Xiaomi – Silver lining

Xiaomi’s love of low margins makes an EV viable.

• Xiaomi can succeed where Apple failed because its hardware is already very unprofitable meaning that adding an EV into the product mix will not dilute profitability as it would have done for Apple.
• When Xiaomi is in favour, it is often feted as the “Apple of China” but there is one area where it has consistently failed to emulate its US peer which is in its profitability.
• What is even more inexplicable is that this lack of profitability is deliberate.
• Even before its IPO in 2018, Xiaomi stated that it would ensure that its net margin after tax on hardware would never exceed 5%.
• I have long viewed this position as non-sensical especially when the company was hoping to offer a decent return for its shareholders as in a rational world, a rising share price needs to be supported by robust financial performance (see here).
• Xiaomi intended to rely on software and its ecosystem to generate profits and cash flow but in a hardware-based business, this is always a small fraction of total revenues.
• This always meant that Xiaomi was squandering its largest opportunity to make money and generate cash which is why its valuation cratered in 2022 and Apple’s did not.
• However, the silver lining to this cloud is that when a business opportunity arises where one is never going to make high margins, then it is a perfect fit for this operating model.
• Vehicles are low-margin products because a large percentage of the price paid for the product goes into seats, pressed steel, and components and so one from which one is never going to make the kinds of margins that Apple enjoys on its iPhones.
• However, these margins fit precisely with Xiaomi’s self-imposed low profitability on hardware, meaning that selling an EV will not dilute Xiaomi’s profitability.
• This is why EVs work for Xiaomi and why they do not for Apple which combined with the weakening market, is what I think caused Apple to give up on this forlorn hope (see here).
• The Xiaomi SU7 looks suspiciously like the Porsche Taycan, but at US$30,000 it is less than 1/5^th of the price.
• This is why I suspect Xiaomi has received 89,000 orders although there appear to be a reasonable number of cancellations as social media wannabes brag about ordering one on social media with their screenshot and then immediately claim a refund.
• Despite this, demand has been stronger than expected despite the weak state of the Chinese economy which is yet another sign that the Chinese are a now force to be reckoned with in the automotive industry.
• A few years ago, the vehicles they made were not of the best quality, but this has changed, and they can now make vehicles that can challenge anyone in the mid-to-mass market.
• Whether they can do so profitably is another matter entirely and there are numerous investigations underway to determine to what degree, the Chinese state is helping its EV companies to be competitive in overseas markets.
• If Xiaomi sells 100,000 vehicles, this will increase revenues by $3bn with the same profitability as if it had sold $3bn in smartphones which is why owners of the shares are getting excited.
• However, making a few vehicles and 10s of thousands are two completely different propositions and the focus now moves to execution which is something that the likes of Rivian and Fisker have really struggled with.
• This will be the key defining element of how 2024 goes for Xiaomi but with a 2024 PER ratio of 25.3x, I am far from convinced I want to be involved.