Huawei

00:00intros for tonight. Oh yeah, I wrote up like a little like thing that's based on exactly what you texted me that I kind of like the idea of. Great, great. What I'm thinking isn't tell me if you like this. Welcome to season five, episode one of Acquired, the podcast about technology acquisitions and IPOs. I'm Ben Gilbert, and I am the co-founder of Pioneer Square Labs, a startup studio and venture capital firm in Seattle. And I'm David Rosenthal, and I am a general partner at Wave Capital, an early stage venture capital firm that focuses on marketplaces based in San Francisco. And we are your hosts. Today, we are covering China's largest private company, Huawei. The company is the second largest smartphone manufacturer in the world. Now, they're only behind Samsung, and they recently pulled ahead of Apple. They also

00:59happen to be the world's largest telecom equipment manufacturer, among other things. Now, David, the company has had a pretty wild last 12 months. That would be putting it mildly. Yes. Barred from doing business with U.S. companies, federal prosecutors have filed charges of wire fraud, and their CFO was arrested upon landing in Canada last year. Oh, and the layoffs last week of hundreds of workers in the U.S. went down amidst the trade war. So what is going on with this company and how did we get here? Yeah, well, that's what we're here to talk about. And this is going to be fun. This is a little bit of an experiment for us here at Acquired. This is obviously not an acquisition nor an IPO. And in fact, there is an interesting ownership structure of Huawei, which we will get into. But we felt like this is such an important moment for tech,

01:53for international relations, you know, critical for all of us to really dig into and understand. And we certainly wanted to. So here we are. And speaking of understand, it's a thing that I didn't understand before starting to do this research. And I would imagine most folks in the tech ecosystem kind of feel the same way. All right, listeners, now is a great time to tell you about longtime friend of the show, Vanta. So David, I want to paint a picture that many founders listening will recognize. You're about to close your biggest customer yet. The product team has hit a bunch of milestones. The sales team built this fantastic relationship. Everyone at the potential customer is fired up. Your legal team has the contract done, but then an email comes in from the security team. Ah, yes. It's usually a very polite email asking something like, Before proceeding, could you share your SOC 2 report?

02:43Or do you mind sharing your ISO 27001? If you don't have one, that deal just went from closing this month to closing next quarter, maybe. Now you have to go find an auditor, go through every system, write the policies, and then prove that you follow them. Right. Or you could just use Vanta. They are the leading agentic trust platform, which means that you can connect it to your systems at your company and it automatically pulls all the relevant data and it tells you exactly what's missing for a SOC 2, an ISO 27001, or whichever framework your customer asked for. Vanta gets you through the audit and then it keeps going. It watches your controls every day afterwards so the report that you hand to the next customer is still true. Yep, and even more impressive is the Vanta agent. It continues to run in the background so it can find the issues and draft the fixes.

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04:26If you want $1,000 off, check out Vanta.com slash acquired. That's V-A-N-T-A dot com slash acquired. And just tell them that Ben and David sent you. All right, David, now on to the episode. And as you put it well, I think in the pre-show, we don't actually know how this one's going to turn out. And that's pretty exciting for us here at Acquired. Yeah, a little bit nervous, but makes it all the more interesting. All right. Well, history and facts of Huawei. we rewind as we so often do here on acquired back to the early 1980s it was a great time i was being born shortly after then close to the important part of the 1984 yeah most important part of the episode but we just and we recall back to a lot of the same themes we talked about in our tencent episode if you remember that and that was uh both shenzhen the city in China across the bay from Hong Kong and Deng Xiaoping and the opening up of China

05:28and the cultural reforms after Mao and the Cultural Revolution that would lead to China becoming the economic, be the first steps in China becoming the economic juggernaut that it has turned into today, both economic and technological juggernaut. As we said, this is a few years after the Cultural Revolution. Deng has taken over leadership of the party. And he has seen and lived through all the turmoil of the Cultural Revolution. And he believes that China needs to move forward. And he seizes the Communist Party's 12th National Congress, which they do every five years. It's the big five-year planning event that the party does in 1982 as the moment that he is going to announce his vision for the future of China. And again, we talked about this on the Tencent episode. And what he sees is China as the system in China as being socialism,

06:20rooted in communism, but with Chinese characteristics. And what he means by that is he wants to introduce a market economy back into China and introduce in a small way capitalism. And he has a very specific idea in mind. He has the city of Shenzhen as a special economic zone that is going to be the testbed for this idea of keeping China as a communist political system, but reintroducing capitalism and the market economy. It's amazing. I mean, looking at that sort of declaration of the special economic zone and the, you know, 40 year effects that it's had on that city and so much innovation has come out of Shenzhen. Yeah. Well, and it's like, this is such a visionary and crazy idea at the time that you could mix communism and capitalism. This city is going to have a different economic structure. Like the economy in this area is going

07:18to be different than that of the rest of our nation. Yeah, yeah, completely. And obviously, the experiment was a success. But in attendance in 1982 at that National Congress, that very National Congress, was a relatively low-level engineering corps director in the army, in the People's Liberation Army of China, whose name was and is Ren Zhangfei. Ren is better known today as the founder and CEO of Huawei, but back then he was a long way from those heights. So who is Ren? Well, one, he's a very witty individual. He's been a little bit of a recluse, at least from Western media over the last few decades. But with all the events around Huawei over the last few months, he's kind of come back out of seclusion and has given many interviews to Western media and Eastern media. He's really a very, very smart and witty individual.

