Xiaomi – Market timing

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Xiaomi considers a big equity 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 I think 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.
  • According to Counterpoint, 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 three big changes implemented by Xiaomi.
    • First: new products. 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.
    • Second: retail channel. I 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.
    • Third: India and overseas: 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 for me is profit, as it is through profit alone that an equity based investment can have any value at all.
  • Here, I am 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 I am as kind as I can be to Xiaomi, I 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 me 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, as I have said above, 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 I 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 I think 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.
  • I suspect that its lack of profitability will keep it from going public until it is capable of putting up much bigger profit numbers.

 

 

Ola vs. Uber – Turntable

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Ola has one chance to turn the tables on Uber.

  • Ola has secured $2bn in funding from Softbank and Tencent which it must immediately put to good work if it is to wrest the advantage from Uber in India.
  • I think that this is an excellent time for Ola to receive a large cash injection as it is almost neck and neck with Uber in India and has the advantage of focus while Uber fights endless fires elsewhere.
  • This advantage will not last for ever and if Ola can push its share back to 60% it will stand a chance of doing to Uber what Didi in China and Yandex in Russia have done before it.
  • Car hailing is one of the best examples of a networked economy and, just like classifieds, it is extremely difficult to make money until one of two criteria are met:
    • First: one must have at least 60% market share or
    • Second: one must have double the market share of the next largest player.
  • Data in terms of market share has been somewhat unreliable but it looks as if Ola has been able to cede only a small amount of market share in the last 12 months.
  • Research by KalaGato Pte shows that Ola’s share in July was around 44% with Uber on 50% with everyone else fighting for the scraps.
  • In October, Ola’s market share was around 50% (see here) and it looked to me like Ola would only survive with state intervention.
  • During March 2017 Ola’s rides per customer stood at 2.95 while Uber were 4.38 with 40.9% of Uber customers paying less than Rs100 per ride while only 31.4% of Ola’s customers paying less than Rs100.
  • While not definitive, this data indicates that Uber has been gaining share through aggressive pricing and the good user experience offered by the app.
  • However, I think that Uber’s troubles have had a massive ripple effect right the way through the organisation resulting in the eye coming off the ball.
  • It is this that has given Lyft a new lease of life in USA and now offers the same chance to Ola.
  • This turmoil has only intensified with Transport for London denying Uber a licence to operate necessitating even more diversion of attention away from India.
  • This $2bn investment and Uber’s focus elsewhere gives Ola a chance to halt its recent losses and turn them around.
  • What it has to do appears to be quite clear:
    • First: cut prices and
    • Second: improve the usability of its app and service.
  • If Ola can get back to 60% share then it will have reached the hallowed status at which it will be able to generate cash and Uber will not.
  • It is at that point it will be in a position (as long as it holds onto 60%+) to eject Uber from India (probably through acquisition) but not before.
  • Now it all comes down to Ola management’s ability to execute and upon this, everything depends.

India e-commerce – Second front.

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Amazon goes for the jugular.

  • Amazon is not content just to let its rivals gift it the Indian market through their own bad decisions but is going for the jugular by opening up a second front in bricks and mortar retail.
  • Amazon is buying a 5% stake in Shoppers Stop for $28m which will enable Shoppers Stop to increase the number of stores it has by 25% thereby expanding its reach into smaller towns.
  • Currently only 5% of retail sales are made online in China meaning that for at least some time to come it will be an advantage to have an offline presence.
  • This is exactly the strategy that Alibaba is pursuing in China and is looking to improve the poor offline experience by adding in technology and know-how garnered through its growth online.
  • All of Shopper Stop’s stores will play host to Amazon experience centres in order to educate and inform users with regard to the benefit of e-commerce.
  • Shoppers Stop’s will also have an exclusive flagship store on Amazon’s Indian website which will help Amazon deepen its offering to Indian consumers.
  • This is yet another blow to the local players Flipkart and Snapdeal whose inability to merge looks likely to hand the Indian market to Amazon.
  • Flipkart, Snapdeal and Amazon are network businesses just like Uber, Alibaba, AirBnB, Craigslist and so on and consequently, they are bound by the same rules.
  • 20 months ago I proposed a rule of thumb that states: A company that relies on the network must have at least 60% market share or be at least double the size of its nearest rivals to begin really making profit (see here).
  • Together, Flipkart and Snapdeal would have just about hit this threshold and with flawless execution might just been able to see off the threat from Amazon (see here).
  • However, Snapdeal recently ended merger discussions with Flipkart in a move that I think hands could easily hand victory to Amazon.
  • Furthermore, having been soundly beaten in China by Alibaba, Amazon is absolutely determined to win the Indian market and I estimate that it is currently burning at least $400m per quarter to make that happen.
  • In my opinion, the move by Snapdeal demonstrates a fundamental misunderstanding of how Amazon works and what it is likely to do to win the Indian market.
  • Most companies have a strategy that involves trade-offs such as offering high quality or low prices.
  • This is the route that Snapdeal is taking by deciding to streamline and focus on giving sellers the best experience in India.
  • This is not how Amazon functions as there is no either / or in its vocabulary.
  • Instead Amazon goes for dominance and offers high quality and low prices or in this case the best experience for both sellers and buyers.
  • Even with extra backing from Softbank, I do not think that Flipkart has the depth of management or the financial resources to withstand this ruthless onslaught and I think that it is unlikely to ever make a good return for its shareholders.
  • The outlook for Snapdeal is even worse as it is much smaller with far less to invest.
  • I think Amazon will now be able to grind its two main rivals down to the point at which they either exit the market or agree to be acquired.
  • Both of these scenarios are likely to result in much lower valuations than were being discussed as part of the merger.
  • Hence, I think that Amazon is the only real winner from the strategic choices being made by Flipkart and Snapdeal.
  • However, in the short-term $400m cash burn per quarter is unlikely to help Amazon’s fundamentals much and so I remain unenthused with an investment in its shares.
  • I continue to prefer Tencent, Baidu and Microsoft.

