Jul 3, 2018 ยท 5 minutes

“We must curb the tendency for greed,” Xiaomi CEO Lei Jun told the South China Morning Post in April.

Which may explain the humbling of Xiaomi's long-awaited IPO. In May, Xiaomi filed for an IPO on the Hong Kong Stock Exchange, hoping to raise as much as $10 billion. That would have made it the largest IPO since Alibaba raised $22 billion in September 2014.

Instead, Xiaomi raised $4.7 billion in an IPO that the Wall Street Journal dissed as “hapless.” The amount could rise if underwriters sell an overallotment of shares set aside for the offering. At $4.7 billion, Xiaomi's offering won't even rank in the 10 largest global IPOs since Alibaba went public.

Xiaomi will begin trading in Hong Kong next Monday. The company's well-known brand name may help the share preice rise once it's actively traded, and yet it's hardly likely to reach the $100 billion valuation hoped for only weeks ago. As things stand, Xiaomi is valued at $54 billion.

That's still impressive for a company that was founded only eight years ago. But consider that in late 2014, Xiaomi raised money at a $46 billion valuation, making it then the most valuable startup in the world. Since then, Xiaomi's worth has increased at a rate of about 5% a year, while other Chinese tech giants like Didi Chuxing and Ant Financial have surpassed it in value.

Xiaomi is growing fast. In 2017, its revenue rose 67% to 115 billion yuan ($17.2 billion). It posted a net loss of 44 billion yuan, most of which came from a one-time charge related to revaluing some preferred shares. Its operating profit came in at 12 billion yuan last year, which was more than triple the 2016 figure.

Before the IPO pricing, Xiaomi's three main underwriters had all maintained that the company is worth much more than shareholders ended up paying for it. Morgan Stanley, Goldman Sachs, and Hong Kong-based CLSA produced analysis valuing the company between $65 billion and $90 billion. 

Their reasoning was based on a line that Xiaomi has pushed ever since the global smartphone market became saturated: Xiaomi doesn't make smartphones as much as it makes devices that become an intimate part of its customers' lifestyles. Those devices are merely a kind of gateway into a more lucrative business for Xiaomi: Internet services. If that sounds familiar, it's because Apple has also been taking this approach.

“Xiaomi integrates the internet user experience with hardware to offer an unrivaled user experience,” Goldman Sachs wrote in its report on Xiaomi. “The company’s hardware aggregates traffic, its software builds platforms, and its internet services generate revenue and profit.”

Xiaomi likes to call itself a services company, but the fact is that 70 cents out of every dollar in revenue still comes from smartphones. And China's smartphone market has been shrinking. Overall, smartphone shipments from Chinese manufactures declined 21% in the first quarter of 2018 to 91 million, according to Canalys. Xiaomi, however, was a bright spot in that dismal performance, with its share of the Chinese smartphone market rising to 13% in the first quarter of 2018 from an 8% share a year earlier.

When Lei made his comment about curbing greed, he was referring less to raising capital than to Xiaomi's willingness to endure thin margins on the devices it manufactures, preferring instead to generate profit from services layered on top of them. That was a barely veiled dig at Apple, which enjoys a gross margin of about 60% on every iPhone it sells. Xiaomi's gross margins on its phones is about 9%.

But this also points to a key concern among Xiaomi's new shareholders – that overall margins remain slim. Apple's attractive profit margin on its devices have always been a draw for investors. And Apple is also succeeding in building a robust services business off its iPhone customer base, with that business segment seeing revenue rising 31% year over year in the first quarter of 2018. 

By one measure, Xiaomi is somewhat cheap relative to Apple. At its IPO pricing, it's valued at 3.2 times its 2017 revenue. Apple, growing much more slowly given its massive scale, is trading at 4 times its last fiscal year's revenue. That might have been enough to draw in shareholders to the Xiaomi IPO like billionaire George Soros, mutual-fund giant Capital Group, Qualcomm, and China Mobile.

Xiaomi's IPO may also have been adversely affected by the last-minute scuttling of plans to list on the Shanghai Stock Exchange. Chinese exchanges have been hoping to list Chinese depository receipts like the ADRs that trade on U.S. exchanges for foreign companies. Xiaomi is headquartered in the Cayman Islands, so would have qualified for CDRs, but disagreements with Chinese regulators on Xiaomi's IPO price and the lack of clarity on exchange rules reportedly prompted Xiaomi to back out.

Whether Xiaomi rallies when it starts trading may help determine the mood for other big IPOs in China's pipeline. Didi Chuxing, Ant Financial and Tencent Music are all said to be planning IPOs as early as this year. Like Xiaomi, however, all are approaching the public market amid concerns about rising valuations in private rounds. Ant's valuation has risen 150% to $150 billion in two years. Didi's valuation has risen to $80 billion from $56 billion in a matter of months

China's IPO market has so far in 2018 been the busiest since early 2015, including Foxconn's $4.3 billion offering in May. But rising trade tensions are taking some of the wind out of that market. Some smaller companies have already pulled their planned IPOs. And China's stock indexes have fallen more than 20% since late January, pushing them into bear-market territory.

It's not clear whether trade concerns sapped demand for Xiaomi's IPO. The company wouldn't be hurt directly by trade tariffs as it sells few phones and devices in the U.S., let alone the more profitable services bundled into its gear. Rather, the concern is a broader one - that a trade war could slow growth around the world should it get out of hand.

While it's still early, the evidence seems to be favoring an escalating trade war rather than the less damaging outcome, a war of words ending peacefully with cooler heads prevailing. What happens to Xiaomi's stock performance in coming weeks could end up influencing the reception that Didi, Ant and others get should they push forward with their own IPOs.