08:19Yeah. And I would define him as reclusive, except when he feels his company is misunderstood. Yeah. You know, just to give you a little taste, we'll link to a few interviews with him that you can find on YouTube and other sites online. But he was asked by Bloomberg in one of these interviews, you know, how he feels about all the action that the U.S. has taken against his company and in particular how it's going to impact these bands, the smartphone division. And he says, this is a quote, we might miss our growth target, but we are still growing. Being able to grow in the toughest battle environment, that just reflects how great we are. That gives you a little flavor for Ren. So who's Ren? He was born in the 1940s in rural southern China. His father had actually been college educated, which was incredibly rare for that time and place. Both he, Ren's father,

09:10and his mother were school teachers. And Ren ends up going to college as well himself. He studies civil engineering at the Institute of Civil Engineering and Architecture in Guangqing. After college, he works as a civil engineer for a few years. But then, of course, shortly after joining the workforce, the cultural revolution happens. Ren signs up. He joins the PLA. As an engineer, he gets put in charge of a really glorious assignment. He gets sent to a remote part of the country in central China, and he gets put in charge of setting up a synthetic fiber factory. He ends up doing well enough at that and succeeding at setting up and managing this factory that he gets rewarded by the army. He gets sent to the country's National Science Conference in 1978. Then he goes back and he continues working at the factory. And then in 1982, because he succeeded

10:04so much, that is how he lands himself the invite to this really prestigious National Congress, historic Congress, where Deng Xiaoping announces the opening up of China. So he's there, he's in the audience. And, you know, he's inspired by Dung and this vision and leader. And he decides he needs to, he needs to follow this call and become an entrepreneur. So he leaves the army very shortly thereafter. And he moves to Shenzhen. He works briefly in the oil industry. He works for the Shenzhen South Sea Oil Corporation, which he realizes that the oil business is not for him. He's an engineer. He wants to work in engineering. He wants to work in technology. But that was his path to Shenzhen. So at the same time, now this is the mid-80s, the Chinese government is trying to modernize all of the technical infrastructure of the country. And one piece

10:59of the infrastructure that is severely underinvested in is telecommunications infrastructure. So what's that at the time? There's no mobile telephones. There's no wireless industry. These are all fixed line wire television switches yeah pbx so the government is trying to find ways to import telephone switches into the country and so ren sees this and of course he had been part of the army and part of part of the party and so he's now finds himself in shenzhen and he says you know maybe i can start a company to start importing these there's this great demand for telephone switches. And maybe I can do that here in Shenzhen. So a couple of years into his job, he leaves in 1987. And he starts a firm along with five other co-founders to do just that, import PBX switches and resell them, import them from Hong Kong and resell them in China. And famously, as the story

11:56goes, he starts it with only 21,000 RMB, which was about $5,000 at the time. That's debatable whether that was actually true, but that is the lore. You know, it's crazy thinking about trying to put yourself in his shoes at this time. You only recently heard that this thing was not only legal, but possible, you know, starting a company and becoming an entity that generates a profit and performs this private sector activity. And become an entrepreneur when entrepreneurs were persecuted during the Cultural Revolution and you were a member of the army during that time. Right, yeah. Not only was this thing illegal, which here in the US, the thought of doing something illegal can totally cross your mind and you can sort of still do it. But this was one step further where it's something that was so culturally shunned that no one would sort of dream of doing it.

12:53You blend ethics and religion and legal all into one and the result is you just don't perform that activity And just a couple of years later, here he is getting a band of people together to start a profit generating corporation. Just another window into what must have been going through his mind at this point in time. He decides to name the company, of course, as we know, Huawei. Well, where does he come up with the name Huawei? Well, Hua means China and Wei means achievement. So the name of the company that he chooses is China Achieving. It's a good name. It's a good name. It's a good pick, especially for the time. Yeah. But you can see, I mean, coming from the army, having been literally there in the audience when Deng Xiaoping is announcing the socialism with Chinese characteristics and the future and this vision for what China's both economy and politics are going to be for the next

13:4840 years, it's all wrapped up in this. Yeah. You'll notice he didn't name it Telephone Switch Inc. It's quite the vessel to be able to do whatever he wants within. So the initial aim of the company, of course, as we said, is to import these telephone switches from Hong Kong and resell them in China, which they do. And they do very successfully. And they follow a playbook that Ren had seen as part of the military in China. And that is that they start in rural areas and they come to dominate rural telephone networks and selling to small villages in the countryside. And then they build up from there and then they sell into cities. And the years go by and they become quite a large importer of this technology into China. But he doesn't really want to stop there. The ambitions are to build a big company and, of course, to achieve and for China to achieve.

14:42The way that they're going to do that and going to do that on an international large scale isn't just to import technology. It's to build and develop their own technology internally. So he starts building alongside this import business, a pretty strong R&D and engineering group that grows to about 600 people over the first couple of years of the company. And that's crazy. You know, I mean, here you have this, this, again, this, this import business that has developed this R&D group of 600 people alongside to build their own technology. The like pattern matching radar going off in my head reminds me of Shoe Dog, where Nike started as the blue ribbon shoes and they were importing Onitsuka Tigers. and reselling those and you'd go to your blue ribbon guy to get your own Suka Tigers. Then it was this big jump to go and start actually doing the R&D and manufacturing their own shoes.

15:34I feel like I don't know as many recent examples of companies that started purely as an importer and then sort of switched the product that they were selling to be their own. But it keeps popping up in things from the 80s. Well, it's funny, like technology now is such a intellectual property driven business where it's really hard to do that. Now, of course, you could argue and lots of people do that it was back then as well. And Huawei played fast and loose with the intellectual property of the gear that it was importing, but it wasn't quite like it is today. That's a fair point. so about five years later in 1992 huawei the fruit of all of this r&d investment that they've been making so they introduced their first product on their own the cnc08 digital telephone switch and they introduce it into the chinese market and it completely dominates it has the largest

16:26switching capacity of any product that was available in china at the time now of course huawei had a large say in what other products were available in china at the time but most importantly, they sell it for about a third the price that the imported switches are selling for. So as you can imagine, this comes to just dominate. And so very quickly, Huawei grows into a very large company domestically. But again, the scale of Ren's ambition is not just to build a large company domestically. He wants to bring this and the technology that they're building within China out to the rest of the world. So pretty quickly thereafter, in 1996, they begin selling this switch that they've developed to other telephone carriers in other countries outside of China. First, they go to Hong Kong back across the bay from, you know,

17:15they're originally importing networking gear from Hong Kong. They're now selling their own gear back to Hong Kong. From there, they go to Russia and Africa and things really start to work. Right around the same time, and this is the mid-90s, wireless is finally becoming a thing And Huawei starts investing heavily in building networking gear for wireless telecoms as well. And pretty quickly, they become the largest CDMA equipment provider in the entire continent of Africa. This really starts to lay the groundwork for that. You know, when I was introducing the episode, you know, saying that they're the largest telecom equipment manufacturer. You know, we'll get into this later, but they have these three business lines. And this is still a huge one for them.

