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.