Last November, Huawei announced that it had sold its budget smartphone brand called Honor to a consortium of state-backed investors. The deal, which Reuters said brought Huawei $15 billion, came just after the U.S. government tightened sanctions against the Chinese telecom giant. Faced with the threat of losing access to American chips, Huawei sold Honor (not its main smartphone brand) to the Chinese government. This week, as part of an occasional feature, The Wire breaks down the Huawei transaction and the broader implications of the deal, with Scott Livingston, a former analyst at the Office of the United States Trade Representative and the Center for Strategic and International Studies, the Washington think tank. Livingston spoke with me after the release of his CSIS report, “Huawei, Honor and China’s Evolving State Capitalist Toolkit.”

About two months ago, Huawei said it was going to divest of a popular smartphone brand called Honor. Why did it do that?

The decision to sell Honor was likely caused by the U.S. Department of Commerce’s decision to place Huawei on the U.S. Entity List [in May 2019], which limited the company’s ability to do business with U.S. suppliers. While the Commerce Department made some exceptions to this listing, allowing some goods to be exported, Huawei was, for the most part, staring at a future where its access to U.S. semiconductor technology would be substantially reduced. [In fact, the Commerce Department had tightened those restrictions in August 2020. See here.] According to some Chinese news sources, at that time a third of all the mobile phone chips imported by Huawei were going to the Honor Brand. Thus, by selling Honor, Huawei could preserve its existing chip stock and ensure a successful sub brand’s continued access to U.S. technology. 

So Huawei decided to sell one of its popular mobile phone brands to insulate it from U.S. sanctions?

That looks to be one reason. The [U.S.] entity listing created two technological choke points for Huawei: access to U.S. semiconductors and access to the Google Play App Store. After the U.S. Entity List designation, Google appears to have interpreted the listing to mean that it could no longer provide services like the Google Play Store to Huawei. This was an additional blow for Honor, which runs on the Android operating system and needs to have access to the Google Play Store to be competitive in international markets. For global customers, that makes Honor a much less attractive phone because if you download a new phone you want to have access to all the apps that your friends are using. So the situation facing Huawei, and China more broadly, was how to salvage a successful international brand in a way that it could continue to compete globally and maintain access to a critical supply line.

You believe that Huawei tried to sell the Honor brand to ensure the brand itself would continue to have access to U.S. hardware and software. Is that right?

That’s right. Chinese media reports on the transaction offered a number of reasons for the deal with three concerns most frequently cited. First, Huawei did this to protect the Honor business as a whole and its significant international revenue. Second, by selling Honor, Huawei could reduce its chip requirements as it seeks to transition towards indigenous technology. And third, there are all of these Honor employees and distributors whose jobs are at stake. If Huawei continues to take this hit by being on the U.S. Entity List, those employees might be out of work. By divesting Honor, Huawei was able to preserve this brand and at the same time receive a nice financial cushion — around $15 billion according to unofficial reports.

Can you just describe the transaction?

Sure. The acquiring company, Shenzhen Zhixin New Technology, is a new company set up last September with both of its initial investors closely connected to the Shenzhen municipal government. The biggest investor, with 98.6 percent of Zhixin, is a company wholly-owned by the Shenzhen government: Shenzhen Smart City Technology Development Group Co. The minority investor, with 1.4 percent, is tied to the Shenzhen Ministry of Finance, which is its ultimate beneficial owner.

Basically, a pair of state firms with ties to the local government in Shenzhen (the city where Huawei is headquartered) bought the assets from Huawei, right?

That’s right. But then there is an additional twist. Shortly after this acquisition, Shenzhen Smart City Technology Development Group Co., the majority owner, decided to sell its shares to three other companies: One a wholly-owned subsidiary; one made up of Honor’s distributors and a state-owned investor; and a local joint venture made up of both private and state-owned companies.

Was it state-owned firms that acquired the bulk of Honor from Huawei?

Right now, it’s unclear. Equity totals for the new company haven’t been updated in China’s corporate records system. So we simply don’t know what percentage of the company is owned by which firm.