Indian e-commerce – Road to ruin.

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The only likely winner in India is now Amazon.

  • Snapdeal has ended merger discussions with Flipkart in a move that, I think, snuffs out the one chance the local players had to keep Amazon at bay.
  • At the same time Softbank is now looking at committing $1.5bn – $2bn into Flipkart in a move that I think will solve nothing because in a network economy, two halves do not make a whole.
  • I think Softbank should not put any more money into Indian e-commerce as the most likely winner in this market is now Amazon in which Softbank has no stake.
  • Snapdeal’s strategy is now to become a niche player and is cutting costs and selling assets in order to raise the capital required to reach profitability in its niche.
  • In my opinion, this strategy demonstrates a fundamental misunderstanding of how Amazon works and what it is likely to do to win the Indian market.
  • Most companies have a strategy that involves trade-offs such as offering high quality or low prices.
  • This is the route that Snapdeal is taking by deciding to streamline and focus on by giving sellers the best experience in India.
  • This is not how Amazon functions as there is no either / or in its vocabulary.
  • Instead Amazon goes for dominance and offers high quality and low prices or in this case the best experience for both sellers and buyers
  • How Flipkart will alter its strategy following the failure of the merger remains to be seen, but without the scale that Snapdeal would have given it, its chances of seeing off Amazon are greatly reduced.
  • Flipkart, Snapdeal and Amazon are network businesses just like Uber, Alibaba, AirBnB, Craigslist and so on and consequently, they are bound by the same rules.
  • 20 months ago I proposed a rule of thumb that states: A company that relies on the network must have at least 60% market share or be at least double the size of its nearest rivals to begin really making profit (see here).
  • This, in a nutshell, is the problem faced by both Flipkart and Snapdeal in India.
  • Flipkart is bigger than Snapdeal and so it is in a slightly better position, but it is not double the size of its nearest rival.
  • Furthermore, both will now have to contend with Amazon which is absolutely determined not to make the same mess of India that it made in China when it went up against Alibaba and lost.
  • I estimate that Amazon pumped $400m of losses into the Indian market in Q1 17A and roughly the same amount again in Q2 17A and I don’t think it will be afraid to up the ante from here if needed.
  • Amazon is not the largest in India but it can lose far more money for far longer than either of the other two.
  • Flipkart has around 35% of monthly active users but it will need to reach at least 50% before it is double the size of Amazon (7Park Data).
  • This is why a Snapdeal merger made sense, because adding Snapdeal’s users to its own would have got it pretty close to achieving that milestone.
  • Consequently, Amazon will now be able to grind its two main rivals down to the point at which they either exit the market or agree to be acquired.
  • Both of these scenarios are likely to result in much lower valuations than were being discussed as part of the deal.
  • Hence, I think that Amazon is the only real winner from the failure of this merger which I think raises existential questions for local providers of e-commerce marketplaces in India.
  • In the short-term this is unlikely to help Amazon’s fundamentals much and so I remain unenthused with an investment in its shares.
  • I continue to prefer Tencent, Baidu and Microsoft.

 

Xiaomi – Back in black

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Xiaomi is back but ecosystem nowhere to be found.

