Xiaomi – Reality Check Pt II

Xiaomi disclosures push valuation even lower.

• A disclosure to the Shenzhen stock exchange has revealed the reality of Xiaomi’s financial performance in 2013A.  
• Xiaomi owns stake in Midea group and it was within this company’s disclosure to the stock exchange that the details were to be found.  
• The key disclosure is that in 2013A Xiaomi had EBIT of $56.1m on revenues of $4.3bn or margins of just 1.3%.
• This is a very far cry from the documents reported by the WSJ that claimed that Xiaomi had profits of $566m in 2013A.
• According to Reuters, this $56.6m figure has been confirmed as accurate by Xiaomi.
• Assuming that Xiaomi has gross margins of around 20%, this would give OPEX in 2013 of $804m or 18.7% of sales.
• Given that Xiaomi relies mostly on viral marketing and Internet sales, I would estimate that Sales and marketing was 3% of sales at $130m with R&D at $674m or 15.6% of sales.
• Xiaomi was pretty small in 2013E and given that it is trying to develop its own ecosystem, this figure looks to be about right.
• In 2014E RFM estimates that revenues will be around $16.3bn (see here) with gross margins of around 20% giving gross profit of $3.2bn.
• The key assumption here is R&D as the degree to which R&D has had to grow to support the development of the ecosystem is by far the biggest determinant of EBIT margin.
• RFM also suspects that R&D has had to be massively expanded to support the ecosystem development but that some operating leverage has been achieved.
• RFM estimates that Xiaomi has spent something around 13.5% of revenues in 2014E giving total R&D spend of $2.2bn.
• Keeping sales and marketing flat at 3% sales would give total OPEX in 2014E of $2.7bn.
• This gives EBIT of $500m or 3.1% of revenues in 2014E
• With expansion in India already hitting a roadblock (see here) and the probability of having to pay royalties on Standard Essential Patents outside of China, margins are unlikely to rise in 2015E.
• On 2015E revenues of $21.3bn (see here), flat margins would give EBIT of $660m.
• Applying the same logic as before in comparing Xiaomi to Apple (see here) and putting this against Apples 10.3x 2014E and 9.1x 2015E EV/EBIT gives a valuation of just $5.6bn for Xiaomi.
• If I then apply the same 300% premium as I did before to account for Xiaomi’s much higher growth, I end up with a valuation of $16.7bn.
• Again the key caveat here is R&D. If Xiaomi has skimped on R&D to show higher profitability, then my short term figures could be way too pessimistic.
• However, R&D is the life’s blood of growth and skimping here will crimp long-term growth meaning that my 300% premium to Apple would be too high.
• I think that Xiaomi is capable of achieving higher margins but only when its ecosystem has firmly established itself and users are willing to pay up to have it on their devices.
• I continue to think that money going into the company at $45bn is already assuming huge success in the ecosystem, all of which is very uncertain.
• The only winners in a round at this valuation will be the existing shareholders and I would steer clear of this at any valuation above $17bn.