Xiaomi: The view from the top
Chinese smart phone manufacturer Xiaomi has become the world’s most valuable start-up, following a $1.1 billion round. Does its growth trajectory tally with the $45 billion price tag?
"Each of us should be proud of what we have achieved last year," Lei Jun, co-founder of Xiaomi, said in an internal email on Monday.
This achievement, in numerical terms, involved the sale of 61.12 million smart phones in 2014, more than treble the 2013 figure, while gross income jumped 135% year-on-year to RMB74.3 billion ($12 billion). In the third quarter last year, Xiaomi become the third-largest smart phone manufacturer in the world, just behind Apple and Samsung. And it has only just scratched the surface in international markets.
During Christmas period, Xiaomi also announced a new funding round of $1.1 billion. This values the four-year-old company at $45 billion, making it the world's most valuable VC-backed start-up. But is Xiaomi worth it?
"The phone business, which is doing well, and the income from operating software could easily justify the valuation," says J.P. Gan, managing partner at Qiming Venture Partners, a Xiaomi investor. "Other things - the smart home appliances and wearable devices - are just options. Even if they don't work out, Xiaomi will still be worth more than $45 billion."
Branching out
When Lei founded Xiaomi in 2010, the firm had three core areas: the MI smart phone series, the Android-based MIUI operating system (OS), and messaging service MiTalk. Coming in at less than half the cost of handsets with comparable specifications, the company's debut smart phone received 300,000 pre-orders in the first 34 hours, thanks to innovative online marketing.
However, competition is intensifying. The likes of Lenovo Group, Huawei Technologies and ZTE Corp. are taking a page out of Xiaomi's playbook and selling phones online. Lei has admitted that the company is unlikely to replicate last year's shipment growth in 2015.
Xiaomi has launched six smart phones under the MI brand and its budget equivalent, Redmi, and Gan expects the low-price strategy to remain in place. Another potential source of revenue is app store Xiaomi Market, which can be used by third-party developers. Chinese internet giant Tencent Holdings already makes most of its money from online games and social networks.
"In China alone, it's a $15 billion market for online games. Once Xiaomi persuades gaming companies to sell games on its app store, taking commission fees somewhere between 30-70%, all income will be pure profit," Gan adds.
Hans Tung, a managing partner at GGV Capital who invested in Xiaomi while at Qiming, notes that Lei has cultivated an investment portfolio with a view to creating a technology ecosystem. Xiaomi has branched out into everything from tables to wearable devices; only three hardware product categories - smart phones, TVs and set-top routers - are designed internally. It likes to back independent manufacturers and help them sell products through the Xiaomi platform.
Huami Technology, which produces MI-branded activity trackers worn on the wrist, is a typical example. It is a joint venture between Hua Heng Technology and Xiaomi and has received VC funding from Shunwei Capital Partners, a VC firm also set up by Lei, among others. Xiaomi has invested in over 20 hardware manufacturers in the last two years. Lei wants to make it 100.
As a result, Xiaomi should be able to generate revenue without spending huge amounts of time coordinating product development.
On the software side, Lei has bought stakes in a number of other tech firms from online video platforms Youku Tudou and Xunlei, and game developer Westhouse Group to healthcare app maker iHealth. The ultimate aim is that a Xiaomi device becomes a deep-rooted part of the consumer lifestyle experience.
"Finding a way to connect many devices within an ecosystem should be worth a lot of money," says Tung. "Xiaomi is using an angel investment plus strategic tie-up approach. It is an interesting way to offer more innovative services to end-users in a short period of time. It takes 1-2 decades to build a conglomerate; Xiaomi's ecosystem could get there within five years."
However, one of the challenges Lei faces is making sure all the investee companies can actually integrate their products and services into the Xiaomi ecosystem.
Furthermore, not every Xiaomi investor appreciates this strategy, according to sources familiar with the situation. They would like to see their money put towards developing the core business. As a result, Xiaomi is a frequent co-investor, relying on VC firms to manage the deals.
Expansion imperative
As to the core smart phone business, at present over 90% of shipments are to mainland China. Xiaomi has targeted specific emerging markets such as Indonesia, Russia and Brazil, based on expected growth in the internet users.
"Alibaba Group's valuation grew from $5 billion in 2005 to $250 billion, while Google went from $100 billion to $350 billion. In other words, if China hadn't added 600 million internet users in nine years, there is no way Alibaba could have grown its valuation by 50x," Tung says. "The next 1-2 billion new internet will come from Indonesia, India, Brazil, Eastern Europe and North Africa. Why shouldn't Xiaomi focus on expanding into these developing countries first?"
The expectation is that these markets will be accepting of the low-cost devices offered by Chinese manufacturers and easier to penetrate than developed markets.
While this sounds great in theory, in practice Xiaomi has found it tougher. The company suffered a setback in India last year after a patent complaint by Ericsson. Xiaomi cleared one million smart phones in the first five months but then sales were suspended pending a court ruling that the company could market devices with Qualcomm's chipsets.
"Last year they planned to enter 10 emerging markets but it entered only five and the sales volume was tiny. I think intellectual property rights are still the biggest issue for Xiaomi, even in emerging markets," says Linda Sui, director of the wireless smart phone division at US-based consulting firm Strategy Analytics.
One potential solution is acquiring international firms together with their patent portfolios. "Xiaomi's margin is very slim. If they have to pay extra cost on patents in each market, it's difficult to make a huge profit," Sui adds.
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