Ep. 14: Xiaomi: Bull or Bear? A Post-IPO Debate

Xiaomi‘s recent IPO in Hong Kong was the world’s biggest tech IPO since Alibaba‘s in 2014, but will it soar in the stock market and become the Apple of China? Listen to the first ever debate on TechBuzz China and take your position as a bear or a bull on the new stock.

TechBuzz China by Pandaily is a weekly technology podcast focused on giving you a peek into what’s buzzing within the tech community in China. It is co-hosted by Ying-Ying Lu and Rui Ma, who are both seasoned China watchers with years of experience working in the technology space in China. They uncover and contextualize unique insights, perspectives, and takeaways on headline tech news that don’t always make it into English language coverage.

Our co-hosts Ying-Ying Lu and Rui Ma take opposite positions on the future of Xiaomi, an eight-year old company founded by billionaire entrepreneur Lei Jun. They battle it out on whether Xiaomi is an Internet company with hundreds of companies within its ecosystem and lots of potential, or simply a smartphone maker whose limitations are set by Lei’s promise of making no more than 5% profit on all hardwares.

Interested in investing in the company lead by the Steve Jobs of China? Listen to the newest episode of TechBuzz China to find out what really goes on inside the “Apple of China”.

As always, you can find these stories and more at pandaily.com. Let us know what you think of the show by leaving us an iTunes review, like our Facebook page, and don’t forget to tweet at us at @techbuzzchina to win some swag!

Full Transcript

Please be advised that parts of the transcript has been edited for enhanced readability.

We are TechBuzz China by Pandaily, powered by the Sinica Podcast Network.
We are a new weekly podcast focused on giving you a peek into what’s buzzing within the tech community in China. We uncover and contextualize unique insights, perspectives and takeaways on headline tech news that don’t always make it into English language coverage. TechBuzz China is a part of Pandaily.com, a new English language site that tells you “everything about China’s innovation.”

(R: Rui Ma; Y: Ying-Ying Lu)

[0:00] R: Wow, Ying-Ying, what a week! We had Wimbledon, the World Cup, those Thai soccer kids getting rescued, and of course, Trump announcing new tariffs on China. My emotions were up and down every single day!
Y: But not as much, I don’t think, as those of Xiaomi shareholders this week. During its historic IPO, it priced at 17 Hong Kong dollars, but opened lower than that on its first day of trading, this past Monday, July 9. It closed the day with the opposite of an IPO pop, at $16.80.
R: On Tuesday though, it gained over 10%, stayed there for the next two days, and then gained over 11% on Friday to close its first week as a public company at $21.45 HKD, 26% above its pricing.

[0:46] Y: Now that’s more like an IPO pop! Congrats to Lei Jun on a really respectable first week. Xiaomi now has a market cap of $61 billion. And this was the world’s biggest tech IPO since Alibaba’s NYSE listing in 2014.
R: Now we are not public market experts here, so we aren’t going to be offering you any advice on whether or not you should be investing in Xiaomi at current prices.
Y: However, today we are going to offer you some perspectives on Xiaomi’s long-term prospects. Is the company, which to most of the world is still known simply as a “Chinese smartphone maker,” truly as amazing as it says it is?

[2:16] R: Congratulations to the winner of our TechBuzz swag giveaway last week: Jogvan Jesperson and Robert Hsiao! The answer to our question was $24.5 billion. Yup, that’s how much in revenues JD booked last month during their annual 618 Shopping Festival.

Y: Now this week, we are going to switch it up a bit more. Some of you have told us that we are always agreeing with each other.
R: I actually think we disagree lots, but maybe we are just too nice about it.
Y: Right, so this week, we are going to do a debate format.

[2:54] R: Yingying will take one position, and I will argue the opposite position. So get ready! It’s going to be a fight to the death!
Y: If you tweet at us with your verdict from this show – are you bullish or bearish on Xiaomi – we will again enter you into a raffle for some swag. Remember, tweet at @techbuzzchina!
R: If you enjoy listening to us, please take the time to leave us a rating or review on iTunes or Facebook!

