The UK government is set to meet on Tuesday to discuss whether, or how, to include Chinese tech giant Huawei in its roll out of a national 5G communications network. The issue is playing on international political sensitivities. The US has warned the UK off embracing Chinese technology, which it considers a security risk not worth taking. Washington unequivocally wants the UK to follow its own path and refuse to engage with Huawei. Boris Johnson and his ministers appear eager to show signs of ‘looking outward’ and developing new relationships with global rather than European partners. Following December’s general election there is also some benefit to be had from demonstrating a degree of engagement with the global leader in a technology. Whilst there will be some increase in clarity today, the situation is particularly confusing for investors. Political horse-trading has for some time been distorting this part of the tech sector.
Tuesday’s meeting in Downing Street could go either way. The consensus forecast is that Prime Minister Boris Johnson will announce some degree of collaboration with Huawei, but at the same will clarify the firewalls and ring-fencing involved in protecting UK information. The UK leader said on Monday:
“There’s no reason why we shouldn’t have technological progress here in the U.K.,” he added that Britain would also need to “protect our security interests and protect our key partnerships with other security powers around the world.”
This outcome can be expected to bring forward curt comments from the White House. US secretary of state, Mike Pompeo, tweeted over the weekend: “The U.K. has a momentous decision ahead on 5G” (source: CNBC).
Tuesday’s meeting could be a trigger for movement in the market. The market has been waiting for some time for the UK to confirm its decision on the issue. In June 2019, Pompeo was already sharing his own thoughts with former Prime Minister, Theresa May. He said:
“Our allies and our partners and our friends, don’t do anything that would endanger our shared security interests or restrict our ability to share sensitive information” (source: The Guardian)
The technical element of the debate centres around the question of whether the UK authorities can guarantee that Huawei won’t be able to illegally access data on the UK network. Mobile giants such as Vodafone have already taken a position on the matter and have invested heavily in rolling out 5G platforms, with Huawei providing key elements to the technological architecture. The UK firm has stated it doesn’t use Huawei at its core and has multiple layers of encryption to ensure unauthorised of access of data is not possible.
The economic and political arguments are more nuanced. The US–China trade dispute, which is the major drag and driver of the global economy, fundamentally comes down to US authorities standing up to a draining of US technical superiority to China. Not only does the US not want to lose its position as a global tech leader, but it feels the playing field is rigged. Elias Groll wrote in Foreign Policy:
“Huawei… has managed to capture 28 percent of the world market by offering high-quality gear at a low price—thanks in part to state subsidies from Beijing.”
Source: Foreign Policy
A political argument for allowing Huawei to tender for business is that there aren’t many alternative providers. The mainstream market runs the risk becoming a duopoly made up of the European firms Nokia and Ericsson who control 17% and 13% of the 5G market, respectively.
The potential boost for alternative providers has so far failed to materialise. In fact, the sector as a whole appears to be struggling, possibly due to the degree of political uncertainty. The global market for 5G chipsets in smartphones is expected to grow at a compound annual rate of 75% up until 2024. Despite this being a growth market, the stock performance of the big players has lagged the Nasdaq over the last 12 months.
5G sector — 12 month stock prices:
Taking the ADR listings of the European firms reduces distortion from forex and both Ericsson and Nokia are showing a negative return in terms of stock price. The Nasdaq itself has posted a return of 33.67%. Qualcomm Inc.(Nasdaq:QCOM), which has exposure to the sector but is not caught up to the same extent in the political bartering has posted stock value growth in excess of 70%. This may temper traders looking to pile into positions following the announcement in the UK. On the other hand, it may open the door to a market neutral pairs trade of long Nasdaq, short a basket of underperforming telecom stocks. Given the shake down in equities, which has been brought on by the coronavirus, some degree of hedging may appeal. Given that the last 12 months saw such disparate levels of performance there is still room to make a return even when stock-loan costs are factored in.
The CRSP US Telecoms index offers broader exposure to the sector than single stocks. The index has been flatlining over the course of the last year.
CRSP US Telecoms index vs Nasdaq — 12-month price chart:
The UK appears to be heading towards selecting Huawei to be included in its 5G network. Despite this, the topic is still marred by confusion and political uncertainty. The US-China trade war may have been scaled back by the phase one agreement of early January but the Huawei issue is firmly behind any red-lines for US trade negotiators.