Huawei

Transcript from https://podmenti.com/t/f9c91b147ded8ada

Intros for tonight.
Oh yeah.
I wrote up like a little
Like
thing that's based on exactly what you texted me that I kind of like the idea of.
Great, great. But what I'm thinking isn't tell me if you like this.
Welcome to season five, episode one of Acquired.
the podcast about technology acquisitions and IPOs.
I'm Ben Gilbert, and I am the co-founder of Pioneer Square Labs, a startup studio and venture capital firm in Seattle.
And I'm David Rosenthal and I am a general partner at Wave Capital, an early stage venture capital firm that focuses on marketplaces based in San Francisco.
We
Are your hosts.
Today we are covering China's largest private company.
Huawei.
The company is the second largest smartphone manufacturer in the world.
Now they're only behind Samsung and they recently pulled ahead of Apple.
They also happen to be the world's largest telecom equipment manufacturer, among other things.
Now David
The company has had a pretty wild last twelve months.
That would be
Putting it my opening.
Yes. Barred from doing business with US companies, federal prosecutors have filed charges of wire fraud and their CFO was arrested upon landing in Canada last year.
Oh, and the layoffs last week of hundreds of workers in the US went down amidst the trade war. So what is going on with this company and and how did we get here?
Yeah, well, that's what we're here to talk about. And um this is gonna be fun. This is a little bit of an experiment for us here at Acquired. Uh this is obviously not an acquisition nor an IPO.
And in fact there is a interesting ownership structure of of Huawei, which we will
get into but we felt like this is such an important moment for tech for
international relations, you know, critical for all of us to really dig into and understand. And we certainly wanted to. So And speaking of understand it's it's a thing that I didn't understand before starting to do this research. And I would imagine uh most most folks in the tech ecosystem kind of feel the same way.
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All right, David. Now on to the episode, and as you put it well, I think in the pre-sho, uh we don't actually know how this one's gonna turn out, and that's pretty exciting for us here at Acquired. Yeah. A little bit nervous.
Alright, well
History and facts of Huawei.
We rewind, as we so often do here on Acquired.
Back to the early
Nineteen eighties.
It's a great time.
I was
being born. Shortly after that. Close to the 1984. Yeah. Most important part of the episode. But
We just. And uh we recall back to a lot of the same themes we talked about in our ten cent episode, if you remember that. And that was uh both Shenzhen, the city in China across the bay from Hong Kong, and Dang Xiaoping and the opening up of China and the cultural reforms after
Mao and the cultural revolution that would lead to China becoming the, you know
economic be the first steps in China becoming the economic juggernaut that it has uh turned into today, both economic and technological juggernaut.
As we said, this is a few years after the Cultural Revolution. Deng has taken over leadership of the party, and he has seen and lived through all the turmoil of the Cultural Revolution and and he believes that China needs to move forward. And he he seizes the Communist Party's twelfth national congress, which they do every five years.
uh it's the big five year planning event that the party does in nineteen eighty two as the moment that he is going to announce
His vision for
The future of China. And again, we talked about this on the Ten Cent episode. And what he sees is China as uh the the system in China as being socialism rooted in in in communism, but with Chinese characteristics. And what he means by that is he wants to introduce
a market economy back into China and introduce in a small way capitalism, and he has a very specific idea in mind. He has the city of
Shen Jin.
has a special economic zone that is going to be the test bed for this idea of keeping China as a communist
political system, but reintroducing capitalism and the market economy.
It's amazing. I mean looking at that sort of declaration of the special economic zone and
the, you know, forty year effects that it's it's had on that city and so much innovation has come out of Shenzhen.
Yeah. Well and it's like
This is such a
visionary and crazy idea at the time that you could mix communism and capitalism. Th this city is gonna have a different economic structure. Like our the economy in this area is going to be different than that of the rest of our nation.
Yeah.
Yeah.
Completely. And um
Obviously the experiment was a success, but in attendance.
In nineteen eighty-two at that national congress, that very national congress, was a relatively low level engineering corps director in the army, in the People's Liberation Army of China.
His name?

Ren Jang Fei.
Wren is better known today as the founder and CEO of Huawei, but back then he was a long way from those heights. Um so who who is Ren?
Well, one, he's a very witty individual. He he's been a little bit of a of a recluse, at least from Western media, uh, over the last few decades. But with all the events around Huawei uh over the last few months, he's kinda come back out of uh seclusion and has given many interviews uh to Western media and eastern media. Yeah. Uh
He's really a very, very smart uh and witty individual.
Yeah, and I would define him as reclusive uh except when he feels his company is misunderstood.
Yeah. You know, just to give you a little taste, we'll we'll link to a few interviews with him that you you can find on YouTube and and other sites online. But he was asked by Bloomberg in one of these interviews, you know, how he he feels about all the action that the US has taken against his company, uh, and in particular how it's gonna impact the these bands. Uh
the smartphone division. And he says, This is a quote, We might miss our growth target, but we are still growing.
Being able to grow in the toughest battle environment, that just reflects how great we are. That gives you a little flavor for for Ren. So who is Ren? He was born in the nineteen forties in rural southern China.
His father had actually been college educated, uh, which was incredibly rare for that time and place. Both he, Rand's father, and his mother were school teachers.
And Ren ends up going to college as well himself. He studies civil engineering at the Institute of Civil Engineering and Architecture in Kongjing.
After college he works as a civil engineer for a few years.
But then of course.
shortly after joining the workforce, the cultural revolution happens.
Ren signs up, he joins the PLA.
As a engineer, he gets put in charge of a uh
really glorious assignment. He gets sent to a remote part of the country.
in central China and he gets put in charge of setting up a synthetic fiber factory.
Um he ends up doing
well enough at that and uh and succeeding at setting up and managing this factory that he gets rewarded by the army. He gets sent to the the country's national science conference in nineteen seventy eight. Then he goes back and he continues working working at the factory.
