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Xiaomi – IPO Valuation
Market and Competitive Assessment
Cheenu Seshadri
June 2018
The analyses included here are the auth...
June 2018 2©2018 by Three Horizon Advisors, Inc. All rights reserved.
Xiaomi is a sprawling company centered on smartphone...
June 2018 3©2018 by Three Horizon Advisors, Inc. All rights reserved.
Investment bankers will employ multiple methods to t...
June 2018 4©2018 by Three Horizon Advisors, Inc. All rights reserved.
Evaluate disparate business models with a sum-of-the...
June 2018 5©2018 by Three Horizon Advisors, Inc. All rights reserved.
Market Forces Vs. Flawless Execution
Xiaomi operates...
June 2018 6©2018 by Three Horizon Advisors, Inc. All rights reserved.
After a disappointing 2016, Xiaomi roared back to li...
June 2018 7©2018 by Three Horizon Advisors, Inc. All rights reserved.
Xiaomi has raised approx. $1.5B in equity and $2B in...
June 2018 8©2018 by Three Horizon Advisors, Inc. All rights reserved.
Smartphone Market Outlook
Note: Developed markets in...
June 2018 9©2018 by Three Horizon Advisors, Inc. All rights reserved.
Smartphone Market Profit Pools
Source: IDC, Strategy...
June 2018 10©2018 by Three Horizon Advisors, Inc. All rights reserved.
IoT market expected to dwarf smartphone industry re...
June 2018 11©2018 by Three Horizon Advisors, Inc. All rights reserved.
Internet Services Opportunity
Internet services is ...
June 2018 12©2018 by Three Horizon Advisors, Inc. All rights reserved.
Sustaining rapid MAU growth and simultaneous expans...
June 2018 13©2018 by Three Horizon Advisors, Inc. All rights reserved.
Xiaomi’s business model most closely resembles Appl...
June 2018 14©2018 by Three Horizon Advisors, Inc. All rights reserved.
Fewer units combined with weaker ASP and margins le...
June 2018 15©2018 by Three Horizon Advisors, Inc. All rights reserved.
Author Bio
Cheenu Seshadri, Managing Director
Cheen...
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Xiaomi Enterprise Value Assessment

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Xiaomi business evaluation, market segment outlook and enterprise value assessment

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Xiaomi Enterprise Value Assessment

  1. 1. Xiaomi – IPO Valuation Market and Competitive Assessment Cheenu Seshadri June 2018 The analyses included here are the author’s own based on publicly available information and expresses his own opinions. He’s not receiving compensation for it and neither does he have a business relationship with any company mentioned in this article.
  2. 2. June 2018 2©2018 by Three Horizon Advisors, Inc. All rights reserved. Xiaomi is a sprawling company centered on smartphones, but also sells hundreds of other products ranging from in-ear headphones to electric scooters o Xiaomi currently has limited appeal, distribution and market share outside of China, India and Russia Xiaomi: More Than a Hardware Company? • 190M MIUI monthly active users as of March 2018 • 18 apps with 50M+ MAUs as of March 2018 including Mi App Store, Mi Browser, Mi Music and Mi Video • Advertising services contributed 57% of service revenues in 2017 • Online gaming revenue via sale of virtual currency contributed an additional 25% of service revenues • $1.52B of service revenues in 2017 equate to approx. $9 per monthly active user • 100 million connected devices excluding smartphones and laptops as of March 2018 • IoT and lifestyle products contributed 20% of total revenues in 2017 • Laptops, smart TVs, AI speakers and smart routers designed in-house • Other product categories (air purifiers, fitness band, robot vacuum cleaner etc.) produced in collaboration with ~90 ecosystem partners • High quality, affordable phones sporting proprietary MIUI OS built on Android kernel • Contributed 70% of company revenues in 2017 at an average ASP of $135 • Majority of volumes shipped are entry level Redmi phones • Phones designed in-house with Qualcomm chipsets • Introduced Mi 5C in Q1 2017 with eight core SoC designed in-house; one of 4 smartphone vendors with expertise to design proprietary smartphone SoCs Sources: Xiaomi, GSMArena, x-rates.com, 3HA Research & Analysis
