Understanding Huawei's 2022 from their financial report

China just wanted to be part of the global supply chain. But U.S. forced China to do everything and build everything on her own. This is actually not good for the U.S.

[This post is contributed by Ginger River's friend red_wallstreet and edited by Ginger River. red_wallstreet works in the financial industry with no affiliation with Xinhua News Agency. For a previous post contributed by red_wallstreet, please see Is the valuation of Hong Kong stocks really that cheap?]

The article below is written by 宁南山 Ningnanshan, a popular blogger that writes extensively on China's industrial policy. The original title is 从财报看华为2022年现状 Understanding Huawei's 2022 from their financial report

The blogger's real identity is not known, but he is generally understood to be a middle-class worker based in Shenzhen, with a background in engineering. In 2018, he wrote a widely-circulated article titled 作为一个中产阶级，我对国家有哪些不满意 As part of the middle-class, what gripes do I have about my country, in which he identified education inequality, distorted real estate and land policies as well as low and unbalanced birth rates as the biggest challenges for the country. The drastic regulatory changes on real estate, education, and birth control since then closely reflected some of his policy proscription in that article. Some have even claimed that his blog was widely read in policy circles.

This translation has not been reviewed by Ningnanshan. The highlights are from both Ningnanshan and red_wallstreet.

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Understanding Huawei's 2022 from their financial report

Huawei announced its 2021 earnings on March 28, with revenue of 636.8 billion yuan (about 100 billion U.S. dollars), down 28.6% year on year, with the Chinese domestic business down a little more, to 30.9%. Net profit increased to 113.7 billion yuan, up 75.9% year-on-year. This makes 2020's revenue of 891.4 billion yuan Huawei's historical peak. Similarly, the 2021 net profit of 113.7 billion yuan for Huawei is also the peak of Huawei's historical net profit.

But this outrageously high net profit is mainly related to the disposal of 荣耀 Honor (mobile phone business) and 超聚变 XFusion (X86 server business). The "gain on disposal of subsidiaries and businesses" in the chart below amounts to 57.431 billion yuan in 2021. In addition, Huawei's selling and administrative expenses decreased by 9.3 billion yuan in 2021, which also contributed to the increase in net profit.

Huawei signed an agreement to sell Honor in November 2020. Then, Huawei's consumer business in 2021 achieved sales revenue of 243.4 billion yuan, down 49.60% year on year. A large part of this decline should be coming from the sale of Honor. If we take into account this factor, [actual] decline of Huawei's consumer business was not large.

CINNOResearch announced that Honor's sales in the Chinese market in 2020 were 43.8 million units, while Honor's sales overseas were also large. For example, in Russia, Honor's share in 2020 was 15%. It is not difficult to calculate that Honor is a large company with revenues of tens of billions or even hundreds of billions yuan. So missing this business line of course affects Huawei's overall revenue.

Also worth mentioning is that Huawei's wearable devices, including TWS (True Wireless Stereo) headphones, smart screens, etc. achieved revenue growth of more than 30% in 2021.

In fact, what is brought to my mind here is still the chip problem. Why can Huawei still achieve revenue growth in 2021 for these smaller products? Isn't it true that Huawei can't buy chips anymore? I think the main reason is that these products are not shipped in large quantities.

Take TWS headphones as an example, according to the report of 旭日大数据 Sunrise Big Data, the global TWS headphone shipments in 2021 stood at 490 million pairs. Excluding white label headphones, branded headphone sales were only 323 million pairs.

And among the branded TWS headphones, Huawei's sales are not high, the 2021 Q4 share is only 3.48%, ranked eighth in the world, while the No.1, Apple, is up to 42.76%. If you look at Huawei's shipments in this quarter , there were only 2.84 million pairs.

Therefore, compared to the 200 million Huawei cell phones that were sold before the sanctions, the chip inventory for these products may be more than adequate.