[3:27] Y: Alright, so we covered Xiaomi’s then-upcoming IPO in one of our earlier episodes, Episode 4! We encourage you to go back and listen to that for some context. But we will review some of it today too, so no worries if you are new to this podcast.
R: Great. Okay, Ying-Ying, question for you: I never did high school debate or anything like that, have you?
Y: No, so we are even.

[3:53] R: Okay, great! I guess in such cases, we often start off with our positions right? Let me start off with mine. I am going to argue that Xiaomi is nothing special, it is not in fact the Apple of China as it sometime claims, nor is it the best representative of Chinese hardware innovation, and it is, in fact grossly overvalued compared to its competitors. Basically, I am going to represent the Xiaomi bears. By the way, the rest of my friends at Xiaomi and Lei Zong 雷总, if you’re listening, please don’t kill me, this is not really my true position, it’s just for the purpose of debate.

[4:25] Y: I will argue the opposite. I represent the Xiaomi bulls. Xiaomi is highly innovative and is already one of the leading tech companies in China. It’s extremely influential, on par with BAT. In fact, here’s my first stat to prove it. Xiaomi, as we all know, makes smartphones and consumer electronics. It was 5th largest last year in terms of shipment volume worldwide.

[4:49] R: And Ying-Ying, there is your first slip-up! We can’t debate if we can’t agree on what Xiaomi is. Lei Jun, the founder, would probably kill you for calling Xiaomi just a smartphone maker. He’s been basically saying for the past eight years since Xiaomi’s founding that it is not a hardware company, but an internet company with hardware – smartphones, IoT, etc. – as its engine of innovation.

[5:14] Y: Well there you go, Rui! Why are you arguing my point, by the way? Xiaomi is indeed an internet company with a sprawling selection of hardware to go along with its services. It made $1.5 billion on services alone last year!
R: Okay, I see what you’re doing. $1.5Bn might sound like a large amount, but that’s only 10% of its total revenues. Guess how much Apple made from services last year? $8.5 billion! Actually, just kidding. I’m lying. That was just Q12018. Just one quarter! Do you know what would happen if the services business from Apple were its own standalone company? It would be 97th on the Fortune 100 list, ahead of Facebook!

[5:58] Y: Well now it’s my turn to say – I see what you’re doing. Yes, Xiaomi likes to compare itself to Apple, or at least doesn’t discourage the comparison. Founder and CEO Lei Jun is generally referred to as China’s answer to Steve Jobs. But while Apple has industry leading smartphones and yeah their laptops are not bad – I know we both use Macbooks and iPhones – here is a question for you, what are their other dominant consumer electronics?

[6:25] R: Um, I think they do pretty well in smartwatches too. As far as I know, they were actually the leader in Q42017 with 8 million units shipped. That’s over 20% market share.
Y: And taking that same quarter, who was number 3?
R: Okay, Xiaomi was number 3. Almost 5 million Mi Bands sold. Where are you going with this?

[6:45] Y: Great. So Xiaomi is number 3 in smartwatches. It’s a pretty close third, and it was head-to-head with Fitbit for a while, who used to be number 1. But my point is, Xiaomi has many other Top 1 or 2 or 3 products. In fact, unlike the relatively limited selection of Apple, it’s got over 100 of what it calls ecosystem partners. It sells everything from smart rice cookers, to home security systems, to air purifiers. When it came out with its cheaply priced by high quality home air purifier in 2014, I know a ton of people who rushed to go get one. Typical foreign made systems ranged from a few hundred to more than a thousand USD, which was unaffordable for most people, especially since you needed a different one for each room. The air purifier quickly surged to #1 in the market, and there’s so much room for growth! The market penetration is laughably low at 0.1%.

[7:45] R: Okay, I will agree with you there that it was a pretty good product, especially considering it was just over $100. I would have gotten one myself but I had already invested so much money into my Blueair. But even counting the social impact of the air purifier business… It’s a pretty small market, not even $3 billion in China. And by the way, there are over 700 brands competing! If anything, Xiaomi might have opened up the market, but now that it’s opened up, the big consumer electronics brands like Haier, TCL, and of course Midea, are coming in in a big way. Does Xiaomi want to be competing with these guys in addition to its main war on the smartphone front?

