Xiaomi – Foot shot pt. III.

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A valuation richer than Alibaba makes no sense.

• Investment banks involved in Xiaomi’s IPO have released their valuations and while they are well below $100bn, I am unable to come up with a single reason why Xiaomi should have a higher multiple than Alibaba.
• Put simply Alibaba is a colossus in the largest Internet market in the world, transacts more business than Amazon upon which it makes excellent margins and is still growing at a very healthy clip.
• Xiaomi is none of these things and looks more like an Android handset maker than it does a giant and hugely profitable digital ecosystem.
• The combination of CLSA, Goldman, JP Morgan and Morgan Stanley have put a range on Xiaomi of $65bn – $92bn (midpoint $79bn) in terms of valuation following its IPO.
• This is based on a 2019 PER ration of around 32x which is far higher than Apple (which I can get behind) but also higher than Alibaba which I cannot.
• The case for a premium to Apple is based on the fact that Xiaomi is growing much faster and by looking at earnings, one is taking into account the huge disparity of profitability.
• However, how a premium to Alibaba is justified (growing around 40% in 2018) is a complete mystery.
• Alibaba is far bigger, very profitable, already dominant in its market and growing just as fast while Xiaomi is not.
• Furthermore, all of Alibaba’s revenues come from Internet services while only a portion of Xiaomi’s do.
• Given Xiaomi’s perplexing move to hobble its own hardware profitability, Internet services are now its only real way to make high margins.
• Hence, I remain mystified as to how a 100% Internet services profit stream growing at a similar rate is worth less than one that is 60% Internet services and 40% hardware limited to 5%.
• Given the hybrid nature of Xiaomi (including its large investment portfolio), the most logical valuation methodology is to value the different profit streams separately.
• This I have done (see here) and I see no rational reason to change either the methodology or the result.
• Consequently, being as optimistic as I dare, I can reach a valuation of $41.6bn some 36% below the lowest syndicate valuation and 47% below the mid-point.
• This still does not take into the issue of corporate governance and the benchmarks I used (Apple and Tencent) have good corporate governance.
• By contrast, shareholders of Xiaomi will remain hostage to the whims of the founders, and for that I think it should trade at a 20% discount to its calculated fair value.
• Therefore, I think that as a public company, a valuation of $33.3bn is where I would put fair value with an optimistic outlook scenario.
• This is 58% below the syndicate midpoint IPO valuation leading me to believe that current holders should exit as soon as possible.
• Furthermore, I see no reason at all to participate in the IPO and am happy to wait for a valuation of $20bn before I would even consider thinking about buying the shares.