  3. 3. June 2018 3©2018 by Three Horizon Advisors, Inc. All rights reserved. Investment bankers will employ multiple methods to triangulate to a rational value o Xiaomi has chosen Morgan Stanley, Goldman Sachs and CLSA to lead IPO process IPO Valuation: Methodologies Notes: WACC is Weighted Average Cost of Capital Sources: CFI, FT, Bloomberg IPO valuation is more of an art than science - Despite extensive valuation work performed by bankers, the issuer and bankers have a vested interest in underpricing it Determine the present value of future cash flows, discounted using WACC* Requires numerous assumptions, allows for scenario and sensitivity analysis Sum of the parts of different businesses – E.g. hardware, IoT platform, services Compare to similar businesses using various multiples - P/E, EV/EBITDA Widely used, easy to calculate and update Need to normalize for variations in maturity, geo focus, business mix etc. Compare to other transacted businesses in the same part of the value chain Including takeover premium makes this more comparable to stand-alone entity However, hard to find multiple recent transactions that are truly comparable Financial Modeling Comparable Analysis Precedent Transaction Analysis
  4. 4. June 2018 4©2018 by Three Horizon Advisors, Inc. All rights reserved. Evaluate disparate business models with a sum-of-the-parts approach, identify comparables for each business unit and normalize for key identifiable differences Xiaomi Valuation Key Questions and Approach • Identify key market segments and determine medium-long term outlook for these markets • Find comparable companies and drivers of valuation for each of the segments and/or overall business • Index Xiaomi’s business segments to comparable businesses (e.g. revenue, margin, growth rate, geographic exposure etc.) to determine corresponding valuation • Model valuation based on most likely scenario, but also identify key sensitivity levers and impact on valuation High-level ApproachKey Questions • What is the medium to long-term outlook for the smartphone market? • How is Xiaomi positioned in this market and how defensible is their position? • What is Xiaomi’s opportunity for smart hardware? • Is Xiaomi likely to succeed in offering an IoT platform and how likely are they to create significant revenue streams? • What is the revenue and margin potential for the services businesses?
  5. 5. June 2018 5©2018 by Three Horizon Advisors, Inc. All rights reserved. Market Forces Vs. Flawless Execution Xiaomi operates in a highly competitive market and most OEMs including Xiaomi have stumbled if not outright exited the market • The smartphone market is mature and for the first time ever, declined in 2017. Increasing competitive intensity in a slow growth market is likely to make sustained growth a challenge • Despite relying on ecommerce, Xiaomi realizes weak margins and will need to continue investing in new markets • Consumer IoT is historically low margin, partly driven by excess capacity and has minimal uptake of recurring revenue services • The likelihood of creating a high ARPU services business in International markets with well entrenched players is much lower Xiaomi has had a dream run in 2017, breaking into new markets and regaining it’s footing in the home market of China • Flash sales and an ecommerce-centric model has allowed Xiaomi to quickly enter new markets and gain mind and market share • By adopting an open innovation model, Xiaomi has leveraged the ecosystem around the high-tech hub of Shenzhen and launched 100’s of IoT / Lifestyle products that would ordinarily not be possible • Restricted access or outright censorship of Google and Apple services in China has enabled Xiaomi to develop a thriving app store and mobile advertising business While there are many unknowns with the IPO process, market maturity and middling profitability makes it challenging to support a high valuation