And uh and then in nineteen eighty two, because he succeeded so much, that is how he lands himself the invite to this really prestigious, you know, national congress, uh historic congress where where Deng Xiaoping announces, you know, the opening up of China.
So he's there, he's in the audience.
And
you know, he's inspired by Dung and and this vision and the leader and he decides
He needs to
He needs to follow this call and become an entrepreneur. So he leaves the army very shortly thereafter, um, and he moves to Shenzhen. He works briefly in the oil industry. He works for the Shenzhen South Sea Oil Corporation, which he he realizes that the oil business is not for him. He's an engineer.
He wants to work in engineering, he wants to work in technology, but that was his path to Shenzhen.
So
At the same time, now this is the the mid eighties, the Chinese government
has is trying to modernize all of the technical infrastructure of the country. And one piece of the infrastructure that is severely underinvested in is telecommunications infrastructure. Um
So uh what's that at the time? You know, there's no there's no mobile
Telephones. Uh, there's no wireless industry. These are all
Fixed line television. Switches, yeah. PBX.
So the government
is trying to
Find ways to import.
Telephone switches.
into the country.
And so Wren sees this, and of course he had been part of the army and and part of part of the party, and
And so he's now finds himself in Shenzhen and he says, you know, maybe I can start a company
to start importing these there's this great demand for telephone switches. Uh and maybe I can do that here in Shenzhen. So a couple of years into his job, he leaves in nineteen eighty seven and he starts a firm along with five other co-founders to do just that.
Import.
PBX switches.
And resell them, import them from Hong Kong and resell them in China. And uh famously, as the story goes, he starts it with only twenty one thousand R M B, which was about five thousand dollars at the time. That's uh debatable whether that uh was actually true, but that is the lore.
You know, it's crazy thinking about
trying to put yourself in his shoes at this time.
U you only recently heard that this thing was
n not only legal, but possible, you know, starting a company.
and and becoming a entity that generates a profit and and performs this private sector activity.
And become an entrepreneur when entrepreneurs were persecuted during the Cultural Revolution and you were a member of the army during that time.
Right, yeah, not only was this thing illegal, which here in the US, you know, you y the the thought of doing something illegal can can totally cross your mind and you can sort of still do it, but this was one step further where
You know, it's something that that was so culturally shunned that no one would sort of
dream of doing it. You know, you blend ethics and religion and legal all into one, and it the result is like you just don't perform that activity. And in a just a couple of years later, here he is getting a band of people together to start a profit generating corporation. Just uh a another window into what must have been
going through his mind at this point in time.
He decides to name the company.
Of course, as we know, Huawei.
Well, where does he come up with the name Huawei? Well Hwa
means China.
And way means achievement.
So the name of the company that he chooses is
China achieving.
It's a good name.
It's a good pick, especially for the time.
Yeah. Uh but you can see, I mean, coming from the army, having been literally there in the audience when Deng Xiaoping is announcing that socialism with Chinese characteristics and the future and this vision for what China's both you know economy and and politics are gonna be for the next forty years, it's all wrapped up in this.
Yeah, you'll notice he didn't name it telephone switch inc. You know, it's pretty it's quite the vessel to be able to do whatever he wants within.
So the initial aim of the company, of course, as we said, is to import these
telephone switches from Hong Kong and resell them in China, which they do and they do very successfully. And they follow a playbook that Ren had had seen as part of the military in China. And
That is that they start in rural areas.
And they come to dominate
rural telephone networks and selling to to small villages in the countryside. And then they build up from there and then they sell into cities.
And the years go by and they become quite a large importer of of this technology into China. But
He doesn't
Really wanna stop there.
To build a big company
And of course to achieve and for China to achieve the way that they're gonna do that and gonna do that.
on a international large scale isn't just to import technology
It's too
build and develop their own technology uh internally. So he starts building alongside this import business.
a pretty strong R D and engineering group that grows to about six hundred people over the first couple of years of the company.
And that's crazy, you know, I mean here you have this this again, this this import business that has developed this R and D group of six hundred people alongside to build their own technology.
the like pattern matching radar going off in my head reminds me of Shoe Dog, where Nike started as the the blue ribbon shoes and they were importing Onituka Tigers.
and reselling those and you you'd go to your m blue ribbon guy to get your own Sukha Tigers. Then it was this big jump to go and start uh actually doing the R D and manufacturing their own shoes. I feel like I don't know as many recent examples of companies that started purely as an importer and then sort of switched the product that they were selling to be their own.
Um, but it keeps popping up in in you know things from from the eighties.
Well it's funny, like
Technology now is such a
Intellectual.
Property driven
business yeah where it's really hard to do that. Now of course you could argue and lots of people do that it was back then as well and Huawei played fast and loose with the intellectu of the uh gear that it was importing. But it wasn't, you know, quite like it is today.
That's a fair point.
So
About five years later, in nineteen ninety two, Huawei.
the fruit of all of this R D investment that they've been making is they introduced their first
product on their own, the CNC zero eight digital telephone switch.
And they introduce it into the Chinese market. And
Yeah.
completely dominates. It has the largest switching capacity of any product that was available in China at the time. Now of course Huawei had a large say in what other products were available in China at the time. But most importantly, they sell it for about a third the price that
the imported switches they're selling for. So as you can imagine, this comes to just dominate. And so very quickly Huawei grows into a very large company
Domestically.
Is
Not just to build a large company.
Domestically, he wants to bring
this and the technology that they're building within China out to the rest of the world. So
Pretty quickly thereafter, in nineteen ninety six,
they begin selling this switch that they've developed to other telephone carriers.
in other countries outside of China. Um first they go to Hong Kong, back across the bay from you know, they're originally importing
Networking gear.
From Hong Kong. They're now selling
Yeah.
