Episode 17: Unpacking Xiaomi’s IPO

GGV Capital’s Hans Tung and Zara Zhang have a conversation about Xiaomi’s IPO, which took place in Hong Kong on July 9. Hans is one of the early investors in Xiaomi and a former company board member of the company.

Hans recounts the original pitch that Xiaomi’s founder Lei Jun gave him back in 2010, and what made him want to invest in a seemingly “crazy” idea.

We also touched on frequently-asked questions like: Why can Xiaomi be thought of as an “Internet company” instead of a hardware company? Why should people stop comparing Xiaomi to Apple? Was Xiaomi’s IPO valuation justified? What does the “Xiaomi ecosystem” mean?

Join our listeners’ community via WeChat/Slack at 996.ggvc.com/community. GGV Capital also produces a biweekly email newsletter in English, also called “996,” which has a roundup of the week’s most important happenings in tech in China. Subscribe at 996.ggvc.com.


Hans: Hi, everyone. I wanted tell you about our sister podcast, Founder Real Talk. It is a bi-weekly show that gets real with founders about the challenges that founders and startup executives face and also how they have grown from tough experiences. This show is hosted by my fellow managing partner at GGV Capital, Glenn Solomon at our Menlo Park Office, produced by our colleague, Fischer Yan, at our San Francisco office.

Zara: Past episodes of the show include Stewart Butterfield from Slack, Sarah Friar from Square and Nathan Blecharczyk from Airbnb. You can take a listen by searching “Founder Real Talk” in any podcast app.

Hans: Hi there. Welcome to the 996 Podcast brought to you by GGV Capital. On this show, we interview movers and shakers of China’s tech industry as well as tech leaders who have a US-China cross-border perspective. My name is Hans Tung. I’m a managing partner at GGV Capital and have been working at startups and investing in them in both in US and China for the past 20 years.

Zara: My name is Zara Zhang. I’m the investment analyst at GGV Capital and a former journalist. Why is this show called 996? “996” is the work schedule that many Chinese founders have organically adopted, that is, 9:00 AM to 9:00 PM, 6 days a week.

Hans: To us, “996” captures the intensity, drive and speed of Chinese Internet companies, many of which are moving faster than even their American counterparts.

Zara: Hi, listeners. Starting from this episode, we’d like to try something new. Instead of having a guest, Hans and I will have a dialogue about a current event or hot topic in China’s tech scene today. On this episode, we’re going to talk about Xiaomi’s IPO which took place in Hong Kong on July 9th. Hans is one of the earliest investors in Xiaomi as well as a former board member of the company. Hans, these two weeks have been a whirlwind for you. You were in Hong Kong for Xiaomi’s IPO and appeared on TV four times in a single day. What was that day like for you?

Hans: Well, I think that’s an amazing milestone for the management team and its board members who have participated in the growth of the company from Day 1. It’s amazing that this company started eight years ago and somebody remarked back in 2010 that the only way Xiaomi will win and become big is if Motorola, Ericsson, Nokia, all of those, go away. Back in 2010, everybody in China was using Nokia or Motorola so it was pretty remarkable how the world has changed a lot in eight years, and Xiaomi was able to come through with flying colors.

Zara: Can you recount the moment when Lei Jun first told you about the idea of Xiaomi? I remember that it was a cold winter night in Beijing in 2010.

Hans: That’s right. It was in late January 2010. Lei Jun called up Richard Liu from Morningside first, had a six-hour discussion with him.

Zara: Six hours?

Hans: Six hours.

Zara: Lei Jun has really good stamina when it comes to talking.

Hans: He does. He can talk for hours. This is just amazing and incredible. I was the second person to call in the same week and I met with him in person because I was living in Beijing at the time. I remember in the first half-hour, I was just in complete shock of what he wants to do. In the history of tech startups, there was no phone company-from 2G, 2.5G and 3G–no startup has ever succeeded from scratch by being a phone company. What he was trying to do was something that has never been done before.

In the next one hour, I decided that this makes sense and they probably have the best team to do it because of two things that he said. The first thing he said was, “In 10 years by 2020, smartphone will replace laptop as the most valuable and most commonly used computing device that people carry around with them every single day,” and the second thing he said was, “To win in this market, the winner has to figure out how to build a brand online and sell online and listen to consumers’ feedback online and be able to iterate fast based on consumers’ feedback.”

He expanded on this point by saying that all the great phones from Motorola, Nokia, even Android or iPhone, HTC, phone companies don’t listen to consumers. Steve Jobs is famous for saying that the consumers don’t know what they want. They may not know what they need. It takes a genius to come up with an amazing product in this category, and Lei Jun took the opposite approach, which is that he will come up with something that’s solid, that’s decent, that’s good but he welcomes user feedback so they can iterate on. I think that’s the second revolutionary idea that he came up with that was interesting.