  6. 6. June 2018 6©2018 by Three Horizon Advisors, Inc. All rights reserved. After a disappointing 2016, Xiaomi roared back to life in 2017 and nearly doubled smartphone unit shipments and grew overall revenues by 67% o Marked shift from historical dependence on online flash sales to offline sales and international expansion drove 2017 performance Xiaomi Historical Performance Notes: Operating margin adjusted for reported non-operating (e.g. investment) gains and losses Revenue conversion done using EOY exchange rates, Service revenue per MAU calculated using annual revenues and year-end MAU counts Sources: Xiaomi, x-rates.com, 3HA Research & Analysis • International expansion contributed to 50% of 2017 revenue growth • 2017 unit and revenue growth aided by: o Retail expansion – 5.5x growth in Mi Home retail stores in China (331 at YE 2017 vs. 51 at YE 2016) o Distribution to support offline expansion with distributor count growing 270% YoY to 1,100+ • Smartphone, IoT and lifestyle products had poor gross margins of 8-9%, while services had 60% gross margins in 2017 • Investment gains contributed approx. $1B in 2017 reported operating profits Key Observations China (% of Total) 94% 87% 72% Gross Margin 4.0% 10.6% 13.2% Operating Margin* -2.3% 1.7% 4.8% Smartphone ASP $124 $127 $135 Service Rev. / MAU** $4.5 $7.0 $8.9 Xiaomi Revenue and Growth Rates ($B, %) $10.29 B $9.85 B $17.62 B 2015 2016 2017 Smartphones IoT & Lifestyle Products Internet Services CAGR (’15 – ’17) 31% 75% 64% 22%
  7. 7. June 2018 7©2018 by Three Horizon Advisors, Inc. All rights reserved. Xiaomi has raised approx. $1.5B in equity and $2B in debt financing, the latest of which was in July 2017 Xiaomi Valuation History Source: Xiaomi, Crunchbase, Venturebeat -10 0 10 20 30 40 50 60 70 Apr-10 Aug-11 Dec-12 May-14 Sep-15 Feb-17 Jun-18 Valuation($B) 2010 2012 20182014 2016 Dec 2010 $41M equity at $1B valuation; 8 months after founding Dec 2011 $90M equity at $2B valuation Jun 2012 $216M equity at $4B valuation $1B 2012 revenue Aug 2013 Equity at $10B valuation Oct 2014 $1B Debt financing Dec 2014 $1.1B equity at $43.9B valuation $10B 2014 revenue Jul 2017 $1B Debt financing ? $1B Financing Xiaomi Equity Raises and Corresponding Valuations ($B)
  8. 8. June 2018 8©2018 by Three Horizon Advisors, Inc. All rights reserved. Smartphone Market Outlook Note: Developed markets included US, W Europe, Japan, Korea, Canada and Australia Sources: IDC, Statista, Pew Research, Kantar Worldpanel ComTech, 3HA Research & Analysis With high smartphone penetration across developed markets and China, worldwide shipments expected to grow sub 3% through 2022 driven by emerging markets o Steadily declining ASPs driven by affordable phone sales in emerging markets will continue to pressure revenues going forward CAGR (’15 – ’17) 2.8% 6.0% -0.4% 0.6% Worldwide Smartphone Shipment Projection (Millions) 1,462 1,493 1,540 1,591 1,640 1,679 2017 2018 2019 2020 2021 2022 Developed Markets Mainland China Other Emerging Markets Most major markets have high smartphone penetration (2017) Replacement cycles are lengthening Smartphone ASPs continue to decline steadily 68 22 77 27 54 59 59 China India USA Indonesia Brazil Japan Russia Top-7 markets in declining shipment volumes $200 $250 $300 $350 2011 2012 2013 2014 2015 2016 2017 -28% 15 20 25 2013 2014 2015 2016 2017 USA China EU5 Xiaomi’s international opportunity lies mostly in emerging markets of India, Indonesia and sub-Saharan Africa where smartphone penetration is low and iOS and Google services have not gained significant traction and loyalty
  9. 9. June 2018 9©2018 by Three Horizon Advisors, Inc. All rights reserved. Smartphone Market Profit Pools Source: IDC, Strategy Analytics, Canaccord Genuity, 3HA Research & Analysis Primarily due to 3X+ industry ASP, Apple dominates revenue and profit pools o Historically, no vendor other than Apple and Samsung have consistently generated profits from smartphones 14.7% 39.0% 79.0% Unit Share Rev Share Profit Pool Share However, due to ASP premium vs. other vendors, Apple consistently garners ~40% share of revenues and 75%+ share of operating margins 2015 2016 2017 iPhone Shipments (M) 231.5 215.4 215.8 Market Share 16.1% 14.6% 14.7% iPhone ASP $672 $647 $688 iPhone Revenues ($B) 155.5 139.4 148.5 Apple’s share of global unit shipments has remained steady at approx. 15% 105% 105% 106% 99% 97% 2013 2014 2015 2016 2017 Apple and Samsung dominate the global smartphone profit pool and often exceed the industry’s profit pool implying every other smartphone company has been losing money or operating at a breakeven level Longer-term Xiaomi is unlikely to derive significant margins from device sales alone 2017 Calendar Year