From there.
They go to Russia and Africa
And things really start to work right around the same time, and this is the mid nineties.
Wireless is is finally becoming a thing, and Huawei starts investing heavily in building
networking gear for wireless telecoms as well. And pretty quickly they become the largest CDMA equipment provider in the entire continent of Africa.
This really starts to lay the groundwork for that, you know, when I was i introducing the episode, you know, saying that they're the the largest uh telecom equipment manufacturer, you know, we'll get into this later, but they have these three business lines, and this is still a huge one for them, these telecom carrier networks business.
that you know, they make five G equipment now, but they they've made basically every generation of
Yeah, equipment that goes on cell towers and is used in the backbone of cell phone technologies since the mid nineties.
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So the question you might ask, you'd we've been telling this story of
Grand
international scale ambition from the unlikeliest of places, uh beginning in the early eighties in Shenzhen. You have to wonder a little bit, like, how did this unlikely story
Unfold.
Besides certainly hard work and ambition and innovation at Huawei, how did they come within the span of a decade to become the largest wireless telecoms gear provider to countries completely outside of China?
And here I thought you were just gonna glaze over that, David. Yeah. Well, you know, if you remember back to what I was saying about how it was a
strategic initiative of the government to modernize telecommunications networks within China.
When they found Huawei and ran as a former, you know, PLA member, and Huawei literally meaning China achieving
Well, the government thought this is a pretty good vehicle to help this happen. And so, you know, all of the gear
for those first few years being of course imported, but then later their own switches that Huawei was selling.
Domestically, who are they selling it to?
They were selling it to the government. They were selling it to cities. They were selling it to towns. They were selling it back to the military itself.
And the government was using it to set up both civil and military communications networks. Oh that's interesting.
Because of that, the government obviously had a big
interest in what Huawei was doing and the products that it was providing, so much so that it started giving loans to the company to help them finance uh these projects that they were these contracts that they're awarding to them. Somewhere along the way, the
ownership structure of the company changed. So if you remember, Ren started the company with five co founders. That is no longer the ownership structure of the company today.
Today.
The Huawei operating.
is one hundred percent owned by a holding company.
Here we go.
Who owns the holding company? Well
one percent of the holding company is owned by Ren Jiang Fei.
Ninety-nine percent of the holding company is owned by another entity that is a trade union committee. Uh what is the trade union committee?
Most directly it represents the
union employees who work at the company. And economically, uh it does. It's effectively a profit sharing structure for employees working at the company. Again, this is China, and China is a communist country. And trade unions
Who do do trade unions ultimately report up to and should there be any liquidation of Huawei, where legally do the assets of the company go? They don't get distributed down
out to the members of the trade union within the company.
It gets distributed up.
And the trade union is ultimately
Rolls up to being re
part of the Chinese Communist Party, which is of course the government.
So this trade union
Has
economic interest in the company, but not sort of
control over the company. If you if you own a lot of the sort of uh it's not equity, but the I believe the phrase is restricted phantom shares.
in the union
Do you actually have any say over the governance of the company?
No, you do not. Um, and it's this is where it gets complicated. So a as you say, economically, if you are an employee of Huawei and you participate in the trade union, which
all at least Chinese employees of Huawei do, um, then yes, you do have an economic interest in the profits of the company. Um but yes, the governance and the control, and again, should there be a liquidation of the company, does not come back to you
It goes ultimately up to the party.
And an interesting uh other thing to note here, I mentioned the restricted phantom shares, which if you hold direct shares in a US company, you know, th that should already feel a little bit different to you. A major way in which it's different is if you are no longer employed by the company, you don't have the right to own those restricted phantes.
they are immediately purchased backed by the company. So you cannot sort of be an outsider who has we already talked about n no control, but now you can't even have economics as an outsider.
So what does all this mean? You can start to see.
In a
competitive global market, such as the market for telecom.
Networking gear.
You all of a sudden how now have this actor in Huawei who
doesn't quite have the same economic incentives as other free market actors. They are
A large portion of their projects are for domestic
Government.
uses uh that government is directly funding the company via loans from uh state banks.
State banks and state owned enterprise banks.
And they also have a
if not economic, a governing um
seat at the table, shall we say, at Huawei. Now there's not anything and you compare that to, you know, a a international company which is purely operating based on supply and demand and pricing, you know, power versus uh over both their suppliers and their customers in a normal market, and that's quite different. Now there's not necessarily anything
unique or necessarily wrong about this. China and other countries, indeed even Western countries, have state owned enterprises. You know, companies like Airbus uh are state owned enterprises. What's interesting is Huawei isn't officially a state owned enterprise and it competes in an international market.
listeners you might think, wow, Ben and David are really harping on this. Like they must feel it's important. Well, Huawei feels it's important too, because if you look at the twenty eighteen annual report on the very first page, before they even get into sort of like outlooks for the company and and sort of the company's ethos,
Of course, they have who is Huawei, and the very second question is who owns Huawei? And the answer is, of course, that they are a private company wholly owned by its employees.
And that says uh if I were to quote this, this scheme is limited to employees. No government agency or outside organization holds shares in Huawei. Now that's in the first five or six sentences of this entire
multi hundred page document.
Of course that was uh
Not highlighted in the way that it is now before all of the events of the past six months uh started. Whatever the reasons.
Certainly.
There's no arguing that Huawei at this time was an amazing growth story. Their products were
good, uh at least as good, if not better, than the competition internationally in these markets that they were entering. And they were certainly cheaper. So you can start to see why, you know, first in
developing and redeveloping countries like Africa and and Russia, their networking gear products were much more attractive than those from competitors like, say, Ericsson or uh Nortel in Canada. But then they keep they keep innovating and they keep investing heavily in R and D, such to the point that as
the years go by and wireless becomes a more and more uh important industry globally and a more technology driven industry, Huawei becomes
One of the very top players internationally,
By two thousand two, they were doing over five hundred million in revenue internationally annually, and by two thousand five, they passed uh the revenue international revenue passed domestic revenue to be the majority of the company.
