Xiaomi & Samsung – Goodbye blue sky.

Smartphone slowdown sinks all boats.

 Xiaomi

• The omens are ill for when Xiaomi begins trading in Hong Kong on Monday as its shares are trading at an 11% discount to the IPO price in the grey market.
• To be fair, in the grey market, volumes are low and there is no issuer support meaning that this price action is only an indication but it is hardly the debut Xiaomi was looking for.
• One can also draw parallels to Razer (see here) which was another hot IPO that came at a high valuation debuting at HKD3.88 a share, peaking at HKD4.69 on the second day and has subsequently lost 63.3% of its value in the following 8 months.
• To make matters worse, Razer priced at the top of its range and rallied strongly on the first day while Xiaomi has priced at the bottom of the range and seems likely to be soft on its very first day.
• I think that this is what happens when the fundamentals are ignored and a story is sold on blue sky.
• In this case, I think the fundamentals price Xiaomi value the company at $41.6bn (see here) in the best instance which is still some 14% below where the grey market has it.
• That is before any deduction is made for the fact that minority shareholders have no say in the running of the company which increases the risks they are taking.
• When I take that into account, I end up with $33.3bn as a fair value and would be very interested in having a look at the shares should they reach $20bn.
• If Razer is anything to go by, I just might be able to see some value in Xiaomi at some point relatively soon.

Samsung

• Samsung has provided preliminary figures for its Q2 18 results clearly demonstrating that the smartphone slowdown has impacted its performance.
• Q2 18A revenues and EBIT were KRW58tn / KRW14.8tn compared to estimates of KRW60.8tn / KRW15.3tn.
• As has been customary with Samsung, the Q2 18 weakness had been well flagged meaning that the shares did not react very violently to the news.
• However, the real issue is that with slowing demand, the flash and memory business will also start to feel the pinch meaning that overall growth will be much slower going forward.
• This is not necessarily a problem for profitability or for cash flow as the secret to Samsung’s margins remains the scale advantage it has in the markets it serves.
• Consequently, as long as no one closes the gap on Samsung, its margins in smartphones, memory and flash should remain intact.
• However, that may not be enough to support the current valuation which could continue to be under pressure as growth disappears from Samsung’s financial statements.
• Samsung has had a great run over the last few years and there are plenty of profits yet to take.

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