(By Mani) In a rare move, the US House Committee on Intelligence last week held an open hearing titled "Threat Posed By Chinese Telecommunications Companies."
Cyber attacks are growing in number, and the Committee believes that Chinese companies operating in the US "provide a wealth of opportunity" to obtain trade secrets for the Chinese government.
The latest hearing follows after Huawei invited the US House Committee on Intelligence last year to investigate its operations to try to refute allegations that Chinese vendors present a cyber-security threat to the US.
Following preliminary steps, the Committee felt disappointed as Huawei/ZTE failed to answer questions with full transparency, and thus the Committee took the next step of open hearing and questioned executives from Huawei/ZTE on their practices.
"We listened in and believe the Committee is convinced that a threat exists. Overall, we view today's hearing as incrementally positive for Cisco, confirming our view that Huawei's progress in the US switch market will be limited near term," Oppenheimer analyst Ittai Kidron wrote in a note to clients.
A full report detailing the investigation will be released this October—a bad press for Huawei/ZTE.
The Committee backed up allegations using Chinese espionage cases, supposed "back-doors" found in Huawei/ZTE products where malicious software could exist, and by questioning the role of government-run committees within their companies.
Both Chinese executives argued their motives were in the interest of shareholders, most of whom are not tied to the Chinese government. The companies also pointed to their international footprints and argued that supporting cyber-crime would be "corporate suicide" for their global operations.
"We believe the Committee is still unconvinced that a threat is not imminent, noting that both Huawei and ZTE failed to produce documents that were asked for in preliminary stages due to "Chinese state secret law," Kidron added.
Huawei has been trying to make inroads in the US market since its battle for 3Com eventually bought by HP in 2008 but with no success.
However, Huawei is still considered as a threat overseas with Cisco Systems, Inc. (NASDAQ:CSCO) and Hewlett-Packard Co.'s (NYSE:HPQ) wiring closet business most at risk, especially outside U.S.
Meanwhile, the silver lining of Huawei's second-quarter results is that it is mainly adding sales in the wiring closet and not in the growing high-margin data center.
Most of Huawei's gains are in fixed 1GbE/10GbE, which reflects wiring closet and up-links revenue, while Huawei's progress in modular switching is mainly driven by carrier Ethernet applications.
Cisco generates about 40 percent of its switching revenue from the wiring closet and 18.8 percent from Asia-Pacific (APAC) where Huawei made most of its gains. HP generates 37.2 percent of its revenue in APAC leveraging its 3Com install base which could come under pressure.
In addition, Juniper Networks, Inc. (NYSE:JNPR) and Brocade Communications Systems, Inc. (NASDAQ:BRCD) have made their key gains in the wiring closet which could be pressured by Huawei.
"We believe Huawei/ZTE will continue making headway in the switch market. That said, today's hearing confirms that traction in the US will be tough to achieve until the US government approves. Overall, we view hearing as an incremental positive for Cisco, which dominates the US switch market (~70% share)," Kidron added.