[8:23] Y: Ah, but it’s not. The air purifier is made by Zhimi, or Smartmi, a Xiaomi-invested company. It’s not super clear how much of Zhimi is owned by Xiaomi. Huami, the company that makes the Miband, is more transparent. According to their IPO prospectus, Shunwei, the billion-dollar VC fund co-founded by Lei Jun and affiliated with Xiaomi, owned 20%. Xiaomi owned about 19%. So, about 40% in total, a non-controlling stake.

[8:53] R: That’s very similar to what Softbank’s strategy is pre-Vision Fund – significant minority stakes. If you have lots of capital, it’s not a bad way to make a meaningful bet without taking all of the risk. But, from the same prospectus, it does show that Xiaomi accounts for well over 80% of Huami’s revenues. I don’t even personally understand how this company was able to go public. It looks like investors agree – since its IPO this February on the NYSE, its stock has declined 14% and its market cap is just $560 million.

[9:36] Y: Fair, so maybe it wouldn’t have been a great bet as a stock to buy, but as an entrepreneur? How many companies IPO 4 years and 2 months from inception on a major stock exchange? Huami did. Because it was able to leverage Xiaomi’s large customer base and jump to a market leading position immediately post launch. And no need to scoff at a half-billion dollar valuation… Fitbit is just $1.6 billion. I’m pretty sure if you were the CEO or one of the shareholders, you wouldn’t be complaining too much. And Xiaomi has 100 of these partnerships of varying types in the wings.

[10:07] R: So what are you saying? Are you saying that there are 100 future IPOs with Xiaomi as a major beneficial shareholder?
Y: It’s not impossible.
R: Sure, not impossible, but not very likely. In fact, there’s already fractures in this so-called ecosystem. There are probably two main reasons for this, the first one of which is – what happens if you are one of these so-called affiliates of Xiaomi, but Xiaomi mothership begins making competitive products? Yi Technology had that happen to them. Yi was one of the earliest so-called partners making Go-Pro and Dropcam-like cameras. I actually bought some of these when they first came out. However, since two years ago, Xiaomi began making home cameras themselves and they basically stopped promoting Yi cameras on their platform. There were even rumors that their relationship had ended. While Lei Jun said that wasn’t the case on his Weibo, if you look on Mi.com now, there are very few products from Yi are being sold.

[11:14] Y: Well, the answer to that is simple! If you are insinuating that Xiaomi went and kicked out Yi Technology because they didn’t want to split revenues anymore, I would argue that’s just very unlikely given how small the business was. But specifically on the ecosystem partners, a book called “Xiaomi Ecosystem Battlefield Notes” came out last year in China and gives an inside look into what happened with 77 of these partners. Apparently Yi lost its favored position with Xiaomi because it failed to be transparent about a manufacturing defect. See, Xiaomi is not greedy, it just wants to protect its consumers and fans, and make sure that we get the best product possible!

[11:50] R: Okay, spoken like a true 米粉, or Xiaomi fan. But I am far from convinced. While the ecosystem does sell plenty of units, the revenues are pretty minimal. All ecosystem products together is only about 22%. Anyway, I suppose now you are going to talk about how noble Lei Jun’s vision of Xiaomi is – revolutionizing the Made in China stereotype, changing it from cheap and unreliable to cheap but beautifully designed and high quality.

[12:20] Y: Yes, exactly! Xiaomi has won over 100 design awards! Xiaomi is way more than a pure tech company. Chinese people are really proud of its beautiful products. And overseas consumers are taking notice. A recent report from WPP, Kantar and Google shows Xiaomi as a top ten Chinese brand builder.

[12:41] R: Okay, I can’t argue with you that even though “Made in China” isn’t quite “very cool,” yet, it’s become a lot less uncool, and certainly brands like Xiaomi have contributed to that. But so have Oppo, Huawei, and many others. For Apple, they were able to leverage their great design, amongst other things, and charge a premium. But Lei Jun, who you say has these great design, has publicly stated he will never make more than a 5% net margin on any of its hardware, ever. Which was my point number two about being part of the Xiaomi ecosystem. For me, that cap on profitability would be a great reason for not joining the Xiaomi family. And it looks like many others agree. Even beyond partners though, this just sounds terrible for shareholders.