  • A monster quarter has brought Xiaomi back into contention as a major player in the smartphone industry but this recovery needs to be more than just a product cycle for it to stay there.
  • In a letter to employees, CEO Lei Jun has announced that Xiaomi has shipped 23.16m smartphones in Q2, up 70% QoQ.
  • Most importantly, this represents a significant gain in market share from 3.6% in Q1 2017 to as much as 6% in Q2 2017.
  • This looks to have been achieved through a combination of factors:
    • First: new products. The new flagship Mi 6 launched at the beginning of the quarter which was well received and looks to have been the backbone of the recovery.
    • Second: retail channel. I 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.
    • Third: India and overseas: 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.
  • This quarter will mean that its revenue target of RMB100bn in 2017 should be reasonably easy to achieve but the company also set itself the target to ship 100m smartphones in 2018.
  • This is achievable as long as the company can hold onto the share that it has so suddenly won back.
  • For me, this is the big question as if most the volume is coming as a result of its nice new products or very generous pricing (India), then this is unlikely to be sustainable.
  • This will result in a few very strong quarters as its fan base upgrades and then a drift back to baseline.
  • I think Xiaomi has a chance to avoid this with its growth outside of China and its push into retail but it will cost it dearly in profitability.
  • This is because amongst all of this success there is no mention of its ecosystem anywhere.
  • This leads me to believe that Xiaomi is still selling its products pretty much on the basis of good quality hardware at very attractive prices.
  • Only by luring users in and having them identify with Xiaomi software and services can Xiaomi ever really hope to make than a commodity margin in smartphones.
  • Hence, I still think that Xiaomi, like all of its Android brethren (except Samsung) is making 2-4% EBIT margins in the best instance.
  • This means that even hanging onto this level of market share in the long term would see EBIT generation of around $1.5bn per year.
  • This is not nearly enough to justify anything like the $45bn at which it last raised money, but it is enough for Xiaomi to remain independent.
  • The risk of being acquired by Tencent or Alibaba will decrease, should this new level of market share prove to be sustainable.

Amazon – A song of ice and fire.

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Project ice has nothing to do with phones.

  • After racking up nearly $1bn in losses from its last foray into handsets, one would think that Amazon would have had enough but it appears that it is at it again but for a totally different reason: India.
  • Project ice appears to be the development of another Android device but this time at the other end of the price spectrum.
  • One of the devices in the pipeline features a 5” to 5.5” screen with 2GB RAM, 16GB of storage, Snapdragon 435 and a cracking price to match at around $93.
  • The device is fully Google compliant with its ecosystem installed and set by default but I am pretty sure that at least Amazon’s core e-commerce apps will also be installed.
  • Amazon’s last set of results (see here) showed a big dent in profitability in its overseas operations that I think can be largely put down to its determination not to lose India as it lost China.
  • Alibaba wiped the floor with Amazon (and Walmart) in China and with developed markets maturing, Amazon’s long-term growth is at least partially dependent on history not repeating itself in India.
  • In the Indian market, Amazon is the underdog with around 23% market share compared to Flipkart on 35% and Snapdeal on 15%.
  • However, it is by far the best financed and if it comes to last-man-standing battle, it is likely to win.
  • However, Softbank, the backer of Flipkart is keen for it to merge with Snapdeal which if perfectly executed, would give the combined entity 50% share (see here).
  • According to RFM’s rule that to become the go to place to transact, a marketplace must have at least 60% market share or be at least double the size of its nearest rival (see here).
  • The combination could be enough to see off Amazon but never to back down from a fight, Amazon has a trick up its sleeve.
  • I have long believed that the internet in India has very little to do with fixed (like developed markets) and everything to do with mobile (like China).
  • Consequently, the ice device portfolio could serve as a way to encourage users to do their online shopping with Amazon rather than Flipkart & co.
  • Google has no e-commerce offering to speak of and so Amazon can produce Google ecosystem devices (which Indian users demand) and at the same time install its shopping apps, optimise them and set them by default.
  • Studies have shown time and again that having apps preinstalled leads to them working better and being used more, even if they are not as good as other apps that need to be downloaded (e.g. Apple Maps).
  • Hence, I can see Amazon selling ice devices at 0% gross margins in order to win over more affluent Indian users to its shopping proposition at the expense of Flipkart & co.
  • This is exactly the strategy that it uses with Fire tablets and Kindle with the money being made on the content sold over the device.
  • This example looks no different except that the strategy here is to gain share in e-commerce before Flipkart can reach an unassailable position through consolidation.
  • This is why Flipkart has to act promptly to consolidate Snapdeal as the longer it delays, the more share Amazon is likely to gain and the harder it will be to become twice Amazon’s size.
  • Amazon’s strategy to control the primary device, from which Indians will do their online shopping, only increases the urgency for it to act and act fast.
  • Winter is coming.

