20 April 2019
Xiaomi is preparing for an IPO in Hong Kong and a CDR issue in China at lofty valuation. Photo: Reuters
Xiaomi is preparing for an IPO in Hong Kong and a CDR issue in China at lofty valuation. Photo: Reuters

Can Xiaomi justify an extremely high valuation?

Xiaomi Corp, which is readying for a blockbuster initial public offering in Hong Kong, has unnerved some investors as it revealed a loss of nearly US$1.1 billion for the first quarter of 2018.

In a filing in China in relation to a planned Chinese depositary receipts (CDRs) issue, which will take place alongside the Hong Kong IPO, the smartphone maker said it recorded a net loss of 7 billion yuan for the first three months of this year.

The negative bottom line, which followed a full-year 2017 loss of 43.9 billion yuan, has left people wondering as to when the company, which was founded in 2010, will turn in a profit. 

More importantly, questions are being raised once again whether Xiaomi deserves the high market valuation it is seeking despite an apparent loss-making business model.

Xiaomi is gearing up for a Hong Kong offering, with the listing plan said to have been approved by stock exchange officials last week.

The Chinese smartphone maker will be the first entity to be listed in Hong Kong under a new regulatory regime that allows companies to issue shares with weighted voting rights.

After getting cleared for the Hong Kong listing, Xiaomi quickly filed an application for issue of CDRs in the mainland to allow investors there as well to buy into the company, becoming the first to launch such depositary securities.

According to latest reports, Xiaomi plans to raise around HK$39 billion in Hong Kong IPO and HK$39 billion in CDRs. The valuation of the firm could be in the range of US$70 billion to US$90 billion.

Xiaomi’s US$10 billion stock sale plan has generated a lot of interest among investors given the surge in share prices of some recent tech listings, but some observers are also questioning the lofty valuation.

The first-quarter financial report has added to such doubts. 

Xiaomi said it had a 7 billion yuan loss in the first quarter, on revenue of 34.4 billion yuan, due to one-off accounting charges. Excluding those charges, it claimed a profit of 1.7 billion yuan, boosted by an 88 percent rise in smartphone sales during the quarter.

Despite the operating profit, observers note that Xiaomi’s reported valuation makes it twice as expensive as Apple.

The Chinese firm is coming to market at 27-34 times 2019 adjusted earnings forecasts, compared to Apple’s current valuation of 14.5 times forward earnings.

Morgan Stanley, one of banks involved in Xiaomi’s Hong Kong IPO, has argued that Xiaomi deserves to trade at a premium to global phone brands in view of its market share gains and faster growth.

The investment bank pegged Xiaomi’s fair value in the US$65 billion to US$85 billion range, Bloomberg reported. 

But not all are convinced. 

Xiaomi’s success has been due to low-price smartphones such as the Redmi series and connected gadgets like air purifiers and rice cookers. The business can’t support such high valuation, skeptics say.

But others aver that what should really be looked at is the growth potential of the internet services behind the hardware.

Xiaomi founder and CEO Lei Jun had said the company will only keep 5 percent gross margin in its hardware business as the tech firm wants to sell advanced technology products at affordable prices. The tech firm is positioning itself as a software and internet services entity, citing its widening user base and connected ecosystem of devices.

Xiaomi is betting on fast growth in smartphone and IoT products to push its business in the next two to three years. Admittedly, its disrupting business model, involving online and offline sales channels in China and some key markets overseas, particularly India, is not easy for rivals to copy on scale.

While smartphone is still a core segment of revenue for Xiaomi, IoT products are also becoming an important component as more people are using such products to demonstrate style and taste. However, IoT products are still in the early stage of the development life-cycle. Also, the internet service is yet to demonstrate the potential to emerge as a core profit center.

Several investment banks had issued pre-IPO research reports on Xiaomi. Deutsche Bank believes Xiaomi can grow its global smartphone shipment market share from 6.2 percent in 2017 to 11.9 percent in 2020. Meanwhile, IoT revenue market share is seen rising from 0.7 percent to 1.4 percent.

Internet service revenue would be linked with the installed base of smartphones. According to the German bank, the service revenue could jump 39 percent between 2018 and 2020. What’s more important for investors is that internet service revenue gross margin is seen several times larger than the hardware gross margin.

In order to reduce its reliance on the China market, Xiaomi has expanded overseas, especially in India and Europe. India has emerged as the firm’s second-largest market, marking a big feather in the cap for the Chinese smartphone maker.

However, that success carries risks as well, given the frequent debates in India about the proliferation of Chinese products in the country and the need to curb imports. Given the often fraught political relations between the two nations, Xiaomi could be vulnerable to changes in Indian government policies on Chinese technology products.

The company certainly cannot take its market position in India for granted, which is something that investors need to bear in mind.

Given all these factors, what valuation does Xiaomi really merit, stripping away the hype from the company and its investment bankers?

Can anyone really be sure?

– Contact us at [email protected]


EJ Insight writer

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