Pretty impressive.
Around the same time.
In the mid two thousands.
Yeah, this is gonna be a recurring theme here. Uh Ren and Huawei's ambition is always growing larger. They've
come to be one of the few dominant players in
international
networking gear for the back end for carriers. They say maybe we need to think about getting into the other side of the business in telecoms and wireless as well, and not just make
Gear for carriers, but also make handsets.
For consumers.
And so in 2003, they released their first handset. And then in two thousand five, which is pretty early for the time, they ship one of the first three G phones available in the world. And and then again in two thousand nine at Mobile World Congress, they launched one of the first Android phones available.
Yeah, v very early to this stuff, and that's that's kind of a crazy idea. I mean, if you think about of course there were others that manufacture the the sort of cell tower side equipment that also made the the handsets. Imagine that today. I mean, imagine that going the other way, like Apple making the telecom equipment that goes on on the towers. I mean I guess the
strongest other example of someone that did that was uh when Erickson partnered with uh
uh with Sony to produce that. My d my dad actually had this phone as like a little candy bar Sony erected phone. Um and they were actually Ericsson, who's also a very large uh telecom equipment manufacturer, was sort of in this business of having consumer branded phones for for a while and they they did pretty well. But
You know, that was before the the smartphone era that we know today. Yeah. And so what's interesting
Huawei
I think saw the opportunity in having both sides of this business that
Because they were driving a lot of the innovation on standards and capabilities on the backend side, by having handsets on the
On the front end side, they could be playing off one another and keep introducing handsets that were
early to taking advantage of all of the feature sets that the carriers were offering. And so that's why you see them being, you know, being relatively early to to three G being relatively early then to four G and relatively early to uh you know the whole smartphone revolution and and embracing Android. You know, I didn't have this in the notes at all, but why
Why weren't they China Mobile? Like why wouldn't you also find a way to be the carrier and really own the whole stack? So you didn't have this thing where it's like
Like right now we're in this strange chicken of the egg game in the the US where
the carriers have to roll out 5G in order for the phone manufacturers to sell a r uh a high number of 5G phones. And consumers are sort of sitting here waiting for
both of those things to happen.
uh it at enough scale that it's useful. And so of course there's five G phones come out, but you only have them in certain cities and it's mostly bad. And so you have these three players where the
handset manufacturers are waiting on the
carriers to roll out
the m cell towers that are made by the Ericssons and the Huawei's the world like
It really does feel like there's this sort of middleman missing in Huawei's business model where they really could own the whole stack.
It's a good question. I didn't think about it, but I think
I think it must be because China Mobile is a state own enterprise, I believe. It must be. Yeah, they probably couldn't couldn't get in that business. So they probably couldn't compete there. In the absence of that, you know, I think this is one of the things that's really so interesting about Huawei is you know, obviously there is all of the
political overtones to all of this, but their business strategy is really brilliant by
Participating heavily in both sides here, as we were saying, you know, they're able to drive a lot of this to benefit of both the tick and the talk of innovation here. And have as much inside information as you possibly could have on what's the best way to use this new technology rolling out. Yeah. Had they
Again, been in a different market, that's a really interesting question of like could they also have been a carrier?
They couldn't in China because China Mobile is a is a state owned enterprise. They couldn't internationally because
they're selling to the carriers in international and what are they gonna g go do set up carriers in in all of these different countries. Um I mean I guess they could have tried to acquire Vodafone or some uh similar player along the way
But that's
Probably would have invited a lot of political lot more political speculation that uh they managed to avoid in the year.
So by twenty ten
Total revenue of the company has eclipsed twenty billion dollars, or almost twenty-two billion dollars, and net profit is almost three billion dollars.
by twenty twelve, they overtake Ericsson, who you were mentioning, Ben, as the largest telecom equipment manufacturer in the entire world.
And then last year, finally in twenty eighteen, as you said at the top of the show, they surpass Apple in handset uh shipments. So they're still smaller than Samsung, but Huawei is the second largest handset manufacturer in the entire world. People love their phones, love the cameras on them, love the technology.
They shipped over two hundred million handsets globally last year, which is an astounding number. I would say on the handset side of the business,
Huawei
His
certainly at parity with other
manufacturers out there, be it Samsung or or Apple or or the like.
On the infrastructure side.
Huawei is ahead of the field. You know, when it comes to five G
Even though five D networks aren't really rolled out.
to the public anywhere yet. You know, consensus in the industry is that the quality of the technology of the gear that Huawei is producing is two to three years ahead of any of the competition out there in the market in terms of 5G.
David, I'm not gonna let you fully say that the Huawei phones are are sort of at parity with everyone in the market. I was gonna save this for t for playbook later, but like come on, there's there's blatant ripoff after blatant ripoff of uh
of sort of Apple UI and their uh their modified Android operating system. And not only but like not only blatant ripoffs, like every
Th this is a uh subjective comment, but it is a copy that is slightly worse on in many, many facets every time they do it.
Ha.
I love it. If Steve Jows were alive today, he would be
Railing against Huawei and not Samsung.
But certainly people like the phones. And so much so that last year in twenty eighteen they surpassed a hundred billion dollars in total revenue across their all their divisions.
Half of that, uh, fifty two billion of which was in handsets. Um, and net profit for the company was almost 10 billion dollars.
So
Things are going
Well but then as you alluded to at the top of the show
In December of twenty eighteen
A fateful event happens.
Which is that the CFO of Huawei, Meng Wan Zhou
Who
is also the daughter of Ren Song Fei, it turns out. Which blew my mind when I I somehow missed that when all this news came out and doing the research for this episode, I was like, Wait, Huawei's CFO is his daughter?