17:57These telecom carrier networks business that, you know, they make 5G equipment now, but they've made basically every generation of equipment that goes on cell towers and is used in the backbone of cell phone technologies since the mid 90s. All right, listeners, now is a great time to thank our longtime friend of the show, ServiceNow. So, David, here's a question that I do not think most enterprise CIOs or CEOs could actually answer today if they were asked. how many agents actually run inside your business? Yes, I don't think anybody really knows. And of course, then there's the harder questions like, what can they access? And who gave them that access? And is any of this paying for itself? ServiceNow has an answer to all those questions. The super intelligence control tower. As friend of the show, CEO Bill McDermott says,

18:51It's the one place to see, secure, measure, and help govern your agent's models and workflows across your entire business, no matter who built it. Yep. So, for example, it finds the agent that someone in procurement spun up on their own and then tracks what it's doing and its ongoing cost. When the CFO inevitably asks whether any of this is working and if there's ROI, you'll be ready with the number. And importantly, if something goes wrong, it can detect and revoke access immediately. There's even a kill switch built into the product. And ServiceNow is uniquely positioned for this because they've spent the last 20 years building the operating backbone of the enterprise from IT to HR, sales, service, and cybersecurity. They know how work gets done, helping support over 100 billion workflows a year across more than 90% of the Fortune 500.

19:43The world's most complicated businesses, like many that we've covered here on Acquired, already run on ServiceNow. And now they're running their AI there too. If you're trying to turn AI ambition into real outcomes, just go to servicenow.com slash acquired and just tell them that Ben and David sent you. so the question you might ask you we've been telling this story of grand international scale ambition from the unlikeliest of places uh beginning in the early 80s in shenzhen you have to wonder a little bit like how did this unlikely story unfold besides certainly hard work and ambition and innovation at huawei how did they come within the span of a decade to become the largest wireless telecoms gear provider to countries completely outside of China. And here I thought you were just going to glaze over that, David.

20:36Yeah. Well, you know, if you remember back to what I was saying about how it was a strategic initiative of the government to modernize telecommunications networks within China, when they found Huawei and Ren as a former, you know, PLA member, and Huawei literally meaning China achieving. Well, the government thought this is a pretty good vehicle to help this happen. And so, you know, all of the gear for those first few years being, of course, imported, but then later their own switches that Huawei was selling domestically, who were they selling it to? They were selling it to the government. They were selling it to cities. They were selling it to towns. They were selling it back to the military itself. And the government was using it to set up both civil and military communications networks. That's interesting. Because of that,

21:24the government obviously had a big interest in what Huawei was doing and the products that it was providing, so much so that it started giving loans to the company to help them finance these projects, these contracts that they were awarding to them. Somewhere along the way, the ownership structure of the company changed. So if you remember, Wren started the company with five co-founders. That is no longer the ownership structure of the company today. Today, the Huawei operating company is 100% owned by a holding company. Here we go. And who owns the holding company? Well, 1% of the holding company is owned by Ren Zhengfei. 99% of the holding company is owned by another entity that is a trade union committee. What is the trade union committee? most directly it represents the union employees who work at the company and economically it does

22:20it's effectively a profit sharing structure for employees working at the company again this is china and china is a communist country and trade unions who do do trade unions ultimately report up to and should there be any liquidation of huawei where legally do the assets of the company go they don't get distributed down out to the members of the trade union within the company it gets distributed up and the trade union is ultimately rolls up to being part of the chinese communist party which is of course the government so this trade union has economic interest in the company but not sort of control over the company if you if you own a lot of the sort of uh it's not equity but I believe the phrase is restricted phantom shares in the union, do you actually have any say over the governance of the company? No, you do not. And this is where it gets complicated. So

23:19as you say, economically, if you are an employee of Huawei and you participate in the trade union, which all at least Chinese employees of Huawei do, then yes, you do have an economic interest in the profits of the company. But yes, the governance and the control, and again, should there be a liquidation of the company, does not come back to you. It goes ultimately up to the party. And an interesting other thing to note here, I mentioned the restricted phantom shares, which if you hold direct shares in a US company, that should already feel a little bit different to you. A major way in which it's different is if you are no longer employed by the company, you don't have the right to own those restricted phantom shares. They are immediately purchased backed by the company. So you cannot sort of be an outsider who has, we already talked about,

24:06no control, but now you can't even have economics as an outsider. So what does all this mean? You can start to see in a competitive global market, such as the market for telecom networking gear, you all of a sudden now have this actor in Huawei who doesn't quite have the same economic incentives as other free market actors. They are a large portion of their projects are for domestic government uses. That government is directly funding the company via loans from state banks, state banks and state owned enterprise banks. And they also have a, if not economic, a governing seat at the table, shall we say, at Huawei. Now, there's not anything, and you compare that to, you know, a international company, which is purely operating based on supply and demand and pricing, you know, power versus over both their suppliers and their customers in a normal market. And that's quite different.

