Richard Windsor
6 December 2017

Xiaomi – Market timing

Xiaomi considers a market event just as growth peaks again

Xiaomi’s genius for timing is confirmed as talk of an IPO is beginning to ramp up just as its recovery growth rates are about to peak. However, this time around, profitability will be open and clear for all to see and it is here where the problems will arise. To be fair to Xiaomi, it has executed extremely well and has been rewarded with a period of very rapid growth as its strategy to distribute through methods other than the Internet and to focus on India has paid off in spades.

Xiaomi’s performance really turned around in Q2 17A where YoY growth in smartphone shipments went from -8% in Q1 17A to 59% YoY in Q2 17A. This was a result of big changes implemented by Xiaomi. The new flagship Mi 6 launched at the beginning of the quarter was well received and looks to have been the backbone of the recovery. We have long been of the opinion that Xiaomi ground to halt because it had fully exhausted the capacity of selling devices over the internet. In order to address a wider slice of the market, Xiaomi has invested heavily in retail with 123 MI stores opened across China and the first results from this push are now being seen in the numbers. Investments in India are beginning to pay off with the Redmi Note 4 becoming the biggest volume smartphone in Q2 17, elevating Xiaomi to No. 2 in India.

By far the largest part of Xiaomi’s overseas fan base is to be found in India and this should help the fan base to grow further. However, India can be one of the most fickle markets as it is so price driven and as many Indian brands have found, success can be all too brief. While growth is clearly back at Xiaomi, the comparisons to the torrid time it had in 2016 are really easy as after Q2 2018, growth is likely to slow substantially as the comparisons to the previous year will become much more challenging. Consequently, sometime in H1 2018 is the perfect time to achieve the best possible IPO price as growth will then be at its highest. However, the big question mark is profit, as it is through profit alone that an equity based investment can have any value at all. Here, we are still very cautious as Xiaomi’s strategy is based on providing good quality hardware at a great price. This combined with the fact that it does not have Samsung’s scale in handsets means that it is very unlikely to make more than a commodity margin.

When we are as kind as we can be to Xiaomi, we can assume that its smartphone ASP is $270 on 118m units shipped in 2018 with $5.4bn in revenues from smart home products. Assuming an EBIT margin of 5%, this gives 2018 revenues / EBIT of $37.31bn / $1.87bn implying an EV / Sales multiple of 1.3x and EV / EBIT of 26.7x if the company is valued at $50bn. For an EV / Sales valuation, this is not difficult to reach as Apple is trading on 2018 EV / Sales of 2.7x and Xiaomi is growing faster. However, equity valuation is about profit with revenues being used as proxy when there are no profits. Using EBIT, a very different picture emerges as Apple is trading on 8.4x EV / EBIT and at $50bn, Xiaomi would be on 26.7x. Xiaomi is growing faster than Apple but this is unlikely to last very long and its efforts to build a software ecosystem have been crushed by the BATmen at home and are irrelevant overseas. Hence, it has very little with which to differentiate its wares meaning that it has to compete almost entirely on price.

Consequently, the most we would be willing to even remotely consider paying for Xiaomi would be double Apple’s EV / EBIT multiple which would give a valuation of $31.3bn, some 37% below the mooted $50bn.To get to $50bn, Xiaomi would need to put up EBIT margins of at least 8.0% which is a stretch given the company’s strategy of selling great hardware at good prices. The advantage of an IPO is that these facts will all be laid bare long before investors have to commit to buying the shares. We suspect that its lack of profitability will keep it from going public until it is capable of putting up much bigger profit numbers.

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