Xiaomi valuation bubble: real bottleneck and illusory crown

　　Around the beginning of this year, Xiaomi broke the news of a 200 billion US dollar IPO; soon after, it quickly changed its words, claiming that it had selected underwriters and the valuation was 100 billion US dollars; and recently, the news report changed again, this time adjusted to 80-100 billion US dollars. Let's follow the mobile phone portable editor to learn about the relevant content.

　　There is no doubt that all these moves, under the guise of adjusting valuations but in reality intended to build momentum for a listing, are mostly public relations tactics.

　　Now the question comes to me. What I want to know is: How much is this company worth? How can we give a rough valuation scientifically? Combining my studies and thinking in the past year, I will try to restore my understanding of Xiaomi 's valuation in the most popular way possible.

　　Before conducting today's valuation, let's think about these three similar valuation questions:

　　1. How to price (value) one pound of vegetables, fish, chicken, pork and beef?

　　2. If you want to buy a commercial house, how do you determine how much you are willing to pay for it?

　　3. If a restaurant opens across from the school, as an investor, what valuation would you be willing to give to the restaurant and how would you invest in it? How is the valuation process conducted?

　　1. How do we usually price daily necessities?

　　Regarding the first question, people have their own life experience. In daily life, people have long known the approximate value range of food. Generally speaking, we think that vegetables < fish < pork < beef. Because we have a value scale in our hearts, we are rarely cheated, and we buy things based on our own life experience. In addition, there is another feature. If you go to the vegetable market or supermarket to see various foods, the prices will change every day. Therefore, short-term demand and supply will affect the price.

　　In the first question, everyone can understand that most things have an intrinsic value, that is, you naturally have a scale in your mind to measure the value of these foods.

　　To be precise, you will not buy a pound of cabbage at the price of pork, nor will you buy a pound of pork at the price of beef.

　　If you find that the price of fish is lower than that of cabbage, you will buy some. The value scale will naturally trigger your next behavior: buy or not buy.

　　But we observe that food prices fluctuate every day, which is due to short-term demand and supply, people's emotional fluctuations, and so on.

　　If you are a dog walker, then the dog is the price and you are the value. When the dog (price) runs ahead of you, the rope (market law) will naturally tie the dog and let it walk with you. Similarly, when the dog is behind you, it is similar. Most of the time, the dog (price) is not synchronized with you (value).

　　Through the first example, what I want to express is that Xiaomi ’s intrinsic value is not a definite number. Just like Schrödinger’s cat, it really exists and you can feel it, and it fluctuates.

　　In addition, I would like to emphasize that the public has a natural "value scale" in their minds due to their frequent contact with vegetables and meat, so we can have a rough valuation (pricing) for various foods. However, due to the complexity of Xiaomi's primary model, people rarely think about the value of the enterprise, so the scale we use to evaluate the value of the enterprise is very vague.

　　But we can be sure that no matter how much Xiaomi is valued, it will never be higher than Alibaba and Tencent, nor lower than Meizu and Hammer. This is just like the price of fish will never be higher than the price of beef, nor lower than the price of cabbage.

　　2. How do we price commercial housing?

　　Let's look at the second question. I believe that when most people buy a house, they will not calculate the absolute value of the house (from the land purchase cost, land tax, building materials, labor costs, marketing expenses, etc.), but will refer to the house prices in the same area, and of course will also consider factors such as school district, transportation convenience, shopping convenience of nearby shopping malls, house type, orientation, property, developer, etc. This leads to our second question: how to conduct relative valuation method.

　　Normally, our valuations are based on the prices of houses in the same area, similar location, and the same batch, especially the most recent transaction prices. The reference factors include whether the school district, apartment type, orientation, property, etc.

　　Of course, another factor is your analysis of the overall macro environment, market prosperity, etc., which are also variable factors.

　　In this process, you give a valuation of a house by comparing similarities. Now returning to the example of Xiaomi , we will obviously also make valuations by comparing similarities, such as comparing Apple, Gree, Midea, Lenovo and other companies.

