ZTE (A-Share):2Q net loss up to Rmb10.7bn due to fines

Event

    ZTE released 2Q18guidance of a net loss of Rmb8.7bn~10.7bn vs a net profitof Rmb1.1bn in 2Q17, owing to the suspension of major operating activitiesand the US$1bn fine during the negotiation with the US in an attempt toremove the denial order (Trading resumes; US$1.4bn settlement, June 13).On July 12, the company signed an agreement for an additional US$400mescrow penalty, paving the way to resume operations (link). It is important tonote that the ban will still be in place before the US issues a notice liftingthe ban once the escrow deposit is completed.

    Impact

    US$400m escrow penalty to be paid within 90days from Jun 8: Accordingto the previous settlement deal, ZTE must place US$400m of suspendedpenalty money in escrow within 90days from Jun 8in addition to the US$1bnfine before BIS will officially remove ZTE from the Denied Persons List. TheUS$1bn fine was booked in 2Q18based on the company’s announcementwhile the company has also come to a detailed agreement with US on theescrow penalty, which marks the final step once the deposit is completed.

    Management reshuffle with the new CEO in place: ZTE tapped an in-houseexecutive with experience in product research and operations, Xu Ziyang, tobe the new CEO as part of the settlement deal. Previously, Xu served as theCEO of ZTE’s German operations, at a time when the company signed a fiveyearservice contract with German telecoms operator E-Plus. Along with otherkey executive appointments, the new management team vows to upholdcompliance as the top priority.Earnings and target price revision

    We factor in 2Q guidance and cut earnings in 2018/19/20E by 420%/11%/4%further due to the fines and customers’ hanging concerns on the sustainabilityof the company. We lower our TP to Rmb12.9(from Rmb29.0) on an updatedPE multiple of 13x as a result, the trading average in the past three months.

    Price catalyst

    12-month price target: Rmb12.90based on 13x 2019E PER.

    Catalyst: full 2Q18results on Aug 23, the removal of the denial order.

    Action and recommendation

    Maintain Neutral.