India e-commerce – The big if.

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Flipkart for Snapdeal looks increasingly likely.

  • The probability of consolidation in Indian e-commerce is creeping ever closer as Softbank, is pushing for the sale of Snapdeal to Flipkart at a valuation considerably less than the $6.5bn at which the company last raised money.
  • I think this move makes complete sense as on their own, both Flipkart and Snapdeal are likely to be crushed by Amazon should it decide to pull out all the stops in order to dominate the Indian market.
  • This is because, on their own, neither of them is large enough to keep Amazon at bay, but together, they might just have a chance.
  • Snapdeal and Flipkart like Alibaba and to a lesser degree Amazon are market places which bring together merchants and buyers in one easy to use location and from which they can take a small cut.
  • In effect, they are network businesses just like Uber, Alibaba, AirBnB, Craigslist and so on and consequently, they are bound by the same rules.
  • 18 months ago I proposed a rule of thumb that states: A company that relies on the network must have at least 60% market share or be at least double the size of its nearest rival to begin really making profit (see here).
  • This, in a nutshell, is the problem faced by both Flipkart and Snapdeal in India.
  • Flipkart is bigger than Snapdeal and so it is in a slightly better position but it is not double the size of its nearest rival.
  • Data from 7ParkData shows that Flipkart has about 35% of e-commerce monthly active users followed by Amazon at 23% and Snapdeal at 13%.
  • As it stands today, not one of the Indian e-commerce players has established itself as the go to place to buy and sell goods, meaning that all parties are likely to be losing large amounts of money through aggressive competition.
  • If Flipkart is able to successfully execute the acquisition of Snapdeal and hold onto all of its users, then its share of MaU will reach 49% more than double that of Amazon.
  • This could give it just enough scale and momentum to become the go to marketplace in India making extremely difficult for Amazon to compete.
  • This is a big if and will require flawless integration, streamlining as well as customer service.
  • This is why I suspect Softbank is willing to take a substantial haircut on its investment as I think it has concluded that should Snapdeal remain independent, its investment could easily be worth nothing.
  • Amazon does not have a good track record in emerging markets as its performance in China vs. Alibaba was dismal and it does not seem to do much with its acquisitions other then leave them to their own devices.
  • Hence, I think the combination of Flipkart and Snapdeal has a chance but Amazon does seem to be determined not to repeat in India the mess it made in China.
  • Valuations are falling, highlighting the prospect of bargain hunting, but the high-level of uncertainty keeps me from wanting to be involved.

India e-commerce – Unicorns and Donkeys Pt. V.

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Flipkart likely to buy Snapdeal. 

  • The latest in a series of woes that has hit the Indian e-commerce market reinforces my view that in network based businesses, there really is only space for one player to do well.
  • This time around it is Snapdeal which is cutting costs by laying of 800 people, cutting the salaries of its founders to zero and exploring the sale of its mobile wallet FreeCharge at a big discount to what it paid for it in 2015 ($400m).
  • The founders of Snapdeal admit to spreading themselves too thin and not executing optimally, but I think that the real issue here is much more fundamental.
  • Snapdeal and Flipkart like Alibaba and to a lesser degree Amazon are market places which bring together merchants and buyers in one easy to use location and from which they can take a small cut.
  • In effect, they are network businesses just like Uber, Alibaba, AirBnB, Craigslist and so on and consequently, they are bound by the same rules.
  • 18 months ago I proposed a rule of thumb that states: A company that relies on the network must have at least 60% market share or be at least double the size of its nearest rivals to begin really making profit (see here).
  • This, in a nutshell, is the problem faced by both Flipkart and Snapdeal in India.
  • Flipkart is bigger than Snapdeal and so it is in a slightly better position but it is not double the size of its nearest rival.
  • Furthermore, both have to contend with Amazon which is determined not to make the same mess of India that it made in China when it went up against Alibaba and lost.
  • Amazon is not the largest in India, but it has the backing of the mothership meaning that it can lose money for far longer than either of the other two.
  • Flipkart has the best chance of reaching this hallowed status as it is the largest in India with around 35% of monthly active users but it will need to reach at least 50% before it is double the size of Amazon (7Park Data).
  • This is why I think it could end up acquiring Snapdeal, because adding Snapdeal’s users to its own would get it pretty close to achieving that milestone.
  • Without this combination, we are likely to be left with 2 unprofitable donkeys that are slowly ground out of existence by the vastly more powerful foreign player.
  • This uncertainty keeps me from recommending investments in either of the Indian e-commerce companies even at the discounts now being offered but if I had to go for one, it would be Flipkart.