Cisco Systems faces a backlash in China, where it generates about $2 billion in annual sales, after state-run media said the company poses a security threat and urged a shift toward domestic suppliers.

While Cisco (Nasdaq: CSCO) has said it didn’t participate in U.S. surveillance programs revealed earlier this month by former government contractor Edward Snowden, state-owned Chinese media outlets are calling for the company to face restrictions there.

China should develop its own Internet technology, the Global Times newspaper wrote in an editorial this week, alleging that the U.S. can “attack China almost at will.” U.S. companies, including Cisco, represent a “terrible security threat,” China Daily reported, citing an industry source it didn’t identify. Shenzhen-based Huawei Technologies Co. is poised to benefit from any clients seeking Cisco alternatives.

“Huawei will take this and run with it, to leverage its position with customers in its home turf,” said Ray Mota, founder of ACG Research, a networking-equipment industry consulting firm.

The media attacks add to Cisco’s challenges in the world’s second-largest economy, where the company has been losing share to local competitors, including ZTE Corp. Even as the Chinese market for switches and routers surged 20 percent to $2.58 billion last year from 2010, Cisco’s market share fell to 18 percent from 21 percent, according to Infonetics Research Inc.

While Huawei also lost ground, its 2012 share was more than double Cisco’s. ZTE’s share climbed to 29 percent from 18 percent over the two-year period.

Obama’s Ban

Cisco has suffered in China over the past year as the U.S. has blocked wireless carriers from using Chinese-made equipment to build mobile networks, citing security concerns. President Barack Obama signed into law a spending bill in March that prohibits federal agencies from buying IT systems from Chinese companies without approval from the Federal Bureau of Investigation or other federal cyber-espionage investigators.

“We also continue to see challenges in China,” Cisco Chief Executive Officer John Chambers said on a May 15 conference call. “We do believe we are making progress, although we expect these challenges in China to last for several more quarters.”

Even so, China accounts for less than 5 percent of Cisco’s revenue and profit, according to John Earnhardt, a spokesman for the San Jose, California-based company. He also denied any involvement in the U.S. surveillance initiatives, outlined in articles in the Guardian and Washington Post this month.

No Monitoring

“Cisco does not monitor communications of private citizens or government organizations in China or anywhere in the world,” Earnhardt said in an e-mailed statement. “We sell the same equipment globally, including both China and the United States, with no customization for purposes of such programs.”

Snowden, a former Booz Allen Hamilton Holding Corp. employee, has identified himself as the source for revelations about National Security Agency programs to collect data on foreigners, relying on U.S. phone and Internet companies. He later said the U.S. had hacked Chinese and Hong Kong targets since 2009 and had tapped Chinese mobile phone companies to steal millions of text messages, according to the South China Morning Post.

Cisco could be insulated from a sustained backlash in China because of its long history there, said Mota at ACG Research. Cisco worked closely with the Chinese government to develop the country’s Internet infrastructure in the 1990s and continues to teach thousands of Chinese technicians to use its products.

China Mobile

Sales to carriers such as China Mobile Ltd. and China Unicom (Hong Kong) Ltd. will not disappear entirely, as these customers can’t risk doing without Cisco’s innovative new products, according to Infonetics co-founder Michael Howard. Cisco recently announced an upgrade of its largest router, the CRS-X, that can process 10 times more data than it did ten years ago.

“Cisco gear is always going to be in China’s backbone networks,” Howard said. Big Chinese carriers “don’t want to wind up having just Huawei and ZTE.”

Scott Sykes, a spokesman for Huawei, and David Dai, a spokesman for ZTE, both said they couldn’t comment specifically on Cisco’s business in China, or how it would be affected by the reports on U.S. spying.

“For cybersecurity in general, it is a global challenge which requires a collaborative approach by governments and the industry to address,” Huawei’s Sykes said in an e-mail. “Governments, operators and vendors need to each take responsibility to raise the standards for cyber security protection.”

ZTE Gains

Snowden’s leak should boost ZTE’s share of network projects at Cisco’s expense, said Ricky Lai, an analyst at Guotai Junan International Holdings Ltd. in Hong Kong, who hasn’t yet produced a detailed forecast for the impact on ZTE. He rates shares of ZTE buy.

Mounting criticism in state media over the past week indicate Cisco’s Chambers has his work cut out in China.

“Recent events mean that it may be quite a long time before we can trust Cisco again,” the Global Times wrote in June 20 editorial titled “Cisco Under a Cloud of Suspicion.” “We can probably expect Chinese authorities to tighten their supervision over Cisco’s operations in the domestic market. It also wouldn’t be surprising to see Cisco soon eclipsed by local competitors Huawei Technologies Co. and ZTE Corp.”

[Cisco operates its second largest campus in Research Triangle Park, N.C.]