Xiaomi and Microsoft – The Office

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This deal is really about Office in China.

• Microsoft and Xiaomi have struck a deal where Xiaomi will take ownership of 1,500 of Microsoft’s patents and Xiaomi will pre-install Office on all of its handsets.
• I suspect that these patents are almost exclusively wireless patents which, with Microsoft’s precipitous decline in smartphones and the sale of its feature phone business to Foxconn, are now worth very little to Microsoft.
• Historically, it has been important for a handset maker to have a patent portfolio so that it has something to negotiate with when other patent holders assert their patents against its phones.
• I think that this is less of an issue these days, as recent interventions by the White House (see here) have weakened the threat of patent infringement, but it is still important to have something.
• Xiaomi is stagnant in its home market and so has been looking overseas to try and find desperately needed growth.
• It has already opened up India and Brazil and I suspect that this deal heralds its attempt to get into the developed markets of Europe and North America.
• This is not a new development for Xiaomi and I still fear that revenues may fall by as much as 10% this year (see here).
• However, for Microsoft this represents an opportunity to do something about the rampant piracy that blights its products in China.
• I have long been of the opinion that Office is by far the most valuable asset that Microsoft owns and, because of that, I suspect that Microsoft virtually gave the patents away in return for this pre-installation deal.
• This arrangement would also suit Xiaomi very well as has very little cash to spend on investments (see here).
• Usage of Office in China is high but not many pay for it and with the rise of mobile, there is an opportunity to convert a portion of this usage over to Office 365.
• On devices with a screen size of less than 10”, the basic version of Office 365, which offers simple editing, is free and being pre-installed on Xiaomi handsets will ensure that it is at least present in the Chinese market.
• China is predominantly a mobile first market where users do far more with their phones than in developed markets meaning that there is a good chance that those that use Office illegally today will begin to use the free version of Office 365.
• This will create a funnel of free users that may eventually decide that that there is value in paying $9.99 per user per month to use Office 365 rather than a pirated, older version of Office.
• RFM calculates that there are 94m Xiaomi device users in China which should hit 150m by mid-2018 meaning that Office will be present on a meaningful number of devices in China fairly quickly.
• This is all upside for Microsoft and even a very low conversion rate will improve revenue and profitability which has come in exchange for a portfolio of patents that Microsoft does not really need anymore.
• This is unlikely to help Xiaomi to recover its fortunes in 2016 and I still think that Xiaomi is worth closer to $5bn rather than $45bn.
• I still see upside in Microsoft and this deal is yet another sign of how much things have changed for the better in Redmond.