Talking Point

Will it be China’s Samsung?

What is Xiaomi and is it worth $100 billion?

Lei-Jun-w

The showman: like Steve Jobs, China’s Lei loves product launches

Before founding Xiaomi in 2010, Lei Jun is said to have been given the chance to invest in China’s biggest internet duo, Tencent and Alibaba (now worth almost $1 trillion combined).

In 1998 Lei was 29 but already the general manager of Kingsoft, the country’s leading software firm. A programmer two years younger than him called Pony Ma then tried to persuade him to buy a messaging software business known as QQ. Lei rejected the offer because he thought he could have written the same programme himself.

Then another Ma, this time Jack, knocked on Lei’s door and invited him to invest in his e-commerce start-up Alibaba. There was no persuading Lei again. He thought the 34 year-old former English teacher was more of a talkative salesman than an internet entrepreneur.

These stories have been widely shared on social media in China, especially in tech and investment circles (although neither tale has ever been confirmed).

What they help illustrate is Lei’s standing as a computer engineer, tech entrepreneur and angel investor all rolled into one. They are also suggestive of his ambitions to achieve similar status to the two Ma’s, who have since surpassed him in fame and fortune.

As Xiaomi prepares for a lucrative listing in Hong Kong – in the biggest IPO for the global financial markets since Alibaba raised $25 billion four years ago – Lei might get his chance to recover some of the lost ground.

Your need-to-know on Lei

First dubbed as China’s Steve Jobs – because of a sartorial style that seemed to mimic the former Apple supremo – Lei has probably been the most mentioned Chinese businessman in WiC’s coverage, after Jack Ma and Pony Ma.

Much of that publicity is related to Xiaomi, one of China’s hippest tech firms. But Lei also has a track record as a tech investor. Between 2007 and 2010, he personally invested in more than 10 successful start-ups (see WiC176), according to Chinese media, including companies that subsequently listed in New York, such as YY, Cheetah Mobile and Xunlei Network.

Before that Lei spent 16 years at Kingsoft, where he was recruited by his mentor Qiu Bojun in 1992.

A graduate of the National University of Defence Technology, Qiu was feted as the country’s leading software programmer after he developed WPS, a groundbreaking Chinese language word processing software, in 1988.

Like Qiu, Lei was considered one of the brightest programmers of his generation and he was even nicknamed by colleagues a “model IT worker” (the kind of award more typically handed out by Party apparatchiks to proletarians in the commanding heights of the economy).

Kingsoft also earned a reputation as a “national hero” in its battle against the global dominance of Microsoft. However, Kingsoft’s homegrown software was eventually outgunned by its formidable American rival and it needed a strategic investment in 1998 – the year Tencent was founded – from computer maker Lenovo to survive.

Many employees left the company to found their own ventures. Lei stayed put, but that loyalty had an opportunity cost: he missed out on the internet boom that saw the likes of Alibaba, Tencent and Baidu grow from start-ups into tech giants (today they are collectively known as the BAT).

Lei resigned from Kingsoft in 2007 following the company’s successful IPO in Hong Kong. He would return in 2011 as chairman after Qiu’s retirement, and he still holds that position today. “My compassion for Kingsoft cannot be measured by money,” Lei said at the time, explaining why he took on the role a year after founding Xiaomi.

What does Xiaomi stand for?

Kingsoft’s market capitalisation is about HK$35 billion ($4.45 billion). Recent regulatory filings suggest Lei controls a 27% stake. Adding to his holdings in other New York-listed firms, Lei was already a multi-billionaire when he started looking for new challenges aged 40.

Lei says he is not driven so much by money as much as by a desire to “lead a Chinese company to become number one in the world” – as he explained it to Bloomberg last week.

Indeed, Lei and his team initially wanted to name their new smartphone venture “Red Star” but the trademark was already registered by a liquor brand linked with the Chinese army.

So Lei picked xiaomi, which means ‘little rice’, or millet.

The name was taken from a popular phrase of Mao Zedong’s – “some millet plus rifles” – that described how his Red Army troops would take over China with inferior weapons but an indomitable fighting spirit.