　　Therefore, if you use the Internet valuation method to value Xiaomi , it is like valuing the housing prices in Tongzhou, Beijing, by comparing them with the housing prices in the Second Ring Road of Beijing. This is extremely inappropriate. Even though this house is in front of the Tongzhou Municipal Government and only 300 meters away from the subway, the valuation in this way will result in a huge error. It is more appropriate to value Xiaomi as an electrical appliance manufacturing or commodity retail industry. Even if it is inappropriate, it is just a comparison between the East Second Ring Road and the West Second Ring Road of Beijing.

　　This ring is a benchmark scale unit of measurement and cannot be wrong.

　　3. Dissecting Xiaomi: How much is Xiaomi worth?

　　The third question, if it involves valuing a restaurant (business), is a question of absolute valuation. You need to know the restaurant's revenue and cost in the past year and each quarter, and then roughly know how much money it earns each quarter.

　　Since I majored in finance and accounting, I used to estimate the value of such problems according to idealized models. For example:

 Xiaomi valuation bubble: real bottleneck and illusory crown

　　This is the income estimate chart for general financial personnel or securities investment bank personnel. In general, income forecasts are not downward. But if you look at the actual income or profit of companies in recent years, you will laugh. The gap between ideal and reality is too big, which is very funny.

　　Thinking back to my past self, I did the same thing. For example, if it grows by 40% this year, 40% next year, and about the same the year after.

　　Of course, I don’t think so now. My current valuation thinking, taking the restaurant at the school gate as an example, the basic process is as follows:

　　1) What tier of city is the school located in? What is the average consumption level of students? How much do they spend on food and beverage each month?

　　This is to understand the industry development stage, industry development level and prospects.

　　For example, the domestic computer industry and PC Internet industry around 2000 and the mobile Internet and smart phone industry around 2010; the computer industry ten years ago and the smart phone industry today, different stages correspond to different industry prospects.

　　During the explosive growth period of an industry, many gold diggers will be attracted. For example, in the familiar smartphone industry, not to mention the early participants and international manufacturers, at that time, there were Huaqiangbei, Xiaomi, Meizu, Lenovo, Huawei, ZTE, TCL, Haier, OPPO, vivo, Hammer, OnePlus, Coolpad, LeTV, 360, etc. in China alone; and at this stage, there are only Huawei, Xiaomi, OPPO and vivo left in China. The bonus period of the smartphone industry is gone, so the analysis will be different.

　　The level of demand and competition will directly affect the changes in a company's revenue and profits. (The income and expenses of a restaurant in front of Beijing PBC School of Finance are very different from those of a restaurant in front of a school in a third-tier city.)

　　2) How many restaurants are there on the street in front of the school?

　　This is analyzing the competitive landscape of competing industries.

　　As analyzed above, when the industry is full of participants, during the blowout period, some people make money, some people grab land, some want to take advantage of the situation, and some want to build a business. The intensity of competition directly affects the benefits.

　　For example, the business performance of two restaurants in front of a school and of twenty restaurants in front of a school are completely different.

　　3) Who is the specific target customer of this restaurant? Or what level of restaurant is it positioned as?

　　This is to analyze the company's positioning and whether its operations are in line with consumer characteristics.

　　For example, opening a high-end business restaurant at the school gate is obviously not in line with the general trend. This is similar to the domestic new retail, which insists on opening unmanned stores like Amanon Go. The technology is not mature and the social culture has not reached the relevant level. It may be more appropriate to open a student-oriented restaurant at the school gate.

　　A more obvious example was around 2005, when Shanda's Chen Tianqiao wanted to make the "Shanda Box", which was similar to today's set-top box.

　　Xiaomi started out as a smartphone brand, targeting first- and second-tier cities’ white-collar users. But when it transitioned from first- and second-tier cities to third- and fourth-tier cities, it still used the same system, and of course it couldn’t beat OV. First- and second-tier cities’ logistics and information transmission are much more efficient and developed than third-, fourth- and fifth-tier cities. Therefore, in 2017, Xiaomi had to make offline channel changes and implement its low-cost strategy in third- and fourth-tier cities.

　　In his theory of strategy and organizational structure, Chandler emphasized that strategy often leads the organization, while organizational change lags behind. The bottleneck that Xiaomi encountered in its development from 2015 to 2016 partially explains this situation because Xiaomi ’s strategy and the distribution channels in the organization did not match.

　　4) How many restaurants with the same positioning are there on this street? How are their operations?

　　This is a clear segmentation positioning and strategic choice.