25:07Now, there's not necessarily anything unique or necessarily wrong about this. China and other countries, indeed, even Western countries have state-owned enterprises. You know, companies like Airbus are state-owned enterprises. What's interesting is Huawei isn't officially a state-owned enterprise, and it competes in an international market. Listeners, you might think, wow, Ben and David are really harping on this. Like, they must feel it's important. Well, Huawei feels it's important too, because if you look at the 2018 annual report on the very first page, before they even get into sort of like outlooks for the company and sort of the company's ethos, of course, they have who is Huawei. And the very second question is who owns Huawei? And the answer is, of course, that they are a private company wholly owned by its employees. And that says, if I were to quote this,

25:55this scheme is limited to employees. No government agency or outside organization holds shares in Huawei. Now, that's in the first five or six sentences of this entire multi-hundred page document. Of course, that was not highlighted in the way that it is now before all of the events of the past six months started. Whatever the reasons, certainly there's no arguing that Huawei at this time was an amazing growth story. Their products were good, at least as good, if not better than the competition internationally in these markets that they were entering. And they were certainly cheaper. So you can start to see why, you know, first in developing and redeveloping countries like Africa and Russia, their networking gear products were much more attractive than those from competitors like, say, Ericsson or Nortel in Canada. But then they keep

26:48innovating and they keep investing heavily in R&D, such to the point that as the years go by and wireless becomes a more and more important industry globally and a more technology-driven industry, Huawei becomes one of the very top players internationally. By 2002, they were doing over 500 million in revenue internationally annually. And by 2005, the international revenue passed domestic revenue to be the majority of the company. Pretty impressive. Around the same time in the mid-2000s, this is going to be a recurring theme here, Ren and Huawei's ambition is always growing larger. They've come to be one of the few dominant players in international networking gear for the backend for carriers. They say, maybe we need to think about getting into the other side of the business in telecoms and wireless as well, and

27:44not just make gear for carriers, but also make handsets for consumers. And so in 2003, they released their first handset. And then in 2005, which is pretty early for the time, they ship one of the first 3G phones available in the world. And then again, in 2009, at Mobile World Congress, they launched one of the first Android phones available. Yeah, very early to this stuff. And that's kind of a crazy idea. I mean, if you think about, of course, there were others that manufactured the sort of cell tower side equipment that also made the handsets. Imagine that today, I mean, imagine that going the other way, like Apple making the telecom equipment that goes on the towers. I mean, I guess the strongest other example of someone that did that was when Ericsson partnered with Sony to produce that. My dad actually had this phone. It's like a little candy bar Sony Ericsson phone. Oh, I remember that one.

28:39Yeah. And they were actually, Ericsson, who's also a very large telecom equipment manufacturer, was sort of in this business of having consumer branded phones for a while. And they did pretty well. But, you know, that was before the smartphone era that we know today. Yeah. And so what's interesting, Huawei, I think, saw the opportunity in having both sides of this business that because they were driving a lot of the innovation on standards and capabilities on the back end side, by having handsets on the on the front end side, they could be playing off one another and keep introducing handsets that were early to taking advantage of all of the feature sets that the carriers were offering. And so that's why you see them being, you know, being relatively early to 3G, being relatively early then to 4G and relatively early to, you know, the whole smartphone revolution and embracing Android.

29:32You know, I didn't have this in the notes at all, but why weren't they China Mobile? Like, why wouldn't you also find a way to be the carrier and really own the whole stack? So you didn't have this thing where it's like, like right now we're in this strange chicken or the egg game in the U.S. where the carriers have to roll out 5G in order for the phone manufacturers to sell a high number of 5G phones. And consumers are sort of sitting here waiting for both of those things to happen at enough scale that it's useful. And so, of course, there's 5G phones come out, but you only have them in certain cities and it's mostly bad. And so you have these three players where the handset manufacturers are waiting on the carriers to roll out the cell towers that are made by the Ericsson's and the Huawei's of the world.

30:23Like, it really does feel like there's this sort of middleman missing in Huawei's business model where they really could own the whole stack. It's a good question. I didn't think about it, but I think it must be because China Mobile is a state-owned enterprise, I believe. Must be. Yeah, they probably couldn't get into that business. So they probably couldn't compete there. In the absence of that, you know, I think this is one of the things that's really so interesting about Huawei is, you know, obviously there is all of the political overtones to all of this, but their business strategy is really brilliant. By participating heavily in both sides here, as we were saying, you know, they're able to drive a lot of this to benefit of both the tick and the tock of innovation here.

31:02And have as much inside information as you possibly could have on what's the best way to use this new technology rolling out. Yeah. Had they, again, been in a different market, that's a really interesting question of like, could they also have been a carrier? They couldn't in China because China Mobile is a state-owned enterprise. They couldn't internationally because they're selling to the carriers and international. What are they going to go do? Set up carriers in all of these different countries. I mean, I guess they could have tried to acquire Vodafone or some similar player along the way, but that probably would have invited a lot more political speculation that they managed to avoid. I'm sure this is something they thought of. So by 2010, total revenue of the company has eclipsed $20 billion, almost $22 billion, and net profit is almost $3 billion. By 2012, they overtake Ericsson,

31:54who you were mentioning, Ben, as the largest telecom equipment manufacturer in the entire world. And then last year, finally in 2018, as you said at the top of the show, they surpass Apple in handset shipments. So they're still smaller than Samsung, but Huawei is the second largest handset manufacturer in the entire world. People love their phones, love the cameras on them, love the technology. They shipped over 200 million handsets globally last year, which is an astounding number. I would say on the handset side of the business, Huawei is certainly at parity with other manufacturers out there, be it Samsung or Apple or the like. On the infrastructure side, Huawei is ahead of the field. When it comes to 5G, even though 5G networks aren't really rolled out to the public anywhere yet, consensus in the industry is that the quality of the

32:46technology of the gear that huawei is producing is two to three years ahead of any of the competition out there in the market in terms of 5g david i'm not going to let you fully say that the huawei phones are are sort of at parity with everyone in the market i was going to save this for playbook later but like come on there's there's blatant ripoff after blatant ripoff of uh of sort of apple ui and their uh their modified operating system and not only but like not only blatant ripoffs like every this is a uh subjective comment but it is a copy that is slightly worse on in many many facets every time they do it i love it if steve jowes were alive today he would be railing against huawei not samsung it's true but certainly people like the phones and so much so that last year in 2018 they surpassed 100 billion dollars in total revenue across their

33:42all their divisions. Half of that, $52 billion of which was in handsets. And net profit for the company was almost $10 billion. So things are going well. But then as you alluded to at the top of the show, in December of 2018, a fateful event happens, which is that the CFO of Huawei, Meng Wanzhou, who is also the daughter of Ren Zhangfei, it turns out. which blew my mind when i somehow missed that when all this news came out and doing the research for this episode i was like wait huawei's cfo is his daughter yes and uh she has a different last name because um he she's his daughter by his first marriage uh her parents got divorced and she ended up taking her mother's family name meng after the divorce but yeah she's his daughter She was on an international business trip en route to Mexico City from Shenzhen and had a stopover in Vancouver, Canada.