In addition, these products are not as important as cell phones. The chips used in this products have low process requirements, and there is also the possibility of the U.S. approving parts of the supply. After all, the U.S. has only banned Huawei's cell phones from getting 5G-supported chips and parts, but allowed Qualcomm to sell 4G chips to Huawei.

The U.S. goal is not to kill Huawei, but to maintain Huawei at a low-tech level, while still generating revenue for the U.S., just like any other companies in China that have focused on buying U.S. chips, operating systems, industrial software and other high-tech products and then specialized in assembling them for three decades.

I think this also reflects the U.S. goal for China in general. Complete annihilation of China is not possible, but goal is to maintain China at a low level of technological capability, so China can keep working for the U.S. and providing markets [for U.S. products]. This is just like how landlords in feudal society needed peasants. After all, someone had to do the dirty work, you can' t let the landlord plow the land himself, right? Besides, the high-tech products made in the United States need to be bought by someone in foreign markets.

In addition, 鸿蒙操作系统 the HarmonyOS was Huawei's key mention in [their product] launches.

On June 2, 2021, HarmonyOS 2.0 officially landed on cell phones, tablets, smart watches and other applications.

Huawei's annual report shows that by the end of 2021, the total number of HarmonyOS-equipped devices reached 335 million, including more than 220 million Huawei devices, and 115 million units of 鸿蒙智联 HarmonyOS Connect products [third party products supported by HarmonyOS].

The reason why Huawei wants to emphasize the installed base of HarmonyOS is because it is valuable. On Huawei Mall's official website, there is a special area for HarmonyOS Connect, from small appliances, smart door locks to motorcycles. [When] these third-party manufacturers of equipment support HarmonyOS, Huawei is able to collect money from it, as not all manufacturers have the ability and willingness to build their own software team.

Huawei relies on HarmonyOS to both make money, and also to avoid the problem of chip shortage.

And then we come to 超聚变 XFusion. A year after Honor announced its disposal, the shareholder of Huawei's Xfusion business, which is responsible for [development of] X86 servers, changed to Henan XFusion Technology Co. in November 2021, with a current equity share of more than 70%.

X86 servers currently comprise the mainstream of the global server market. Besides them there are ARM-supported servers. Taking Q4 2020 as an example, according to data from IDC, X86 server revenue grew 2.9% to about $23.1 billion [globally]. Non-X86 server revenue declined 9% year over year to $2.8 billion.

Huawei's enterprise business achieved sales revenue of 102.4 billion yuan in 2021, up just 2.09% year on year. This had to do with the disposal of the X86 server business, although Huawei did not disclose the exact effect of this.

So Huawei's 28.6% [revenue] decline in 2021 is needed to take into account the sale of Honor and XFusion.

After selling Honor and the X86 server business to gain cash flow, what about the businesses of Huawai that are still growing consistently?

Huawei's business highlights from 华为云 Huawei Cloud and 数字能源 Digital Power,

At the earnings conference, Huawei said Huawei Cloud in 2021 has achieved sales revenue of 20.1 billion yuan, an increase of 37% year on year, ranking second in China. According to industry leader Alibaba Cloud's financial report, the profitability of the cloud business is not very good. This should be similar for Huawei Cloud. However, for Huawei, the cloud is a growing market . When Huawei Cloud subsequently achieves scale, it is possible for Huawei to bring more profits.

Huawei also announced that Digital Power has achieved business growth of more than 30%. The scale of this business compared with Huawei Cloud is also quite large. According to the information currently available, such as the speech of Huawei executives, in 2019 the sales revenue of Huawei Digital Power (then named "Huawei Network Energy") has exceeded 30 billion yuan, with a year-on-year growth of 40%, and in 2020 also they announced that it had gained growth, so it is reasonable to estimate that its 2021 revenue is already at least RMB 40 billion or more, in other words RMB 40-50 billion, and should also be more profitable than Huawei Cloud.

