Xiaomi - No favours
Xiaomi’s ecosystem remains its biggest weakness.
Comparing itself to Costco helps Xiaomi’s valuation somewhat but does no favours when it comes to its business model.
In a recent interview, Xiaomi founder said that he sees his company more like Costco than Apple which does make some sense. Xiaomi has pursued a typical Internet economy model which is to gather users as quickly as it can and then monetise when their numbers hit critical mass. It has done this by selling nice looking devices at very low margins and then hoping to monetise users through its ecosystem of services.
What Costco does is similar in that it sells groceries at wafer thin margins and makes good margins on the subscription that it charges for membership. However, where Costco and Xiaomi differ is that Costco has a service that users are clearly willing to pay for but I am not convinced that Xiaomi does. Around 15% of all Chinese users have a Xiaomi phone but Edison research indicates that it is the ecosystems of the BATmen that Xiaomi’s users predominantly use.
This strongly implies that users are buying Xiaomi phones due to attractive prices and form factor but do not care about the ecosystem that Xiaomi offers. Overseas the situation is even worse because outside of China, Xiaomi sells its devices with the Google ecosystem installed because its own ecosystem is irrelevant. This is the critical difference between Xiaomi and Costco.
We have previously estimated that Xiaomi does make some money from selling content and games ($100m in 2016) but this is very far from Xiaomi successfully monetising its ecosystem in China. To try and restore growth, Xiaomi is going into retail and plans to open 1,000 stores in China as well as a good number in India with revenues of $10bn targeted within the next three years. This is the right strategy to break out of the limitations of Internet-only sales, but will have the impact of increasing costs.
Consequently, we are comfortable that Xiaomi could hit its RMB100bn ($14.4bn) sales target for 2017, but we are certain that margins will not be going up. If we take this outlook and compare it to Costco rather than Apple, we do get a slightly better valuation but not one that would make Xiaomi’s current shareholders very happy. Using Costco’s 2017 EV/Sales and EV/EBIT multiples and applying them to my estimates for 2017 Xiaomi, we end up with valuations of $8.6bn / $8.3bn respectively.
However, in using this methodology, the question needs to be asked should Xiaomi trade at a discount because Costco has already established the service it sells whereas Xiaomi has not? This is somewhat higher than our current $5bn valuation using Apple, but still way below the last raise at $45bn and the $20bn or so where we understand that the shares are changing hands.
We do not see any threats to Xiaomi’s viability as a company but we still think it would make a good acquisition for one of the BATmen that we think will need to become more vertically integrated to continue growing in the home market.”
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