　　In its early days, Xiaomi targeted first- and second-tier cities’ enthusiasts, implemented a low-cost strategy, and chose online channels. Now Xiaomi still chooses a low-cost strategy.

　　Huawei's early choice was also a low-cost strategy, and the channel it chose was the operator's bundled sales channel, which was also a natural extension of its core competitive advantage as a communications operator. At this stage, it is taking the high-end, R&D route, taking into account the mid- and low-end, and developing a new brand, Honor. Since Huawei has 20 years of technology accumulation in the communications industry, it is very reasonable to go from a low-cost route to a R&D differentiation route. It has a certain amount of experience in R&D technology accumulation.

　　If Xiaomi takes the route of R&D differentiation, it will be like a skilled cook without rice. It has no technical accumulation, or even culture, so it is difficult. So it chose diversification and the reform of commodity distribution channels, that is, Xiaomi ecological chain products and new retail.

　　In other words, Xiaomi will survive first by adopting a low-cost manufacturing strategy in the mobile phone industry and expanding its product categories at the same time. Later, when it may have cash cows, it can then conduct R&D differentiation. Just like Huawei, it always has the cash flow support of its dominant position in the communications industry to help the mobile phone industry conduct large-scale R&D.

　　Therefore, Xiaomi's mobile phone industry is more likely to be low-cost manufacturing in the later stage, among which the most critical is channel change. In other words, Xiaomi does not represent advanced productivity (it cannot produce high-end and high-priced products), but is more likely to be advanced production relations (low cost, channel change).

　　Taking PC as an example, I think Xiaomi is the Dell of the new era. Its efforts in marketing channels and other aspects do not correspond to improved product quality, but rather reduced costs and fewer distribution channels. To put it bluntly, Xiaomi’s victory is more likely to be a victory of production relations.

　　The production relations are more efficient, ahead of contemporary competitors, the distribution costs are low, the distribution channels are extensive and diverse, and the Internet also has huge traffic, which is unmatched by traditional manufacturers.

　　It is like a battlefield. When the traditional ones were still scattered and mobs, Xiaomi had already formed a militarized organization with rules and regulations. Xiaomi's chances of winning were naturally high. But Xiaomi's weapons (R&D products, etc.) were not leading. There is a difference between hot weapons and fire weapons. When Huawei, OV, etc. learned online channel organization and advanced production relations (troop organization), Xiaomi naturally had no advantage in the competition. Apple, on the other hand, has always had a huge advantage because of its advanced weapons (better products) and excellent organization (distribution channels), so it cannot threaten Apple.

　　OV has adopted a concentrated differentiation route since the beginning. On the one hand, the product positioning is differentiated, such as women, music, photography, etc. On the other hand, the channels are also differentiated, mainly in third-tier, fourth-tier and fifth-tier cities. In addition, in terms of marketing, it is also the first manufacturer to launch large-scale advertising, which is in line with the marketing culture of Duan Yongping's Subor learning machine and BBK repeater in the early years.

　　From a military perspective, OV is better than Xiaomi and others in terms of military strategy. Although it was behind in terms of military organization (online marketing channels) at the beginning, it learned quickly, such as personnel organization and military formation. Therefore, OV survived smoothly.

　　On the other hand, companies that adopted a similar low-cost strategy to Xiaomi in the early days, such as LeEco, Coolpad, Smartisan, Meizu, 360, etc., have either died, been disabled, or been injured. Among them, there are rumors of a merger between Smartisan and 360, which is not surprising at all. Their channels (military organizations) are not the best, their strategies are also average (LeEco kills 800 enemies and loses 1,000 of its own), and their weapons are even more average. It would not be surprising if they merged.

　　Under the low-cost strategy, Xiaomi is the only one that has survived.

　　5) What unique competitive advantages does this restaurant have? Or when other restaurant owners imitate it, what moat does the restaurant have to prevent others from invading?

　　This is to analyze the core competitiveness and moat of the enterprise.

　　Xiaomi is similar to Lenovo ten years ago in some ways: the core components of mobile phones are basically purchased from outside, and Xiaomi puts its own brand on them and assembles them. In addition, Xiaomi also produces many similar electronic products.