On June 7, 2021, Huawei Digital Energy Technology Co., Ltd. was established with 胡厚崑 Hu Houkun as its legal representative and a registered capital of RMB 3 billion. The company's sole shareholder is Huawei Technologies Co., Ltd.

In the context of carbon neutrality, Huawei's Digital Power business, which includes data center energy, electric vehicle power, photovoltaics, etc., is expected to continue to grow. This is advantageous for Huawei, and can give it different options [for this business line].

The first option is to sell it [/sell down shares], but it does not seem like a good idea to sell a business that continues to grow.

The second is to go public independently. With such a quality business, going public can help to get cash flow, but at the same time can bring returns to the shareholders and the company. Although Huawei has historically insisted not to go public, this is a different time we live in.

At least in my opinion, going public is a better option than selling. Either way, a business that has tens of billions of RMB and is still growing is certainly good for Huawei, and it gives it more options in the future.

In addition to the growth of Huawei Cloud and Digital Power, Huawei is also fighting to invest in a new business with a broader market space: electric vehicles. Truth be told, in 2021 Huawei's business of selling parts to electric car manufacturers has not seen much of an uptick, as shown by the tepid sales of 塞力斯 Seres and 北汽极狐 BAIC Arcfox, which are both equipped with Huawei hardware and software.

But in this business Huawei has shown its resilience to invest continually. I think doing hardware and providing parts is actually what Huawei is better at, and it is expected that Huawei's EV business will see growth in the future.

Huawei said in its annual report, "We are continuing to increase investment in intelligent automotive components, as they represent long-term strategic opportunities for Huawei. In 2021, our investment in intelligent automotive solutions reached one billion U.S. dollars and our intelligent automotive solution R&D team reached 5,000 people."

At the same time, Huawei said this year, the new HI version of the BAIC Arcfox Alpha S, 长安阿维塔 Changan Avita 11 and AITO 问界 Asking World M5 (Smart Choice version) will be delivered in mass production, of which AITO is a brand launched by Huawei itself in cooperation with Xiaokang Co.

Huawei's core fundamental is [still] its carrier business, its deepest moat. With a variety of patented technology standards, they are the most powerful, the most well-organized, with the most complete level of 国产化 localisation.

A typical feature is that all of Huawei's executives have a deep background in communications business, and have a global experience of business success and failure. Conversely, no one at the top of Huawei comes from the background of software business, which means that Huawei's transition to the software business will not be smooth, and they will certainly pay some learning costs.

In fact, for any business [to develop well], it is important to have someone on top who understands you, something I think some of you may appreciate.

If Huawei loses the communications business, it will lose its soul, and to see the rise and fall of Huawei is to look at its carrier business, so to speak.

Huawei's revenue from the carrier business entered a plateau after reaching 290.5 billion in 2016, and stabilized between 290-300 billion yuan for four consecutive years from 2016-2019, breaking through 300 billion to reach 302.6 billion yuan in 2020.

And in 2021 it was 281.5 billion yuan, down 7.0% from the previous year.

But the decline was not large, while Huawei announced its own highlights when it said that in 2021 its carrier business overseas revenue [still] accounted for more than 50%.

[Then] I checked the capital expenditure of Chinese operators.

The largest was China Mobile's capital expenditure in 2020 is 180.6 billion yuan, including 102.5 billion yuan of 5G-related capital expenditure.

The capital expenditure guidance for 2021 was 183.6 billion yuan, including 5G-related capital expenditure of 110 billion yuan, and there is no significant decline, so at least the scale of the Chinese market is still stable.

As for why the operator business is in decline, as Huawei did not publish the data for each sub-market, there is no way to judge.

But theoretically, as the chip inventory becomes gradually depleted, it is likely to lead Huawei to stop expanding new business in some non-key customers, or even strategic contraction.

In addition, some customers may consider this as Huawei's weakness when signing a three-year or five-year contract for long-term supply stability, and that will affect their final choice.

In short, the 7% drop in operators [business] can be considered to be the beginning of pains, but not yet devastating.

