China offers U.S. tech hardware companies a deal they can't refuse: long-term, double-digit growth without the ensuing cyclical downturns that afflict American and European markets.
In exchange, executives from those companies sacrifice visibility in their short-term outlooks. As the latest earnings season shows, tech outfits that sell into China are finding it increasingly tough to forecast their business from quarter to quarter. And that's likely to get worse.
Problems loom both on the demand side, given Beijing's attempts to dial down economic growth, and on the supply side, as new entrants in China's crowded handset and PC markets create oversupply. Add in China's ever-impenetrable inventory situation, and forecasting gets even trickier.
, a Taiwanese notebook manufacturer, cited China among the reasons for their lackluster profits. Chipmaker
, which offered weaker-than-expected quarterly sales guidance on an August conference call, likewise noted a pullback in China orders.
These reports underscore the difficulty of teasing out demand trends in one of the fastest-growing, least-understood markets in the world. Because China ranks as the world's No. 1 cell-phone market and second-biggest purchaser of PCs, problems there often ripple throughout the tech world.
The quarterly shortfalls also belie the commonly held view among tech investors that China's market offers only an upside. Over the past couple of years, U.S.-based tech companies frequently talked up its long-term growth potential but almost never singled out China as a culprit for an earnings shortfall. (The exception occurred when China suffered through a disastrous outbreak of Severe Acute Respiratory Syndrome in the spring of 2003; the resulting inventory backup in technology goods, particularly cell phones, took a couple of quarters to work off.)
But don't be surprised to see short-term business hiccups in China start to figure more prominently in earnings results of large foreign technology companies. After all, the country is consuming an ever-greater percentage of the world's electronics goods at the same time its government is trying to slow GDP growth by at least a couple of percentage points.
Beijing has refrained from raising interest rates, a move that would likely sap consumer buying power. Instead, the government has sought to cool down overheated industrial sectors such as steel, cement and aluminum by reining in loan growth and slowing the pace of construction.
China watchers are split over the potential for such measures to hurt consumer demand.
"It's the consumer side that's really bringing greater balance to the Chinese economy. Certain pronouncements show
that the government is hugely sensitive to this and are freeing up working capital for companies doing good business," said Edmund Harriss, manager of the
Guinness Atkinson China & Hong Kong fund. So far, he added, "Most of the slowdown is really affecting heavy industry rather than technology or technology investment."
Yet a few analysts point to signs that consumer tech demand has been hurt by Beijing's macroeconomic decisions. In its July survey of Asian analog chip distributors, FTN Midwest Research reported that for the first time in a year, distributors had seen sales fall below plan. The bank attributed weaker August bookings to "declining end-market growth, overly aggressive expectations, and some impact from China's move to slow growth."
Although it's still early, "We think those efforts
to dampen economic growth have begun to impact both production and consumption in China," says FTN analyst Benjamin Bollin.
Similarly, in a research note downgrading wireless chip supplier
RF Micro Devices
to a sell rating, Deutsche Bank analyst Brian Modoff cited macroeconomic concerns in China, as well as potential delays in the rollout of new products as reasons.
An existing handset inventory buildup in China is "likely being further aggravated by the Chinese government's attempts to slow down the economy there," wrote Modoff. "While consumer demand in China remains healthy, the credit squeeze has disrupted the supply chain. Distributors and local retailers have found it difficult to find financing, and inventories have piled up."
Modoff concluded that the resulting crunch is likely to weigh on RF Micro, which garners over 60% of sales from Asia.
At the same time that a slowdown in GDP growth looms as a worry for tech firms, emerging supply-side pressures in China are also making business more difficult.
China's cell-phone market has become increasingly crowded with new players -- many of whom got their start making DVD players or household appliances -- vying to profit from the growth of the country's emerging middle class. Competing with established handset vendors such as Ningbo Bird, TCL,
, these entrants to the market have contributed to an oversupply of handsets and thus depressed demand for cell-phone chips from some suppliers.
The same increasingly aggressive supply-side picture is evident in China's consumer PC market.
said on Aug. 16 that it would reduce its emphasis on the low-end market for PCs, citing a round of price wars from competitors, including China's homegrown market-share leader
As a result, even near-infallible overachiever Dell was forced to rein in its business targets in China, saying it now expects PC shipments there to grow closer to two times the overall market rate, rather than Dell's initial goal of three times the average.
A Beijing representative for Intel, which sells to Dell, among other leading China PC vendors, declined to comment on how recent demand and supply trends might affect Intel's quarterly outlook.
For technology players trying to get a bead on short-term business trends, forecasts are further complicated by the difficulty in understanding inventory levels in China.
Case in point: the cell-phone market. Because distribution and delivery systems aren't as efficient as in developed markets, Chinese cell-phone retailers act almost like distributors, typically carrying more than 100 handset models with plenty more inventory in back. Cell phones that don't sell in big cities are likely to get shunted to retailers in far-flung provinces, where they will become even more difficult to track.
By comparison, U.S. cell-phone stores carry much tighter inventories and might offer only a few dozen models on display, because they can expect to receive new deliveries once a day or every couple of days.
Despite the difficulty in making forecasts, technology firms are more than willing to accept China's recurring uncertainties in exchange for its long-term growth prospects.
Some 150 million of its 1.3 billion citizens already belong to the country's emerging middle class, broadly defined to include households with incomes of around $10,000 a year, and their ranks are expected to expand dramatically in the next five to 10 years.
"Is China less transparent than the U.S., with logistics and marketing challenges? Sure, so that might make short-term earnings visibility a little less clear, quarter by quarter," said Andrew Foster, director of research for the Matthews Funds, an Asia-oriented fund group.
"But the glass is more than half-full from my perspective. The growth potential is so strong right now that if you've got a good product or service, economic growth is like the rising tide that lifts all boats," he said.
That's likely to be true in coming years. But in the months to come, the Chinese technology market could also offer some surprises to the downside. While the payoff is bound to be worth it, investors should be ready for some short-term turbulence.