Yes. And uh she has a different last name because um he she's his daughter by his first marriage. Uh the her parents got divorced and she ended up taking her mother's family name, Mang.
after the divorce. But yeah, she's his daughter. She was on a
uh international business trip en route to Mexico City
from Shenzhen and had a stopover in Vancouver, Canada.
and after getting off the plane and attempting to go through customs was detained
by Canadian Border Patrol.
ultimately arrested and it turns out that the US had issued a a extradition request for her and asked Canada to apprehend her and extradite her to the US to stand trial
For
allegations that Huawei had been
Reselling
U S
technology equipment to Iran through a shell company that she had helped set up.
Which would of course violate sanctions.
Now this is interesting.
it wouldn't necessarily violate Chinese law, but because so many of the components of the products that Huawei sells are made by US manufacturers.
They
By selling
Huawei products, uh and systems of Huawei products to band countries like Iran
they would be violating US
Trade law.
By doing so, because so many US components were part of it.
not only is it a
you know, absolute bombshell of a piece of news and a and a thing to do, but it's not completely clear cut
that there's a case here. At some point this will go to trial and we will sort of see what the courts decide. I believe the current state is that she's uh on house arrest in Vancouver, uh awaiting extradition to the US for for trial. She has not been she has not been extradited to the US yet. She is still in Canada. Canada is not
uh released to the US.
But it really begs question, you know, uh as we were talking about the Iran sanctions, you know.
That is
Uh the charge.
But
I don't think anybody really believes that that is what this is.

It's about
Um
the US and many other countries uh feeling
Threatened here.
Yeah.
telecommunications infrastructure has become such an important part of any society.
And Huawei is clearly the leader in five G roll out.
And what would it mean if
a Chinese, you know, uh company with strong ties to the state is now responsible for the majority of the backbone of the internet in countries around the world.
Yeah, and and I'll say on top of just this notion of, wow, can this be owned by a foreign power, there have been several different research firms and different news stories that have come out sort of alleging that people have found uh security vulnerabilities in Huawei products, then of course Huawei the company
says is completely false and the the security is of the utmost importance and not only are they not doing anything intentionally, but these are this complete falsehoods and uh the company is
you know, is one of the most secure companies on the planet, and and this is ridiculous that they're being accused of such things. And so you have this stalemate.
Where, you know, the company says there's absolutely nothing wrong and yet different journalists and different security researchers keep keep saying, Hey, there are things to be concerned about here.
Yeah. And what's interesting is like it it it is, at least to me as as I was doing the research, it
It's not entirely clear that there is something wrong right now. It's more the potential that something could go wrong uh that people are worried about here.
And of course
very shortly after the arrest of Meng Won Chou, uh
Of course, in the beginning of twenty nineteen
President Trump begins his trade war with China.
In earnest. Uh, and that has fall out for many companies, but Huawei kind of chief among them.
So on May sixteenth of this year in twenty nineteen, the US goes so far as they put
Huawei on what's called the entity list.
Which freezes all US companies from doing any type of business with Huawei without special permits. So what does that mean? We already alluded to the fact that you know if you think about a Huawei handset.
And the same applies to Huawei networking gear on the back end.
The number of chips that are part of that and components that are made by US companies from Qualcomm to Broadcom to you know, what have you, um
Is quite large.
fifty percent or more of the total manufactured product. No
component, at least on the smartphone on the handset side of the business.
is more important, of course, than the operating system, which is Android, which is sold by Google, which is a well not sold, but is made by Google, which is of course a US company. And on top of
That, David, even one more thing is ARM, and we discussed this being a British company that, you know, s started out of Cambridge. Um you can go back and listen to the ARM episode if you want details on that, uh, that of course is owned by a Japanese company, SoftBank Now.
believes that they have significant US based IP as a part of ARM. And so they have also, even though they're they're over in the UK, they have also stopped licensing
Chips with
the ARM instruction set architecture, which is basically all mobile chips, to Huawei.
So not just mobile chips, but but
Chips of all types in all use cases, including back end infrastructure.
Oh, so that's that's all the impact on
uh what can't be sold to Huawei from
the US as an ingr ingredients in the product.
One more um
Super interesting.

Is
There's commercial Android through Google.
Obviously you can understand how that would be prohibited from being distributed to Huawei because of the
being played why being placed on the entity list. You might say, well of course there's also the Android open source project. You know, Android is an open source operating system and many of the flavors, well really all of the flavors of Android that are on handsets in China are not Google Android.
It's open source Android because of course Google doesn't operate its services in China, as we've talked about on other episodes. What's really interesting here is that because it really begs the question of is that open source software. Now
legally it's a little bit of gray area, but experts believe that because Google is the primary maintainer of the Android open source project, and Google is a US
corporation and entity, that actually makes even the Android open source project subject to this entity list ban by the United States and even the core
open source version of Android.
Could potentially be
Off limits to Huawei from now on.
It's wild.
That's wild.
Well wait.
didn't have their head in the sand uh for the last ten years or so, thinking that like this was would never happen. They have been preparing
contingencies if this were to happen and and they've been working on their own operating system internally since twenty twelve. But this is super interesting. Like even if it were really great.
If you could build your own operating system today.
How far would that get you? Because you wouldn't have access to all the third party
applications that are available on Android and iOS. So they could release their own their own OS.
But
they wouldn't have the whole ecosystem of third party developers from, you know
Ten cent and WeChat on down, uh, that would participate in it.
So Google has actually appealed this to the government and said, look, we should be able to to do this. It's actually better for US national security if they are using Android, because otherwise if they switch to a fork and start, you know, working on a completely different system that we no longer
you know, maintain in any way, shape, or form, you know, we actually have a lot less control. And we actually th it it it could be that
they fork something that has a security exploit, and this is Google's argument here, that uh then gets sold in the US, and then suddenly there's a bunch of Android phones in the US that have a security vulnerability that Google has no ability to fix. And so, you know, Google's argument to the US government, and of course this is all in flight right now is
Uh, can we please keep licensing Android to Huawei? It's really important for all of us here.