[13:33] Y: Well, 5% is not high, but again, that’s only for hardware! Remember the beginning of this conversation… Xiaomi is not a hardware company! As the company CFO has saidXiaomi is the rare company that can do hardware, internet, and e-commerce. It’s even tapping into offline retail. It recently opened up Mi Home stores. Go search for some photos of those. These stores remind me of the Japanese retailer Muji, known for minimalist products. In fact, I’m pretty sure that’s what Lei Jun is going for. Since speaking at an event in Shanghai last August, he said that he wants Xiaomi to be “Muji in the science and technology sector, with high quality, high value, cost-effectiveness, and a variety of products.” Muji, by the way, sells everything from snacks to stationery to suitcases to clothing.

[14:19] R: Okay, I don’t know about you guys, but that doesn’t sound at all appealing to me. Maybe 米粉 will go and get their pillows from the Mi Home store along with a new drone, but I think this is a recipe for disaster. In fact, it reminds me of one of Lei Jun’s previously high-profile unicorn investments, it was this fashion e-commerce brand called VANCL, which started off super hip, shot up to $3 billion in valuation, and then way too quickly expanded into product categories that really didn’t make sense, like laundry detergent. The story goes Lei Jun told Chen Nian, the CEO, to focus and not expand too quickly. I’m curious here why he’s not applying the same advice to himself? I mean, Xiaomi hasn’t even won the domestic Chinese smartphone market yet, but it’s doing all these other things that just don’t seem like they will move the needle but are bis distractions.

[15:18] Y: It’s interesting that you mention its market position in China, which is definitely not as strong as it could be. But China is a mature market with high penetration already. It’s much more interesting to look at India, which is the world’s second largest smartphone market. There, Xiaomi accounted for 31% of shipments there last quarter, beating out Samsung. It has also said it’s going to launch at least six new smartphones and open 100 stores in India. And oh, Xiaomi accounts for 60% of online smartphone sales. The business model that was originally started in China has worked really well – that of really focusing on Mi fans and creating scarcity, 饥饿营销. We talked about that in detail in Episode 4.

[16:00] R: OK, great for Xiaomi that it is winning in India, but it shipped 92 million smartphones last year, just over 25 million of those were to India, and it still makes 72% of revenues from China! And here is where I make the argument that, even Chinese regulators, and also investors were quite cautious or bearish about Xiaomi’s listing. It was supposed to be the first company to list using CDRs, or China depositary receipts. But as we know, that didn’t happen.

Y: I do acknowledge that it’s been a rocky road to IPO. When we first started hearing rumors of Xiaomi’s listing, the number being thrown around was $100 billion. That is, Xiaomi raising $10 billion at $100 billion valuation.
R: Exactly, but it ended up raising less than half, or only about $4.7Bn. Honestly, whoever is doing these predictions, they are about as accurate as Elon Musk’s forecasts for Tesla. Seriously. Anyway, Xiaomi abruptly pulled out of the CDR process in late June. It would’ve allowed them to list on the mainland exchanges, but the Chinese SEC equivalent, the CSRC, just could not get its head wrapped around the one core question – why is a company with 70.4% of its revenues from smartphones considered an internet company? It’s been written that Xiaomi pulled its offering because it was unable to answer this question, to the sufficient satisfaction of regulators.

[17:38] Y: Okay, well, we don’t know exactly what happened there, and there are many arguments for and against the CDR. For example, it would have been a big risk for Xiaomi in case it didn’t go well. It’s just a big move for Chinese tech companies in general, and I think the team was right in not hurrying it and chancing a bad listing.
R: Well I’d argue even without the CDR, the HK listing itself was very important. Hong Kong went to great lengths to woo Xiaomi, including changing rules on dual class ownership structures. As a well known VC, CDH’s Wang Gongquan noted, a bad Xiaomi IPO could have signaled the end of the current exuberant investing environment in China. According to him, it would have burst the bubble.