　　Objectively speaking, it is indeed unrealistic to require Xiaomi to develop top-notch chips, memory, cameras, screens, processors, and special materials in the short term. This is somewhat different from Huawei.

　　Therefore, if Xiaomi wants to develop well, while accumulating R&D and technology in the past five years, the area with the highest input-output ratio should be to adopt a low-cost strategy, widely develop a channel strategy, transform production relations, and continue to occupy the market.

　　On the one hand, we are running online and offline in parallel. In this process, we strive to ensure the interests of offline businesses and make them profitable. At the same time, products are also within reach.

　　Accessibility is the core goal of Xiaomi's new retail. Just like Coca-Cola, you can buy it for three yuan, whether in a convenience store in Shanghai or in the frontier villages of the motherland. Through the strategy of opening new retail stores, Xiaomi has made mobile phones and ecological chain products available everywhere, changing the early problem of focusing only on first- and second-tier cities. With the opening of Xiaomi stores or the expansion of dealer channels in fourth- and fifth-tier cities, Xiaomi's low-cost strategy has strong vitality in the vast rural areas and prefecture-level cities.

　　On the other hand, other smart hardware products are also sold together to increase sales revenue and change the problem of single product structure and single income.

　　When various channels are rolled out, sales will continue to increase, which in turn will further reduce procurement costs and lower supplier purchase prices. This positive feedback loop will continue to implement the low-cost strategy.

　　Xiaomi's ecological chain also follows Xiaomi's low-cost principle. For example, Xiaomi bracelets, Xiaomi power strips, Xiaomi batteries, Xiaomi purifiers, Xiaomi balance bikes, Xiaomi trolley cases, etc. Many smart hardware products use the same strategy, harvesting an industry that has not been transformed by the Internet, and then cutting out all the middlemen.

　　This is also what I think is Xiaomi’s strongest point: first transforming traditional smart hardware, then using traffic to support a certain manufacturer, and finally adopting a harvesting model.

　　If Dell created the direct sales model (eliminating the middleman) in the computer industry, then Xiaomi is a large-scale production and sales model (production and direct sales), or a further deepening of Dell's direct sales model. This model is the Costco model in the supermarket field and the MUJI model in the daily necessities field. However, Xiaomi is in the direction of smart hardware and is in line with the low-cost strategy.

　　Xiaomi has already successfully proven itself online, and its main focus now is on offline third-, fourth-, and fifth-tier cities as well as more remote areas.

　　Therefore, Xiaomi's core competitiveness, for now, is its sales model and low-cost strategy that is ahead of its competitors. With a distribution network that is as ubiquitous as possible, although this network has not yet been fully formed, Xiaomi's rise in India further proves the scalability of the low-cost strategy and online marketing.

　　Offline feasibility will be Xiaomi's biggest challenge in the next two years.

　　6) What is the quality of the restaurant's staff, cooks, lobby managers, etc., especially the management and cooks?

　　This is to analyze and judge the management, which is also to judge the level of the jockeys.

　　The problems encountered by Xiaomi in 2016 are not just isolated cases. The low-cost strategy, especially the difficulties in supply chain and channel expansion, also tested similar companies such as LeEco, Coolpad, Hammer and 360. The former two basically collapsed, and the latter two may now be considering a merger.

　　The management team represented by Lei Jun can be regarded as the first mobile phone manufacturer in China to seize the opportunity and also the first mobile phone manufacturer to reverse the decline. Since the rating of management is very personal and subjective, I believe that everyone has their own judgment on the management of each domestic mobile phone manufacturer, so I will not tempt or mislead you too much.

　　But in terms of specific performance, you can still look at what the management has done. This is not subjective.

　　In the favorable situation from 2011 to 2015, perhaps the industry wind blew up Xiaomi, the pig, and the first-mover advantage or even luck played a big role, so it can't prove anything. But in the unfavorable situation from 2015 to 2017, it depends more on how the company's management can judge the situation and its specific and refined capabilities.

　　Therefore, relatively speaking, as the management level in the mobile phone industry, the Xiaomi team can be ranked among the top three in the country.

　　7) Will this restaurant undergo any operational changes as time goes by and students come and go? In other words, what areas should we keep an eye on after a few years?

　　This is to analyze whether the company poses long-term threats or potential risks.

