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Xiaomi eyes a giant Chinese IPO

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IN CHINA no company achieved $1bn in annual revenue as quickly as Xiaomi did, in the year following the launch of its first smartphone in 2011. Chinese media initially nicknamed Xiaomi the “Apple of the East” (its literal translation is “little rice”). That was a stretch, even in good times. But within another two years the affordable-handset-maker became the world’s most valuable startup, worth $46bn.

Analysts reckon that it now wants to raise up to $10bn in an initial public offering (IPO) on Hong Kong’s stock exchange which was announced on May 3rd. (Its filing documents disclose neither the valuation that it is seeking, nor a fundraising target.) That could afford it a very generous valuation of as much as $80bn—not far off the $91bn market capitalisation of Baidu, China’s biggest search engine and one of the country’s three “BAT” tech titans alongside Alibaba and Tencent.

Yet only 18 months ago such talk would have seemed outlandish. In 2016 Xiaomi’s sales fell sharply and it tumbled from first to fifth place among Chinese handset-makers. Lei Jun, its founder, blamed clogged supply chains at a time of rapid growth. Many thought it had overstretched, launching internet-connected gadgets, from rice cookers to drones, to create an ecosystem of devices that could be controlled from smartphones. Sales of these gizmos and Xiaomi’s low-cost but high-specification handsets accounted for 91% of its $18bn in revenues last year, yet they made only wafer-thin gross profits of 8.8%, a small fraction of the 39% that Apple makes on its iPhones.

Since then, Xiaomi has bounced back again. At a launch event in Shanghai in March for the MIX2S phone, Mr Lei strode on stage in gleaming white trainers in a stadium filled with Mi-Fans, as the company calls its devotees, claiming that his newest smartphone had “crushed” Apple’s iPhoneX. There was much cooing at the unveiling of the Mi Gaming Laptop, which allows users to place a food-delivery order mid-game with a programmable button.

A resurgent Xiaomi wagers that its Mi-Fans, to whom it has regularly turned online for ideas and feedback, are loyal, and that “amazing products” at “honest prices” will encourage more people to snap up its phones. It says that already 1.4m users own more than five of its hardware products. By 2022 it expects to generate $10bn in annual revenues from 1,000 physical Mi stores that sell its phones, laptops and some of its 300-odd lifestyle gadgets (mainly built by startups in which Xiaomi has stakes). Last month Mr Lei announced, to the horror of some potential investors, that he would aim to keep overall net profit margins for all of this hardware under 5%. For a long time his approach has been to make money on internet services by luring users into the Xiaomi universe with unbeatable handset prices.

The firm does indeed make its fattest gross margins, of 60%, through services and ads on Xiaomi-developed apps that are pre-loaded on to its home-grown MIUI operating system, a tweaked version of Android. These include Mi Music for streaming audio, for instance, and its own Mi App Store. The average revenue per user of MIUI doubled between 2015 and 2017. A banker who has helped prepare its listing sees big moneymaking potential in India, where Xiaomi overtook Samsung at the end of last year as the country’s top-selling smartphone-maker, a major reason for its bounce-back. Last year 28% of Xiaomi’s sales came from foreign markets, up from 6% in 2015. Remarkably, in the first quarter of 2018, it made over half of its sales abroad, among the first of China’s firms to do so.

Possible snags abound. Huawei, a domestic rival, grew faster than Xiaomi in India in the first three months of this year. Neil Shah of Counterpoint Research in Mumbai says that in foreign markets, where Google’s services are not blocked (unlike in China), Xiaomi will find it hard to sustain its services-based profit model. Mr Lei had been hoping to take his phones to America this year, but as troubles mount for Chinese peers such as Huawei and ZTE, it is “now unlikely to pour resources into such a tough market”, says Shelly Jing of IDC, another market-research firm. At home it will be under pressure to increase the average price—and quality—of its phones (currently 881 yuan, or $138) as veteran smartphone buyers are tempted by its rivals’ higher-end models. Excluding one-time charges, Xiaomi’s net income was a relatively modest $700m last year.

