December 17, 2014 by ...
Xiaomi just announced financials and made a slim operating margin of 1.8%. From the looks of it, they are barely eking out a living while they toil away at upper crust of the bottom dwellers in pricing. The financials may seem surprising, but not for the right reasons, which I will soon explain. But the fact is that Xiaomi’s financial position does not look that strong and will only get worse.
First off, Chinese companies are known for fudging the numbers. There are two primary reasons for this. The first is to fool the tax man. Chinese, like people across the globe can think of millions of things to do with their cash and handing them off to the government is not one of them. This goes double for people residing in a one-party state.
The other reason, which may come as a shock to many, is that Xiaomi wants to cry poor mouth. By doing this, they can preempt other players from entering the fray. A trick that many firms here play is to claim that they are on the verge of collapse. Cut throat competition has lead them to sell on razor thin margins. This means that there is barely enough room for them, let alone anyone else.
Since its inception Xiaomi has claimed that it makes nothing on its handsets and would profit from other things. This has been proven to be untrue, but set that aside for the moment.
Why Xiaomi is in trouble
Even if Xiaomi is fudging the numbers, that does not take away from the fact that if they are not in trouble today, they soon will be. Call it the ‘India’ effect. As you may know, Ericcson is suing Xiaomi for fees they should have been collecting all along. Xiaomi has been borrowing tech and despite warnings, continued to do so. Ericcson has sued and now Xiaomi is forced to dole out some cash.
This best exemplifies how Xiaomi has flourished under the watchful eye of Beijing. Irrespective of what their legal codes say, the party is loath to find in favor of a foreign firm over a local one. This means that Xiaomi has not been paying a dime to Ericcson on fees or licenses since they began selling phones.
What this means to Xiaomi
The bad news is that such fees can be as much as 30% of revenue. As of the time of this writing, Xiaomi has skirted this cost. In other words, because Beijing allows it, Xiaomi is given a 30% subsidy vis a vis IP infringement, which has enabled their growth. Based on the financial data, this meas a lot.
Recent stats show that Xiaomi sold RMB 26.6 billion and had net profits of RMB 347. Diving all of this by 6 in order to convert it to dollars, we see that they sold approximately $4.6 billion and had profit of about $58 million. Assuming that the vast majority of their sales comes from handsets, we can assume that their cell phone revenue was $4 billion. Doing the numbers we see much Xiaomi has benefited from IP theft.
Revenue $ 4 billion
profits $58 million
Revenue $4 billion
Net profits $58 million
$132 million license fees minus $110 million
New net profit minus $52 million
Problems at Xiaomi
The math may not be precise but is a good indicator. Xiaomi has been soaking up the cream but not paying for the milk. By venturing outside of China they have new cost pressures which they so far have avoided. Coming clean and paying that debt means a change in attitude and financial management. In order to go global, they must abide by the laws that they should have been following for the past 3 plus years.
Xiaomi has caught the eye of many and perhaps Alibaba or someone else will snap them up. This is not a stretch as they have a loyal following. Their biggest issue will be IP theft. Initially I thought of this in terms of being kept out of markets. Now we see that this is only part of the problem. Xiaomi will also be forced to compensate other firms for their hard work which the Chinese company has borrowed. Failure to do so means no opportunity to sell into those markets.