Xiaomi – African safari

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Africa should help volumes but not margins.

• Moving into Africa might help Xiaomi’s volume shipments but margins are going to remain under severe pressure in this market.
• Xiaomi has entered into a distribution relationship with Mobile In Africa Group to distribute its devices in Nigeria, South Africa and Kenya.
• This looks like a good place to start as these three are Africa’s most populous and economically developed countries.
• Xiaomi is starting with phones and if the relationship goes well, I would expect this to expand to the other devices that it sells as part of its ecosystem.
• Xiaomi’s shipments in 2015 have ground to a halt at 18m units per quarter as there is only so much volume one can achieve by selling devices online in China.
• Xiaomi is perfectly set up to sell devices online in its home market but outside of that comfort zone, I remain concerned that it has little differentiation.
• In China its devices come with the Chinese version of its ecosystem (MIUI) which includes a very popular media consumption offering.
• This offering is so popular that some Xiaomi devices consume more data than iPhones albeit almost all concentrated on this one service.
• This is the acorn from which I suspect that Xiaomi will grow its ecosystem to cover many more Digital Life services and therby compete against Baidu, Tencent, Alibaba and China Mobile who are also all engaged in this strategy.
• If Xiaomi can be successful then this will drive user preference for its devices and crucially, that will give it the ability to raise prices and earn more than a commodity margin.
• The problem is that outside of China, Xiaomi’s ecosystem is not relevant which leaves it in the position of having to compete on price just like everyone else.
• Furthermore, online distribution will only get the company so far and it is reliance on online-only that has caused its growth to grind to a halt.
• Africa has virtually no online sales at all and that means for the company to get real traction in both India and Brazil, it will also need to utilise the traditional channels: mobile operators and distributors.
• While these channels will help Xiaomi to re-start stalled growth, it will have to give away some of its margin in order to secure their help.
• This means that any scale benefits that the company is able to glean from higher volumes will be eaten up by giving margin to channel partners.
• Consequently, the move into Africa may very well help the top line but the bottom line is likely to remain under real pressure.
• The one hope is that the ecosystem inside China is successful and that improving margins at home can be augmented by the lower manufacturing costs of selling the same devices overseas.
• RFM’s current forecasts put Xiaomi’s ecosystem at 223m by 2018E in China.
• This puts it in a stable position when it comes to its ecosystem, which if scale benefits can be gained from overseas, could see margins at 7-8% in the long-term.
• While this is perfectly respectable, I suspect that it is not the kind of return that investors who put money in at a valuation of $45bn are looking for.
• I see more value in some of the other players in China as well as companies like Microsoft and Facebook where the market is discounting the long-term potential.