June 12, 2018 / 3:01 AM / 7 days ago

Breakingviews - Only a bold call dials up $75 bln Xiaomi valuation

HONG KONG (Reuters Breakingviews) - For Xiaomi to dial up a $75 billion valuation requires a bold call. The Chinese company would have to deliver another year of huge growth. Superior profit margins and premium multiples also must be assumed, a Breakingviews calculator shows.

A booth of Chinese smartphone maker Xiaomi is seen at an industrial design expo in Wuhan, Hubei province, China December 3, 2017. Picture taken December 3, 2017. REUTERS/Stringer

Run the numbers: tmsnrt.rs/2M380NY

Beijing-based Xiaomi plans to raise as much as $10 billion in what would be the world’s largest initial public offering in almost four years. Boss Lei Jun has been struggling to persuade investors, though. A $100 billion valuation had been doing the rounds in the run-up to the listing, but after the prospectus was filed last month the figure dipped to between $70 billion and $80 billion.

Lei insists that Xiaomi is an internet company. The idea is to sell cheap handsets at razor-thin margins and then make money from apps and services, whose gross margin topped 60 percent last year. For now, the company is overwhelmingly reliant on manufacturing mostly phones. Revenue from that segment soared 70 percent to $16 billion in 2017, accounting for 90 percent of Xiaomi’s top line.

Assume hardware can sustain the same blistering growth pace. At an optimistic 5 percent net profit margin, that would translate into a $1.4 billion bottom line this year. Apple trades at 17 times expected 2018 earnings. Apply a premium to Xiaomi’s division at, say, 24 times, and it would be worth about $33 billion.

Xiaomi also raked in $1.5 billion of revenue last year from online advertising, mobile games and such. That figure is set to rise quickly as the company sells more phones and develops more apps. While the company doesn’t break out net margins for the division, profitability is probably higher than the 23 percent average forecast for Tencent and Baidu. For one thing, at Xiaomi the cost of acquiring customers is borne by the phone business.

Suppose the net profit margin in the internet segment hits 35 percent. If sales were to double, and the resulting earnings were put on the same eye-popping multiple of 38 times that Tencent shares fetch, then the business could be worth $41 billion.

Combined, that would get the valuation to nearly $75 billion. Any remotely more conservative estimates, though, could become a hang-up for Xiaomi.

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