(Bloomberg Opinion) -- Talk about spin!
I can’t think of many companies in the world that would trumpet razor-thin margins as a reason to be proud.
Xiaomi Corp. did just that late on Tuesday. Prior to listing last year, the Chinese smartphone maker promised to keep net profit margin on its hardware under 5 percent. As I noted at the time, that was a little misleading because it was nowhere near hitting that ceiling.
That didn’t stop it from shouting this achievement loudly from the rooftops in its full-year earnings statement.
“During the Reporting Period, our hardware business (including smartphones, IoT and lifestyle products) was profitable with a net margin of less than 1.0%, fulfilling our pledge.”
Actually, that too may be a little bit of a fudge because the company conveniently chooses to exclude share-based compensation from the metric. If those expenses were accounted for it’s entirely possible that Xiaomi actually sold hardware for a loss last year. I asked the company’s PR team to confirm this, but they didn’t immediately respond.
What’s annoying about this game of misdirection is that there’s a collection of numbers in Xiaomi’s financials that it should be proud of.
The one that jumped out at me is the relative stability of selling and marketing expenses as a percentage of revenue. This rose 94 basis points in the fourth quarter, but given an even larger quarter-on-quarter leap a year earlier, such a climb indicates seasonality effects.
On a full-year basis, the ratio barely budged while revenue itself increased 53 percent. This suggests a tame marketing budget, and a company that isn’t backed into a corner and forced to spend buckets of money to beg for attention.
A second data point supports the idea of Xiaomi finding itself in a strong position. The average smartphone sales price climbed to 1,004.7 yuan ($149.7) in the fourth quarter from 823.9 yuan a year earlier, due in part to a pickup in the share of shipments to western Europe. For the company as a whole, unit sales growth figures were impressive when compared to the rest of the industry.
The one cost that is trending up is the exact line item I am most happy to see rise at a technology company: R&D. As a percentage of sales, this hit a record in the fourth-quarter. Some of that could be attributed to weaker sales, yet it’s no anomaly — the figure is also higher on a full-year basis.
Unfortunately Xiaomi didn’t give much information on exactly where that extra spending is going, beyond a bland statement that listed pretty much all of its business. Nevertheless, when a company tightens its R&D purse strings it risks being left with fewer innovations that can differentiate its future products from competitors. It appears Xiaomi is doing the opposite.
Not all of Xiaomi’s numbers are wonderful, though. The story it told investors for the IPO was that hardware is merely an anchor for the fat-margin internet business which was the true heart and soul of the company. The data aren’t convincing.
By the fourth quarter, this division accounted for just 9.1 percent of revenue. The figure for the full year was about the same, so wasn’t markedly higher than the 8.6 percent result in 2017.
It’s true that this business has high gross margins. Yet the unit’s contribution to gross profit climbed to 46 percent in no small part because the smartphone division posted slimmer margins.
And so while Xiaomi proudly proclaims its dismal profit from hardware, it’s yet to make a convincing case that the internet business will become a sustainable long-term earnings driver. Perhaps that’s why it’s resorting to unnecessary distractions.
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Tim Culpan is a Bloomberg Opinion columnist covering technology. He previously covered technology for Bloomberg News.
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