Blue Lotus

May 20, 2022
Robert McKay, Senior Research Associate at Blue Lotus Research Institute, was interviewed by CNBC on the recent earnings results of Xiaomi. Despite easing lockdowns in Shanghai, we remain pessimistic about Xiaomi given (1) increasing overseas competition, (2) a lack of on-going demand due to low levels of handset innovation, and (3) increasing operational and input costs.

Q: Let's get to Robert McKay, He's a senior research associate at Blue Lotus Research Institute and joins us live from Shenzhen, a very good morning to you. Let's talk about the Xiaomi numbers because the revenue picture is very similar to that of what is happening overall in the general tech space when it comes to performance. Now the issues are still there in the covid and supply chain issues. Is the worst over for Xiaomi?
Robert McKay: Well, we don't think so yet. We think there's a lot of issues on the horizon. We can see even if Shanghai lifts the lockdown, there's risk of further lockdowns as well as inflation concerns. One of our biggest concerns really is semiconductors. We can see that there will be inflation on the horizon in the third quarter and fourth quarter that is going to raise prices for smartphones and likely negatively impact consumer demand, and this is just one thing. Of course, there are still issues regarding Europe, not only inflation, such as the war in Russia of course. Both Russia and Ukraine are top markets for Xiaomi, and given the situation, they’re going to lose those shipments for the foreseeable future. These are all going to continue being quite problematic for the company.
Q: Locally, they have issues with the Covid containment. But looking overseas, now the company does have ambitions to become the world’s number one smartphone maker. Having a couple of hurdles right now. Where are they on that path, do you think that they can get there?
Robert McKay: Okay well that’s going to be a bit of a difficulty, I think. Because there’s also Honor, which used to be the subsidiary of Huawei. They’re actually coming back quite strong. We were a little bit pessimistic about their growth potential originally, but we’ve seen that they were number one in shipments in the last quarter in China. And last month they announced their ambitions to go overseas. So that is still going to hangover Xiaomi in the coming quarters. Especially in Europe where Honor has set its sights on, and I would remind everyone that Huawei used to be one of the top smartphone suppliers in Europe and Honor will probably utilize its channel connections with carriers and online networks to quickly penetrate the overseas market. So, I think Xiaomi could have some difficulty, not just from the macro environment, but also from competitors that look to take their market share. 
Q: Yeah Rob, talk to us a bit more specifically about the India market where it is doing extremely well. This becomes a lot more important now that things don’t seem to be going so well in their home market China largely because of Covid. I think shipments in the first quarter were down, what, 18% for Xiaomi. Your sound broke up there so I’m not sure whether I missed it or not, but these guys have gotten in trouble with authorities in India for “allegedly” shipping money out that they shouldn’t have shipped out. Remittances etc., right? I’m not sure where they are with this. I mean it’s India so this could take four, five, maybe six months to sort out. How much of an overhang is this for Xiaomi and its business?
Robert McKay: Right. Well I think we’re quite concerned about that. We think that it could have some implications for consumer sentiment towards the company. There is also plenty of competition in the market. It’s a very crowded market. We have OPPO, and they have a sub-brand called Realme. They’re grabbing market share very quickly, and we’re looking to see if this issue with the Indian government in terms of the tax remittances, if that will impact consumer sentiment. From my understanding, the issue in India dealing with remittances was mostly regarding Qualcomm, which they were paying some royalties for the use of their chips. That seems to be the issue in India. And so the timeline for that, that will definitely overhang on sentiment for the stock for quite a while. There’s the risk that this could turn into a 15 billion RMB fine, at the worst. In the best case scenario they’d get away scot-free, but we’re not too optimistic about that. We think there will probably be some kind of penalty, but we’re just waiting to see what form that will take. In the meantime, we think the stock is going to have some difficulty.
Q: Indeed, Robert. And if you could broaden to this down as well. I mean we know for a fact that India has very very strict foreign exchange control laws. And this isn’t specifically a Xiaomi issue, is it. Other foreign companies, have got into “trouble” with Indian authorities for basically the same thing, remittances, right? What is the issue here?
Robert McKay: Right. So I think the issue that the Indian government’s bringing up is that these companies are remitting money without having to pay taxes on the remittances, or the money should have been taxed originally. That seems to be the case for the Indian government. By remitting it, they somehow avoid certain taxes that they would otherwise have been responsible for.
Q: Hi Rob, you’ve got a HOLD rating on Xiaomi with a price target of HK$13.5. What do you need to see in terms of constructive news from the company for you to turn more constructive as well?
Robert McKay: There’s two big things, really. The first thing is the slowdown of the market. We can see that there is slowing consumer demand for smartphones in general, and that is impacting everyone in the industry. But of course, Xiaomi needs to somehow overcome that and gain market share in the slowing market. It’s going to be difficult for the company to do. There’s Honor and other companies, such as Vivo and Oppo, which have been battling for market share from Xiaomi. So, it not only needs to overcome the slowing market, it also needs to gain market share. That is the key thing, and that’s going to be difficult to do. Their competitors are spending huge amounts on advertising and research to win market share, and it’s difficult for one company to compete against the likes of Honor and others, which are backed by some very wealthy investors and entities.
Q: Robert there’s been some changes in the C-suite recently at Xiaomi with Richard Liu, the company’s founder, stepping back from day-to-day operations, with Xu Lei stepping in now. Do you expect there to be any changes in the company's direction, the way that it’s managed. And it’s actually quite similar to what we’re seeing with other tech companies in China as well. Is this a theme?
Robert McKay: What I see is Lei Jun, CEO of Xiaomi, is really hyper-focused on the EV business. Meanwhile, its smartphone and IoT business, which has really been their bread and butter, is in the rear-view mirror, so to speak. But the problem with focusing on the EV business is that it's not going to generate any revenue until best case scenario 2024. So, what we’re really going to see is that operating expenses are going to ramp up, the operating margins are going to decline, and investors are not going to see any kind of benefit from that until 2024. And who knows whether this EV business will have any kind of success. So that’s where I see the company headed right now, on the path to EV. But in two years, what will the market landscape be like? It’s difficult to say whether Xiaomi will even have an opportunity.
Q: Rob, have you got any visibility on when the Mi 12 Ultra could be released, and to what degree is it really going to drive the revenue stream? Are consumers going to go for it? Could it be delayed because of all these supply chain challenges?
Robert McKay: Well, I’m not sure about the delays, but I think we could see more news about it sometime in mid-June, I think that could be a target for the company. And as Emily said in the introduction, the June 18th sales event is a major opportunity for the company. That could be a potential catalyst if they could overcome the weakness in the macro environment, but we’re a bit pessimistic with that. In regard to the Mi 12 Ultra, from what I understand they’re going to be using TSMC’s process for their smart-phone processor, and that could lead to some consumer demand for the product. In the previous iterations, Qualcomm and Xiaomi had been using Samsung’s manufacturing process to develop their chips, and I think many consumers had expressed concerns about the suitability of those chips. Many consumers had reported overheating issues and the speed wasn’t quite satisfactory. Whereas Xiaomi and Qualcomm this time will be utilizing the latest technology from TSMC as the basis for the Snapdragon 8 Gen 1 and think consumers could show a bit more interest as a result, although we expect sales are unlikely to be a major factor given the overall industry weakness.