[China] ZTE: Surging In Cheapie Smartphones, But At A Price


Sanford Bernstein’s Pierre Ferragu this morning offers what he terms a “deep dive into the economics of the $150 smartphone,” in which he zeroes in on ZTE (0763HK), the Hong Kong-based maker of networking equipment and, lately, cheap smartphones.


By $150, he means the actual cost to the phone company, which then subsidizes that down to nothing, or almost nothing, to the consumer.


Ferragu has an Underperform rating on ZTE stock, and thinks the Street is too bullish in its expectations.


“ZTE is well positioned to grow in the non-branded smartphone segment, but believe this growth is margin-dilutive and unlikely to move the needle in the medium term.” In contrast, he rates Taiwan’s HTC (2498TW) Outperform, believing the company can expand margins as it moves into the low-cost lane.


ZTE, and Chinese competitor Huawei, have grown their combined share of the smartphone market to 5% in Q2 of this year from nothing a year earlier, thanks to greater scale than the myriad of smaller vendors, whom Ferragu refers to as the “Shenzhen Ecosystem.” By the end of next year, they may have a combined 17% of the market for “non-branded” smartphones costing under $300, wholesale.


But Ferragu examines a couple of ZTE smartphones and finds the company following a well-established pattern, he thinks, of introducing a desirable phone, but then following with a cheaper model to expand volume of sales. That ploy comes at the cost of lower margin — perhaps less than 20% — which can only have an overall dilutive effect on the company’s gross margin, he thinks.


The “Blade” phone from ZTE, for example, was introduced with an OLED screen selling at $224 and costing $150, for a gross margin of 25%. But ZTE then followed with simpler models priced at just $157, wholesale, and costing $133 to make, bring gross margin down to 15%.


As a result of such moves, the gross margin of these things is “right in the middle of PC/laptops and leather handbags,” he writes.


Source: Barron's