  10. 10. June 2018 10©2018 by Three Horizon Advisors, Inc. All rights reserved. IoT market expected to dwarf smartphone industry revenues, but most use cases are industry focused and other than China, do not play to Xiaomi’s geographic strengths IoT Market Evolution Source: IDC, iResearch, 3HA Research & Analysis Manufacturing Transportation Utility Consumer Cross-Industry Other Hardware Services Software Connectivity China Japan Other Asia-Pac N America EMEA Industry Spend Category Region 772.5 772.5 772.5 Worldwide 2018 IoT Revenues ($B) • Consumer IoT is 4th largest industry segment and expected to grow fastest at 21% CAGR through 2021 • Key consumer use cases include home automation, security, and smart appliances • Hardware is largest segment with key spends on modules and sensors as well as infrastructure and security • Service is 2nd largest and is expected to grow faster and rival hardware in total spend • Application software, analytics software, IoT platforms, and security software to grow fastest • China is single largest country but spend driven by manufacturing, utilities, and government • U.S expected to have largest consumer segment in the near-term • Consumer IoT revenues till date largely driven by hardware o Minimal uptake of recurring revenue services within consumer segment o Key sub-segments include smart home devices and wearables • Hardware market is highly fragmented o 1000’s of SKUs and product categories drive extreme operational complexity o Top-5 vendors combined have less than 5% installed base share globally • Xiaomi offers 100’s of products primarily designed by ecosystem partners o Key segments include information and entertainment, health and fitness, home automation, home security and safety Consumer IoT Takeaways
  11. 11. June 2018 11©2018 by Three Horizon Advisors, Inc. All rights reserved. Internet Services Opportunity Internet services is a $1.5T sector globally and expected to grow at 11% YoY through 2022 to $2.6T o Apple and Google app store and services are well entrenched in developed markets o Revenue per active user beyond mobile connectivity in large emerging markets of India and Indonesia is likely very small Note: mi.com, miui.com and xiaomi.cn rank 55, 70 and 242 in internet traffic in China during May 2018 per iResearch Source: iResearch, 3HA Research & Analysis 1,541 1,823 2,012 2,209 2,408 2,601 2017 2018 2019 2020 2021 2022 Internet Retail Online Advertising Online Gaming Internet Finance App Store Other CAGR (’17 – ’22) 11.0% 16.5% 17.1% 12.4% 18.5% 7.7% 8.4% Worldwide 2018 Internet Services Revenues ($B) Prospect Rationale Alibaba (Taobao, Tmall and Alibaba.com) and JD.com dominate C2C, B2C and B2B retail online and on mobile in China; other major markets also have dominant eCommerce players Online advertising indexed to traffic; Xiaomi not a top-50* website; in-app, home-screen ad opportunities Primarily rev share China mobile payment leader, Alipay and Wechat dominate Rev share indexed to MAUs
  12. 12. June 2018 12©2018 by Three Horizon Advisors, Inc. All rights reserved. Sustaining rapid MAU growth and simultaneous expansion of ARPU / MAU not likely Internet Service Revenue Drivers Sources: Apple, Xiaomi, China Telecom, Vedemosti, Telkom Indonesia, TIM Brazil, Facebook, 3HA Research & Analysis 112 23 135 36 171 33 55 2015 YE MAUs 2016 Smartphones Sold 2016 YE MAUs 2017 Smartphones Sold 2017 YE MAUs 41% Yield 39% Yield $26.74 $8.78 $2.49 $1.84 40% 40% 26% 30% 4% 7% 24% 17% $- $10 $20 $30 $40 0% 10% 20% 30% 40% 50% US & Canada Europe Asia-Pac RoW Q4 '17 ARPU ARPU Growth ('15 - '17) MAU Growth ('15 - '17) Country Monthly ARPU China $9.1 India $2.8 USA $42.9 Indonesia $3.1 Brazil $6.4 Japan $28.3 Russia $4.8 • Xiaomi’s key international markets include India, Russia and Indonesia – markets with 50-70% lower mobile ARPU vs. China • India, Indonesia and to an extent Russia all have well entrenched Western mobile internet service providers • Accelerated unit growth in these emerging markets will likely pressure service revenue / MAU International growth, esp. in emerging markets will likely depress service revenue growth / MAU For Facebook, despite low ARPUs in emerging markets, high MAU growth has come with moderate ARPU growth Xiaomi realizes significantly lower MAU yield on device shipments vs. Apple 1,000 300 1,300255.10 2015 YE Active Base 2016-2017 Units Shipped 2017 YE Active Base 54% Yield [iPhone, iPad, Mac] Likely shorter device lifecycle & greater share being sold into existing base of users