The third idea was the fact that to win, you have to be able to be a triathlon athlete, meaning that you have to be able to design hardware, have the best manufacturer to manufacture it, has to be able to build up some kind of Android-based OS so you have a chance to do a UI that’s tailored to the needs of the local consumers, starting with China, and the third thing you need to do is be able to monetize through Internet services and not through hardware. The hardware has to be as cheap as possible, as low-margin as possible, to get into the hands of as many users as possible to make it work.

Those are the three things he said that I thought were extremely revolutionary that no one else in China had a similar thought at that point in time. It was designed to be more customer-friendly than the existing hardware players at the time and also more integrated than Internet service companies in China were willing to do. There are people who want to do software-only solutions but not many want to do the combination of all three to make that work.

Zara: I think the second point of Xiaomi listening to its users is pretty revolutionary in that Lei Jun really wants to be friends with the users. Xiaomi always says they treat their users as friends, as equal counterparts and they’re not condescending in saying, “You don’t know what you want. I’m going to make a product and you’re going to like it.” There’s a book I really recommend called 《参与感》 which means “Sense of Participation” in Chinese, by Xiaomi co-founder, Li Wanqiang, which talks about how Xiaomi does marketing. Their philosophy is to build loyalty first before fame so they want to have a really deep relationship with their core users before going big. I think it’s really crucial to its success.

Hans: Definitely, and I think that people overlook this. Xiaomi had cofounders from Google, Microsoft and Kingsoft and, after Kingsoft, other Chinese Internet companies. A lot of the tactics that worked came from cofounders with experience operating in China, whether it’s from big companies or Chinese companies. I think in this area, Richard Lu from Morningside was very smart in pointing out that how you mesh these two or three different company cultures into one unique Xiaomai culture will be the key determinant to decide whether Xiaomi can be big or not. And I think they can see that’s the most serious thing that he did. Once he started, he made sure that people functioned well as a team and spent a lot of time listening to consumer feedback. That strategy definitely panned out after the first year of hard work.

I think what convinced me to invest in Xiaomi was that Lei Jun and his team was the only team in China that had the software experience from Kingsoft, the Internet services gaming experience from Kingsoft, had the online brand-building experience from Vancl and the online e-commerce experience from Joyo. Even though on Day one, there was nobody with strong hardware experience, Lei Jun was able to recruit and build up a team over time to overcome that issue. No one else in China had all five so I thought that Lei Jun had the best shot with four out of five attributes to win in this market.

Zara: It was definitely not an easy decision or obvious decision, I guess.

Hans: I think all the people who passed on Xiaomi early on passed for all the logical right reasons, either the price was too expensive or there wasn’t enough data points showing that this can definitely make it, and hardware is a difficult business to win for a sustainable period of time. For all those people who passed on Xiaomi, I think it’s completely reasonable and logical. This does not just apply to Xiaomi. If you look at all the unicorns coming out of China in the next few months for IPO, whether it is Meituan or a Pinduoduo or ByteDance and Didi, for every single one of them, for most of the rounds, to pass on them is extremely logical and reasonable, and I’d even argue data-driven.

To make these judgment calls and make those bets, one, you want to have belief that the founder has the right vision, the right direction, exuding capability and, two, that the market is changing to favor the new way of doing things and then, three, in many cases, existing players must not get it and not be able to adjust to give new commerce the big opportunity to make disruption happen and possible. A lot of it comes down to judgment because you know the founder well enough to determine that he or she has the right attributes to take advantage of market opportunities.

If China doesn’t take off, if Internet doesn’t make enough impact in China in the offline world, then it’s not possible that these opportunities alone can make it work. Now, we have saying that because you’re betting on China, it’s going to be different because you’re not betting on Internet is going to change China and improve China. Therefore, you should bet on founders who have the most audacity to make the biggest change possible because the few of them that can make it work will have gigantic outcomes. I think they even did a calculation on the first round of Xiaomi, the one that Richard Liu led and I participated, that the first round investment in Xiaomi at IPO last week yielded 866-x return. If you don’t take that risk with an audacious founder early on, it’s not possible to make that return. If you’re very rational and reasonable, the room for return, unfortunately, will be a lot less.

Zara: You have appeared in the press a number of times talking about Xiaomi and I’ve noticed one question that a lot of US reporters ask is, “How does Xiaomi compare to Apple?” I guess they’re always trying to find a Xiaomi equivalent in the US and the closest they think of is Apple because of the smartphone business. Why do you think people should stop comparing Xiaomi with apple and, if not Apple, then which company do you think it’s the closest to Xiaomi?