Xiaomi’s corporate logo “Mi” is also open to interpretation, either conferring ‘mobile internet’ or ‘mission impossible’ – the latter a reference to the competition that the start-up faced from domestic and foreign hardware giants such as Huawei, Lenovo, Apple and Samsung – as well, of course, as the BAT internet trio.

What business is Xiaomi in?

“The most difficult question for me is answering exactly what Xiaomi does,” Lei told news agency Xinhua in an interview last July.

In a listing document filed with Hong Kong’s stock exchange this month, Xiaomi describes itself as “an internet company with smartphones and smart hardware connected by an IoT [Internet of Things] platform at its core”.

Analysts initially thought Xiaomi had set out to imitate Apple. And when Lei launched Xiaomi’s first handsets in August 2010 he did it much the same way as Steve Jobs would have done, dressing down in black shirt and jeans (for our first mention of Xiaomi back in 2011 see WiC119).

And even when the company diversified from phones to a range of less flashy household goods like rice cookers, air purifiers and ‘smart’ toilet seats, the products and packaging appeared to mimic Apple’s iconic white colour scheme.

But the similarities largely end here. Unlike Apple Lei’s handsets and consumer products compete at the more affordable end of the market. Margins are lower too. Indeed, in what looks like an incredible pledge in its IPO prospectus, Xiaomi says it will keep prices down for customers of its “hardware businesses” so that net profit margins will not exceed 5% any given year.

Putting that in context, Reuters reported last year that the iPhone X, which sell for $999, makes Apple a gross margin of 64%.

Of course, Xiaomi is no charity and it plans to make most of its profits through a business model that it describes as “tipping”, which means selling its hardware at minimal profit margins, but monetisising an ecosystem in which it sells software and services from its hardware base.

“We sell our smartphones at affordable prices, but if you use our browser, watch streaming video on our phones, or use our online services, we earn a profit,” Lei told the South China Morning Post last month.

Xiaomi’s web services and ad business generated at least Rmb9.9 billion (with a 60% gross profit margin) last year and the company already had 190 million active customers in its ecosystem at the end of March. Dubbed as “Mi fans”, over 1.4 million of them have more than five connected products from Xiaomi (excluding smartphones and laptops). This kind of fan base is expected to support what the company terms “the world’s largest consumer IoT platform in terms of connected devices”, which will be crucial for Xiaomi’s future growth.

How big is Xiaomi?

Xiaomi’s revenues grew 68% to Rmb114.6 billion ($18 billion) in 2017 last year. At such a heady pace Lei’s firm looks to be on course to catch up with electric goods major Gree (see page 10), which reported 37% growth in sales to Rmb148 billion last year.

The two firms have been pitted against each other by analysts since Gree’s boss Dong Mingzhu challenged Lei during a televised business awards show in 2013.

Dong said that Xiaomi’s revenues wouldn’t overtake Gree’s in the five years ahead. If Xiaomi proved her wrong, she vowed to pay Lei Rmb1 billion.

The outcome of the bet is still in the balance (at various points the terms have been disputed too). Nevertheless the wager has given Xiaomi invaluable media exposure as a disruptive presence in the “new economy”. Now it is looking to raise up to $10 billion in an IPO that could see the eight year-old firm’s valuation inflate to $100 billion. Such a price tag would see it overtake Baidu, currently trading at $90 billion, as China’s third biggest internet firm, and threaten a renaming of the BAT as the TAX (Tencent, Alibaba and Xiaomi).

With $1.9 billion in operating profit in 2017, many argue that a $100 billion valuation is a bit rich. Both Alibaba and Tencent have been trading on similar price-to-earnings multiples (over 40 times), but on net profits. In the West, only Uber has achieved such a stellar value in such a short space of time. Founded in 2009, the car-hailing app is reportedly worth $70 billion.

Many of China’s other 164 unicorns are lining up to go public too, although the tepid Hong Kong debut of Ping An Insurance’s healthcare unit Good Doctor last week (see WiC407) suggests that investors are wary of toppy valuations.

Why IPO in Hong Kong?