And it's fascinating to watch this game. And what we're we're really seeing here
is th if you think about this geopolitically, what the US government is basically doing in this chess game is daring China.
They're saying
Okay.
Um, you wanna make a smartphone?
Well
You can't
Use our operating system.
And of course
If you make your own, you don't have access to our apps, but sure, maybe you'll figure that out.
Um
You actually can't use the instruction set architecture for the chips that all the phones use. So
Go make your own
Chips.
and instruction set architecture for those chips.
And oh yeah, you can't use any of the sort of
like telecommunications chips either. So you're gonna need to really do all of that on your own. And you end up basically in this world if this fully gets played out where there's two completely different technology stacks, one for the China world and one for everywhere else. And it's it seems to be like the US government daring China to do that.
and Daring Huawei to be the ones that that sort of figure out how to rebuild the the
Phone computing stack.
Yeah. Obviously this has not been a traditional acquired episode, but we thought it was so important to do this because you know, knowing now all this history and what
the current state of play is here.
Between
Huawei and Google and the US and China.
And you start to think about that future, that's a really like
Weird and
Not good.
future, you know, where they're you know, right now
Basically all of the standards, of course there are you know, there are differences, like Google services don't work in China. They do here, you know, WeChat services work much better in China than they do, you know, WeChat is crippled outside of China. But basically, like we're all on like pretty much the same internet.
This is a future where like
Both sides, the infrastructure backhand side.
And the
You don't
operating front end side for consumers really diverges and
Uh I don't know what that means.
w one thing that we haven't talked about is the the other side of the bi directional exchange here. So y you'll notice if you go
Like we're talking about
Huawei here who makes these smartphones that are theoretically the second most sold in the world. Plenty of your friends, or maybe you have a Samsung Galaxy, I bet very few people you know have a Huawei phone if you're you're here in the US. If you're in the US.
Totally.
So one thing to observe from that is you know
W let's walk through a little bit more of a timeline. So in December, of course, we had this happen with the CFO of Huawei being being detained and arrested. Then in January, uh ATT was
very close, days away from from executing their deal with Huawei to distribute
Huawei phones that on their network in the US and it would be available when you go to an ATT store and at the very last minute they dropped that. They they blew up the deal. And I'm not sure this was reported that it was because of pressure from US officials who distrust Chinese companies. I I'm not sure if that is a a a fact or sort of just something that that uh um is sort of uh alleged, but
Holy crap, this is uh some very serious effort to limit the number of Huawei devices in the US, and they've really done it. If you look around, we don't there's not a lot of Huawei phones. There's not a lot of Huawei tablets or or laptops that are distributed in the US. And so to the extent that the US government was concerned about security uh on these devices,
and they wanted to to limit the distribution, they've really done that.
Mm-hmm. But now the the question is, you know, and this is back to
really the troubling implications of
Separate Internets.
Yes, they've limited that in the US. But Huawei is incredibly popular in the rest of the world, you know, outside of the US and China. And that's everything from Europe to Africa to the Middle East to the rest of Asia, uh to Australia. It's the number two global handset manufacturer.
Yep.
I will say too the other thing that they limited in the U
all of these telecoms that are that are you know, Verizon ATT that are rolling out uh five G networks.
uh are not doing it with Huawei equipment.
Mm-hmm. So it's not just the handset side, but it is the the infrastructure side.
Yeah. So the last um
couple pieces in the chain of events here of history and facts is
Uh as many people know, at the end of the G twenty summit uh this year in on June twenty ninth, Trump and Xi Jinping announced that they intend to resume trade negotiations, and Trump implied that as part of that, he might ease the restrictions on Huawei.
And you know, kinda we back down from the edge here. But just yesterday on July sixteenth
A bipartisan bill was introduced in the Senate. Imagine that a bipartisan bill in the Senate, uh at all these days, um that would prevent
uh the executive branch from l unilaterally lifting r those restrictions on Huawei. That's how critical Congress believes these restrictions are. So they want to keep the restrictions in place even if Trump wants to remove them.
Wow. I did not see that. That is pretty uh is pretty intense. That's pretty pretty crazy. So
Here we are.
So one of the interesting things I think to discuss, uh, and this kind of falls into the category of what would have happened otherwise, is
You know, we've talked on the show about other Chinese companies. We've talked about Tensin, we've talked about Xiaomi, a handset manufacturer, we've talked about Alibaba.
Why is Huawei being treated so differently from these other companies? And I think a big piece of it is just the ownership and the structure of the companies. Like what's interesting is, you know, the Tencent Alibaba, Xiaomi, Baidu, these are publicly traded companies that have a diverse international investor and ownership base.
That is clearly not the case with Huawei.
Yeah, Huawei, a company that did one hundred and eight billion dollars in revenue last year and is still quote unquote privately owned by employees.
Yeah. Like the think think about that in the US, the s the scale of that revenue, like you're a public company. And of course there's exceptions. Like there are certainly private companies in the US and and elsewhere that are very large that are privately held. But but the difference is um
They're privately held by
individual
Shareholders.
They're not held by a union that reports to essentially a government.
So lots of concern among uh among the United States government about this company.
All right listeners.
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Let's recap a little bit just so that we understand where they are as a business today. So they've got these three business lines. The uh telecom carrier networks business, which we were talking about that makes all the the telephone pole equipment, the devices business that with with smartphones, that's the second largest by units in the world. And then they've got this enterprise business that
uh provides equipment, software, and services to enterprise customers and government institutions. So this is a solutions or sort of a services business. If you look at
what each of these businesses are doing. It's pretty interesting. So the the business as a whole
grew twenty one percent last year. So they they went from ninety three billion in sales to a hundred and eight and a half billion.
