The China Syndrome: It's getting rough but US firms can't quit China
President Obama told Reuters Monday he has "raised directly with President Xi [Jinping]" concerns about pending Chinese legislation that requires technology companies provide the Chinese government "backdoor" access to encrypted files and store data on Chinese users in China.
The law, which is expected to be adopted by China's parliament in the near term, "would essentially force all foreign companies, including U.S. companies, to turn over to the Chinese government mechanisms where they can snoop and keep track of all the users of those services," Obama said. "We have made it very clear to them that this is something they are going to have to change if they are to do business with the United States."
President Obama's response to what China calls an anti-terrorism law is just the latest escalation in a series of policy disputes over cybersecurity and related issues initially triggered by Edward Snowden's 2013 leak of classified NSA surveillance programs. The Justice Department's indictment of five Chinese military officers in May 2014 for allegedly stealing trade secrets was another major event in what Reuters calls "a major irritant in U.S.-China relations."
Starting last summer, Chinese government agencies were ordered to use home-grown technologies vs. those made by Microsoft (MSFT), IBM (IBM), Cisco (CSCO) and Oracle (ORCL), while Google's (GOOGL) service were disrupted ahead of the 25th anniversary of the 1989 Tiananmen Square protests.
"To resist the naked Internet hegemony, we will draw up international regulations, and strengthen technology safeguards, but we will also severely punish the pawns of the villain," China's The People's Daily said last June. (The obvious irony here is that China is accusing U.S. tech companies, including our corporate parent Yahoo, of being tools of the government when that is almost certainly how China's government is using its homegrown tech firms, with Huawei being a prime example.)
In addition, Western automakers General Motors (GM), Mercedes, Audi and Volkswagen were targeted for allegedly violating Chinese antitrust regulation while local offices of Microsoft and its China Accenture partner were raided in August.
Generally speaking, most investors have looked at these US-Sino cyber security issues -- if they're even paying attention -- as mainly a political sideshow for local Chinese consumption or, at worst, a mere rhetorical battle between the world's first- and second-largest economies. But China has both national security and economic interests behind its "Buy China" campaign and investors ought to start paying more attention to these developments, as I wrote here in August.
U.S. companies aren't forced to break-out their revenue by any particular geographical segment; as such, many firms don't specifically mention China. According to S&P Capital IQ, only 40 S&P 500 companies disclosed specific figures on China sales in their fiscal 2014 annual reports, with the average proportion of full-year revenue at 16.3%. Based on that data, we compiled a list of the S&P 500 companies with the greatest share of sales in China, of those that disclosed such information, at left. Qualcomm, for example, which last month agreed to pay a $975 million fine to settle allegations it violated the country's antitrust regulations, generated nearly 50% of its fiscal 2014 revenue from China. (Qualcomm shares have risen since the settlement was announced since it removed "uncertainty" over its China legal issues.)
The bottom line is, naturally, the bottom line: Even as the pace of economic expansion slows, China is still viewed as a huge "growth opportunity" for U.S. multinationals and there's real money at risk if China closes its markets -- or makes it cost prohibitive for foreign firms to enter (or stay) in the world's most-populous nation.
"Western firms know they've got to be in China because the market is expanding so rapidly but playing by Chinese rules is often difficult," says Wharton Dean Geoffrey Garrett. "It's not trivially easy to operate in the Chinese market but the upside is incredibly high."
As you'll see in the accompanying video, Garrett believes the Chinese market is simply too big for Western firms to ignore, even if it's becoming more challenging to operate in the Middle Kingdom. Five years ago, Apple was assemblying phones in China for exports, he notes; now sales in China account from 17% of its revenue.
Still that's not to suggest there isn't plenty for U.S. firms and investors to worry about, especially as 2014 marked the first time China's investments abroad outstripped inward direct foreign investment.
"I don't want to be pollyanna-ish about China...but when we see the protectionism of Internet in China it tends to take our eye off something: the scale and innovativeness of Chinese tech companies," says Garrett, who has extensively studied China's economic rise and was previously President of the Pacific Council on International Policy in Los Angeles. "For 10 years the Chinese strategy has been to grow companies that are not only Chinese champions but global champions and tech looks like a good place for the Chinese to focus."
It looks 'good' unless you're trying to compete with them on an uneven playing field, of course.
Adam Samson contributed to this report.
Aaron Task is Editor-at-Large of Yahoo Finance. You can follow him on Twitter at @aarontask or email him at altask@yahoo.com.
