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Investors Shouldn't Worry About Cisco's Blacklist Risks in China

By Leo Sun – Sep 23, 2020 at 10:32AM

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China could punish Cisco for the Trump administration's moves against Huawei -- but the networking giant probably isn't too concerned.

China's government has nearly finished drafting its trade blacklist, which it calls its "unreliable entity" list, in response to the United States' addition of Chinese firms to its own Entity List -- which bars American companies from doing business with blacklisted overseas firms.

China initially announced the list last May, after the U.S. blacklisted Chinese tech giant Huawei, but the "phase one" trade deal in January paused those plans. However, the Trump administration's recent attempts to ban ByteDance's TikTok and Tencent's WeChat apps have seemingly convinced China to restart those plans.

China's Commerce Ministry hasn't named any individual companies yet, and said the blacklist would be "strictly limited to a very small number of illegal foreign entities." But a recent Wall Street Journal report claims that Cisco (CSCO 0.93%), Huawei's top rival in networking hardware, has appeared in each draft of the blacklist.

That sounds like bad news for Cisco, which lost nearly 20% of its value this year as its revenue fell year-over-year for three straight quarters. However, I believe the blacklist threats in China shouldn't significantly affect Cisco, for four reasons.

Chess pieces placed on Chinese and American flags.

Image source: Getty Images.

1. China isn't a top priority for Cisco

Cisco generated 15% of its total revenue from the APJC (Asia Pacific, Japan, and China) region in fiscal 2020, which ended on July 25. It doesn't regularly disclose its exact revenue from China.

But during a conference call last August, Cisco CEO Chuck Robbins said the company generated less than 3% of its revenue in China. Cisco's total revenue in China fell 34% in 2020 (though it didn't disclose an exact figure), making it the worst-performing market of the APJC region.

Cisco attributed its struggles in China to competition from rivals like Huawei, slower enterprise spending throughout the economic slowdown, and the loss of contracts amid the trade war. Last August, Robbins admitted Cisco had been "uninvited" from bids for contracts at China's state-owned firms, which cleared the path for Huawei and its domestic peers.

In other words, Cisco's prospects were already dim in China, and losing the entire market would only slightly dent its total revenue.

2. Cisco's loss of the Chinese market was inevitable

In the early 2000s, Cisco helped China expand its "Great Firewall." which allowed its government to censor content, track users, and block access to overseas websites. But starting in 2012, China's government agencies stopped using Cisco's products and barred it from future government bids, citing security risks in allowing an American company to handle its network traffic.

Therefore, China's latest moves against Cisco aren't surprising, and would likely have happened even if the trade war didn't start.

3. Huawei's pain could generate gains for Cisco

Cisco seems destined to lose the Chinese market, but it could offset those losses by expanding in other countries. A growing number of countries -- including the U.S., U.K., Australia, New Zealand, Taiwan, and Japan -- have already banned Huawei's technologies from their new 5G networks.

A visualization of networking connections across the world.

Image source: Getty Images.

Those bans should help 5G infrastructure equipment companies like Ericsson (ERIC 0.35%) and Nokia (NOK 0.42%) more than Cisco, but customers in those countries could also replace Huawei's routers, switches, and wireless equipment with Cisco's products.

In short, China's actions against Cisco probably won't offset Huawei's losses in other markets, which will continue as long as governments and companies remain wary of the alleged ties between the tech giant and the Chinese government.

4. China isn't ready to push the button yet

The Wall Street Journal claims China's leaders are currently split regarding the release of the blacklist, with a few arguing that the decision should be postponed until after the U.S. election.

That hesitation indicates that China realizes it's still too dependent on U.S. technologies, and escalating the trade war with its own blacklist could do more harm since it would likely encourage the U.S. to blacklist even more Chinese companies.

The key takeaways

Cisco isn't out of the woods yet, since COVID-19 disruptions, sluggish orders from enterprise and data center customers, and competition from smaller rivals will likely throttle its growth over the next few quarters.

But investors shouldn't fret over Cisco's fading presence in China or a potential blacklist against the company. Those events were largely inevitable due to Huawei's expansion and escalating tensions between the U.S. and China, but the short-term pain should pass as Cisco's growth in other markets offsets those declines.

Leo Sun owns shares of Cisco Systems and Tencent Holdings. The Motley Fool owns shares of and recommends Tencent Holdings. The Motley Fool has a disclosure policy.

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