If you look at and and sort of zoom in on that, what's going on there, the consumer business, which I think is their handset business, grew by 45%.
So at the scale they're operating that that business unit grew at
You know.
Forty five percent.
The carrier business actually shrunk by one percent last year.
Which is pretty interesting. I'm wondering if that's sort of
people were refusing to buy the Huawei 5G equipment before this whole sort of consumer goods thing started to to really shake out. But you know, the if you look at twenty percent six percent growth and one of your enormous businesses shrunk at one percent.
Well, that you know, they clearly made that up in uh in the consumer business. The the enterprise business also shrunk, but it's sort of less important to them than the than those other two.
Yeah. My understanding is the enterprise business is as you were saying basically uh
implementations and solutions business for the carrier of uh networking equipment.
Yeah.
Exactly.
Fifty two percent of revenue is from uh China itself. So that's shifted back and is uh is China is more dominant for the company now from a purchasing perspective. If you read their annual report, they make a lot of noise about five G.
that this is this is something the company is really beating the drum on. But if you look at the revenue line, smartphone shipments are really the the primary growth driver of the company. So sort of interesting to see a sort of narrative and numbers mismatch there.
Mm-hmm.
Well, do you want to move into playbook, David? And and you know, not that we're not already here, but feels like we've laid all the facts on the table. Yeah, yeah. So
From a playbook perspective.
Aside from all the
political questions surrounding Huawei, it's a really incredible example of seeing a long term trend.
that is gonna happen, uh, and capitalizing on it and capitalizing on it with really
stellar strategy the trend and and trends that they capture were, you know, one
Bringing China
Online.
Period.
building up telecommunications networks within China, you know, first is fixed line telephone, but of course that then bled into wireless and then the internet. But also capturing that
internationally and and better than any of their competitors realizing this this symbiotic relationship between the back end and the front end. As you said, Ericsson and Nortel and other um other backend equipment providers, you know, made half hearted attempts at handsets over the years, but nobody has really been able to take
the roadmap of what was gonna be coming on the infrastructure side and translate that into compelling consumer devices and compelling consumer devices available, you know, relatively early.
uh versus uh competitors in the market, uh as Huawei did.
It's it's really well executed.
There's a couple that I had on my list. The first uh is just obs an observation, the second is a geopolitical comment, which
we should probably say we're pretty unqualified to to do geopolitical analysis here and and much like drifting into the airline industry for a little bit with the the Alaska uh airlines episode. Here we are drifting into geopolitics away from our sort of tech and business analysis just a bit because I think it's it's obviously incredibly important to this company in this story.
This
playbook that they ran of how they grew in their first ten years is really something that could only be done in China.
If you thought you know, hey, I'm going to
start a company in the US. I mean I'm I'm pretty US centric in my
in this show because like it's what we know. But if you were say living in Ohio and you said, Hey, I'm gonna start a a business and and over the next ten years, I'm gonna start by importing things
And then I'm going to uh slowly start making my own and then I'm gonna emerge as the dominant.
creator of that thing when I make my own. There are certain things that you wouldn't get to do, such as
be really the only importer of something uh for an extended period of time and then undercut the price by, you know, two thirds in order to to to really get yours at the deepest distribution and have it. Well it is important to note there there actually is one thing we
We
glossed over a little bit in history and facts, which Huawei was not the
only company that was benefiting from state support in doing this throughout these decades. Um there is another company called ZTE, which is a uh Chinese telecoms company. Uh it's a direct competitor to Huawei on both sides of the market, the back end and and the uh hands out side. It's smaller and not as successful as Huawei, but the the government was also supporting that.
Yeah.
Company as well.
Okay.
So there was some competition, but it was limited.
Let me generalize my comment then and say that a lot of the lessons that could be learned and extrapolated from this company are not ones that would sort of universally apply the way that we think about a lot of our business model frameworks.
Yeah.
The second sort of like geopolitation that I want to make is
It's kind of unbelievable that
to use the title of a book, The Earth Becoming Flatter and the World Becoming More Globalized, that
we are moving into an era where there could be two technology stacks. There's already kind of two internets. Like if you think about the
There's sort of an hourglass shape here where
Th for thousands and thousands of years the East and the West developed
differently. And it's kind of incredible that two completely different language systems emerged. I mean, the the sort of Latin character set and Germanic languages and Romance languages are all sort of super similar and use a similar character set or read a certain way or written a certain way.
And
It eastern languages are
they influence each other, but they definitely don't
borrow from the sort of Western character set and and western way of writing things down and communicating. It was a long time until, you know, the eighteenth, nineteenth, twentieth centuries where those two worlds really met and then did business and
you know, started to really mesh and the world became flatter and more globalized.
And
Here we are. Like
Two two thousand nineteen and there's little cracks where it's starting to drift apart again. And it's just not a thing that I would have predicted.
Yeah, me neither. And it's so weird. And again, part of why we're doing this episode, uh weird and a and a little scary. I mean, to me it's
It's wonderful. It's awesome that like here for us at acquire, like our some of our most popular episodes are Tencent or Alibaba are these amazing stories of globalization, of wealth creation, of
Education
And really, uh not just in China, but across borders, you know, uh the ability for US investors and investors all over the world to be able to invest into those companies.
at a corporate level of like like Yahoo, uh and like Naspers, uh Yahoo in in Alibaba and Nasper's in Tencent. Uh and then of course individual shareholders on the public markets. But then here you have this like weird
other story that is now taking center stage. You know, I really hope this becomes a blip and we go back to the incredible trajectory that this other narrative had been on, and with recent IPOs, of course, from China of Pindu O Duo and Maitwand King and uh so many other great companies. It's really a noddity.