34:46And after getting off the plane and attempting to go through customs, was detained by Canadian Border Patrol, ultimately arrested. And it turns out that the U.S. had issued a extradition request for her and asked Canada to apprehend her and extradite her to the U.S. to stand trial for allegations that Huawei had been reselling U.S. technology equipment to Iran through a shell company that she had helped set up. Which would, of course, violate sanctions. Now, this is interesting. It wouldn't necessarily violate Chinese law, but because so many of the components of the products that Huawei sells are made by U.S. manufacturers, by selling Huawei products and systems of Huawei products to banned countries like Iran, they would be violating U.S. trade law by doing so because so many U.S. components were part of it.

35:48And not only is it a, you know, absolute bombshell of a piece of news and a thing to do, but it's not completely clear cut that there's a case here. At some point, this will go to trial and we will sort of see what the courts decide. I believe the current state is that she's on house arrest in Vancouver awaiting extradition to the U.S. for trial. She has not been extradited to the U.S. yet. She is still in Canada. Canada has not released her to the U.S. But it really begs the question, you know, as we were talking about the Iran sanctions, you know, that is the charge. But I don't think anybody really believes that that is what this is truly about. It's about the U.S. and many other countries feeling threatened here that telecommunications infrastructure has become such an important part of any society. and Huawei is clearly the leader in 5G rollout. And what would it mean if a Chinese company

36:56with strong ties to the state is now responsible for the majority of the backbone of the internet in countries around the world? Yeah, and I'll say on top of just this notion of, wow, can this be owned by a foreign power? There have been several different research firms and different news stories that have come out sort of alleging that people have found security vulnerabilities in Huawei products that, of course, Huawei, the company, says is completely false and that security is of the utmost importance. And not only are they not doing anything intentionally, but these are complete falsehoods and the company is, you know, is one of the most secure companies on the planet and this is ridiculous that they're being accused of such things.

37:44And so you have this stalemate where, you know, the company says there's absolutely nothing wrong. And yet different journalists and different security researchers keep saying, hey, there are things to be concerned about here. Yeah. And what's interesting is like it is, at least to me, as I was doing the research, it's not entirely clear that there is something wrong right now. It's more the potential that something could go wrong that people are worried about here. And of course, very shortly after the arrest of Meng Wanzhou, of course, in the beginning of 2019, President Trump begins his trade war with China in earnest. And that has fallout for many companies, but Huawei kind of chief among them.

38:28So on May 16th of this year in 2019, the U.S. goes so far as they put Huawei on what's called the entity list, which freezes all U.S. companies from doing any type of business with Huawei without special permits. So what does that mean? We already alluded to the fact that, you know, if you think about a Huawei handset and the same applies to Huawei networking gear on the back end, the number of chips that are part of that and components that are made by U.S. companies from Qualcomm to Broadcom to, you know, what have you, is quite large. I mean, it's 50% or more of the total manufactured product. No component, at least on the smartphone, on the handset side of the business, is more important, of course, than the operating system, which is Android, which is sold by Google, which is a, well, not sold, but is made by Google, which is, of course, a US company.

39:23And on top of that, David, even one more thing is Arm. And we discussed this being a British company that started out of Cambridge. You can go back and listen to the ARM episode if you want details on that. That, of course, is owned by a Japanese company, SoftBank Now, believes that they have significant U.S.-based IP as a part of ARM. And so they have also, even though they're over in the U.K., they have also stopped licensing chips with the ARM instruction set architecture, which is basically all mobile chips, to Huawei. So not just mobile chips, but but chips of all types in all use cases, including back end infrastructure. Oh, so that's that's all the impact on what can't be sold to Huawei from the US as an ingredients in the product. One more super interesting wrinkle here back to Android for a minute is there's commercial Android through Google.

40:22obviously you can understand how that would be prohibited from being distributed to huawei because of the being played huawei being placed on the entity list you might say well of course there's also the android open source project you know android is an open source operating system and many of the flavors well really all of the flavors of android that are on handsets in china are not google android it's open source android because of course google doesn't operate its services in China, as we've talked about on other episodes. What's really interesting here is that because Google... Is that open source software? Right. It really begs the question of, is that open source software? Now, legally, it's a little bit of a gray area, but experts believe that because Google is the primary maintainer of the Android open source project, and Google is a US

41:10corporation and entity, that actually makes even the Android open source project subject to this entity list ban by the united states and even the core open source version of android could potentially be off limits to huawei from now on it's wild that's totally wild no of course huawei didn't have their head in the sand uh for the last 10 years or so thinking that like this was would never happen they have been preparing contingencies if this were to happen and they've been working on their own operating system internally since 2012 but this is super interesting

41:47Like, even if it were really great, if you could build your own operating system today, how far would that get you? Because you wouldn't have access to all the third party applications that are available on Android and iOS. So they could release their own their own OS, but they wouldn't have the whole ecosystem of third party developers from, you know, Tencent and WeChat on down that would participate in it. So Google has actually appealed this to the government and said, look, we should be able to do this. It's actually better for U.S. national security if they are using Android, because otherwise, if they switch to a fork and start, you know, working on a completely different system that we no longer, you know, maintain in any way, shape or form, you know, we actually have a lot less control. And we actually it could be that they fork something that has a security exploit.

