China Plays Security Card With Cisco Freeze Out

Nov.15.13 | About: Cisco Systems, (CSCO)

Beijing is showing that Washington isn’t the only one that can play games over national security concerns, with word that networking equipment giant Cisco Systems (NASDAQ:CSCO) is loosing big business in China due to revelations about US spying. Frankly speaking, this latest development in the networking equipment Cold War between Beijing and Washington doesn’t surprise me too much, and some might even say that China’s national security concerns are justified. But no matter what you think, it seems likely that Cisco’s new China freeze is at least partly and quite possibly completely in response to similar moves by Washington against Chinese networking equipment giants Huawei and ZTE (OTCPK:ZTCOF).

Cisco has just warned that its revenue could drop around 10 percent in the current quarter and continue to contract through the middle of next year due to a steep drop in sales from developing markets, most notably China. (English article) Cisco said the big drop in China has come after revelations by former US government contractor Edward Snowden about major US spying programs, which included electronic eavesdropping on China.

Cisco didn’t detail the decline in its China sales in the report that I saw, but I suspect it must be greater than 20 percent to have such a dramatic effect on the company’s global sales. Other major tech firms that have cited weakness in their China sales include IBM (NYSE:IBM), which saw its third-quarter China revenue drop 22 percent, and Microsoft (NASDAQ:MSFT), which singled out China as one of its weakest global markets in the third quarter.

In all fairness, China’s economy is going through a major adjustment right now and these global tech giants are probably not the only ones suffering big slowdowns in the market. But I do suspect that politics is also at least partly at play in this particular situation. Washington banned all US telcos from buying Huawei and ZTE networking equipment last year, citing national security concerns due to suspicions that the pair were closely tied to Beijing. Both companies have denied that their products pose any national security concerns, even as leaders in other western markets have also raised similar questions.

Snowden’s revelations certainly show that US companies worked with Washington in its spying programs. But in most cases I’ve seen it’s Internet companies like Yahoo (NASDAQ:YHOO) and Google (NASDAQ:GOOG) that provided information after being subpoenaed by Washington. I have yet to see any allegations that Washington worked with systems designers like IBM or hardware makers like Cisco to spy on individuals or foreign governments. It’s possible we could see such allegations later, though the fact that we haven’t heard any yet seems to indicate that Washington focused its efforts on telcos and other service providers.

Regardless of that distinction, the next year or 2 could certainly be chilly for Cisco and other hardware and software sellers in China. Such concerns have been raised before, with Microsoft making the unusual decision to open its Windows source code to Beijing a decade ago to ease security concerns. More recently, China Unicom (NYSE:CHU) reportedly replaced Cisco equipment in some of its core networks last year due to security concerns. (previous post)

So, what does all this mean for companies like Cisco, Microsoft and IBM in China? It does seem clear that most will see their sales slow or contract in China over the next year, both due to the slowing economy and also national security concerns. I would expect any such freeze will probably thaw eventually as memories of the spying scandal start to fade, though that might not happen until 2015.

Bottom line: Cisco and other major American IT firms will suffer weak China sales in the next 1-2 years as local companies avoid their products over security concerns.