After nearly a year of rumor and speculation, Chinese tech unicorn Xiaomi (HK:1810), which manufactures smartphones, smart appliances and other lifestyle products, is finally set to IPO in Hong Kong on Monday, July 9th. The much anticipated initial public offering, which has been closely watched, had many originally believing this would be a $100 billion IPO. Those numbers have, however been revised down, first to $85 billion, then to $65 billion.
The company was hoping to price at between 17 and 22 Hong Kong dollars ($2.17-2.81 USD). It appears Xiaomi will have to settle for the lower end of that spectrum since it announced shares would be priced at 17 HKD.
That would give the company a total valuation of $54 billion, significantly lower than most—if not all—estimates. Nevertheless, it's still being viewed as one of the biggest IPOs of the year.
With a date and starting price established, it's worth a look at the company itself. Xiaomi was founded in 2010 by current Chairman, and CEO Lei Jun.
Their first product, the Mi 1 smartphone, was introduced in 2011. Since then, its diversified and in the process grown, to become one of the hottest tech companies globally. And the company isn't embarrassed to acknowledge that position.
In case you missed it, in early May Xiaomi released the material necessary for an IPO filing. You can find it here.
Beware, however, it's 600 pages long and includes 46 pages of 'Risk Factors' to its business, 64 pages on the business itself and 51 pages of financial information. Since that's a lot to digest, here are the highlights:
Xiaomi's Vision: "Be friends with our users. Be the coolest company in the heart of our users" (Page 176).
On a more serious note, Xiaomi sees itself as a business built on two main pillars; hardware, and internet services. Lei Jun claims Xiaomi is "more than a hardware company. [It is] an innovation-driven internet company." However, since hardware brought in about 91% of Xiaomi's $17.3 billion in revenues in 2017, or $15.6 billion, that's a good place to start.
Xiaomi Hardware
This division is divided into two parts: smartphones (77% of hardware revenue, $12.1 billion) and Internet of Things (IoT) and Lifestyle Products (23%, $3.5 billion). Right now Xiaomi's smartphones are its de-facto business. Fortunately, the revenue of the segment grew 65% in 2017, making the company the fourth largest globally in terms of smartphone unit shipments.
Xiaomi aims for broad audience appeal, offering about a dozen smartphones at different price points, from $120 to over $700. This strategy has fueled growth, so the company plans to continue selling high volume, low margin products. It competes mainly on value.
Lifestyle products and smart devices are the second part of the hardware equation. As illustrated by the graphic, above, Xiaomi manufactures everything from a vacuums to pens. This segment has performed even better than smartphones, growing revenue in 2017 by 88%.
Overall, Xiaomi's hardware operation looks promising. The low price of Xiaomi's smartphones is appealing, their clean design is often 'inspired' by Apple's (NASDAQ:AAPL) devices, and the performance is more than satisfactory. The company's value proposition makes it very attractive to a broad spectrum of consumers. (Full disclosure: I use a Xiaomi smartphone.)
Internet Services
Internet services, while still small, is the direction Xiaomi sees itself moving in the future. This $1.5 billion segment is built on advertising revenue and transactions in games and content platforms operated by Xiaomi. The company estimates it has 170 million daily active users on its operating system, MIUI. For comparison, Apple has about 1.3 billion active devices worldwide.
Advertising revenue comes from Xiaomi's online distribution systems, such as mobile apps and smart TVs. The company operates an app store, a music service, a video service,and its own browser, among things.
The company expects that as its user base grows, additional users will gain exposure to these services. Though that makes sense, with literally thousands of competitors, including specialized powerhouses in the browser space (Google (NASDAQ:GOOGL)), music arena (Spotify (NYSE:SPOT), Apple) and streaming video niche (Netflix (NASDAQ:NFLX), Amazon (NASDAQ:AMZN)), it's difficult to see Xiaomi compete effectively outside China. Of course, there's an enormous Chinese market.
Geographic Reach
About 72% of Xiaomi's smartphone sales come from China. Moreso, Xiaomi is strongest in an especially coveted market within China, the country's rural areas. Those regions are projected to modernize significantly in the coming decade, potentially providing a powerful growth engine for the company's future revenue stream. As of 2017, internet penetration within China was at 70% for urban areas verus 35% for rural areas. That's a pretty significant runway with plenty of room for expansion.
Xiaomi could benefit from an additional advantage: while many western brands have had trouble penetrating the Chinese market, Chinese brands have proven more appealing to western consumers. Xiaomi is currently making a big push toward Europe, and it's more than likely European consumers will see the value in Xiaomi's product line. The brand isn't yet slated to be sold in the US.
Shareholder Voting Rights
As with every IPO, the governance structure is an important factor to consider. Xiaomi, is the first public offering since a reform was initiated in Honk Kong's stock exchange that allows founders to retain oversized voting rights by issuing dual class shares with weighted voting rights. As such, Lei Jun will own about 29.4% of the shares, but almost 60% of the voting rights. This will enable him to have final say in any matter. Still, since under his tutelage the company has done remarkably well, it's not too risky to trust him to continue leading the company forward on his terms. However, it could become a concern in the future.
Bottom line
Xiaomi's operating profit in 2017 was $1.8 billion, more than three times what it was in 2016. After accounting for the issuance of redeemable preferred shares, it estimates a net profit of $800 million. Taking the $54 billion market cap figure, Xiaomi will IPO with a P/E ratio of 67.5. That's clearly very high, but given that it's going public with a P/E ratio, that's means the company is already profitable.
According the Bloomberg News, the IPO price translates into 22.7 times expected 2019 earnings, assuming a so-called over-allotment option (allowing the underwriter to issue additional shares in a secondary offering after the IPO) is fully exercised.
Conclusion
As far as tech valuations go, this IPO seems reasonably priced. Given all the metrics, we'd expect more growth from Xiaomi in the future; 22.7 times future earnings for next year is acceptable since there's potential upside outside of China. However, the IPO price is often not the first trading price, so we're interested to see what the 'retail' price will be.
Xiaomi is listing in Hong Kong, and it is not clear if or when an American Depository Receipt (ADR) will become available. However, Xiaomi wants to be a technology product game changer worldwide, and compete with the likes of Apple, Google, and Samsung (KS:005930).
Whether one cares to invest in Xiaomi or not, if you're in the technology sector, be aware there's a new, highly competitive player in town.