(Bloomberg) -- Investors hadn’t even sifted through Xiaomi Corp.’s 597-page filing for an initial public offering last week when doubts over the smartphone maker’s lofty valuation figures began percolating.
People close to the deal had built up the idea that Xiaomi could raise at least $10 billion at a valuation of $100 billion, which would make it the biggest global offering since Alibaba Group Holding Ltd. debuted in New York four years ago. Once investors got a peek at Xiaomi’s actual numbers last week, however, a new number has been making the rounds: the valuation would be more likely to start around $60 billion to $70 billion, people familiar with the matter said, asking not to be identified because the process isn’t public.
It’s not entirely clear whether potential buyers are balking at the initial $100 billion number, or whether bankers and executives are seeking to temper expectations so Xiaomi can enjoy a higher first-trading-day pop.
Estimates for the eight-year-old startup’s valuation have fluctuated from $30 billion to more than $100 billion in anticipation of its IPO. What’s clear is that this is partly due to mixed messages about what Xiaomi does. While 70 percent of revenue comes from selling smartphones, co-founder Lei Jun insists that Xiaomi’s real goal is to be an internet services company making money off ads and online games.
“Xiaomi is still an early stage company with multiple businesses investors don’t fully understand,” said Haifeng You, an accounting professor at Hong Kong University of Science and Technology. “With high uncertainty, there’s a greater chance of a company getting overvalued.”
Internet companies such as Tencent Holdings Ltd. and Alibaba Group Holding Ltd. tend to fetch much higher multiples — 41 and 54 times 2017 earnings — compared with smartphone makers such as Apple Inc. and Samsung Electronics Co., which have price-to-earnings ratios of more than 18 and 8.76, respectively.
Value Xiaomi’s entire business using Tencent’s 2017 price-to-sales multiple of 14 and giddy investors could assume a market valuation for Xiaomi at $250 billion, based on numbers from Xiaomi’s prospectus. Applying Tencent’s price-to-earnings multiple of 41 to Xiaomi’s total operating profit and investors arrive at an $80 billion valuation.
Looked at as a hardware maker, investors valuing Xiaomi using Apple’s 2017 price-to-sales multiple of 3.5 will arrive at a $62 billion valuation. Applying Apple’s price-to-earnings multiple to Xiaomi’s total operating profit implies a $35 billion valuation. To be sure, those numbers all apply to 2017 financial figures and investors buying into an IPO will be calculating their own valuations based on their expectations for Xiaomi’s future growth potential.
Xiaomi’s prospectus confirmed it doesn’t make much profit off its mobile phones and plans to limit its hardware profit margin at 5 percent in the future so it can lure in more customers and get them to use its web browser, games, videos, and financial services. Xiaomi’s web services and ad business generated 9.9 billion yuan ($1.6 billion) at a 60 percent gross profit margin last year. Some analysts say this is Xiaomi’s secret sauce, and a part of the business that will only grow as the company sells more phones and gadgets in India, Indonesia and the rest of the world.
Detractors point out that internet services are less than 10 percent of Xiaomi’s business today. Investors should only assign those Tencent-like multiples to a small sliver of the company’s operations, according to Richard Windsor, a former Nomura telecom analyst and founder of independent researcher Radio Free Mobile. Based on different market multiples applied to Xiaomi’s hardware, internet and other businesses, Windsor estimates that the company is worth $33 billion.
You of Hong Kong University of Science and Technology said the debate is coming to a head now because there’s no way for negative sentiment to be reflected in anticipated valuations.
“The only way to express negative opinion in the stock market is to sell shares you already own or sell short,” You says. “That’s impossible ahead of an IPO, so all you’re left with is positive opinions that can make a new company hard to value.”
©2018 Bloomberg L.P.