Xiaomi – Reality check pt. III

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Stagnation puts an 87% hole in the valuation.

  • In 2014, Xiaomi was growing very rapidly, had a valuation of $45bn and there was talk of an IPO being done at $100bn.
  • Consequently, it could afford to splash-out on the best components as no one cared whether Xiaomi was making any money or not.
  • By early 2015, it was clear that problems were emerging as growth ground to a halt and nothing that Xiaomi has done since has been able to re-start it.
  • I have long argued that Xiaomi has ground to halt because there is only so much volume that can be sold through the Internet (see here).
  • This has been compounded by competitors catching on and mimicking its style meaning that it no longer really stands out from the crowd.
  • This is why the ecosystem is so important.
  • By developing its own ecosystem, Xiaomi will have something that no one else can copy and I still think that this is the only route that Xiaomi has to reaching substantially better profitability.
  • Xiaomi must either start growing its volumes again or it must create value for its devices through the development of an ecosystem.
  • Both of these routes require significant investment in the short-term which puts Xiaomi in a very difficult position.
  • Its Android competitors (Samsung and Huawei) and its ecosystem competitors (Baidu, Tencent and Alibaba) all have strong internal cash flow giving them the ability to invest.
  • Xiaomi does not as it is barely profitable meaning that a big increase in investments will require it to return to the market for more money.
  • This is where the real problems begin as it is very unlikely to be able to raise money again at $45bn meaning raising the spectre of a down round.
  • I have previously valued Xiaomi at $21bn (see here) but I can see downside risk to this unless either growth or margin starts to go in the right direction.
  • In 2014, the $45bn valuation was arrived at by assuming that Xiaomi was the next Apple and applying the same EV/Sales multiple.
  • The fact that Apple has a high EV / Sales multiple because it is extremely profitable was deemed not to be an issue due to its very high growth at the time.
  • However, I have long believed that a comparison to EV/EBIT is far more appropriate as this accounts for the fact that Apple makes money and Xiaomi does not.
  • Apple is currently trading on EV/EBIT of 6.4x 2016E and 6.3x 2017E
  • If I assume that Xiaomi generates 4% margins on $22.8bn (91.2m units x ASP $250) of revenues in 2016E and $23.3bn (93m units x ASP $250) in 2017E, I end up with profit forecasts of $912m in 2016E and $932m in 2017E.
  • Applying Apple’s EV/EBIT multiple gives a valuation of Xiaomi of just $5.9bn some 87% below the current valuation of $45bn.
  • In 2014, I was prepared to value Xiaomi’s EBIT at a 300% premium to Apple’s because of its much higher growth but that is no longer the case (see here)
  • Consequently unless Xiaomi can re-start real growth or substantially lift its margins there is no way anything close to $45bn can be justified.
  • I can see hefty write downs coming.

RICHARD WINDSOR

Richard is founder, owner of research company, Radio Free Mobile. He has 16 years of experience working in sell side equity research. During his 11 year tenure at Nomura Securities, he focused on the equity coverage of the Global Technology sector.

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[…] have used this logic to value Xiaomi at $5.9bn (see here) but the fall in Apple’s share price and Xiaomi’s worsening performance Q4 15 are now pointing […]