BookWatch: Xiaomi needs to destroy another industry, not just conquer phones, to be worth its IPO price tag

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Chinese smartphone maker Xiaomi, the world’s fourth-largest mobile-phone maker, recently won approval for its planned initial public offering in the Hong Kong stock exchange. Its targeted US$10 billion offering will become available to investors by early to mid-July, putting Xiaomi at a potential valuation of $100 billion that, if realized, would make it the world’s biggest IPO debut since Alibaba’s in 2014.

But whether Xiaomi can achieve that $100 billion valuation depends on if it convinces investors that it can conquer more than the mobile-phone industry. One way it might: its sizable investments in companies that are connecting our appliances to our phones, part of the emerging “connected home” category.

Xiaomi’s smartphones have been a growing concern for industry leaders such as Samsung Electronics Co 005930, -1.00%  and Apple AAPL, +0.07% During the final quarter of 2017, Xiaomi toppled Samsung as the top smartphone seller in India. Its flagship smartphone stacks up against Apple’s iPhone X in features but is sold at half the price in China. The company has yet to enter the U.S. market.

But stock-market analysts were quick to benchmark comparable ratios—price-to-earnings, which measures share price relative to annual net income, or price-to-sales, which measures share price relative to annual sales revenue — and point to a huge disparity. Using Tencent’s P/S of 14 would give Xiaomi a market valuation of $250 billion. Using Apple’s P/E would give Xiaomi a $35 billion valuation.

So is Xiaomi potentially a good buy at the high end of its sought-for valuation?

The brutality of the startup world today is that a wildly successful company must create an enormous amount of value but also destroy even more to justify its existence. This is what Scott Galloway of NYU’s Stern School of Business concludes on how Google parent Alphabet GOOG, +0.24% GOOGL, +0.15%   and Facebook FB, +0.09%  have redrawn the media industry. The two firms have accounted for 103% of all digital media revenue growth since 2006. That means except for the duopoly, all digital media “now joins newspapers, radio, and broadcast TV as sectors that are in [rapid] decline,” he wrote in his latest book, “The Four.”

That’s why for Xiaomi to enter the $100 billion club, it can’t simply beat competition like Samsung and Huawei and Oppo and Vivo. It needs to destroy another industry. Can it?

Xiaomi’s ecosystem has enabled it to deliver a wide range of devices from Bluetooth speakers, to internet-enabled rice cookers, to the first affordable air purifier in China.

At the heart of a Xiaomi phone is its preinstalled Android-based operating system, MIUI, which allows consumers to tweak the user interface and advanced users to reprogram the otherwise hard-coded firmware of their handsets. Xiaomi then releases new MIUI features based on popular votes every Friday at 5 p.m. Beijing time. Of its 190 million monthly active MIUI users, 9 million actively participate in an online forum to suggest new features. One killer feature in India is to automatically switch off a Wi-Fi hotspot when the data limit is reached.

Xiaomi CEO Lei Jun’s greatest achievement lies in the cultivation of this passionate online fan base, which in turn makes Xiaomi’s offerings a continual delight. By “outsourcing” the design and development to end users, the company also lowers the cost of production.

Still, Xiaomi doesn’t stop short of making mobile phones. Lei Jun took his open innovation approach and leapt to other product categories. By March 2016, Xiaomi, still a startup itself, had invested in another 55 startups, making products from power banks to air purifiers. Of these companies, 29 were incubated from the ground up by Xiaomi, and four are already unicorns worth more than $1 billion.

PublicAffairs

This is how Xiaomi is poised to become an emerging powerhouse for the all-important category of “connected home.” Its goal is to take the MIUI approach to other sectors. According to Wang Xiang, the company’s senior vice president and the head of international business, Xiaomi’s ecosystem has enabled it to deliver a wide range of devices from Bluetooth speakers, to internet-enabled rice cookers, to the first affordable air purifier in China — products that are built by independent startups but sold through Xiaomi.

These independent startups get access to Xiaomi’s brand and distribution — its online channel, its app, and its 300 offline stores. But Xiaomi only takes “noncontrolling shares” and leaves “maximum interest to the startups” so that “they are much more incentivized and willing to fight on the front line,” explains Liu De, Xiaomi’s co-founder.

As of the fourth quarter of 2017, Xiaomi was the world’s third-largest wearables maker by volume, behind Apple and Fitbit FIT, -1.91%

The idea of branching outside of mobile phones, and to reinvent the electronic industry, fits well with Lei Jun’s grander vision. After all, for any company trying to become a $100 billion entity, it must not only outcompete the incumbents but reinvent the fundamentals of an industry.

A risky proposition? A full 45 pages of Xiaomi’s IPO application is dedicated to the topic of “risk factors.”

Howard Yu is the LEGO professor of management and innovation at the IMD Business School in Switzerland and the author of “LEAP: How Businesses Thrive in a World Where Everything Can Be Copied.”

Now read: China’s Xiaomi lost $1.1 billion ahead of IPO

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