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In China, U.S. tech firms weigh 'Snowden Effect'

A demonstrator from the pro "Caring Hong Kong Power" group holds up a sign of Eric Snowden protesting the National Security Agency spying on National Chinese territory.  Reuters/Bobby Yip
A demonstrator from the pro "Caring Hong Kong Power" group holds up a sign of Eric Snowden protesting the National Security Agency spying on National Chinese territory. Reuters/Bobby Yip

By Matthew Miller

BEIJING (Reuters) - Battling a perfect storm of government suspicion and pricing probes in China, U.S. technology companies are having to re-think how they sell hardware and services in the world's second-biggest economy.

U.S. multinationals, including IBM, Cisco Systems and Qualcomm, are looking to settle price-gouging investigations and restore trust with Chinese regulators in the wake of reports that U.S. government agencies directly collect data and tap networks of the biggest domestic technology companies.

All U.S. IT firms are "on the defensive" in China, said Scott Kennedy, director of the Research Center for Chinese Politics and Business at Indiana University. "They are all under suspicion as either witting or unwitting collaborators in the U.S. government's surveillance and intelligence gathering activities."

Former National Security Agency (NSA) contractor Edward Snowden's revelations about U.S. government surveillance may cost U.S. technology firms billions of dollars in lost sales, analysts say. The U.S. cloud computing industry alone may lose as much as $35 billion in worldwide sales over the next three years, the Information Technology & Innovation Foundation (ITIF), a Washington, D.C.-based non-profit think-tank, estimates.

"The ability of U.S. companies to sell abroad has been seriously compromised by foreign customer concerns about the relationship between the U.S. intelligence community and the tech sector," said Daniel Castro, a senior analyst at ITIF.

Nowhere is the so-called 'Snowden Effect' expected to have greater impact than in China, says Sanford C. Bernstein analyst Toni Sacconaghi. "U.S. technology companies face the most revenue risk in China by a wide margin, followed by Brazil and other emerging markets," he wrote in a research note this month.

EARNINGS IMPACT

IBM, which reported a 22 percent drop in third-quarter China sales, led by a 40 percent decline in hardware revenues, may be a bellwether for the 'Snowden Effect' when it reports fourth-quarter results later on Tuesday.

Revenue at the Armonk, N.Y.-based company is expected to contract 3.7 percent in October-December from a year earlier, to $28.2 billion, though net profit is seen rising 6 percent to $6.5 billion, according to Thomson Reuters SmartEstimates.

The mutually antagonistic relationship between Washington, D.C. and Beijing, alongside China's drive to promote indigenous champions and the deep ties between big U.S. tech firms and the government, further complicate the outlook.

On Saturday, China's Commerce Ministry condemned the $1.1-trillion spending passed by the U.S. Congress last week for including a cyber-espionage review process for federal purchases of technology from China.

Cisco Systems, which is locked in a commercial battle to sell telecoms network equipment with Chinese domestic competitor Huawei Technologies, reported China orders declined 18 percent last quarter, as top-five emerging market sales slumped by more than a fifth. "I've never seen that fast a move in emerging markets," said Cisco CEO John Chambers.

"BETWEEN A ROCK AND A HARD PLACE"

For Qualcomm and InterDigital Inc, which face anti-monopoly investigations by China's top planning agency, the National Development and Reform Commission, related to their patent licenses for wireless mobile handsets and networks, the challenges may be greater.

Qualcomm CEO Paul Jacobs said earlier this month the company was still in the dark on developments in the China probe, which the company announced in November. Qualcomm, the leading provider of handset chipsets for 4G networks, reports its earnings on January 29.

"These firms are between a rock and hard place," said Kennedy of the Research Center for Chinese Politics and Business. "They can push the U.S. government to stop using them to spy, but that will alienate them from an important source of political support and business, and perhaps put them in violation of the (U.S.) Patriot Act or some secret executive order."

IBM may address official concerns by rolling out more technologies and services. Last month, IBM announced it was expanding its enterprise cloud platform into China as part of a $1.2 billion global initiative. That followed Amazon.com Inc's announcement that Amazon Web Services would launch its own cloud computing services in China.

Amazon said it signed a technical deal with the Beijing city government and with the government of Ningxia, an autonomous region, "to help foster development of a robust IT sector in western China."

IBM also is reportedly in talks with China's Lenovo Group Ltd to sell its low-end server business, a move that "may cool things down," said Alberto Moel, a Hong Kong-based analyst at Sanford C. Bernstein.

On Friday, U.S. President Barack Obama proposed making changes to the NSA, without addressing the government's unauthorized access to company systems and technologies.

That may not be enough for U.S. tech firms.

"The president's speech was empathetic, balanced and thoughtful, but insufficient to meet the real needs of our globally connected world and a free Internet," said Ed Black, president of the Computer & Communications Industry Association, a group that represents Google, Microsoft, Facebook, Yahoo, and other U.S. firms targeted by NSA surveillance.

(Additional reporting by Michael Martina; Editing by Ian Geoghegan)

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