Huawei & Xiaomi – Easy come, easy go.

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Huawei and Xiaomi need a deal with the BATmen. 

• The rise of Vivo and Oppo in China against incumbents Huawei and Xiaomi is just another indication that all of the value in the handset industry has long been ceded to the ecosystem.
• The Chinese ecosystem is almost completely dominated by the BATmen (Baidu Alibaba and Tencent).
• Counterpoint Research’s Q3 16A figures for China show improved growth in smartphones to 8% YoY but Huawei and Xiaomi have lost 0.6% and 1.9% of their market share respectively in just 3 months.
• The net result is a 6% YoY decline in shipments in China for Huawei and a 22% YoY decline for Xiaomi.
• It is Oppo and Vivo that have stolen the limelight with unit shipment growth of 82% YoY and 114% respectively.
• This sudden reversal of Huawei’s fortunes is a sure-fire indicator that Chinese users do not care about handset brands other than Apple.
• Instead all they care about is that they can get their hands on the best hardware for the price they are willing to pay to ensure that the services they use from the BATmen work as well as possible.
• For the handset makers in China, this is nothing short of a disaster because it means that the only weapon they have is price, meaning that they will eke out a commodity existence with 2-4% operating margins in the best instance.
• With the amount of money that Huawei has spent in 2016, I suspect that this will mean that ends up losing money in handsets this year.
• There are two ways to make a good return in digital devices:
  • First. Create an ecosystem and keep it exclusive to your device.
  • If the ecosystem is in high demand by users, they will be willing to pay a premium for the device giving a good gross margin.
  • This is what Apple does so effectively and what Xiaomi has tried but failed to achieve.
  • This is also what LeEco (see here) seems to be aiming at.
  • Second. Outsell the next competitor by at least 2 devices for every one that it sells.
  • This gives substantial scale benefits and is the main reason why Samsung is able to make a double-digit EBIT margin in Android while everyone else languishes on 2-4%.
  • This is what Huawei has strongly implied that it intends to do but I have doubts whether it has either the stomach or financial resources to withstand a vicious price war with Samsung (see here).
• Xiaomi has done a pretty good job with its user interface but its fledgling ecosystem has failed to generate the traction it needs and the company does not have the resources to compete with the BATmen.
• This is why I continue to think that Xiaomi could easily be acquired by either Baidu or Tencent as RFM research has highlighted the strong possibility of increasing verticalization among the Chinese ecosystems (see here).
• Hence, it may be in Huawei’s interests to do a deal with one of the BATmen to aid the BATmen in putting more of their ecosystems directly in front of users.
• This would not aid Huawei’s margins in hardware per se, but a good deal by Huawei would include some traffic acquisition cost paid by the BATmen to Huawei which would help boost gross margins.
• RFM research also indicates that Huawei is engaged in creating its own software for its mobile devices but with Google dominant outside of China and the BATmen at home, it will have to be revolutionary in order for the users to notice.
• Huawei’s other opportunity is to use the volume that it has overseas in conjunction with shipments in China to gain a scale advantage over Oppo and Vivo but the fact that it is no longer the leader in either territory will make this strategy very difficult.
• The net result is that both Huawei and Xiaomi have a very difficult time ahead of them as their current strategies are not working.
• Of these two, I see only Huawei with a chance to turn it around but whether it has the stomach or the skill set remains to be seen.
• I continue to value Xiaomi at $3.6bn and view any transaction opportunity above $10bn as a great opportunity to exit.