  13. 13. June 2018 13©2018 by Three Horizon Advisors, Inc. All rights reserved. Xiaomi’s business model most closely resembles Apple’s o Both sell smartphones, offer a range of connected devices (tablets, laptops, wearables) and derive meaningful revenues from services Xiaomi Vs. Apple (2017 Comparison) OverallFinancials Revenue ($B) ‘16 – ’17 Revenue Growth Gross Margin Operating Margin* Smartphones Units Shipped (M) ASP Other H/W Revenue ($B) Services Revenue ($B) Active Base – MAU (M) Service Revenue / MAU** 2017 MAU Conversion*** Apple metrics for CY 2017, Operating margin adjusted for reported non-operating gains and losses, Service Revenue / MAU calculated using full year service revenue and end of year MAU count MAU conversion is increase in MAU count per smartphone unit, Scale not uniform or comparable across metrics Sources: Apple, Xiaomi, 3HA Research & Analysis $17.6 67% 13.2% 4.8% 91 $135 $3.6 $1.5 171 $8.9 39% $239.2 10% 36.9% 25.6% 216 $688 $59.4 $31.3 1,300 $24.1 58% ~14x ~2.5x ~5x ~8x ~3x ~21x ~16x ~5.5x ~3x 0.15x Apple has 15-20x greater revenue scale and 3 – 5.5x greater profitability; Xiaomi expected to grow significantly faster, but business model and regional skew likely to keep profits relatively depressed
  14. 14. June 2018 14©2018 by Three Horizon Advisors, Inc. All rights reserved. Fewer units combined with weaker ASP and margins lead to lower Xiaomi valuation o Smartphone unit share gains and margin expansion, accelerated IoT product revenue growth and MAU expansion in turn driving services revenue growth lead to base case enterprise value of $25B Enterprise Value Build-up (Based on 2019 Projections) Xiaomi operating margin adjusted for reported non-operating gains and losses Sources: Apple, Xiaomi, IDC, iResearch, Stock Analysis on Net, 3HA Research and Analysis Smartphone 2019 Units: Base case – 123M; High – 174M IoT Revenue Growth CAGR (‘17-’19): Base – 25%; High – 64% Internet Services MAU (2019 YE): Base – 263M; High – 308M $948.0B 878.2 56.7 13.1 2.0 0.6 9.4 25.0 3.5 3.5 3.5 3.5 1.2 1.2 1.2 3.6 3.6 Apple Enterprise Value (6/26/18) Revenue Marginality Equivalent Xiaomi Enterprise Value Smartphone IoT and Lifestyle Products Internet Services Xiaomi Enterprise Value Base Case High Case $33.3B Regional mix differences included in smartphone growth rate and service rev / MAU assumptions
  15. 15. June 2018 15©2018 by Three Horizon Advisors, Inc. All rights reserved. Author Bio Cheenu Seshadri, Managing Director Cheenu advises PE and corporate clients in the tech and telecom sectors. He draws on 18+ years of consulting and industry experience, helping organizations achieve sustained revenue and market share gains and top-quartile profitability. Cheenu focuses on new product development, market entry, operations strategy, corporate turnarounds and strategic planning. Cheenu’s experience includes Director & Partner at Altman Vilandrie & Co, a leading TMT focused strategy consulting firm; Chief Strategy Officer and later COO at MTS, a greenfield wireless company in India; VP of Strategy & Planning for Motorola's Mobility business; Case Team Leader with Bain & Co., helping Fortune-500 clients with growth strategy and restructuring and Acterna (now Viavi Solutions) in multiple roles including Manufacturing Manager. Cheenu graduated with Honors from the University of Chicago, Booth School of Business and is a member of the Beta Gamma Sigma Honor Society. He received a MS in Industrial Engineering from Binghamton University and a Bachelor’s degree in Mechanical Engineering from the Indian Institute of Technology, Madras.

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