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  • Venture

Asia Awards: VC Deal of the Year – Xiaomi

  • Tim Burroughs
  • 05 December 2012
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The hugely successful launch of Xiaomi’s smart phone, and the subsequent $216 million Series C round, justified Morningside Technologies and Qiming Venture Partners’ early faith in the Chinese company

It is fitting that the origins of Xiaomi can be traced back to an, admittedly extreme, example of mobile phone usage in China. Super angel Lei Jun spent 12 hours explaining his concept for a high quality but marketing-lite smart phone brand to Richard Liu, managing director at Morningside Technologies, in 2009.

"We were on the phone from 9 p.m. to 9 a.m. discussing the business model," recalls Liu. "We had to change batteries and chargers several times. We wanted to identify the next big wave and get the timing right. The Xiaomi model is interesting because of the rapid growth in the smart phone market globally."

Lei's approach stood out in two respects. First, he didn't just want to launch a new smart phone but create an ecosystem around it as well. By covering both the hardware and software angles, Xiaomi could essentially mimic the Apple approach and tie in customers on the basis of user experience. Second, Lei wanted to compete on cost. The idea was to strip out marketing and distribution expenditure by launching, promoting and selling the smart phone online.

Morningside and Qiming Venture Partners provided $10 million in seed funding in 2009 alongside the founders. They were joined by IDG Capital Partners in the $41 million Series A round in December 2010. A Series B round worth $92 million came one year later, with Beijing Shunwei Venture Capital - an investment firm backed by Lei Jun - Qualcomm Ventures and Temasek Holdings joining the existing investors.

Validation of Xiaomi's approach was provided by Yuri Milner of DST Advisors who led a $216 million third round of funding in June - valuing the company at $4 billion - with Government of Singapore Investment Corp. (GIC) also involved.

Smash hit

By this point the customers had also spoken. After focusing on R&D in the first year, Xiaomi's debut handset, the MI-ONE, launched in August 2011 with a price tag of RMB1,999 ($310), less than half the cost of smart phones with comparable specifications. There were 300,000 pre-orders in the first 34 hours. Orders for 2012 are expected to number at least six million units, with revenue likely to reach RMB10 billion.

"We would have been happy with 300,000 orders in 2012 as a whole, so everyone has been surprised by how fast it has grown," says Hans Tung, Beijing managing partner at Qiming. "Xiaomi is the fastest start-up to reach $1 billion in revenue and achieve profitability. Google did it in year six, Facebook in year seven, Amazon reached the revenue target quicker but it took nine years to achieve profitability."

Xiaomi's ecosystem comprises three elements: the MI-ONE smart phone series, the Android-based MIUI operating system, and instant messaging service MiTalk. This ecosystem is protected by its liberation from expensive distribution channels and high inventory costs - Xiaomi can sell its products directly while the likes of Nokia must navigate regional- and city-level distributors - and the fact that no other domestic player has replicated the model.

"Other mainstream phone companies have the hardware capability and want to do the same thing but I don't think they've made much progress," says Morningside's Liu. "You also see internet companies trying to do it but they lack the hardware capability."

There is also the Lei Jun factor. Xiaomi's founder made his name with software company Kingsoft and online bookstore Joyo before emerging as a super angel investor, seeding 20-plus companies across e-commerce, mobile and social networking. Morningside has collaborated with Lei on seven deals;Qiming on four. Tung volunteers that if anyone else had walked in and made the same pitch, they wouldn't have invested in many.

Stick or twist?

Yet, at the same time, the decision to back Xiaomi wasn't a slam dunk and it depended as much on the team Lei had assembled as on the founder himself. Morningside committed $5 million in seed funding and its total investment in the company now stands at more than $50 million. Liu notes that the ticket sizes prompted a lot of internal consideration.

According to Tung, no deal Lei presented to Qiming has been cheap, but many occasions the team has overachieved, delivering strong gains. The big question mark over Xiaomi was whether it could develop a successful smart phone without the backing of a multinational brand.

"The downside protection was that the team could do software and this was enough for us to do the Series A," Tung says. "The Series B was more complicated. The company was valued at over $100 million, MIUI was working with more than 50,000 active users, a lot of them overseas. But could they design the phone, could China have its own HTC? We didn't know for sure."

One of the clinching factors was the presence of Dr Guangping Zhou, who previously ran Motorola's R&D operation in China and had successfully designed mobile phones before.

As for the future, the company is in no hurry to go public, with Lei ruling out an IPO before 2016. There is a general desire to follow the Alibaba Group approach and build up scale while remaining a private entity, so there is no danger of capital expenditure plans being thrown of course by shifting investor sentiment.

"Xiaomi wants to get a significant market share in China, which is already the world's largest smart phone market," adds Liu. "It can also expand into other emerging markets like India, Brazil, Russia, Indonesia and eventually Africa. Xiaomi can become a global player."

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