Back from the Dead: The Lessons of ZTE’s Near Demise
Trade conflict has a way of creating “zombie” companies.
Consider ZTE (OTC: ZTCOF). The China-based telecommunications equipment provider got a death row pardon from the U.S. government when trade sanctions were lifted, but the damage the company suffered in its three-month limbo could be too great to overcome.
ZTE’s fate might be a predictor of how industries awaiting permanent news on tariffs can experience life-threatening harm to their business models and bottom lines. Here’s a closer look at the ZTE story, with the lessons for investors.
To be sure, investors don’t seem greatly worried about the trade battle being waged by President Trump and the rest of the world. They’ve chalked up the tariffs and harsh rhetoric to blustery negotiating tactics.
Washington imposed the first wave of tariffs on $34 billion in Chinese goods on July 6, prompting an immediate retaliation from Beijing. Stocks dropped that day but have since recovered. Despite a few tariff-triggered sell-offs along the way, the S&P 500 is up almost 5% year to date:
Investors certainly don’t seem to be putting much weight on the possibility that tariffs will cause long-term harm to U.S. companies.
But tell that to ZTE, the electronic component supplier that just barely escaped the jaws of death while U.S. legislators decided its fate. Despite the Commerce Department reaching a deal that opens supplies of critical components to ZTE, three months of uncertainty and idle factories have left the firm a fragile shell of its former self.
And while ZTE’s banishment and its ensuing freedom aren’t part of the current trade war, the erosion of its fiscal health while waiting in the balance is a situation worth exploring. It’s a dilemma that threatens many industries awaiting the fate of tariffs, potentially decimating demand or hindering access to affordable supplies.
Investors might be burying their heads in the sand. The trade war already has exerted tangible harm, as reflected by ZTE’s persistent woes.
ZTE makes handsets and equipment for telecommunication networks. It’s been a serial transgressor of sanctions rules forbidding sales to North Korea and Iran. After months of ZTE continually making false statements regarding shipments, the Department of Justice threw down a severe penalty on ZTE, banning U.S. companies from exporting parts to the company.
Because ZTE relies on U.S.-made parts to manufacture virtually all of its products, the stiff punishment effectively put the company out of business.
Just after the April announcement, ZTE’s stock plunged and investors and customers wondered how the company could maneuver a workaround allowing it to resume business. Like the surly teenager who is accustomed to lax discipline, ZTE assumed it could negotiate with the Commerce Department. Yet policymakers remained firm.
In early May, reports of a likely bankruptcy started flying. In an exchange filing the company wrote:
“As a result of the Denial Order, the major operating activities of the company have ceased. As of now, the company maintains sufficient cash and strictly adheres to its commercial obligations subject in compliance with laws and regulations.”
Fast forward a week and President Trump tweeted out a possible lifeline to the company, noting he hoped to “work something out” with the Chinese government.
This week the Commerce Department agreed to allow the resumption of exports to ZTE by U.S. companies. In return, ZTE is required to place almost one half a billion dollars in an escrow account, pay a $1 billion fine, replace its board of directors and senior leadership and pay for a team of U.S.compliance officers who will monitor its business for the next 10 years.
The jury is out on whether ZTE can resurrect itself.
While few U.S. industries have such concentrated supply or demand economics, customers and suppliers to companies in tariffed groups may see permanent damage to their way of doing business, whether the tariffs are reversed or not.
Smart investors should do their homework to determine the vulnerability of companies in their portfolio to swings in demand caused by tariffs. Anyone with an easily replaceable product could be at risk as well as any company with a concentrated customer or supplier base in China. Until the dust settles over tit-for-tat tariffs, limit your stakes in export-dependent companies with heavy overseas exposure.
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