Hans:One of the questions that I have heard from an American audience–obviously, very smart investors in general, especially investing in tech over the last decades–one of the first question I heard was that Xiaomi has a propriety system so it’s compatible to Android. For those of us who have tracked Xiaomi over the last eight years, it is amazing how even smart investors take successful examples that they know and put on top of companies from emerging markets and think that one is similar to the other.

It’s very difficult for any investor to fully understand Xiaomi’s model which is uniquely Xiaomi’s. Besides that, listening to consumers and therefore not presuming they know what consumers want and quickly iterate to meet and exceed expectations of customers. A lot of people look at Xiaomi’s revenue source and think that, “Hey, 70% comes from hardware,” and another 20% comes from smart-home appliances and that percentage seems to be growing in 2018 at least in the first three months versus 2017 so it’s hardware company.

For people who haven’t tracked Xiaomi, that’s very easy conclusion to make. Unfortunately, most of the smart investors, whether it’s Hong Kong, or US, or elsewhere, have not gone through the rise of middle class or upgrade of consumption in China or Japan or even in Taiwan. When people and the large middle class rise and go through organization and want to consume, they end up buying brands they trust and they’ll grow up with them, whether it’s with Uniqlo in Japan in the ’90s or Samsung through the ’90s and 2000s in the US,  whether it is HTC in Taiwan.

People in the US in the ’80s with GAP and then, most recently, last 10-15 years, with Zara and H&M. Consumers grow up with a brand they trust and they end up buying more from that brand. Muji is another good example coming out of Japan. What Xiaomi has done is becoming a brand that consumers first like because of the phone and end up liking the experience, spend a lot of time on the Internet through the Xiaomi phone. They end up buying a Xiaomi TV and other smart home appliances from the Xiaomi ecosystem.

When you go into a Xiaomi store or its online mall, you can’t help it but, over time, many new products come out each month from the Xiaomi ecosystem companies and you end up going there often and buying all the product from Xiaomi brand and, as such, ends up spending more time on Xiaomi app. The most popular example will probably be Xiaomi videos. When that happens, you would see a lot of faster growth of hardware-first but what comes later in each cohort is that more users will end up spending time on the Xiaomi app thereafter.

Xiaomi’s very good at building aggregation apps that take the best of content from related areas and put it on its platform and build a subscription business around it. That Internet service impact will come later and it needs to have users to use multiple Xiaomi hardware products to get them to want to use those apps. What foreign investors haven’t had a chance to see is the lagging effect that will happen with more growth from Internet services. Only time will tell to prove that this is right. It’s what we see from what we looking at a cohort data, but I think, over time, smart property investors will learn that there’s a different kind of company than what they’re used to.

Zara: One of the Xiaomi cofounders once compared Xiaomi’s business model to that of a small restaurant. They sell food, which is the smartphone, but they really make the money from tips, which comes from Internet services.

Hans: Correct, and a lot of people forget that, for any pure Internet service company, people have the growth hack, meaning that you’ve got to figure out ways to grow your user base through a mechanism that you have to spend money on to calculate LTV versus CAC to figure out what is a good way to scale your user base. Instead of paying for users, Xiaomi actually gets paid at least 5% gross margin if not more through hardware to get users. Their Internet services actually have a negative CAC instead of a positive CAC to grow users by getting paid for it instead of having to pay for users. It’s a very different model than almost any other Internet service companies out there. If this is sustainable–and to make sure it is sustainable is through having a lot more hardware products out there that a middle-class consumer family can buy and then use that portfolio of hardware devices to get paid for acquiring users so that their Internet services can scale thereafter. It’s a very different model than what people are used to and I think, over time, people will see if this will work out as some of us think they should.

Zara: Would you compare Xiaomi to Muji given the feel of Xiaomi stores and how it’s more adopting the concept of “new retail” more and more?

Hans: I think there’s definitely elements of Muji and Uniqlo in a different field for Xiaomi. There’s definitely elements of the Costco model, of subscription plus very low costs, to make sure that more products are affordable by the rising consumer class. There are definitely elements of Amazon in there as a platform that sells, many products being very focused at delivering superior experience to target users. What Lei Jun and his team has come up with is a mixture of different models that, at its core, is figuring out how to be the customer’s best friend and delivering experience that exceed consumer expectations. I think in his seven words Internet strategy of being focused, delivering superior experiences, positive word-of-mouth impact, and being extremely fast (雷军的互联网七字诀:专注、极致、口碑、快). These four terms make a lot of sense.