But a challenge for Huawei is that 2022 will be the last year of China's 5G construction peak, "5G investment is down slightly this year compared to last year. From next year onwards 5G investment is also no longer growing and will be on a gradual downward trend." said Yang Jie, chairman of China Mobile. In other words, the three years from 2020 to this year was the peak period for 5G investment.

Of course, at least in 2022 the big customers will still make investments [in capital expenditures].

Anti-cyclical R&D investment

In fact, I think this is the biggest highlight of Huawei's financial report. 2021 R&D investment was 142.666 billion yuan, compared to 141.893 billion yuan in 2020. Despite the significant decline in revenue, R&D investment actually increased by 0.5%, and the percentage of R&D over revenue rose significantly from 15.9% to 22.4%.

And for the main areas of investment, Huawei in the financial report reads: "We continued to invest in business continuity as well as future-oriented research and innovation in technologies such as cloud, artificial intelligence, intelligent automotive components, and foundational software technologies."

2022-2023 will be the most difficult winter for Huawei, but simply put, Huawei has done a lot of preparation for survival:

1: From the perspective of Huawei's three core businesses: first of all, the carrier business as Huawei's core foundation began to be affected in 2021, but overall situation was still stable. Even assuming another 10% decline in this year, 2022 can still bring Huawei more than 250 billion yuan in revenue.

For Huawei's consumer business, although the smartphones are certainly not able to grow because of lack of chips, but as for the wearable products such as TWS headphones, smart screens and other products, they still have room to grow because the sales are not large [now].

Another is the growth of the installed base of HarmonyOS, on not only Huawei's own devices, but a variety of third-party manufacturers. This will achieve the interconnection of everything, and will also be able to bring revenue for Huawei.

Huawei is currently engaged in the whole house intelligent products. If you are curious about technology you can go to Huawei's store to actually see for yourselves. So Huawei's consumer business will continue to bring cash flow to Huawei despite the decline.

But overall, because the smartphone business is the big one, the core, so whether it's HarmonyOS or various wearable products, they can't make up for the decline in smartphone revenue.

[Consequently] Huawei's consumer business revenue of 243.431 billion yuan in 2021 is expected to shrink to less than 200 billion this year.

Huawei's enterprise business is the focus of its efforts to achieve growth.

Huawei has made changes in its business model in 2021, establishing the 煤矿军团 Coal Mining Legion, 智慧公路军团 Smart Highway Legion, 智能光伏军团 Smart PV Legion, 港口与海关军团 Ports and Customs Legion, and 数据中心能源军团 Data Center Energy Legion, as well as issuing documents at the end of 2021 to establish ten reserve legions, including 互动媒体（音乐） Interactive Media (Music), 运动健康 Sports and Health, 显示芯核 Display Chips, 园区网络 Campus Network, 数据中心网络 Data Center Network, 数据中心底座 Data Center Base, 站点及模块电源 Site and Modular Power, the 机场轨道 Airport & Rail, 电力数字化服务 Power Digital Services, and 政务一网通 Government One Network.

At Huawei's 2021 annual report launch, Huawei's rotating chairman Guo Ping said.

"Huawei's product line is relatively long, and the technology is also more and more complicated. Through the 军团 legions, which have short chain of operation and management authorization, we make it easier for our customers to do business with Huawei. We hope that this approach can create a new win-win business model for both customers and also for Huawei. "

In other words, a legion is primarily a customer-oriented sales organization.

I looked at the names of the fifteen legions. They are classified by industry such as coal mining, ports and customs, but also by product, such as intelligent PV, display chips.

One particularly interesting part is the display chip legion. This legion is responsible for the driver chip for OLED display panels. Its customers are BOE, Huaxing photoelectric and other display panel companies.

The market share of domestic manufacturers in the display chip sector is very low, while the market is occupied by manufacturers from South Korea and Taiwan. The process requirements of the display chip is not high, in the 28nm, 40nm or above. Huawei must have seen this as a market with large potential. In general, the 28nm and above sector will be the first for our country to achieve 去美化 de-Americanisation.

