while Xiaomi (OTCPK: XIACY) is facing a major headwind at the moment, it is still a force to be reckoned with in the smartphone industry. Globally, it is behind Samsung (OTCPK: SSNLF) hail (AAPL), with Global smartphone market share 13.6%. With the global smartphone market down nearly 10% year-on-year in the first three quarters of the year, stocks have been under pressure. However, this has created an interesting investment opportunity. We believe that the difficult circumstances the company is facing will eventually dissipate, and if that turns out to be true, the current valuation can be said to be very attractive.
To make things more interesting, Xiaomi has invested heavily to bring the EV to the market. The car has yet to be launched, and relatively little information has been shared. Investments in the smart electric vehicle project currently add to costs, but not to revenue or earnings, making the company look even worse for the time being. In fact, we think that at the current valuation, Xiaomi shares are cheap, and they don’t seem to assign any value to a potential success in the electric vehicle market.
There are other positives that make us believe that the company will continue to grow in the future. To start, it is a company that invests heavily in research and development. Its R&D expenditure has reached RMB 4.1 billion, an increase of 26% year-on-year, and now has more than 30,000 employees, about half of whom are R&D personnel. ISPs are also doing relatively well, with the number of connected devices on their AIoT platform increasing by more than 40% annually.
At the moment, 2,000 of the nearly 10,000 stores remain closed due to the pandemic. If China eases Covid measures next year, and many of its stores are able to reopen, this should provide a good wind for growth. As for when electric vehicles may start contributing to the company’s growth, the company is guided by launching them in the first half of 2024.
Results for the third quarter of 2022
The total revenue in the third quarter was CNY 70.5 billion, which is approximately US$9.8 billion given the exchange rate of one dollar is roughly equal to CNY7.15.
Most of the revenue came from smartphones, at about CNY 42.5 billion. The revenue of Internet of Things and lifestyle products was 19.1 billion yuan, and the revenue of Internet services was 7.1 billion yuan. Adjusted net profit was CNY 2.1 billion in the quarter, which included an expense of CNY 829 million for the smart electric vehicle project and other new initiatives.
Xiaomi is not getting enough appreciation from the investors for being such a strong player in the smartphone market. Its market share is only about 4.2% less than Apple’s, yet it trades for close to 1% of Apple’s value. Of course Apple is stronger in the very lucrative North American market, and they have other very profitable products and services beyond the iPhone, so there are differences. However, Xiaomi has other products and services as well, and it could also become a very suitable EV player as well.
In this quarter, Xiaomi’s market share improved year on year in Europe, the Middle East and Latin America. Impressively, it ranks second in Europe and the Middle East, and number one in India. In Latin America and Africa, it ranks third.
Given its success in the highly competitive smartphone market, and with its reputation for outstanding research, development and innovation, we believe that Xiaomi has a reasonable opportunity to become a significant player in the electric vehicle segment. Right now, she’s trying not to talk too much about it for competitive reasons, but she confirmed during the most recent one Earnings call It expects to mass-produce its first car in the first half of 2024. The company has not yet decided whether manufacturing will be in-house or out-sourced, as it is still studying various alternatives. CFO Alain Lam gave an interesting response when asked about the EV project during the call’s Q&A session:
I think, first of all, electric vehicle expenses are going to continue to go up, right, as we get closer to our launch, which we’re still anticipating in the first half of 2024. So — as you can see — in the last three quarters, our expenses have been going up gradually, and we expect that That continues in the third and fourth quarters of this year. So I think this is the year. I think — so I guess that’s the first question.
As we continue to invest in headcount as well as our capital expenditures, I think we expect expenses to continue to increase. At present, our R&D team has already exceeded 1800 people. So we continue to increase the number of employees in our electric vehicle business.
In terms of development, at present, we have not talked about development in the public. So most likely, we’ll say this is going to be — still in stealth mode at this point. So we haven’t talked about some of these developments publicly. So I hope you understand. I think we’re trying to stay low profile now on the EV side. I think the two things are, we still expect to be mass-producing our first car in the first half of 2024. And secondly, we’re over 1,800 employees.
This would put Xiaomi in direct competition with other Chinese EV makers, including BYD (OTCPK: BYDDF), Xpeng (XPEV), Li Auto (L.I) and NIO (nio) and also Tesla (TSLA) which is famous for its huge factory in China to address the domestic market.
In the third quarter of 2022 the overall gross margin was 16.6%. Third quarter gross margin was up from second quarter gross margin, in part due to premium products launched in China in the third quarter that generated high margins.
Zooming out on the revenue graph, it’s clear that Xiaomi has grown quite significantly in the past few years, and only the last few quarters have the growth been disappointing. Once the macroeconomic conditions improve, and the global smartphone market recovers, we believe that Xiaomi will start growing again at a decent pace.
Xiaomi’s balance sheet is very strong, containing more money and short-term investments than long-term debt. In fact, we were surprised to see that Xiaomi has become so cheap that net cash is currently about a third of its market value.
The rating is so low that we don’t think the market is assigning any value to the electric vehicle option. Xiaomi’s enterprise value is about $24 billion, which is about 1% of Apple’s value.
The EV/revenue multiplier is very low at about 0.5x, certainly well below Apple’s 6.2x. In other words, the market values Apple’s revenue at more than 10x as much as Xiaomi’s. Of course, Apple has much higher profit margins, but that’s partly because it’s a more mature company. Xiaomi’s profitability could improve as it gains more scope that allows it to take advantage of operating leverage.
Xiaomi has several risks worth considering, including the fact that it operates in a highly competitive smartphone industry. The operating margin is also very low and declining. At the very least, the company has a strong balance sheet that will help it weather the downturn and keep investing when the good times return. The Altman Z score was above the critical 3.0 threshold, but not by much. Overall, we think Xiaomi is an above average investment for risk, but also high potential rewards.
Xiaomi is facing major headwinds at the moment, but we think things will work out eventually. At the current valuation, the market appears to be assigning no value to the EV opportunity, which could be significant. Since Xiaomi now has more than 1,800 R&D engineers working on the EV project, we think it’s serious about the opportunity. The stock looks attractive at the current valuation, assuming the company can reignite growth.
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