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Spy scandal weighs on U.S. tech firms in China, Cisco takes hit

A sign marking a Cisco office is pictured in San Diego, California November 12, 2012. REUTERS/Mike Blake
A sign marking a Cisco office is pictured in San Diego, California November 12, 2012. REUTERS/Mike Blake

By Matthew Miller

SINGAPORE (Reuters) - U.S. technology companies including Cisco Systems Inc, International Business Machines Corp and Microsoft Corp may face new challenges selling their goods and services in China as fallout from the U.S. spying scandal starts to take a toll.

Cisco shares tumbled 11 percent on Thursday, a day after it warned that revenue could drop as much as 10 percent this quarter, and continue to contract through the middle of next year, in part due to a backlash in China after revelations about U.S. government surveillance programs.

"All the big U.S. IT companies are concerned," said Jim Lewis, a senior fellow with the Center for Strategic Studies in Washington, who is an expert on China and technology. "But so far Cisco is bearing the brunt of it."

Lewis said Beijing may be targeting Cisco in particular as retaliation for Washington's refusal to buy goods from China's Huawei Technologies Co, a telecommunications equipment maker that the United States claims is a threat to its national security because of links to the Chinese military.

Cisco's much smaller network equipment rival Juniper Networks said on Thursday that it was not seeing an impact from leaks by former U.S. National Security Agency contractor Edward Snowden about U.S. spying.

"The Snowden effect is not real," Juniper Chief Marketing Officer Brad Brooks said. "Our business continues to grow in Asia Pac as well as China. As we look at that business there we've not seen those types of conversations from our customers."

Snowden's revelations provoked a storm in the Chinese media and added urgency to Beijing's efforts to use its market power to create indigenous software and hardware, analysts and business executives say.

"The U.S. government isn't doing any favors for Cisco," said Evercore Partners analyst Mark McKechnie.

Cisco Chief Executive John Chambers said on a conference call that Cisco and its peers face "challenging political dynamics" in China.

IBM last month reported a 22 percent drop in China revenue, leading to a 4 percent decline in its third-quarter profit. Chief Financial Officer Mark Loughridge attributed the company's problems to the "process surrounding China's development of a broad-based economic reform plan," which caused delays in purchases.

Microsoft executives singled out China as the company's weakest performing area in the world during the September quarter in an October 24 earnings call.

"The macro conditions in China, which I think are consistent with what some of the other companies have reported as well, have been challenging," said Chris Suh, Microsoft's general manager for investor relations.

Company officials could not be reached for comment.

FOREIGN COMPANIES MISTRUSTED

Beijing has long mistrusted foreign technology companies, and those concerns have been exacerbated since Snowden first revealed the existence of the NSA's clandestine data mining program in June.

"This is all about China using its own technology, and China building leading technology companies," said James McGregor, chairman for Greater China at consultancy APCO Worldwide.

Although Beijing has not prohibited state firms from purchasing Western-made technology services and equipment, the government has sent a clear message to choose Chinese-made equipment first, China-based executives say.

"While a formal document hasn't been issued, in the future we will try to buy IT equipment from domestic brands, such as Lenovo," said a person familiar with technology purchases at one of China's four big state-owned banks.

"The government's signal is pretty clear - they want to rely less on U.S. products, such as IOE (IBM, Oracle and EMC Corp)," said a former China-based telecommunications executive.

Oracle officials could not be reached. Representatives with EMC and IBM declined to comment.

BEIJING'S PRIORITIES

In August, the National Development and Reform Commission, China's top economic planning body, published a statement setting cyber-security standards for financial institutions, cloud computing and big data, information system secrecy management and industrial controls.

Four domestic software and hardware makers, including China National Software & Service Co, announced this month they have received a "top-tier" rating from the Ministry of Industry and Information Technology.

China National Software's share price has gained nearly 250 percent since the Snowden revelations.

"We hope and demand that relevant foreign companies respect China's laws," Chinese Foreign Ministry spokesman Qin Gang said on Thursday, when asked about Cisco's woes. "At the same time, as the Chinese government we of course have an obligation, a responsibility, to protect the country's security."

Snowden's revelations have reverberated in other big emerging markets such as Brazil, Mexico and India.

Cisco CFO Frank Calderoni said China was where the company was most affected by a political backlash, but noted that it was difficult to quantify how much of its revenue shortfall was due to politics versus macroeconomic trends.

To be sure, the impact of any Snowden scandal backlash is unlikely to hit all U.S. tech firms equally.

Cisco is perhaps most vulnerable, experts said, because it competes with two well-established Chinese telecommunications equipment providers: Huawei and ZTE.

Chinese companies are less competitive in producing semiconductors and database software, which means that any fallout from the scandal will have less impact on U.S. firms in those areas.

"Everyone is feeling the heat from the NSA revelations," said a former employee at a major multinational technology firm. The important point, however, was that companies like IBM don't have competitors for their high-end equipment, the expert added. "If they don't buy from IBM they can't buy from anyone else."

(Additional reporting by Jim Finkle in Boston, Joseph Menn in San Francisco, Sinead Carew in New York, Michael Martina in Beijing, Jeremy Wagstaff and Lee Chyen Yee in Singapore and Beijing newsroom; Editing by Alex Richardson, Richard Chang and Ken Wills)

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