We are all very concerned about when the chip can achieve de-Americanised production. In fact, judging from the fact that Huawei has set up this display chip legion, it means that Huawei has already started to expand its display driver chip business, showing that Huawei is optimistic about the expectation of achieving de-Americanised production. Generally speaking, the sales staff of each company will start to expand their business six months to a year before the product is listed for mass production, and if they start to expand their business, that means that the time for mass production is not far away.

Huawei's first batch of display driver chips are estimated to be 40nm, and the first will begin production on the de-Americanised chip production line, and then the next step will be full localisation.

2: The disposal of Honor and XFusion brought a huge cash inflow, making the net profit of 2021 of more than 100 billion. And the 57,431 million disposal income in 2021 of subsidiaries, may not be the entire earnings from sale of Honor and XFusion. If this assumption is correct, then the disposal of these two businesses will also contribute to the net profit in Huawei's 2022 financial results.

3: Huawei still has Huawei Cloud and Digital Power, two fast-growing business, and their scales are not small.

2021 Huawei Cloud has achieved revenue of 20.1 billion yuan, and Digital Power has achieve revenue of about forty-five billion yuan. The overall market sizes of both the cloud and energy businesses are also developing rapidly, which is beneficial for Huawei. [If they can] maintain the growth rate of these two businesses to achieve more than 100 billion yuan of revenue in 2023, then it will be very beneficial to Huawei.

I can give an example here. 阳光电源 Sungrow, which is an photovoltaic inverter company listed on A shares, achieved 15.374 billion yuan for the first 3 quarters of 2021 and it is estimated that the whole year revenue is about 20 billion yuan. Its market capitalization is more than 150 billion yuan, which is despite the current downturn in the A shares market. At the same time, Huawei Digital Power's revenue and profitability are much stronger than that of Sungrow.

Likewise, Alibaba, the domestic cloud business leader, has made the development of Alibaba Cloud a highlight of its financial report, which obviously helps its share price.

For a fast-growing business, Huawei can choose whichever way that can help to maximize Huawei's interests, whether to continue to hold, sell shares, or publicly list the business for cash flow. This proves the proverb 发展才是硬道理 development is the hard truth.

Huawei also has a lot of small businesses with lower revenues, such as Huawei intelligent security business . Despite entering the market for a few years, the gap with Hikvision and Dahua is still very large and has not shown explosive growth yet.

For these non-core businesses, if they can not achieve rapid growth, they are also likely to be considered for sale.

4: Electric vehicle components and software business (e.g. autonomous driving, automotive software) is Huawei's largest future market, but it has not entered harvest period yet in 2021.

Electric cars are high-value products. A Huawei cell phone sells for around 5,000 yuan, while for an electric car Huawei can provide parts and software worth over 50,000 yuan.

When this business scales, Huawei can earn big money even just from selling autopilot software and HarmonyOS intelligent cockpits. Let's see whether Huawei's electric vehicle business can have a good performance in 2022.

5：Huawei also has other potential revenue streams. For intance, 华为商城 Huawei Mall is actually Huawei's e-commerce business. Huawei can earn commissions from selling third-party products sold over there.

Another example is licensing fees and royalty from patents. This is a business with extremely high margin.

On the afternoon of March 16, 2021, Huawei released its Innovation and Intellectual Property White Paper 2020 in Shenzhen. Huawei said to the public that in order to promote openness and transparency with the application of 5G technology and balance innovation protection with industry development, Huawei will start charging royalties on 5G patents from 2021, and will offer a reasonable percentage rate applicable to the selling price of 5G phones, with a license fee cap of USD 2.5 per unit.

But I think although this will bring more revenues for Huawei, it will not be its main source of revenue. For details please check my previous article: 聊聊华为能收到多少5G专利费 Let's talk about how much royalties Huawei can earn from 5G

Since it suffered sanctions in 2019, Huawei has generally fulfilled its social responsibility relatively well.