If the latest estimates are accurate, this flotation will be the biggest IPO since Alibaba fetched $21.8bn in New York in 2014. Xiaomi is eager to prove to investors that it is an internet company, and so deserves higher valuations than a simple hardware firm. It claims that more than 100m devices have been connected to its “internet-of-things” platform. Its array of investments in over 210 companies lend it the air of an incubator. Fu Sheng, who founded Cheetah Mobile, a leading maker of utility apps for smartphones, says that BAT may soon become “ATM”. M for Xiaomi would replace B for Baidu.

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Japan still has great influence on global financial markets

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IT IS the summer of 1979 and Harry “Rabbit” Angstrom, the everyman-hero of John Updike’s series of novels, is running a car showroom in Brewer, Pennsylvania. There is a pervasive mood of decline. Local textile mills have closed. Gas prices are soaring. No one wants the traded-in, Detroit-made cars clogging the lot. Yet Rabbit is serene. His is a Toyota franchise. So his cars have the best mileage and lowest servicing costs. When you buy one, he tells his customers, you are turning your dollars into yen.

“Rabbit is Rich” evokes the time when America was first unnerved by the rise of a rival economic power. Japan had taken leadership from America in a succession of industries, including textiles, consumer electronics and steel. It was threatening to topple the car industry, too. Today Japan’s economic position is much reduced. It has lost its place as the world’s second-largest economy (and primary target of American trade hawks) to China. Yet in one regard, its sway still holds.

This week the board of the Bank of Japan (BoJ) voted to leave its monetary policy broadly unchanged. But leading up to its policy meeting, rumours that it might make a substantial change caused a few jitters in global bond markets. The anxiety was justified. A sudden change of tack by the BoJ would be felt far beyond Japan’s shores.

One reason is that Japan’s influence on global asset markets has kept growing as decades of the country’s surplus savings have piled up. Japan’s net foreign assets—what its residents own abroad minus what they owe to foreigners—have risen to around $3trn, or 60% of the country’s annual GDP (see top chart).

But it is also a consequence of very loose monetary policy. The BoJ has deployed an arsenal of special measures to battle Japan’s persistently low inflation. Its benchmark interest rate is negative (-0.1%). It is committed to purchasing ¥80trn ($715bn) of government bonds each year with the aim of keeping Japan’s ten-year bond yield around zero. And it is buying baskets of Japan’s leading stocks to the tune of ¥6trn a year.

Tokyo storm warning

These measures, once unorthodox but now familiar, have pushed Japan’s banks, insurance firms and ordinary savers into buying foreign stocks and bonds that offer better returns than they can get at home. Indeed, Japanese investors have loaded up on short-term foreign debt to enable them to buy even more. Holdings of foreign assets in Japan rose from 111% of GDP in 2010 to 185% in 2017 (see bottom chart). The impact of capital outflows is evident in currency markets. The yen is cheap. On The Economist’s Big Mac index, a gauge based on burger prices, it is the most undervalued of any major currency.

Investors from Japan have also kept a lid on bond yields in the rich world. They own almost a tenth of the sovereign bonds issued by France, for instance, and more than 15% of those issued by Australia and Sweden, according to analysts at J.P. Morgan. Japanese insurance companies own lots of corporate bonds in America, although this year the rising cost of hedging dollars has caused a switch into European corporate bonds. The value of Japan’s holdings of foreign equities has tripled since 2012. They now make up almost a fifth of its overseas assets.

What happens in Japan thus matters a great deal to an array of global asset prices. A meaningful shift in monetary policy would probably have a dramatic effect. It is not natural for Japan to be the cheapest place to buy a Big Mac, a latté or an iPad, says Kit Juckes of Société Générale. The yen would surge. A retreat from special measures by the BoJ would be a signal that the era of quantitative easing was truly ending. Broader market turbulence would be likely. Yet a corollary is that as long as the BoJ maintains its current policies—and it seems minded to do so for a while—it will continue to be a prop to global asset prices.

Rabbit’s sales patter seemed to have a similar foundation. Anyone sceptical of his mileage figures would be referred to the April issue of Consumer Reports. Yet one part of his spiel proved suspect. The dollar, which he thought was decaying in 1979, was actually about to revive. This recovery owed a lot to a big increase in interest rates by the Federal Reserve. It was also, in part, made in Japan. In 1980 Japan liberalised its capital account. Its investors began selling yen to buy dollars. The shopping spree for foreign assets that started then has yet to cease.

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