The ouster of Beijing evaluates the valuation of Xiaomi at 30% below the price of IPO – Xiaomi (BATS: XI)

Xiaomi's (BATS: XI) offers for IPOs in China and Hong Kong have been hit hard in the past two weeks. It withdrew its application for the Chinese IPO, while its optimal valuation is estimated at 30% below its listing price in Hong Kong. The nightmare of Xiaomi began after its China IPO application was repressed by Beijing. A lack of official approval will continue to haunt Xiaomi.

The world's fourth largest smartphone maker was hoping to win the "double first" envied by all Chinese unicorns: to be the first in Hong Kong with a two-class share the structure and the first registered system in the system of the Chinese Depository Receipt (CDR), similar to the American Depository Receipt (ADR) of Wall Street.

Chinese IPO is desisted; The price of the Hong Kong IPO has been narrowed down

But Xiaomi's dream has been closed by the following chilling strokes:

1. On June 14, the Securities Regulatory Commission (CSRC), the country's securities supervisory body, published on its website the document "Notice of Review on Xiaomi Group's application documents on its issue". certificate ". The "Feedback" document asks Xiaomi 84 to search for questions on virtually every detail of its application.

2. On June 18, the group decided to postpone its CDR application until its IPO in Hong Kong, without giving a date.

3. On June 19, the market announced that Xiaomi had lowered its valuation target range between $ 55 and $ 70 billion, from an initial $ 100 billion figure early in the year. It was also lower than the more recent $ 70 billion floor price that the company and its advisers had informally used as a guide for investors.

4. On June 21, Xiaomi announced its intention to set the price of its IPO between Hong Kong and Hong Kong between $ 17 and $ 17 billion, a capital increase of $ 4.7 to $ 6.1 billion. Both figures will increase by 15% if the over-allotment option is exercised.

5. On June 23, CEO Lei Jun (see photo) abandoned his previous claim of Xiaomi as an Internet service company. He has repositioned the company as being the first of the "new species" of technology companies to be a maker of money-making equipment from Internet services.

Source: Sohu.com

6. On June 28, Xiaomi announced that its IPO would cost HK $ 17 per share, the lower end of its target range. The capital to be raised will thus be lowered to 4.7 billion dollars while the valuation would fall to 54 billion dollars.

7. On July 6, Xiaomi confirmed the listing price of 17 Hong Kong dollars.

8. On July 9, Xiaomi's shares stumbled on their first trade in Hong Kong, closed at $ 16.8 HK after slipping to $ 16 HK or nearly 6% below the IPO price

Xiaomi grilled on the positioning, financial performance and market data 19659015] These events all occurred after the Chinese title watchdog released the document "Feedback", which is very critical with respect to the Xiaomi CDO CDR application. A look at the "feedback" tells us what are the challenges that Xiaomi faces in its two IPO applications.

Some of the 84 grill questions are hard to answer. In particular, the CSRC requires Xiaomi to position itself as an internet company that normally deserves higher prices than a smartphone maker.

On the Issue # 81 the CSRC notes that Xiaomi's smartphone sales amounted to 53.715 billion yuan, 48.764 billion yuan and 80.564 billion yuan respectively over the three years ( 2015, 2016 and 2017) covered by the application, representing respectively 80.4%, 71.26% and 70.28% of the group's total income. Internet service revenues, mainly derived from advertising and mobile games, representing respectively only 4.8%, 9.6% and 8.6% of the group's total revenues over this period.

"The transmitter is asked to indicate whether it is correct to position an Internet company – not a hardware company – at this point, by a comprehensive view of the main products of the company , the exact nature of the business, the composition of the receipts and the sources of profits. "[19659020] The Commission also questions Xiaomi's sources of customers in the following question. Xiaomi claims to be a technology start-up using hardware sales to boost Internet traffic while using internet services to earn revenue.

"By combining the (existing) way of passing clients over the internet, the issuer (Xiaomi) get customers through internet methods other than selling equipment? You also like to illustrate the future trend of Internet monetization, the growth margin of enterprises and if (the issuer) has the capacity for sustainable growth, based on the growth trend and the penetration rate of the smartphone market in China. "[19659019] The financial performance of Xiaomi is also questioned To the question # 83 the CSRC points out that Xiaomi's revenues were generally stable in 2015 and 2016 but rose sharply in 2017. During these three years its gross profit margin has improved significantly from year to year, yet its inventory and accounts receivable have also increased significantly, far exceeding the revenue growth rate. "S & # Please ask the issuer to explain the reasons and the rationality (of this discrepancy). "

Elsewhere, Xiaomi cites extensively in its prospectus the market information and data of 39, a report from iResearch. At question # 41 the committee questions the credibility of the report. "Sponsors and lawyers are welcome to check if the report is personalized for the issuer's registration; it's a paid report; it's a public report. Please, give advice on its objectivity and impartiality! "

Worst of all, it is that the commission shows an undisguised dislike for the IPO application from Xiaomi. The question # 39 states: "With respect to the presentation of the contents of the prospectus, the issuer is requested to use an objective and clear language for the descriptions in the prospectus; Xiaomi will be haunted by CSRC comments in the next two years

Given the 84 swarming questions of the CSRC, it is easy to have the following observations:

1. To answer the 84 questions thoroughly Xiaomi has to prepare hundreds or even thousands of pages of documents The task takes months to complete and therefore impossible to meet the deadline for double registration

2 As the CSRC has a deep reservation about the positioning of Xiaomi as an Internet company, the company faces a huge challenge to present an explanation that the securities supervisory authority might find satisfactory.It takes time to change its sources of sales, its profits and its users to convince the watchdog that its positioning as an Internet company is appropriate.