42:39And this is Google's argument here that then gets sold in the U.S. And then suddenly there's a bunch of Android phones in the U.S. that have a security vulnerability that Google has no ability to fix. And so, you know, Google's argument to the U.S. government. And of course, this is all in flight right now is can we please keep licensing Android to Huawei? It's really important for all of us here. And it's fascinating to watch this game. And what we're really seeing here is, if you think about this geopolitically, what the U.S. government is basically doing in this chess game is daring China. They're saying, okay, you want to make a smartphone? Well, you can't use our operating system. And, of course, if you make your own, you don't have access to our apps, but sure, maybe you'll figure that out. you actually can't use the instruction set architecture for the chips that all the phones

43:31use. So go make your own chips and instruction set architecture for those chips. And oh, yeah, you can't use any of the sort of like telecommunications chips either. So you're going to need to really do all of that on your own. And you end up basically in this world, if this fully gets played out, where there's two completely different technology stacks, one for the China world and one for everywhere else. And it seems to be like the US government daring China to do that and daring Huawei to be the ones that sort of figure out how to rebuild the phone computing stack. Yeah. Obviously, this has not been a traditional acquired episode, but we thought it was so important to do this because, you know, knowing now all this history and what the current state of play is here between Huawei and Google and the US and China.

44:27And you start to think about that future. That's a really like weird and not good future, you know, where they're, you know, right now, basically all of the standards, of course, there are, you know, there are differences like Google services don't work in China. They do here, you know, WeChat services work much better in China than they do. You know, WeChat is crippled outside of China. But basically, we're all on pretty much the same internet. This is a future where both sides, the infrastructure backend side and the operating system frontend side for consumers really diverges. And I don't know what that means. One thing that we haven't talked about is the other side of the bidirectional exchange here. So you'll notice if you go, like we're talking about Huawei here, who makes these smartphones that are theoretically the second

45:19most sold in the world, plenty of your friends, or maybe you have a Samsung Galaxy. I bet very few people, you know, have a Huawei phone if you're here in the U.S. Well, it depends on where you live if you're in the U.S. Yeah, yeah, yeah. But if you're in Europe, I bet you may have a Huawei phone. Totally. So one thing to observe from that is, you know, let's walk through a little bit more of a timeline. So in December, of course, we had this happen with the CFO of Huawei being detained and arrested, then in January, AT&T was very close, days away from executing their deal with Huawei to distribute Huawei phones on their network in the US. And it would be available when you go to an AT&T store. And at the very last minute, they dropped that. They blew up the deal. And I'm not sure this was reported that it was because of pressure from US officials who

46:06distrust Chinese companies. I'm not sure if that is a fact or sort of just something that is sort of alleged, but holy crap, this is some very serious effort to limit the number of Huawei devices in the U.S., and they've really done it. If you look around, there's not a lot of Huawei phones. There's not a lot of Huawei tablets or laptops that are distributed in the U.S., and so to the extent that the U.S. government was concerned about security on these devices and they wanted to limit the distribution, they've really done that. Mm-hmm. But now the question is, and this is back to really the troubling implications of separate internets. Yes, they've limited that in the US, but Huawei is incredibly popular in the rest of the world outside of the US and China. And that's everything from Europe to Africa to

46:55the Middle East to the rest of Asia to Australia. It's the number two global handset manufacturer. Yep. I will say too, the other thing that they limited in the US is all of these telecoms that are Verizon, AT&T, that are rolling out 5G networks are not doing it with Huawei equipment. So it's not just the handset side, but it is the infrastructure side. Yeah. So the last couple pieces in the chain of events here of History and Facts is, as many people know, at the end of the G20 summit this year on June 29th, Trump and Xi Jinping announced that they intend to resume trade negotiations. And Trump implied that as part of that, he might ease the restrictions on Huawei. And, you know, kind of we back down from the edge here. But just yesterday on July 16th, a bipartisan bill was introduced in the Senate. Imagine that a bipartisan bill in the Senate at all these days that would prevent the executive

47:55branch from unilaterally lifting those restrictions on Huawei. That's how critical Congress believes these restrictions are. So they want to keep the restrictions in place, even if Trump wants to remove them. Wow. I did not see that. That is pretty intense. That's pretty crazy. So here we are. So one of the interesting things I think to discuss, and this kind of falls into the category of what would have happened otherwise, is, you know, we've talked on the show about other Chinese companies. We've talked about Tencent. We've talked about Xiaomi, a handset manufacturer. We've talked about Alibaba. Why is Huawei being treated so differently from these other companies? And I think a big piece of it is just the ownership and the structure of the companies. What's interesting is the Tencent, Alibaba, Xiaomi, Baidu, these are publicly traded companies

48:45that have a diverse international investor and ownership base. That is clearly not the case with Huawei. Yeah. Huawei, a company that did $108 billion in revenue last year and is still, quote unquote, privately owned by employees. Think about that in the US. The scale of that revenue, you're a public company. And of course, there's exceptions. There are certainly private companies in the US and elsewhere that are very large that are privately held. But the difference is. They're privately held by individual shareholders. They're not held by a union that reports to essentially a government. So lots of concern among the United States government about this company. All right, listeners, now is a great time to talk about one of our favorite companies, Lagora, the agentic operating system for legal work. Yes. Most of you have dropped a contract into a chatbot by now. But as a lawyer,

49:44how far can that really take you? It's never seen your firm's precedents. It doesn't respect confidentiality, and you can't check where its answer came from. So Lagora's founders approached this the way that great founders do. Early on, the team moved into the office of a big law firm in Stockholm and learned, for months, how the work actually gets done. A couple of thousands of enterprise customers and 100,000 users later, they still work that way. They employ 100 legal engineers on staff. These are lawyers sitting inside of firms and legal departments to deploy Lagora onto live situations like the deal closing this week or the policy review due Friday. The product has gotten very powerful in a short period of time. A year ago, the goal was a good answer from a chatbot. With the Lagora agent, you hand it the work and it comes back with a plan.

50:36Tasks like running diligence on a data room or reviewing a new vendor contract get completed inside the tool you use every day, like Microsoft Word, and against your own precedents and playbooks. Every finding is sourced, the lawyer directs the work and signs off before the system executes any steps. Every legal team can get access to the same AI models, so the models themselves do not give you an edge. What you can do with your own data, people, playbooks, that's the whole game. Today, over 100,000 legal professionals at more than 1,800 law firms and in-house legal teams in over 50 markets use Lagora. And when Lagora goes head-to-head with its top competitor and a pilot, it wins 70% of the time. A demo is one thing, but what matters most is an associate who reaches for it at two in the morning during a closing or whether a general

51:26counsel trusts what it says before the board meeting. So if your legal team wants to check it out, whether you're at a firm or in-house, go to lagora.com slash acquired and be sure to tell that Ben and David sent you. Let's recap a little bit just so that we understand where they are as a business today. So they've got these three business lines, the telecom carrier networks business, which we were talking about that makes all the telephone pole equipment, the devices business that with smartphones, that's the second largest by units in the world. And then they've got this enterprise business that provides equipment software and services to enterprise customers and government institutions. So this is a solutions or sort of a services business.