Zara: I think the lesson here is that it’s not possible to take a shortcut and just find a US equivalent for every company in China or every emerging market. A lot of times, there is no complete equivalent and we just need to take the time to understand their business model, how they really work.

Hans: Right, and this doesn’t just Chinese company but also applies to any company with a new business model. Facebook IPO was at $38.00 a share, within the first six months after IPO, it went down to $19.00 a share and now today is over $300.00 a share. In four years, people learned that it is a very different model than what they’re used to before. I remember back in 2008-2009, a lot of people poo-pooed on Facebook, thinking that it’s a company, even though it’s web 2.0 is not as profitable as Google and never will be as profitable as Google.

Therefore, it’s very easy even for the smartest investor in the world to miss on something that’s new. The fact that Xiaomi – the primary market is in Asia makes it harder for US investors or even Hong Kong investors to truly understand it. Only time can show that it is a superior model but when you look at how Xiaomi has expanded over the last few years, now they’re among the top phone makers not only in China but also number one in India and in some other three countries. The penetration is a lot faster and deeper than we all thought was possible. If we look at number of Internet users that’s coming online, the next 1.5 billion users that are coming online between now and 2030, most of that growth will come from the 74 countries that Xiaomi is in already. A lot of people ask me about whether Xiaomi’s coming to the US or not. I think they completely miss the point that the growth is coming from the existing countries that Xiaomi is already in.

Zara: Xiaomi calls itself an “Internet company” and a lot of people are skeptical of that term. How would you convince people that Xiaomi is an Internet company, and can you elaborate on some of the Internet services that they provide to their users?

Hans: Sure. Xiaomi, in their prospectus they mentioned that it has over 18 apps, with each of them with monthly active users over 50 million. It also has about, in total, 38 apps, each of them has over 10 million in monthly active users. These are amazing numbers and, in aggregate, it did over RMB 1.5 billion in Internet services revenue in 2017, which already places them as a top 25 Internet service-only company in the world. I think the most popular one people know is probably Xiaomi Video.

Xiaomi Video has an interesting way of becoming an aggregation of services. It doesn’t license content from anyone. What it does is it aggregates content from iQiyi, from Youku Tudou, from all the top Chinese video apps, each of which have already licensed the content. Whenever a user clicks on a video in Xiaomi Video, it takes you to the content from its partners but within the app itself so that you can have a more integrated experience. It charges advertising revenue and also subscription from the users so it makes money in multiple ways from different stakeholders and they share that revenue with those partners that provide the original video content.

You can focus on providing the most comprehensive collection of content to their user. At the same time, at least so far, they don’t have to spend much money on acquiring the content themselves and figuring out a way to coexist with other content producers. It’s a good way to build an ecosystem to provide better service that other people can make their share of the money as well. It’s a very good way to grow a business, and they’re applying that philosophy in other categories as well, not just in China but also out of China.

In the process of doing so, they also become a strategic investor in these service providers that they work with. In iQiyi, Xiaomi invested early and so it was able to grow with iQiyi as well. They’re doing that not just in China but also in many of the other 73 countries that they are in. Again, some investors haven’t seen this ecosystem approach and, from our experience of investing in China since 2000, we know that if a country takes off that Internet makes an impact, many of the top in the companies in that country will have tremendous growth. Xiaomi will win multiple ways as a result of investing and building an ecosystem in each of the countries that they’re in.

Zara: I wanted to talk about the IPO itself and the valuation and the pricing. There were a lot of fluctuations on the first day. Do you think Xiaomi had a reasonable pricing? What would you expect in the coming months?

Hans: I think the last two weeks have shown that Xiaomi’s stock price has steadily risen so around HK$20-21 a share. I think whatever the short-term fluctuation was in the first day or so, over the last two weeks, it has steadily ended up being in the high end of the range. I think pricing at the lower end of the range makes it easier for investors to believe in the story and the trading volume in the last two weeks show that not only is the volume reasonable but the stock price also appreciated.

I think investors should be looking at a longer term, how Xiaomi will continue to grow based on the trends that I mentioned earlier. We always think that IPO is just a blip or milestone. At the end of the day, you’ve got to build a business for value over a larger addressable market to continue to grow. Looking at Facebook, and Google, and Apple, and Alibaba, and Tencent, all the great companies out there show that that’s the way to create value over a longer period of time.

Zara: What’s one question about Xiaomi that you wish you were asked but you were never asked?

Hans: I think a lot of people don’t understand what Xiaomi ecosystem means, both in terms of the hardware ecosystem and the Internet services ecosystem.