3. It takes at least two years before Xiaomi presents a series of new triennial financial data that the CSRC might consider rational. Similarly, the company may have to work hard for a few years in order to become an Internet company before it can quote a public market report that the watchdog considers as impartial.

4. Xiaomi's most important task is to improve its business performance and prepare a new IPO application to give the CSRC a better impression.

Xiaomi asks too much by positioning herself on the Internet

Doubts and dislikes of the two-digit related CSRC – the amount that Xiaomi wants to increase in its Chinese IPO and the valuation of the company. The watchdog of the titles could have considered that Xiaomi was asking too much.

Let's take two recent examples of IPO. Foxconn Industrial Internet, a subsidiary of Foxconn, Apple's leading provider (NASDAQ: AAPL), began trading on the Shanghai Stock Exchange on June 8 after a successful IPO of 27.2 billion yuan, without any objection from the CSRC. Previously, the market had been rumored that Foxconn had considered moving some of its smartphone assembly lines to India.

By contrast, CATL, China's largest car battery manufacturer, began trading on the Shenzhen Stock Exchange on June 10. in its IPO, but got only 6.5 billion yuan.

Xiaomi asked for more than 30 billion yuan in her aborted Chinese IPO. In view of these two recent IPOs, Xiaomi could have asked too much.

The fact that the CSRC defies Xiaomi's positioning as an Internet company means that the watchdog of the securities evaluates the high valuation of Xiaomi. When Xiaomi started its duo IPO application process, the market estimated that the company was seeking an appraisal of more than $ 100 billion, apparently assuming that the company was accepted as an Internet company and not as a smartphone maker.

$ 7.5-12 per share: At best 30% under the IPO price

So how to get a more reasonable valuation of Xiaomi? As the company has not been able to make profits in the first quarter of 2018, I evaluate the company from its results. Like the CSRC questions, Xiaomi's revenue performance has been erratic. Its annual turnover has increased slightly by 2% in 2016, but jumped 67% in 2017 and jumped 87.8% in the first quarter of 2018.

For optimal valuation, I suppose that Xiaomi maintains the growth rate of 87.8% overall in 2018 and maintains its EBIT margin of 11% in 2017. This gives an EBIT of 17 billion yuan for 2018.

Since Xiaomi and Apple (AAPL ) are mainly smartphone manufacturers with Internet business, I take Apple as a price standard for Xiaomi. With Apple's EV / EBIT ratio at 13, I guess Xiaomi deserves a higher ratio of 15 because of its higher growth rate. This translates into a valuation of only $ 38.2 billion on a value per share of $ 12,000, or about 30% below its floor valuation of $ 54 billion and the IPO HK 17 price set by Xiaomi.

But it is the most optimistic valuation. Xiaomi's business environment has quickly deteriorated in recent months due to two developments. The US ban on Huawei smartphone sales has signs of spread to other Chinese technology products. The trade war between the United States and China, which took place last Friday, will further deteriorate the perspective of sales of Chinese technology in the United States. Xiaomi smart phone sales and other Chinese brands in the United States will be almost zero in the foreseeable future

Worse still, the Chinese domestic smart phone market has shown signs of saturation. The two headwinds mean that competition between Chinese smartphone manufacturers will intensify – they must all fight to keep or increase their market share in stagnant or slowing domestic and foreign markets.

Therefore, Xiaomi should not maintain its 87.8% revenue growth rate in the first quarter for the entire year. An annual growth rate of 50% would already be a remarkable achievement. With a lower growth forecast, Xiaomi does not deserve a price premium over Apple. Thus, a more realistic valuation based on an EV / EBIT ratio of 13 arrives at $ 23.83 billion or a stock value of $ 7.5 HK, or 56% less than the IPO price.

Conclusion: Xiaomi's stock performance will be haunted by CSRC questions

CSRC's questions on China's Xiaomi IPO were undoubtedly the reasons for the withdrawal of the application of the company as well as repeated price reductions and its IPO valuation in Hong Kong. The company must wait at least a few years before presenting a new set of commercial and financial data that are more acceptable to the watchdog of Chinese securities.

Prior to this, investors will continue to ask the same questions to Xiaomi, particularly on the rationale for claiming to be an Internet company rather than a smartphone maker. There is a simple criterion: Xiaomi will be universally accepted as an Internet company when any change in the sales figures of its smartphones no longer affects the course of its action. Obviously, Xiaomi is still far from reaching this milestone.

Therefore, according to my estimates, Xiaomi can now be valued at $ 38.2 billion only on a value of $ 12 Hong Kong. This is 30% lower than its IPO price of $ 17K, which is already the low end of the initial target range of $ 17-22K

However, two headwinds are currently developing. One is Washington's virtual ban on sales of all Chinese-branded smartphones in the United States. The other is a saturating domestic Chinese market. Together, they are forcing Xiaomi and other Chinese smartphone manufacturers to compete more strongly to maintain or even expand their market shares in domestic and foreign markets other than the United States. This will inevitably reduce Xiaomi's revenue growth and profit margin. A more reasonable valuation should therefore be as low as 23.83 billion dollars or 7.5 Hong Kong dollars per share, or 56% less than the price of the IPO.

Disclosure: I do not have any positions on the mentioned shares initiate any position within the next 72 hours.

I wrote this article myself, and this expresses my own opinions. I do not receive compensation for this (other than Seeking Alpha). I do not have a business relationship with a company whose stock is mentioned in this article.