Xiaomi:Welcome to Mi world

Internet services, monetizing user traffic

User traffic is the key asset Xiaomi monetises, rather than devices. This is thecore differences between Xiaomi and its smartphone peers, in our view. Xiaomiattracts user traffic through fast fashion devices, and monetizes the user trafficvia internet services, such as advertising, online gaming operation services,APPs, IoT platform, etc. Internet services contributed 39% of Xiaomi’s GP,carrying 60% GM (vs. 13% blended GM), and we expect the GP contribution torise to 42% / 45% / 49% in 2018-20E, driven by growing internet services market,MIUI MAUs (monthly active users), and ARPU (average revenues per user).

India; a strong smartphone market

We model Xiaomi’s smartphone shipments to grow at a 30% CAGR in 2018-20Eto 221m units in 2020E (vs. 91m / 55m in 2017/ 16), or 14% global market share,driven by India market growth and market share gains in Southeast Asia (SEA),Europe, and China. We model the India market to grow at a 15% shipment CAGRin 2018-20E, driven by rising smartphone penetration rate, internet users, and 4Gnetwork. Offline channel expansion, local production in Indonesia, fast fashiondevices, and competitive prices are the keys to drive market share gain in SEA,Europe, and China. Xiaomi penetrated operator channel (Three) in Europe viapartnership with CK Hutchison (1HK, Outperform, David Ng) in May 2018(link).We also see Xiaomi’s capability in raising price (p.2). It raised high-endsmartphone models price by 39% YoY in 2017with units still up 6% YoY.

Fast fashion; competitive price strategy, growing user base

Fast fashion, competitive prices, and multiple devices is how Xiaomi wins overuser traffic. Xiaomi’s smartphones are innovative and first to the market, such asAI, facial recognition, edge-to-edge screen, ceramic unibody, etc. Apart fromsmartphones, Xiaomi drives its product lines fast to capture every market need on‘smart life’ to drive its user traffic, such as NBs, wearables, TVs, air purifiers, ricecookers, tooth brushes, etc. The Mi ecoystem is the unique strategy Xiaomi usesto drive its product portfolio. Competitive prices (usually 50% below peers, Fig 1)also accelerates Xiaomi’s user traffic expansion.

Initiate with Outperform rating TP of HK$30(35x 2019E PE)

We believe a 35x PE multiple is justified by Xiaomi’s monetization through usertraffic, similar to internet / e-commerce companies, and different from smartphone/ devices brand makers. The 35x is attractive considering its strong EPS CAGR at+40% in 2018-20E with GM expansion, and compared to Amazon (e-commercepeer) at 67x 2019E PE, and BAT (internet peers) at 36x 2019E PE on average.The IPO attracted 7cornerstone investors, including Qualcomm and ChinaMobile at US$100m each, or 2% of total funding each. Downside risks: slowerthan-expected smartphone market growth and internet services growth.