Xiaomi has a lot to prove to US investors who are skeptical of Chinese tech

FAN Editor

Chinese gadget maker Xiaomi was in the U.S. at the end of last month, pitching its upcoming share sale to big money managers, who were potentially interested in participating.

American investors have come to know Xiaomi, the world’s fourth-largest smartphone maker, as the “Apple of China.” Beyond that, they’ve still got a lot to learn.

A person who attended one of the roadshow events alongside about 50 hedge fund and mutual fund managers told CNBC that many investors who were there didn’t have a good understanding of Xiaomi, other than that it was a giant handset manufacturer. The person asked not to be named because the event was private.

While smartphones account for 70 percent of Xiaomi’s revenue, the company’s fastest-growing segment is the business that sells and invests in connected devices, ranging from smart TVs and routers to electric scooters and air purifiers. The IoT (internet of things) and lifestyle products group grew 89 percent last year to 23.4 billion yuan ($3.5 billion), accounting for 21 percent of total revenue.

Xiaomi’s breakdown

Two years ago, smartphones made up 80 percent of sales, while IoT and lifestyle accounted for 13 percent. Xiaomi’s third business is internet services, which includes a popular app store, browser and music service. That unit grew 51 percent to 9.9 billion yuan ($1.5 billion) last year.

Here’s how Xiaomi Chairman Lei Jun wants you to think about the company:

“We are more than a hardware company. We are an innovation-driven internet company,” Jun wrote in a letter affixed to Xiaomi’s filing with the Stock Exchange of Hong Kong. “Xiaomi is an internet company with smartphones and smart hardware connected by an IoT platform at its core. Our mission is to relentlessly build amazing products with honest prices to let everyone in the world enjoy a better life through innovative technology.”

Xiaomi priced its IPO on Friday at 17 Hong Kong dollars ($2.17) per share, raising about $4.7 billion. The company, which is slated to debut on Monday, is valued at around $54 billion.

Earlier reports suggested that Xiaomi was targeting a $100 billion valuation. At the current price, investors are clearly valuing Xiaomi more like a hardware company than a high-margin provider of software and services.

The person who attended the roadshow said that most investors in the audience weren’t aware that Xiaomi had a vast portfolio of apps or that it has a smartphone operating system called MIUI that sits on top of Google’s Android and has 190 million monthly active users. And in comparing Xiaomi to Apple, the person said, investors were missing the fact that its software and services don’t work exclusively with Xiaomi phones.

Xiaomi’s gross margin, or the profit left after subtracting the costs of goods sold, has more than tripled in the past two years. But it’s still only 13.2 percent, as of last year. That’s far below Apple’s margin of 38 percent or Alphabet at 57 percent.

There are other reasons for U.S. money managers to shy away from Xiaomi.

Kevin Landis, the chief investment officer of Firsthand Capital Management, a tech-focused firm in Silicon Valley, said that Chinese companies can make for challenging investments. Landis owns shares of Chinese internet giant Tencent, but he said that it’s generally difficult to get comfortable with corporate governance of many Chinese companies or to get a sense that you’re getting a full and transparent view of the business.

“There’s a pretty deep-seated skepticism about Chinese companies — that they’re not really being straight with you,” said Landis, who did not attend the Xiaomi roadshow. He cited Alibaba’s subtle move in 2011 to transfer control of Alipay to a separate entity owned by CEO Jack Ma, thus taking value away from Yahoo, which owned a big stake in Alibaba.

“It’s not surprising that if you’re asking Western investors to value a Chinese company, they get a little bit leery,” Landis said.

A Xiaomi spokesperson didn’t respond to a request for comment.

Xiaomi also has faces plenty of competitive threats. In addition to the other big smartphone makers like Apple, Huawei, Lenovo and Samsung, the company is up against local low-cost handset makers Vivo and Oppo.

Starting Monday, public market investors will get their first chance to see how the eight-year-old company trades. Landis said he’ll keep any eye on it to see if anything pops up that excites him. He invested in Tencent about four years ago when he noticed that its WeChat service was surging in popularity. The stock has soared since then, making Tencent the world’s sixth most-valuable company.

“We have to find something that’s underappreciated,” Landis said.

— CNBC’s Josh Lipton and Arjun Kharpal contributed to this report.

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