52:05If you look at what each of these businesses are doing, it's pretty interesting. So the business as a whole grew 21% last year. So they went from $93 billion in sales to $108.5 billion. If you look at and sort of zoom in on that, what's going on there, the consumer business, which I think is their handset business, grew by 45%. So at the scale they're operating, that business unit grew at, you know, 45%. The carrier business actually shrunk by 1% last year, which is pretty interesting. I'm wondering if that's sort of people were refusing to buy the Huawei 5G equipment before this whole sort of consumer goods thing started to really shake out. But, you know, if you look at 26% growth and one of your enormous businesses shrunk at 1%, well, that, you know, they clearly made that up in the consumer business.

53:00The enterprise business also shrunk, but it's sort of less important to them than those other two. Yeah. My understanding is the enterprise business is, as you were saying, basically implementations and solutions business for the carrier networking equipment. Yep, exactly. 52% of revenue is from China itself. So that's shifted back and China is more dominant for the company now from a purchasing perspective. If you read their annual report, they make a lot of noise about 5G. This is something the company is really beating the drum on. But if you look at the revenue line, smartphone shipments are really the primary growth driver of the company. So sort of interesting to see a sort of narrative and numbers mismatch there. Well, do you want to move into playbook, David? And, you know, not that we're not already here, but it feels like we've

53:46laid all the facts on the table. Yeah, yeah. So from a playbook perspective, aside from all the political questions surrounding Huawei, it's a really incredible example of seeing a long-term trend that is going to happen and capitalizing on it and capitalizing on it with really stellar strategy. The trend and trends that they capture were, you know, one, bringing China online, period, you know, building up telecommunications networks within China, you know, first as fixed line telephone, but of course that then bled into wireless and then the internet, but also So capturing that internationally and better than any of their competitors realizing this symbiotic relationship between the back end and the front end. As you said, Ericsson and Nortel and other back end equipment providers, you know, made half-hearted attempts at handsets over the years.

54:42But nobody has really been able to take the roadmap of what was going to be coming on the infrastructure side and translate that into compelling consumer devices. and compelling consumer devices available relatively early versus competitors in the market, as Huawei did. It's really well executed. There's a couple that I had on my list. The first is just an observation. The second is a geopolitical comment, which we should probably say we're pretty unqualified to do geopolitical analysis here. And much like drifting into the airline industry for a little bit with the Alaska Airlines episode, here we are drifting into geopolitics away from our sort of tech and business analysis just a bit because I think it's obviously incredibly important to this company in this story. This playbook that they ran of how they grew in their first 10 years is really something that could only be done in China.

55:36If you thought, you know, hey, I'm going to start a company in the US. I mean, I'm pretty US centric in this show because like it's what we know. But if you were, say, living in Ohio and you said, hey, I'm going to start a business and over the next 10 years, I'm going to start by importing things and then I'm going to slowly start making my own and then I'm going to emerge as the dominant creator of that thing when I make my own. There are certain things that you wouldn't get to do, such as be really the only importer of something for an extended period of time and then undercut the price by two thirds in order to really get yours at the deepest distribution. There actually is one thing we glossed over a little bit in History and Facts, which Huawei was not the only company that was benefiting from state support in doing this throughout these decades.

56:30There is another company called ZTE, which is a Chinese telecoms company. It's a direct competitor to Huawei on both sides of the market, the back end and the handset side. It's smaller and not as successful as Huawei, but the government was also supporting that company as well. Okay, fair point. So there was some competition, but it was limited. Let me generalize my comment then and say that a lot of the lessons that could be learned and extrapolated from this company are not ones that would universally apply the way that we think about a lot of our business model frameworks. Yeah. The second sort of like geopolitical observation that I want to make is it's kind of unbelievable that to use the title of a book, the earth becoming flatter and the world becoming more globalized, that we are moving into an era where there could be two technology stacks.

57:18there's already kind of two internets. Like if you think about the, there's sort of an hourglass shape here where for thousands and thousands of years, the East and the West developed differently. And it's kind of incredible that two completely different language systems emerged. I mean, the sort of Latin character set and Germanic languages and Romance languages are all sort of super similar and use a similar character set or read a certain way or written a certain way. And Eastern languages are, they influence each other, but they definitely don't borrow from the sort of Western character set and Western way of writing things down and communicating. It was a long time until, you know, the 18th, 19th, 20th centuries where those two worlds really met and then did business and, you know, started to really mesh and the world became

58:06flatter and more globalized. And here we are like to 2019. And there's little cracks where it's starting to drift apart again. And it's just not a thing that I would have predicted. Yeah, me neither. And it's so weird. And again, part of why we're doing this episode, weird and a little scary. I mean, to me, it's wonderful. It's awesome that like here for us at Acquired, like are some of our most popular episodes are Tencent or Alibaba, these amazing stories of globalization, of wealth creation, of education, and really not just in China, but across borders, you know, the ability for US investors and investors all over the world to be able to invest into those companies at a corporate level of like, like Yahoo, and like NASPERS, Yahoo and Alibaba and NASPERS and Tencent. And then of course, individual shareholders on the

58:59public markets. But then here you have this like, weird, other story that is now taking center stage. You know, I really hope this becomes a blip. And we go back to the incredible trajectory that this other narrative had been on. And with recent IPOs, of course, from China, Pinduoduo and Meituan Dengping and so many other great companies, it's really an oddity. Well, listeners, you know, this next section is usually grading, but since there's never been a transaction with this company, we have nothing to grade. I suppose maybe in the initial structure of setting up that 99% and 1% ownership, there's something there, but no party has ever taken control and watch value either appreciate or depreciate after that. And so what do we do here? Well, Dave and I were chatting before the episode and we thought what might make sense is just kind

