Xiaomi IPO – Foot shot pt. II.

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Prospectus yields valuation of $33.3bn.

• Being as optimistic as I dare, I can only value Xiaomi at $33.3bn, one third of the mooted $100bn IPO valuation.
• Xiaomi has filed for its IPO in HK meaning that real numbers can be applied to the valuation logic that I applied in part I (see here).

• • Hardware: For this business, Samsung is a more than fair comparison.
  • It is dominant in Android handsets, flash memory and DRAM and is based in the same continent as Xiaomi.
  • For 2017 profits, Samsung’s price earnings ratio is 8.3x, meaning that if I adjust for Xiaomi’s higher growth from its intended market share gains, I might be willing to pay 15x in the best instance.
  • In 2017 Smartphones, IoT and other products revenues were RMB104bn ($16.4bn) upon which gross profit of RMB9.1bn was made giving gross margins of 8.8%.
  • Assuming that 70% of OPEX (Total RMB9.5bn) is going to hardware, gives EBIT of RMB2.4bn or margins of 2.3%.
  • Adding a 15% tax rate gives net profit of RMB2.0 which might be RMB2.2 in 2018.
  • Given Xiaomi’s promise never to make more than 5% net margins, the scope for margins to really improve is non-existent.
  • I am prepared to pay 15x, giving a valuation of RMB33bn or US$5.2bn for the hardware business.
  • This leaves me with $94.8bn of value to find to make the mooted valuation of $100bn.
  • Internet Services: In 2017 Xiaomi reported internet services revenues of RMB9.9bn (US$1.6bn) of which 57% was advertising and 42% from content sales (not unlike Tencent).
  • It made gross margins of 60.2% giving gross profit of RMB6.0bn ($945m).
  • Allocating the other 30% of OPEX (RMB9.5bn) gives me EBIT of RMB3.15bn (32%).
  • If I take another 15% off for tax I get net profit of RMB2.68 ($422m) which I value against Tencent.
  • Tencent is biggest and strongest of the Chinese ecosystems and is trading on 41x 2018 PER.
  • If I assume a small premium to Tencent (higher growth slightly offsets higher risk), then I could just about stomach a PER ratio of 50x on 2018 profits.
  • 2017 Internet services revenues grew at 51% and I will be generous and assume another 50% in 2018.
  • This gives 2018 net profit of RMB4.02 ($633m).
  • This gives me a valuation of the internet services business of $31.7bn.
  • Other businesses. Xiaomi also enjoys a substantial contribution to its bottom line from valuation adjustments that are being made from the smaller companies that it has invested in.
  • In 2017 these contributed RMB6.4 towards EBIT making up 52% of total EBIT reported which was RMB12.2bn.
  • These are not really operating profits and, in my opinion, should be valued separately when considering the overall value of Xiaomi.
  • Furthermore, almost all of these companies are not listed and so the valuations upon which Xiaomi is relying to report investment gains have not really been tested against the full force of a public market.
  • I will be generous and assume that these investments are worth around RMB30bn ($4.7bn).

• The net result of adding up these three separate businesses is $41.6bn some 58% adrift of the mooted $100bn IPO valuation.
• This makes some sense as RFM research indicates that secondary, over-the-counter transactions have recently been occurring in Xiaomi shares at and around this level.
• However, for a public company there is also the issue of control.
• The prospectus clearly indicates the presence of a super-voting share distribution ensuring that the founders will continue to control the company despite a meaningful reduction in their economic ownership.
• I have long argued that while these super-voting distributions provide benefits to small, early stage companies they have no place in large public corporations (see here).
• Sadly, the HKSE, which used to be a beacon of good corporate governance (see here), has given in to its desperation to attract technology companies to its bourse and is now allowing this practice to occur.
• While I think that this practice should be eliminated in large public companies, I am happy to invest in companies with these distributions as long as there is a discount applied to the valuation to compensate the investor for the greater risk assumed.
• Historically, I have assumed somewhere between 10% – 30% depending on how concentrated control is and in Xiaomi’s case I think about 20% is fair.
• 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 just one third of the mooted IPO valuation leading me to believe that 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.