This can be seen from two figures.

One is that its number of employees in fiscal 2021 is 195,000, which is only slightly lower than in 2020, while still higher than Huawei's 194,000 employees in 2019.

The second is that from 2020 to 2021, Huawei will recruit roughly 26,000 fresh graduates. This is actually also very important. Huawei is a major recruiter of fresh graduates from 985 and 211 universities every year. If the number of fresh graduates recruited is significantly reduced, it will greatly squeeze the job market of fresh graduates. Huawei said in a press conference in 2022, Huawei plans to recruit more than 10,000 fresh graduates, which means that Huawei is trying not to affect the employment of fresh graduates.

Finally, let's talk about chip localisation. In fact, we are not very far from breaking free from sanctions and manufacturing [our own] chips.

First order of business is to achieve de-Americanisation in our production lines. We should use equipment and resources from Europe, Japan, South Korea, China Mainland as weill as China Taiwan to achieve de-Americanisation before achieving localisation. It is very difficult for China's local equipment and resources to completely supplant similar products from all of the developed markets. But it's relatively easier to first use products from non-U.S. developed markets to replace U.S. products. So [I] expect de-Americanisation to come before localisation.

At the same time, de-Americanisation does not have to start from 28nm [chips]. It can start at 40/45nm with lower technical difficulties, as seen from Huawei's efforts in display chips.

Of course, even if we build de-Americanised chips in 2022-2023, it does not mean that the problem is solved. [We still] need to achieve full localization in the future, while also maintaining technological edge over global peers. This will be a long-term process. That is, even if Huawei is expected to solve the problem of supply of low-end chips in 2022-2023, it will still face a long-term problem of using only low-end chips and international competition. Huawei will still face a long-term test.

This is especially true for high-performance chips such as smartphone chips. [The world has gone] as far as 5nm. To achieve de-Americanisation or localisation on this level, it is obviously not feasible in the short run. This is why Huawei is focused on expanding the large market of electric vehicles at the moment. With a bigger size [of the product], one can achieve higher performance through system designs.

This can also be seen from Huawei's overall strategy, as it's moving towards "large-sized products" such as Digital Power and EV parts, and "software" such as HarmonyOS, AI and Huawei Cloud. This is because it is only possible to achieve de-Americanised production of 45nm/40nm/28nm chips in the next 2 years. And it will take more time to achieve 5nm.

Fortunately, communication equipment, Huawei's traditional strength, is also a "large-sized product". Better performance can be achieved through excellent system design and algorithms.

As soon as China achieves its first step towards de-Americanisation, not only can the global market increase its confidence for Huawei and even the whole China, it will also be a shock for the U.S. Because that will mean 4 years after the 2018 trade conflict, it actually have no impact on China. And if the sanctions on chips are also ineffective, U.S. will have fewer and fewer options for controlling China's economic and technological development.

Out of economic interests, in the beginning, China just wanted to be part of the global supply chain. But U.S. forced China to do everything, build everything on her own. This is actually not good for the U.S.

I have always believed that the U.S. sanctions on ZTE in 2018 and on Huawei in 2019 are good for China in general. Even though there are adverse impacts on Huawei and ZTE, the bright side is general advancements across the whole supply chains. From 2018 to 2022, hundreds of thousands of jobs were created in the nation's chip industry. The salaries have also increased significantly. When one local chip equipment maker starts to recruit fresh graduate hires for 2022, for example, the annual starting salary can be as high as 300,000 yuan [about 47,000 U.S. dollars]. This is much better than before.

This mode of development is actually better for Huawei. It used to only act like a lone wolf in a no-man's land, [now they may enjoy a broader supporting industrial eco-system].

The circumstances also forced Huawei to resolutely enter hitherto untouched areas. HarmonyOS is a telling example.

Above are some simple analyses and thoughts on Huawei's financial report.

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