59:48of to speculate on the future of the company and sort of think about which way things could go here. And if you're purely sort of an economic investor and thinking about the company, like, how would you sort of go about evaluating it at this point? Not that you could be, but just for fun. The downside is certainly down, but, uh, and this, these are some of the things that, that Ren was has been talking about in the interviews he's been given. It's not terrible. Like Huawei is, if things go, you know, South internationally for them, they're still very well positioned domestically in terms of 5g rollout. I mean, they do have the best integrated 5g technology in the market. And they of course have a tight relationship with the Chinese government, it's very plausible to believe that Huawei is going to be a big, if not the sole

60:39beneficiary of 5G rollout in China and in China's allies. I literally can't imagine a world where that doesn't happen. Now, what's interesting internationally, and I think this gets back to why is Huawei being treated so differently than these other great Chinese companies, is if this were happening with, say, Alibaba or Tencent, they would have a very, very powerful deterrent from any sort of less than malicious behavior or anything smelling like it internationally because they have the profit incentive. They would lose huge amounts of their business internationally if other countries stopped using their products. But for Huawei, because of the ownership structure and the incentives that they have, that's not as big a problem for them.

61:27That's pretty interesting to think about. Yeah, that capital structure, it's kind of like in early stage startups. And we've talked about this a little bit on the LP show, David, but that governance is a blessing in some ways where it can actually be to your advantage. because then if their capital structure was such that they did have a bunch of shareholders who could, of course, not only have the economic upside of the company being able to address a larger market and therefore the company naturally steering that way, but also a board who would sort of vote and say, it's important to us because we need to maximize the per share value of our ownership and every common shareholder's ownership. They could actually steer the company to do that. that is not the case here. The way that I sort of thought about grading is I have no concerns about

62:13the China market continuing the sort of massive, massive appetite to buy Huawei's great consumer devices. But they seem to be having a rough time selling their telecom or consumer equipment into Europe or North America. And so were this a company you could economically participate in, I would sort of want to evaluate the prospects of being able to do either one of those things, sell the telecom or consumer equipment abroad and i guess i shouldn't say abroad but in in uh in the u.s specifically and the u.s as allies and i also would want to really dig into how so how expensive is it going to be for us to write a new instruction set architecture build new chips write a new operating system and and build that new developer ecosystem that's a new stack so yeah totally agree all right carve outs well on that note it shouldn't rush us here like

63:07should we take a deep breath should we say oh my god like yeah this is this is quite the uh quite the different acquired episode yeah quite the different acquired episode well yeah thanks for bearing with us listeners as the show has grown it's been great to get feedback on every episode so i think if you if you do know more than we do here um would love to hear it and happy to do any uh any follow-up or or maybe do a follow-up as a as an lp episode or something like that but would love your uh your takes on this and if you know anything we don't would love to hear that too yeah car routes car routes i just got back from uh summer vacation in europe had a great time we were in morocco and portugal portugal is a great great country highly recommend it if you want a beautiful, relaxing travel with diversity of all types there. It was really

63:57wonderful. But while I was on vacation, I reread the Dune series by Frank Herbert. Just excellent, classic, classic, classic science fiction series apt for this episode because, you know, really an analogy of politics and political systems and long-term implications of different versions of that but so good and super cool also like i i didn't realize the first time when i read dune many years ago but reading it now like the influence on star wars is like so clear so clear especially the first one dune very very clearly you can see where george lucas was influenced by it. That's cool. I have to confess I did not make it through Dune. I may pick it up and give another shot. My carve out is the Showtime original series Billions. David, have you watched this? I have not, but so many people have recommended it. I am, after this

64:56episode, going to watch the final episode of season four after just binging all four seasons over the last month or so, it is absolutely spectacular. And if you like this show and you like good drama, it is like an absolute treat to watch every episode. So the show is created by Brian Koppelman, David Levian, and Andrew Ross Sorkin, who some of you may recognize as a New York Times writer. Brian Koppelman, who sort of is the lead on it, is also the guy behind the movie Rounders, which some of you may remember with Matt Damon and Ed Gordon. classic great story so billions uh getting into the plot is is loosely based on preep barara who was the u.s district attorney for the southern district of new york and his massive legal battle um with uh steve cohen who's a of course a big uh hedge fund manager and it's played uh sac right

65:50yep yep and the roles are so paul giamatti plays the attorney for the southern district and uh Damian Lewis plays Bobby Axelrod, who is running Axe Cap, which is the sort of top, top fictional hedge fund on the street. And the drama that ensues and the cat and mouse game and the whole dance between these two characters and every other character involved is like a total treat to watch. And frankly, I want to hurry up and finish this episode so I can go and watch the last episode. All right. Well, on that note. All right, listeners, now is a great time to talk about one of our favorite companies, Statsig. Yes, there is a reason why the best product teams rely on Statsig, whether they are iterating on their core product features or shipping AI-powered experiences at scale. Yep. In the crazy speed of today's AI world, shipping fast is just table

66:45stakes now. It's basically trivial to build and deploy your app constantly. The real advantage is how quickly you learn what changes actually created value for customers and how fast you can use that signal to guide what you ship next. This is where Statsig comes in. It brings experimentation, feature flags, and product analytics into one unified system so teams can ship safely, test rigorously, and directly link what they changed to how users actually behaved. So if you want to make learning your competitive advantage, whether you're building new AI experiences or just evolving your existing core product, Go to statsig.com slash acquired to get started. If you aren't a limited partner yet, subscribing gets you access to our bonus show where we dive deeper into the nitty gritty of building companies. And last week we covered due diligence and the work that typically gets done

67:35by a venture capitalist and an entrepreneur in the diligence process. To listen, you can click the link in the show notes or go to glow.fm slash acquired and all new listeners get a seven day free trial. David and I are going to record another one of those this week and you should see that popping into your podcast player if you are already an LP or if you're trialing a new subscription you will see it as well so with that we will see you next time see you next time