[18:20] Y: For now though, it looks like Xiaomi did just fine! After the first day drop, it gained 10% or so the second day.
R: Yes, after it was announced that it would join the Hang Seng Index, a major indicator for the Hong Kong Exchange. But anyway, let’s wrap this up. Ying-Ying, do you just believe that the company can do no wrong?

[18:37] Y: No, not at all, but I believe in Lei Jun. As he’s fond of saying, Xiaomi is the only smartphone company that turned around declining revenue. Here is a leader who is known for working incredibly hard and is very detail oriented. Supposedly, he is super active in the Wechat groups of his Tier 1 and 2 distributors. How can you not want to work with a billionaire who cares so much that he is interfacing with his core customers on a daily basis? He’s got an amazing reputation with employees as well.

[19:07] R: Well, chatting is great, but I’d rather make money. And it seems that only 20% of Xiaomi‘s offline franchise stores are marginally profitable, and the rest lose money. Also, I know that Lei Jun loves using the very bloody Sino Japanese war as metaphor for his business battles. I’d be afraid of being one of the casualties of his business battles. But okay, yes, he does work hard. Apparently the internal slogan this year inside of Xiaomi is that “even sleeping is a waste of time.”

[19:38] Y: Well, he’s always known when to really lean into it. That’s the Lei Jun philosophy, 顺势而为, take advantage of the tail wind.
R: And I don’t disagree with that, but I think I just see more headwind. Anyway, it looks like we both really got into the debate and neither of us are going to back down from our positions. We both want to win right? Do you have any concluding remarks, Yingying?

Y: I believe this is just the beginning. It’s the start of the story of a tech company that’s really figured out how to synergize between online, offline sales and is focused on delivering superior hardware and software products which are of good quality and which suit the middle class – around the world, not just in Chinese. As Lei Jun says, it’s really three companies in one – a “triathlon business model”. And I really like its ecosystem strategy – I think there’s still plenty of room to innovate, especially in AI, and partnering is the way to do that. As for all that volatility at IPO? I quote our friend Hans Tung, managing partner at GGV and early investor in Xiaomi, who had this to say: the company’s performance is more reflective of investor confusion than the strength of the stock.

[20:52] R: OK, my turn. Yes, apparently many have compared Xiaomi’s performance to Facebook’s, which also had a rocky IPO. And yes, they have the thesis is that investors simply don’t understand Xiaomi. But I ask you, why is it so hard to understand? Xiaomi only makes $2 per smartphone. It lost $7 billion last year. Yes it did grow revenues 70% last year, but how much of that was aggressive spending in India to grow market share? Very few companies do even one thing well. Is Xiaomi going to do 3 things super well? What do you think? How did we defend our respective positions?

[21:37] Y: Oh by the way, all those numbers were just accounting losses. Cashflow wise, Xiaomi was negative $1 billion RMB for the year, only about $150mm usd.
R: Hey, no cheating! You already gave your concluding remarks! Ok, but that was a fair comment. But now I have to add that Xiaomi has patent concerns as well, especially as it expands abroad. It’s just got a lot less patents than its rivals. It’s already been sued by Ericsson a few years ago and a rival electronics brand called Coolpad sued it recently for patent infringement as well.
Y: Gee, was that your final, final comment Rui?
R: Yes, yes, I promise to stop or we will never stop debating!
Y: So what do you think everyone? Are you a Xiaomi bull or a Xiaomi bear? Remember to tweet at us at @techbuzzchina!

[22:30] Y: We’d like to give a shoutout to our partners at SupChina. In addition to our podcast here with Pandaily, they publish the excellent Sinica podcast, a weekly discussion of current affairs on China with journalists, writers, academics, policy makers, and business people.
R: So while we only focus on tech, they really give you the entire overview.

Follow us on twitter, at @thepandaily, @techbuzzchina, @ruima and @ginyginy. Thanks to our producers Carol Yin and Kaiser Kuo, and our intern Ska Du.