But your conclusion is that the state played a crucial and perhaps hidden role here in aiding Huawei so that it would not be hurt by sanctions placed on the company by the U.S. Department of Commerce. Is that right?

That’s right. And that gets to this idea of this investor of first resort, where the government is basically acting to promote economic activity under its watch. In the U.S. in recent memory, we don’t do that. We’re more likely to step in as an investor of last resort, like with government bailouts. But what you see here is a municipal government deciding that it has a valuable local asset and choosing to encourage its continued growth through facilitating a sale of the entity to a mix of private and public players.

You have called this an example of “China’s evolving state capitalist tool.” What do you mean by that?

This gets to the idea of “CCP Inc.” Here in Washington, when we talk about the Chinese economy or when we talk about Chinese companies, it’s often very firm-specific — it’s Huawei or it’s ZTE. But that understanding suggests the Chinese model is similar to ours, and that their “independent” actors are truly independent. But we know that under China’s system of state capitalism there is often quite a bit of overlap between the Chinese Communist Party, local governments, state-owned banks and both private and state-owned enterprises. And this overlap has only strengthened under Xi. So in one sense, CCP Inc. is an attempt to zoom outward a bit and look at the overall ecosystem of actors in China and how they interact with one another, and how that drives enterprise decisions.

China’s economy has long been state-led; the idea of state capitalism has been around for a while. Did something change?

In the 2000s, we had this idea that state-owned enterprises were in charge of certain defined sectors — the commanding heights — and that outside these sectors, the private sector would eventually be allowed to take over. But under Xi Jinping, that’s shifted. The government is increasingly pursuing the idea of “managed capital” and mixed-ownership reform, which looks to utilize state assets to invest in both state-owned and private companies with the government seeking to control these companies, as one regulation puts it, “through the investment relationship.” This is increasingly blurring our traditional notions of the public/private distinction. At the same time, the Chinese Communist Party is re-emphasizing its overall leadership of the Chinese state and economy. And that is a break from the past, from the pre 2013 state of affairs. Of course, the Communist Party has always been there. There’s always been influence over private companies. But the overall degree and the level that we’re now seeing is manifestly different than we saw in the 1990s and early 2000s.

Does this mean there’s a fundamental misunderstanding of how China’s system works?

Well, I think insofar as we look at China’s economy as a reflection of our own — e.g., that their companies are private, that they have a judiciary, they have banks — then yes, there is a fair amount of misunderstanding. When China suggests that its state-owned companies are independent or that transactions such as the Honor divestment are “market-based,” these words have very different meanings in the Chinese context than they do in ours. So yes, I think there is a pressing need to better understand the Chinese political economy, their socialist market economy specifically, and how China uses the English language to obfuscate what’s really going on in their system.

So getting a handle on how money is funneled in the Chinese economy, through state banks and these state-owned investment companies towards private enterprises is important because, at the end of the day, it’s market based companies that have to go out into the global marketplace and compete with Chinese enterprises. And if [Chinese firms] are all bankrolled by the seemingly inexhaustible well of capital from the Chinese state, that’s going to cause incredible distortions in the market economy and ultimately place our companies at a disadvantage. 

Let’s go back to the Honor transaction. Reuters is reporting that Honor just signed new deals with Intel and Qualcomm, American firms that would not have been able to sell to it as part of Huawei. Does this deal change anything about how the U.S. should be implementing sanctions?

Well, one obvious issue is ensuring that sanctions are properly targeted and tracked in an environment where the state maintains significant levers to move assets around. Beyond sanctions is also the issue of subsidies, which involves the same issues we’ve talked about above — where the Chinese state maintains significant political and financial levers to channel state funds towards key strategic sectors. Ultimately, this is a socialist market economy that is causing tremendous distortions in the global economy, and these distortions are being primarily felt by foreign businesses, including our own. I’d hope that with this new administration we can not only improve our understanding of the Chinese system and seek, where possible, to learn from it, but also increase our attention and action on illegal subsidies and how a free market system like the U.S. can coexist with an increasingly state-run economy like China. 

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