Zara: A lot of people don’t know they have an ecosystem.

Hans: Correct. I think those who have invested in China over the last decades who had the fortune of having a front-row seat to see ecosystems forming in China, whether it’s in the form of Tencent investing in gaming companies around the world and e-commerce players in China or Alibaba investing in companies in O2O space and acquiring some of them, or companies like Meituan that that became super app and plug many apps onto it and WeChat doing this and Sina Weibo doing the same to let a lot of content providers to be on top of their platform.

This kind of ecosystem were things that Chinese companies learned and tried through four generations of entrepreneurship in China just in the last 10-13 years, and we are very fortunate to see that happen and gain that perspective. When we started investing outside of China, in Southeast Asia, in the US or even Latin America and in Europe maybe down the road–that perspective, how to build ecosystem companies, I think, can be replicated and expanded. We’re already seeing that happening with Uber learning from Meituan and Didi wanting to be a super app for transportation services and be willing to invest in companies like Lime and others, that services its ecosystem. I think more companies should learn from that and have a better chance of becoming a bigger company not on their own but also help other companies grow with them. And over the last 10-15 years, we have seen that’s extremely profitable and value-creating for Chinese companies so those have great lessons that I hope entrepreneurs from around the world are willing to consider, and we’ll be happy to help them.

Zara: I think the best way to appreciate Xiaomi’s ecosystem is just by visiting a Xiaomi store in China. You see not just phones and laptops and TVs but also rice cookers, air purifiers, Segway, headphones, bags, umbrellas, et cetera. These are all products made by companies that Xiaomi invested in, and it helps later in use to be an angel investor.

Hans: When you see 100+ different kinds of products inside each Xiaomi store, it’s amazing that Xiaomi itself only makes three products: the phone, the TV and the laptop. Everything else is made by other companies that Xiaomi has invested and helped to scale. When you have about 80+ companies that you can work with, each month, somebody will have some interesting new products that will get the consumers want to go back to the store and just check what’s going on. The foot traffic repeatability and frequency of the foot traffic’s much higher for Xiaomi than any other phone-only company out there.

Zara: I feel that’s one of the key differences between Apple and Xiaomi, is I would never go to Apple’s store, like once a month, just to check what’s new because there’s nothing new and I know what’s there. I only go there when my phone is broken but I would go to a Xiaomi store whenever I feel like shopping and browsing because there’s always something new. There’s always a pleasant surprise waiting for me.

Hans: Right, and that’s the appeal to a rising middle class and an increasingly-urbanized environment to want to do that. Many people are starting to have their first apartment and first house for the first time in their life and starting a family. There are a lot of needs that could be fulfilled by a trusted brand with a strong and a robust ecosystem. You’re right. If Lei Jun didn’t work for three years as an angel investor prior to the start of Xiaomi, he would not have come up with this idea of building an ecosystem. I think those of us who invest with him when he was an angel investor are very fortunate to have a chance to participate in something as big as this phenomenon.

Zara: Cool. That’s all we have for today. Thanks for listening and we’d love to hear your thoughts on this new format. You can reach Hans and I directly by joining our listeners’ WeChat groups and Slack channel at 996.ggvc.com/community. The community has grown into over a thousand people within the last couple of months and I think that’s a testament to the growing interest in tech in China. Thank you.

Hans: Thank you.

Hans: Thanks for listening to this episode of 996. By the way, we also produce a biweekly email newsletter in English also called 996 with just the roundup of the week’s most important happenings in tech in China. Subscribers have told us it is informative and fun to read. The newsletter also features original content and analysis from Zara and me. Subscribe at 996.ggvc.com.

Zara: GGV Capital is a multi-stage venture capital firm based in Silicon Valley, Shanghai and Beijing. We have been partnering with leading technology entrepreneurs for the past 18 years from seed to pre-IPO. With $3.8 billion in capital and management across eight funds, GGV invests in globally-minded entrepreneurs in consumer Internet, e-commerce, frontier tech and enterprise. GGV has invested in over 280 companies with 29 IPOs and 22 unicorns. Portfolio companies include Airbnb, Alibaba, Ctrip, DiDi Chuxing, DOMO, Hashicorp, Hellobike, Houzz, Keep, Slack, Square, Toutiao, Wish, Xiaohongshu, YY, and others. Find out more at ggvc.com. We also highly recommend joining our listeners’ WeChat group and Slack channel where we regularly share insights, events, and job opportunities related to tech in China. Join these groups at 996.ggvc.com/community.

Hans: If you have any feedback on this podcast or would like to recommend a guest, please email us at 996@ggvc.com.