The Wall Street Journal suggested on Wednesday that Xiaomi has already cut its valuation target to between $70 billion and $80 billion. It is set to be the first heavyweight IPO since Hong Kong regulators changed their listing rules last month in a move designed to make room for companies with so-called dual shareholding structures. After going public, Lei’s effective stake in Xiaomi will be diluted to about 25% but he will still have more than 50% of the company’s voting rights.

Such arrangements weren’t previously allowed, which was why Hong Kong missed out on Alibaba’s $25 billion IPO in 2014.

For the Xiaomi IPO, Hong Kong-based bankers may now be anxious that it trades up on its debut, thus setting an example for other Chinese unicorns as they choose between Hong Kong or elsewhere as their primary listing platform.

Lei already has strong ties to Hong Kong. Jiemian, a news portal, notes that Morningstar, a venture capital group and one of Xiaomi’s founding shareholders in 2010, is also backed by the family investment fund of Ronnie Chan, the chairman of Hong Kong property firm Hang Lung. The Chan family, Jiemian suggests, was a key intermediary in introducing Lei to Indian Prime Minister Narendra Modi in 2014 too. Xiaomi was the top seller of smartphones in India during the final quarter of 2017 and its market presence there has become a key plank in its valuation. The goal is that sales of gadgets in countries like India and Indonesia will supercharge the Xiaomi ecosystem in other, highly-populated parts of the world.

Lee Ka-kit, the vice chairman of Henderson Land, another of Hong Kong’s property majors, also serves as a non-executive director at Xiaomi, and last week Xiaomi sealed a deal with Hong Kong’s richest real estate tycoon Li Ka-shing to sell its products in Li’s 17,700 retail stores. (Next magazine has also reported that the son of Carrie Lam, Hong Kong’s political chief, is a Xiaomi executive in Beijing.)

How about the risk factors?

Despite its status as one of the world’s most valuable start-ups, Xiaomi has had to deal with growing pains. Expanding too fast led to supply chain challenges in 2016, which saw handset production fall behind schedule. It could only meet half of a preset goal of 100 million units and its smartphone sales fell to fifth place in the Chinese market. Many speculated that its best days might already be behind it.

Lei then asked one of Xiaomi’s seven co-founders to step aside as its supply chain chief and announced that he would personally negotiate with key suppliers, including Foxconn and Samsung.

To fix the problems Xiaomi had to “go big or go home” Lei told Bloomberg. “We went big.”

Besides beefing up production, Xiaomi has opened hundreds of physical retail stores, and upstream it has been investing in designing its own semiconductor chips.

Lei plays the patriotic card whenever he can, telling Xinhua that Xiaomi’s goal is to be to China what Sony was to Japan in the 1970s, and Samsung to South Korea in the 1980s. “I really want to change the world’s perception of made-in-China products,” he insists.

The vision is of a Samsung-style conglomerate that straddles a variety of industries, providing a sustainable base for further investment in product development. But can the 48 year-old pull it off? Buyers of the forthcoming IPO are punting that Lei can build a company as profitable as Samsung and as adored by its customers as Apple, which seems like quite an ask. Detractors have pointed out that 70% of Xiaomi’s revenues come from selling smartphones, and not those internet services (a tenth of sales currently) that Lei is counting on for future profits. So the real test is whether he can deliver on Xiaomi’s promised transition from phonemaker to a broader software-and-services empire.

 

 

Keeping track, Jun 22, 2018: Xiaomi decided to postpone its mainland China share offering until after its Hong Kong floatation is completed in July. The delay, according to Bloomberg, was triggered by a dispute between the company and regulators over the valuation of its China Depository Receipts, while the rules for the financial product newly rolled out in China, are yet to be finalized. Xiaomi’s first-time share sale is therefore scaled back to $6.1 billion, versus $10 billion from a potential dual listing in Hong Kong and Shanghai. Its valuation has also come down to $55-70 billion from $100 billion. China Mobile, the country’s largest carrier, and US chipmaker Qualcomm have each agreed to invest $100 million in Xiaomi’s Hong Kong IPO as cornerstone investors. China Poly Group, China Merchants Group, SF Holding, and the private equity arm of China Development Bank have also committed to purchase shares in the IPO. Xiaomi is set to debut on July 9.


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