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NSA Revelations Tarnish Reputations of US Tech Firms Abroad

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Companies like Cisco, IBM, and Hewlett-Packard are seeing revenue drop in China.

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At the height of the Cold War, Xerox (NYSE:XRX) was one of America's top spies.

The company, which was once synonymous with the cutting edge of technology, produced the first copy machines. They were so complex and difficult to reengineer that even Soviet Embassies had no choice but to use them. When the CIA noticed that the only American allowed into the Soviet Embassy in Washington was the Xerox repairman, they approached the top management and arranged for a secret group of engineers to install a home-movie camera into the copier. Every two weeks, the servicer cleaned the Soviet copier, pulled out bugs, and walked off with negative images of documents such as the identity of Russian spies all over the globe.

Eventually, the CIA began to install these surreptitious cameras into the Xerox machines in embassies of both enemies and allies.

Imagine if those countries had known that the same machine that relieved them of carpal tunnel syndrome was silently sending their secrets to Washington.

This story might sound quaint to today's readers. Former National Security Agency contractor Edward Snowden has made us all aware of how closely US tech firms work with America's intelligence community. Now that the secret is out, it's hurting IT companies' bottom lines. The IT sector in the US stands to lose tens of billions due to this stain on its reputation.

This summer, Snowden released (via journalists) thousands of secret documents that described phone-record surveillance and monitoring of Internet usage for anyone believed to be a foreigner. The spy agency also hacked network backbones to suck up traffic data. Later, reports by several outlets found that the NSA had some device makers install backdoors to facilitate their spying.

Now, Chinese firms, many of which are tied to the state, are wary of importing machinery from American IT giants.

This month, Cisco Systems (NASDAQ:CSCO), the biggest networking company in the world, reported a 10% sales drop in China for the June-September quarter. Cisco's stock dropped after the company warned that revenue would be weak due to "challenging political dynamics" in China. IBM (NYSE:IBM) reported a 22% drop in China revenue.

According to a Reuters report, Hewlett-Packard (NYSE:HPQ) also stumbled on fears that it will experience the same difficulty in the world's second-largest economy, where it derives a fifth of its revenue. As the PC market stagnates, HP relies on emerging markets such as China for growth. Much of this could be illuminated in tomorrow's HP earnings report.

China was also the weakest market for Microsoft (NASDAQ:MSFT) in the past quarter.

Forrester Research estimates that the NSA disclosures could cost US companies $180 billion in lost business, or 25% of all IT services by 2016.

Beijing has long mistrusted foreign IT firms, and the Snowden revelations have made it worse, according to the Chinese executives that Reuters interviewed. The government hasn't prohibited deals with Western companies, but the state media labels Cisco and others as "terrible" security threats. The message that private and state-owned companies should be buying from Chinese companies is clear.

Ironically, it is the United States that officially shut out Chinese players a year ago. The House of Representatives Intelligence Committee said that Huawei (SHE:002502) and ZTE (SHE:000063) are credible national security threats because of their ties to the state and the military. The panel urged regulators to block any mergers or acquisitions from those two companies. At a cybersecurity conference in October, Huawei representatives gloated over the fact that the Chinese government has never asked for access to its technology.

Damage from the Snowden revelations could still spread into other markets. Germany and Brazil, whose heads of state were allegedly phone-tapped by the NSA, are incensed. Germans are calling for more home-grown tech as a result. India is reportedly considering banning popular email services like Yahoo (NASDAQ:YHOO) and Google (NASDAQ:GOOG).

Whether this storm will last long enough for foreign rivals to develop sophisticated high-end equipment to rival US technology is uncertain, but it should be evident that this summer's NSA revelations are not doing any good for American companies.

Twitter: @vincent_trivett
No positions in stocks mentioned.
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