UPDATE 1-China's ZTE logs biggest quarterly profit fall since 2006

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* Q2 net profit 94 mln yuan - Reuters calculations

* Telecoms gear spending should pick up in H2 - analyst

By Lee Chyen Yee

HONG KONG, Aug 22 (Reuters) - ZTE Corp, the world's fourth-biggest mobile vendor and fifth-ranked telecoms gear maker, posted an 85 percent drop in quarterly profit on Wednesday, squeezed by sluggish equipment sales and fierce competition in handsets.

The outlook for Shenzhen-based ZTE is further clouded by an FBI probe into allegations it illegally sold U.S. computer products to Iran. U.S. lawmakers have also called on U.S. Treasury Secretary Timothy Geithner to investigate ZTE, which could face steep fines and restrictions on its U.S. operations. Separately, the European Union is investigating whether ZTE benefited unfairly from Chinese government subsidies.

Those probes and the weakening business outlook have more than halved ZTE's stock price in Hong Kong this year.

"ZTE's performance for the whole of this year should be an improvement from last year," Michael Li, an analyst with Everbright Securities in Hong Kong, said ahead of the earnings release. "Spending by China's telecom carriers should be a bright spot compared to other markets globally, especially next year."

"The biggest risk in sight is the U.S. probe over ZTE's sales of banned equipment to Iran," added Li.

STEEPEST FALL SINCE HK LISTING

ZTE posted January-June net profit of 244.88 million yuan ($39 million), better than market expectations for 223.6 million, according to seven analysts polled by Reuters, but well below the 769 million yuan reported a year earlier.

Based on Reuters calculations, ZTE earned 94 million yuan in the second quarter, compared to a forecast of 72.7 million yuan and down from 642 million yuan a year ago - the steepest drop since the first quarter of 2006.

Apart from the first quarter, ZTE has logged net profit falls since the second quarter of last year.

ZTE had warned last month that first-half profit could fall by as much as 80 percent, as gross margins have been squeezed, foreign exchange losses have mounted due to the credit crisis in Europe and China Mobile Ltd postponed its network tender.

Analysts also noted that ZTE's year-ago earnings were inflated by the sale of shares in its Shenzhen-listed unit Nationz Technologies Inc.

TELCO GEAR PICK-UP

Telecom equipment makers such as Ericsson, Huawei Technologies Co Ltd and Alcatel Lucent have reported disappointing results this year as telecom carriers cut back on spending during the tough economic climate.

But analysts expect a pick-up in Chinese telecom spending later this year, which should help ZTE's second-half earnings.

"Our channel check shows that Chinese telecom operators completed only 30 percent of their full-year capex in the first half, and we expect them to fulfill their full-year plans," BOCI Research said in a recent report.

Chinese vendors Huawei and ZTE have been diversifying into handsets, where they have aggressively chased market even at the expense of low margins. Both have said they plan to sell higher-end smartphones to boost margins in the coming years.

ZTE has seen its gross profit margins fall to below 30 percent, lower than Alcatel's around 40 percent and Ericsson's 38 percent, according to Thomson Reuters StarMine data.

ZTE is around one third owned by Zhongxingxin Telecom Equipment, which is based in the southern city of Shenzhen and has state-owned shareholders. Other stakeholders include China Life Insurance Co and BlackRock Asset Management.

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