　　Back to Xiaomi, I am more concerned about four issues:

　　1. Can Xiaomi's offline channels and physical channels be well integrated?

　　At present, we see that Xiaomi is trying to open retail stores, but in the future, there will probably be franchise stores, especially in fourth- and fifth-tier cities. The expansion of channels must give a share to dealers, but this will undermine the original unified online pricing strategy, and it is contrary to Xiaomi's fundamental strategy - the low-cost strategy is to cut out middlemen. This includes the support for self-operated and non-self-operated stores, etc. This is a very delicate and slow process.

　　The success or failure of this area will directly determine the future revenue growth rate of Xiaomi, especially the expansion of channels in fourth- and fifth-tier cities and the integration of online and offline. If the integration goes well, Xiaomi's performance in the next two years will be guaranteed.

　　2. How can Xiaomi grab as much market share as possible in a stock market, such as taking away market share from Apple, Huawei, and OV in the mainland market?

　　If we look at the development of the industry, the current mobile phone industry is similar to the PC industry ten years ago. It has basically been occupied and has become a stock market. In a stock market, competition is a life-and-death struggle. Xiaomi's low-cost strategy may be able to snatch a part of Huawei's low-end market and the market of OV factory girls, but how difficult is it? If it really snatches them, why? The money earned from selling a Xiaomi is far less than that from OV, so why should dealers sell it?

　　It's always a difficult question, a business question, the baseball player on the field should swing the bat better than me.

　　3. Can Xiaomi find enough smart hardware products to expand?

　　Xiaomi has entered the fields of wristbands, batteries, scales, notebooks, headphones, purifiers, etc. How many varieties can Xiaomi expand in this way? How big is the corresponding market space? Is it enough to change Xiaomi's structure of over-reliance on a single variety? In addition, this issue also involves Xiaomi's new retail strategy. How many SKUs are appropriate? Too few is not good, and too many is not good either.

　　4. How did Xiaomi solve the problems similar to Lenovo’s “trade, industry and technology” and Huawei’s “technology, industry and trade”?

　　To put it bluntly, if Xiaomi simply changes its marketing channels and implements a low-cost strategy, I doubt whether Xiaomi will become the next Lenovo.

　　Electronic products are not homogeneous and standardized products, so they are destined to be replaced by the next round of new products. The rapid iteration of product changes means that products must be supported by "technology". Xiaomi said in the early days that it was so "black technology" in technology, which was simply nonsense. It is impossible for a start-up low-cost strategic manufacturer to develop differentiated products, and differentiation must be matched with high gross profit. Only Apple has achieved a balance between low cost and differentiation and mutual positive feedback.

　　For Xiaomi, this is undoubtedly a process of evolution from "ape" to "human". This is also the only way for Xiaomi to become a respected company. Otherwise, it will be just a copy of Lenovo in the era of smartphones.

　　8) Take a closer look at the restaurant's quarterly financial statements, revenue, cost, and profit. Check whether the restaurant's past financial data is consistent with history and give a rough estimate.

　　This is probably the job of an accountant, analyzing financial statements, checking the company's development status in previous years, analyzing the company's possible room for improvement, comparing industry ratios, and finally making business forecasts and estimating the company's value.

　　The data I have seen now is that the mobile phone business is about 80-90 billion yuan, and the revenue of Xiaomi's other businesses is about 20 billion yuan, with a profit of about 1.5 billion US dollars.

　　Due to the lack of more detailed data, I am not sure about the specific valuation, so I can only adopt a relative valuation: compared with Apple's P/E ratio, it is about 18 times, and the basic valuation is 27 billion US dollars; but considering that Xiaomi is a bit like the new era of Dell's direct sales model, a more advanced production relationship, and has the potential to subvert traditional electrical hardware, I double the P/E ratio, that is, 36 times, which already includes growth potential and sustainability.

　　That is to say, as of the end of 2017, my valuation of Xiaomi was US$54 billion, not exceeding US$60 billion.

　　But after three quarters, if everything goes well for Xiaomi and it maintains a growth rate of more than 40%, I would be willing to give it a valuation of 80-90 billion US dollars when it goes public.

　　Xiaomi wants to wear the illusory crown of "ATM", but the bottleneck is so real and the process is quite uncertain. Lei Jun still has to take his time to wear the crown.

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