Why Xiaomi Is Not A Threat To Apple - Seeking Alpha

Summary

• The financial media is obsessed with portraying Chinese low-cost smartphone maker Xiaomi as a huge competitive threat to Apple.


• This is a misconception.


• Xiaomi has razor-thin margins, because of its low-priced devices.


• Apple has much higher margins and is a premium brand.


• Apple's growth in China remains intact, particularly when you consider its wider ecosystem.

In recent weeks, much has been made in the financial media about the looming threat to Apple (NASDAQ:AAPL) from a company many people probably haven't even heard of. Xiaomi is a smartphone manufacturer that is often referred to as "the Apple of China." That's because Xiaomi's business model is to produce devices that look and feel like Apple's iPhone, yet are much cheaper. For example, on January 15, Xiaomi released a phone called the Mi Note that mimics the iPhone 6. The key difference is that the Mi Note will cost $375 while the iPhone 6 costs $865 in China.

The response from the financial media was predictable. As soon as the new Xiaomi model was announced, it was lauded by some as an Apple killer. However, there is a critical point Apple bears are missing. Xiaomi is a low-margin operator with low-priced devices, whereas Apple reaps significantly higher profit margins with premium-priced devices. This implies that those individuals buying Xiaomi devices do so primarily because of the low cost. This is not true competition to Apple, because those customers would likely not have purchased the more costly Apple device anyway.

For this reason, I would argue that Xiaomi steals market share not from Apple, but from other low-cost smartphone manufacturers in China, such as Lenovo (OTCPK:LNVGY) and to a certain extent Samsung (OTC:SSNLF). That is why the real danger from Xiaomi is to other device makers on the low-end of the price spectrum, not Apple.

The 'Apple Of China' Is Apple

The argument that a smartphone that mimics the iPhone is a threat to Apple in China made sense years ago when Apple did not have a meaningful presence there. But Apple has built a powerful business in China, as part of its broader goal of further penetration into the emerging markets. Apple is experiencing rapid growth in China. In fact, China was Apple's fastest-growing geographic region in fiscal 2014 posting 17% revenue growth. Apple's China business is now a $30 billion business annually, which makes it the third-largest region for Apple behind only the Americas and Europe. (Source: Apple 10-K, Management Discussion & Analysis)

Xiaomi was founded in 2010, and although it has enjoyed its own rapid growth, it has not come at Apple's expense. The real danger that Xiaomi poses is to other smartphone manufacturers at lower price points.

Xiaomi is privately-held, which makes it difficult to analyze its operations. However, a recent Forbes article revealed Xiaomi's weak financial position. According to a Xiaomi financial filing, the company's operating profit margin in 2013 stood at just 1%. By comparison, Apple generated $52.5 billion in operating profit in fiscal 2014 on $182.7 billion of total sales, for an operating profit margin of 28%. Apple's margins tower above Xiaomi's, which reveal it has a much stronger business.

Xiaomi has grown alongside Apple, but Apple has not been worse off for it. If anything, Samsung and Lenovo are the ones truly suffering from Xiaomi's emergence. Xiaomi recently passed Samsung to become the largest smartphone company in China by number of handsets sold. Last quarter, Samsung's total revenue fell by nearly 4% year-over-year, due partly to stiffening competition in the company's smartphone business. By comparison, Apple is, and always will be, a premium brand. Despite Xiaomi's success in recent years, Apple still believes China will eventually become its biggest market. Clearly, there is little that suggests Apple is overly concerned about Xiaomi.

Even with Xiaomi's emergence, Apple's growth story in China remains intact. This is supplemented by Apple's partnership with China Mobile (NYSE:CHL), the largest wireless carrier in the world with more than 803 million customers. Apple has only been able to sell its products to China Mobile customers for one year. Now, the ability to bring all these customers under Apple's products and services umbrella opens up a massive opportunity for continued growth in China. This is true for both the iPhone as well as the other products within the Apple ecosystem.

Apple Set To Crush Q1 Estimates, Thanks, In Part, To China

All eyes are on Apple's first fiscal quarter results, set to be released Tuesday, January 27. Expectations are high, but I believe there is a good chance Apple will handily beat estimates, and growth in China will have a lot to do with that.

Currently, analysts expect Apple to earn $2.58 per share in profits on $67.28 billion in revenue, which would represent roughly 24% earnings growth and 16% revenue growth, year over year. I believe these expectations are too conservative, based on the likelihood that the iPhone 6 is a huge success. Apple sold more than 10 million iPhone 6 devices in the first weekend of sales. And, it's worth noting that this number did not even include sales in China, where the iPhone 6 wasn't available until weeks later. Plus, analytics firm Flurry found that 51% of all smartphones activated in the week before, and including Christmas, were iPhones. These reports indicate Apple's momentum accelerated through the first quarter.

If Apple does manage to top estimates, the stock could enjoy a sizable rally, because Apple's valuation clearly has room to expand. Apple's stock price has weakened in recent weeks, perhaps based in part on worries that competitors such as Xiaomi are taking market share in a critical market. Apple is about 11% off its 52-week high, and has sat out big up days for the market as a whole. This includes Apple falling about 1% on January 16, when the S&P 500 was up 1.3%. Apple is valued at just 16 times trailing earnings, which is a lower multiple than the S&P 500. This could set the stage for a snap-back rally if Apple can manage to beat expectations this quarter, which I view as highly likely, regardless of Xiaomi making noise in the news headlines.

Editor's Note: This article discusses one or more securities that do not trade on a major exchange. Please be aware of the risks associated with these stocks.

via apple - Google News http://ift.tt/1BxJLiq