Jul 09, 2012 07:33 PM

The Rapid Rise of Smartphone Maker Xiaomi


Lei Jun, smartphone maker Xiaomi's chief executive officer

(Beijing) — Two-year-old Beijing-based smartphone maker Xiaomi Mobile Internet Co. received investment of US$ 216 million on June 23 from international investors, the third round financing it has completed. At the time, the company's estimated value was US$ 4 billion, Xiaomi's chief executive officer Lei Jun said.

Xiaomi's surging valuation has surprised many. In the summer of 2010, when the company secured a US$ 41 million investment from Morningside Ventures, Qiming Venture Partners and IDG Capital Partners, the company's valuation was US$ 250 million. In October 2011, Xiaomi attracted another three investors with US$ 90 million, and the company's valuation at that time was US$ 1 billion.

Caixin learned that the investors in Xiaomi's latest round of financing include Singaporean sovereign wealth fund GIC, Russian investment firm DST's founder Yuri Milner and two of Lei's friends.

The surging valuation is backed by Xiaomi's fast sales growth and boosted by lower prices and direct sales from the Internet. "Xiaomi's sales growth is the fastest in the world," Qiming's Tong Shihao said.

Lei is confident in Xiaomi's growth model, and said the company would not seek a public listing within five years. But with fast changes in the mobile and e-commerce market, Xiaomi's model faces many tests.

The Valuation Question

Lei said the estimated value of Xiaomi would reach US$ 10 billion within five years.

Mi, a handset produced by Xiaomi, will sell at least 5 million units this year, Lei predicted. A source inside Xiaomi said that the sales target for the company in 2013 would be 10 million smartphones. Xiaomi sold 3 million from January 1 to June 12, the company said.

The valuation was normal, said Zhou Hongyi, chairman of the anti-virus company Qihoo 360. He said that if the net profit of each smartphone was 500 yuan and Xiaomi can sell 5 million handsets by the end of the year, then the total net profit will be 2.5 billion yuan. The price-earnings ratio was 10, according to the formula for calculating the valuation of a hardware company, meaning the estimated value of the firm was 25 billion yuan, or US$ 4 billion.

But Lei said Xiaomi's value cannot simply be estimated based on that price-earnings ratio because it is a startup company with fast growth.

However, some say it has been overvalued.

"Xiaomi's valuation is about half of Nokia, but Nokia sells over 100 million smartphones annually with a global sales network and has more than 10,000 patents," Zong Ning, brand director of Tang Capital Investment Management Ltd, said. "In these aspects, Xiaomi cannot compare to Nokia."

But compared with traditional cellphone makers, many see Xiaomi as more of an e-commerce company.

As of June 12, its sales volume was more than 6 billion yuan for 3 million smartphones. If Xiaomi can meet its annual sales objective of 5 million handsets by the end of this year, then its sales will be 10 billion yuan. More importantly, Lei said: "Xiaomi broke even in February and started to turn a more than 10 percent profit in May."

Just because of fast growth in sales, it has brought costs down and profit margins up, making Xiaomi's valuation quadruple to US$ 4 billion from US$ 1 billion in 2011, Tong said.

Profit Potential

Disputes remain over the profit for each Xiaomi smartphone. Zhou said the cost for every Mi model was 1,200 yuan and the gross profit is 800 yuan. But Lei said that taxes and patent royalties were 400 yuan for each phone sold at 1,999 yuan.

Industry insiders said the cost for each Mi should be 1,200 to 1,300 yuan, with gross profit ranges from 700 to 800 yuan.

"This gross profit range is reasonable and far from exorbitant," an insider at a mobile phone manufacturer said. "If the cell phone maker doesn't have 20 percent in gross profit, the company cannot guarantee sustainable research and development, quality control and brand marketing."

Deducting the company's operating cost based on the gross profit, the net profit is 300 yuan.

Xiaomi's handset, sold exclusively through a Chinese website, is designed primarily as an Internet access tool. Lei is betting on long-term moneymaking potential among Mi owners who watch, shop and surf the internet on their handsets. "It is the superiority of e-commerce," Lei said.

Compared to traditional marketing, Xiaomi's advantage is obvious. The cost for the Mi's storage and distribution is 20 yuan. The factory price of one type of Huawei cell phone is 1,500 yuan, but its retail price is 2,499 yuan because the marketing channel cost is almost 1,000 yuan, Yu Chengdong, Huawei's senior executive, said.

Service Issues

This year, Xiaomi smartphones have had quality problems, such as system crashes, and Mi owners have complained on microblogs.

The repair rate of the Mi model is 2 percent, Lei said, but industry insiders doubt this figure. They said the average return rate in the industry is 4 to 5 percent, and it makes no sense for Xiaomi to be below this.

The fund-raising obtained by Xiaomi will used in research and development, after-sales service and to supply cash flow for daily operations, the company said.

Xiaomi has stepped up efforts to solve the after-sales problem, Tong said, adding this was inevitable for a start-up company that grew quickly. "I am confident that Lei's team will deal with this problem very soon," Tong said.

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