that it acquired over the years, including Siemens’ telecoms division and Alcatel-Lucent. As such, it has a much more diversified shareholder base.

So Nokia may be easier for the US government, or a designated American company, to acquire, says Lee.

Dotcom bubble

So, why is there not a Western telecoms equipment maker like Huawei? Look no further than the dotcom mania of 2000. After the tech bubble burst, equipment makers such as Lucent, Canada’s Nortel and, indeed, Cisco, which provided the picks and shovels for the internet gold rush, were stuck with a ton of inventory and few buyers who could afford to buy their equipment. Nortel went bust, Lucent tottered for a few years before selling itself, while Cisco focused on networking equipment as well as software and services.

Twenty years on, the telecoms equipment business is again undergoing a dramatic transformation, notes Ferragu. “Networking technology is getting more integrated, and boundaries between switching, routing and optics are getting blurred,” he says. Moreover, equipment makers need huge R&D budgets and it takes years for those investments to bear fruit. Listed players are focused on meeting and beating quarterly earnings guidance rather than investing for the long term. Huawei, which has the world’s largest telecoms equipment market to itself and access to cheap capital from state-owned Chinese banks, has been successful because it is not constrained by the same pressures that its Western counterparts are.

Ferragu believes Nokia has several options.

It could seek to merge with Ericsson to create a behemoth that would then help Western telcos access state-of-the-art equipment and technology. But the New Street analyst argues this is unlikely because the enlarged company would command a near 80% market share in the US, which will raise the ire of regulators worldwide.

Moreover, Ericsson’s board is likely to reject any merger proposal.

Nokia might seek a merger with networking gear maker, Cisco. Such a combo would make “a compelling case”, he argues, but Cisco’s management and board are strongly opposed to it, which rules out that option. Nokia could, however, try to dispose of its wireless business to Cisco but that too would not fly with the US tech giant’s board. Moreover, what would be left of Nokia is a company few investors would covet. It might look at disposing of its IP routing, optics or fixed-access business.

But that is highly unlikely because there are not many buyers who are willing to pay much for that segment of the business.

Lastly, the Finnish firm, which famously sold its dying cellular handset business to Microsoft for US$7 billion, only for the software firm to shut it down three years later, could strike a strategic deal with Washington. That is an option the Nokia board would seriously consider, Ferragu believes. But he notes that Ericsson will likely compete for that as well. “The shape of such a public-private partnership remains unclear,” he says. Whether America buys Nokia, Ericsson or both under Trump, or if he fails to get elected, under a socialist president like Sanders, it would be a mistake to abandon what has worked well in a free market economy and imitate China and pick winners by creating national champions in telecommunications, artificial intelligence or facial recognition.

Picking winners and throwing resources at them, rather than letting the market decide, is at the core of socialism. The pride of American free market capitalism is the Silicon Valley, which has an ecosystem of innovation that is the envy of the world, with four top tech giants worth a combined US$5 trillion ($6.9 trillion), despite the recent market rout. Trump, Sanders and Biden would do well to remember that.

Assif Shameen is a business and technology writer based in North America