Well, listeners, you know this next section
is usually grading, but since there's never been a transaction with this company we have nothing to grade.
I g I suppose maybe in the initial structure of setting up that ninety nine percent and one percent ownership, there's something there, but th you know, the no no party has ever taken control and watched value either appreciate or depreciate after that. And so
What do we do here? Well, Dave and I were chatting before the episode and we thought what might make sense is just kind of to to speculate on the future of the company and and and sort of think about which way things could go here. And if you're purely sort of an economic investor and and thinking about the company, like how would you sort of go about evaluating it at this point?
Not that you could be.
But just for fun.
Yeah.
The downside is
Certainly down. But uh and this is these are some of the things that that Ren was has been talking about in the interviews he's been given. It's not terrible. Like Huawei is if things
Go.
You know, south internationally for them. They're still very well positioned domestically in terms of five G roll. I mean, they do have the best
integrated five G technology in the market. And they of course have a tight relationship with the Chinese government. It's
very plausible to believe that Huawei is going to be a
big, if not the sole, um beneficiary of 5G roll out uh in China and in China's allies. I literally can't imagine a world where that doesn't happen.
Now what's interesting internationally, and I think this gets back to
Why is Huawei being treated so differently than these other great Chinese companies is
If this were happening with, say, Alibaba or Tencent, they would have a very, very powerful deterrent from any sort of less than uh malicious behavior or anything smelling like it internationally because they have the profit incentive, they would lose huge amounts of
their business, uh, internationally, if
other countries stopped using their products. But for Huawei, because of the ownership structure and the incentives that they have, that's not as big a problem for them.
That's pretty interesting to think about. Yeah, that capital structure
It's kind of like in early stage startups and
We've talked about this a little bit on the L P show, David, but that governance is a blessing in some ways where it it can actually be to your advantage because then
if uh their capital structure was such that they did have a bunch of shareholders who could um of course not only have the economic upside of the company being able to address a larger market and therefore the company naturally steering that way, but also a board who would sort of vote and say
It's important to us because we need to uh maximize the per share value of our ownership and every common shareholder's ownership, the they could actually steer the company to do that. That is not the case here.
Mm-hmm.
The way that I sort of thought about grading is
there's I have no concerns about the China market continuing the sort of massive, massive appetite to buy the the Huawei's great consumer devices. Um
But they seem to be having a rough time selling their telecom or consumer equipment into Europe or North America. And so, you know, were were this a company you could economically participate in, I I would sort of want to evaluate the the prospects of of being able to do either one of those things, sell the telecom or consumer equipment abroad.
And I guess I shouldn't say abroad, but in in uh in the US specifically and the US as allies.
And I also would
Wanna really dig into
How so how expensive is it gonna be for us to write a new inst instruction set architecture, build new chips, write a new operating system, and and build that new developer ecosystem? That's a new stack.
Mm-hmm.
Mm-hmm.
So
Yep, totally agree.
All right.
Carve outs.
Well on that it shouldn't rush us here.
Should we take a deep breath? Should we say Oh my g like this is this is quite the uh quite the different acquired episode.
Yeah, quite the different acquired episode. Well
Yeah. Thanks for bearing with us, listeners.
As the show has grown, it's been great to get feedback on every episode. So I think if you if you do know more than we do here, um would love to hear it and happy to do any uh any follow up or or maybe do a a follow up as a as an L P episode or something like that. But would love your uh your takes on this and if you know anything we don't, we'd love to hear that too.
Yeah.
Car outs.
Carve outs.
I just got back from uh summer vacation.
in Europe. Uh had a great time. We were in Morocco and Portugal. Portugal is a great, great country. Highly recommend it. Uh if you want a beautiful
relaxing uh travel with uh
Diversity of
all types uh there. It was really wonderful. But while I was on vacation, I read the uh reread the Dune series by Frank Herbert. Uh just
Excellent.
classic, uh, classic, classic science fiction uh series uh apt for this episode because um you know really an analogy uh of
politics and political systems and uh long term implications of uh different versions of that. But so good. And super cool also, like I I didn't realize the first time when I read Dune uh many years ago, but reading it now, like the influence on Star Wars
Is like
So clear. So clear. Especially the first one, Dune. Very, very clearly you can see where George Lucas was influenced by it.
That's cool.
I uh have to confess I did not make it through Dune. I may uh take it.
My carve out is the Showtime original series billions.
David, have you watched this?
I have not, but so many people have recommended it.
I am after this episode going to watch the f final episode of season four after just binging all four seasons over the last month or so.
It is absolutely spectacular.
And if you like this show and you like
Good drama.
It is like a d absolute treat to watch every episode. So the show is created by Brian Koppelman.
David Levian and Andrew Ross Sorkin.
who some of you may recognize as a a New York Times writer. Brian Koppelman, who who sort of is the lead on it, um, is also the um guy behind the the movie Rounders, which some of you may remember with uh Matt Damon and um and your own classic great story.
So billions, uh getting into the plot is is loosely based on Preet Barara, who was the US district attorney for the Southern District of New York and his massive legal battle um with uh Steve Cohen, who's a of course a a big uh hedge fund manager. And it's played uh S A C right.
Yep.
Yep. And the roles are so Paul Giamatti plays the attorney for the Southern District and uh
Damian Lewis plays uh Bobby Axelrod, who is uh running Axe Cap, which is the sort of top fictional hedge fund on the street, and the
drama that ensues and the cat and mouse game and the whole dance between these two characters and every other character involved is uh like a tot to watch. And frankly I want to hurry up and finish this episode so I can go and watch the last episode. All right. Well on that note.
All right, listeners.
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Dave and I are gonna record another one of those this week and uh you should see that popping into your your podcast player.
um if you are already an LP or if you're trialing a new subscription, you will you will see it as well.
So with that
We will see you next time.
See you next time.