Facing Double Whammy in India, Will Xiaomi Look Home for Comfort?

Key Takeaways:

• Xiaomi has been accused of tax evasion in India, though the company claims its activities complied with local laws
• Ban of company’s local apps is dealing a second blow to Xiaomi in India, leading some to predict it could switch its focus back to its home Chinese market

By Ken Lo

Beware the dangers of operating in a foreign land – especially one that has tense relations with your home government. That’s the situation now facing smartphone maker Xiaomi Corp. XIACF, whose seemingly run-of-the-mill tax dispute in India has snowballed into a major incident involving the seizure of a huge amount of assets.

The Chinese company was recently accused by Indian law enforcement authorities of misleading local banks to engage in illicit wiring activities involving licensing payments. The company is also being accused of violating local foreign exchange laws.

Xiaomi said it was only engaged in normal business activities. But that didn’t seem to satisfy the Indians, who seized 55.51 billion rupees ($725 million) worth of the company’s local assets while the case is pending. All of this is happening as concerns mount that New Delhi will turn up the heat on Chinese companies’ local operations as relations between the two governments remain tense over military skirmishes on their shared border in 2020.

The company said that all of its Indian operations strictly comply with local laws and regulations, and that its bank statements related to royalty payments were legitimate. It added that all intellectual property used in its locally sold phones was authorized, and that it would work closely with the local government to clear up any misunderstandings.

In the latest development of the case, the high court in the state of Karnataka stayed the government’s asset seizure so Xiaomi could keep making salary and other payments until the next court hearing on May 12.

The dispute began with audits of local smartphone makers by the Indian tax authority last year. Xiaomi’s latest financial statement released in March discussed the audit, saying the company had yet to receive results and that it hadn’t made any provisions against potential losses. It added it didn’t think the matter would have any serious implications for its 2021 performance.

Declining market share

Based on media coverage and the company’s responses alone, it is hard to tell how serious the incident is and what kind of losses the company might suffer as a result, said Jason Chan, head of the research department of uSmart Securities. He added the company has already met with some other headwinds in India in recent years, and intense competition has eroded its market share.

The company entered India in 2014 when China’s own smartphone market was reaching a saturation point characterized by cutthroat competition. The company quickly built India into its second stronghold outside China. A cost-effective local production chain and a masterful marketing campaign catapulted it to the top place in the market in 2018 when it supplanted Samsung (005930.KS) as the biggest player with more than 30% share.

But as more manufacturers threw their hats into the ring, many from China, Xiaomi’s Indian market share fell from around 27.4% in 2020 to 25.1% last year and further slipped to 23.3% in this year’s first quarter, according to data tracking firm IDC.

The company prides itself on its savvy marketing, which has helped it rank among the top five smartphone brands in 62 countries based on shipments. Last year, its overseas revenue, including India and Europe, reached 163.6 billion yuan ($24.3 billion), up 33.7% and equal to roughly half of its total. But in last year’s fourth quarter the company encountered a tough competitor there in the form of Chinese rival realme, which conveys a more indigenous vibe and has emerged as the market’s second largest player with 18.8% share.

The bad news doesn’t end there. The Indian government has pulled more than 100 Chinese apps from local app stores since the border tensions broke out with China two years ago. While that hasn’t affected Xiaomi’s phones, its previously preinstalled internet browser was among the banned apps. The bottom line is that while the market is clearly still quite important for Xiaomi, it’s quickly losing its attractiveness.

Falling advertising revenue

uSmart’s Chan pointed out that the suspension of some apps will chip away at Xiaomi’s online advertising revenue, which is an important part of its internet-related business that helps to make up for limited margins from its smartphone business. The company might pivot back to China if its internet business worsens, he added.

The company’s shares reached an all-time high of HK$30.45 last June, but have sagged since then. The release of its 2021 annual results in March, which beat market expectations, did little to stem the fall. Its stock closed at HK$10.36 on Thursday, off by nearly two-thirds from last year’s high. Brokerages have also scaled back their outlook on the company. A disappointing fourth-quarter performance and slowdown of its internet business are both concerns, and investors also worry about the company’s big bet on electrical vehicles.

Last year Xiaomi’s revenue increased by 33.5% to 328.3 billion yuan and its non-GAAP net profit grew 69.5% to 22.04 billion yuan. But the fourth quarter was a different story. Revenue for the quarter grew by a much slower 21.4% to 85.6 billion yuan, and its non-GAAP net profit also grew by a slower 39.6% to 4.47 billion yuan.

The gross margin for its smartphone business last year was 11.9%, while its IoT and lifestyle products businesses were both slightly better at around 13.2%. By comparison, its internet business was far more profitable with a gross margin of 74.1%, showing just how dependent it is on the internet business for its profits.

The company has been moving faster than expected in its electric vehicle plans since announcing them just over a year ago. That team has more than 1,000 people engaged in R&D and expects to see its first cars roll off assembly lines as early as the first half of 2024. But uSmart’s Chan said the company has so far been cagey about details for the business, which was a key reason for his skepticism about the stock’s potential. He said he believes the shares won’t return to HK$15 level anytime soon, which would represent a nearly 50% gain from their latest close.

Xiaomi trades at a current price-to-earnings (P/E) ratio of 10.7 times using its non-GAAP net profit, similar to a 10.4 for Samsung. Both are severely overshadowed by U.S. superstar Apple Inc. with a forward price-to-earnings (P/E) ratio of 21.4 times. Then again, Apple is probably in a different sphere from the other two, which is reflected in the big premium for its stock.