Description

Viomi (in Chinese: Yunmi / 云米 is a Chinese manufacturer of smart home appliances, consumables and services. The company was founded in 2014 as founder and CEO Xiaoping Chen partnered with Xiaomi (and specifically with Lei Jun - Xiaomi’s founder and CEO) to create one of the first Xiaomi Ecosystem companies. For those not familiar with Xiaomi’s business model and the ecosystem segment specifically, Xiaomi has been investing in (mostly) hardware startups for over 6 years now, with the idea of decentralizing product development and manufacturing in order to scale its product catalog in a faster, more efficient manner. The way it works is that in most cases the ecosystem company would get early-stage funding from Xiaomi, as well as some resources related to the design and procurement process. Once the products are ready to ship, they are marketed through several different distribution channels: 

(i) Xiaomi’s offline and online properties and under the Xiaomi brand; 

(ii) Under the ecosystem company’s own brands through either DTC or 3rd party retailer/eCommerce platform. 

To show one example, Huami (NYSE:HMI) is a Xiaomi ecosystem company specializing in wearables. When you purchase the Xiaomi mi-band (currently the world’s best selling wearable), what you’re really buying is a Huami designed and manufactured product that is marketed and sold exclusively under the Xiaomi brand, with both companies splitting the gross profit between them (in the process Xiaomi would act as a retailer and take some inventory risk). The Amazfit brand is Huami’s own, where Xiaomi is not a distribution partner and only benefits indirectly through its equity stake in the company. Huami and Viomi are two examples of ecosystem companies who have done well building their own brands and distribution channels, while gradually reducing dependency on Xiaomi.

While the high dependency on Xiaomi clearly has some embedded risks, we find the ecosystem relationships to be highly beneficial to both sides in most cases. Xiaomi gets to rapidly expand its product offering without either manufacturing risk or a long development process. It also enjoys healthy incremental margins as OPEX associated with the ecosystem products is minimal, and builds on the existing distribution and marketing infrastructure. The ecosystem company gets a “fast-track” to scaling its hardware business, a much needed capital to develop its own brand and distribution channels, and benefits from Xiaomi’s experience and guidance in supply chain management and product design. 

Although this isn’t the topic of this writeup, if you are interested in investing in Viomi, I think it’s worth gaining a better understanding of the Xiaomi ecosystem and I’d recommend starting with this 2016 speech from Liu De, Xiaomi’s SVP for ecosystem products and a member of Viomi’s BoD. 

Of all the ecosystem companies that are currently publicly traded in the US and China (we counted 4 - Viomi and Huami in the US, Roborock and Ninebot in China), we think Viomi offers the most compelling investment opportunity for three main reasons. First, we think the home appliances industry is going through a secular change that should result in better economics for industry participants in general. Second, Viomi is well managed and perfectly positioned to emerge as a major winner from this trend. Third, at 10x our estimated 2021 GAAP EPS, Viomi is very cheap - not something you’d expect to find in today’s market for a fast growing consumer brand that excels in exactly the “right” places (DTC, IoT+5G). 

Home Appliances Industry

“It’s the distribution, stupid” (soon-to-be an ancient Chinese proverb).

Unlike many other consumer facing sectors, the home appliances industry has only seen small gradual changes over the past couple of decades. We’ve seen plenty of consolidation and a clear shift of power as three Chinese giants (Midea, Gree and Haier) practically took control of the industry, but for the untrained eye not a lot has changed. The experience of buying a washing machine, a dishwasher or an A/C is pretty much the same as it was 20 years ago, except that it at least partly takes place online nowadays. 

The pictures above illustrate the offline and online experience of getting a new washing machine for >95% of the world. Whether offline or online, the experience is quite similar. There’s very little brand differentiation or visual differences between the different models. What it comes down to is basically the cheap option, the expensive option, and the one somewhere in the middle that the salesman tells you is the best price/quality combination that you usually end up going for. Since I’m writing this for the value investors club, you wouldn’t be surprised that the outcome of this is relatively poor economics for the OEMs. Dependence on key distributors, inability to raise prices and low customer loyalty resulted in low ROIC and a general lack of appetite to the sector from most good investors.   

But things ARE actually changing, and unsurprisingly China is leading the way. 

Two key trends are currently disrupting this model. Direct-To-Consumer (DTC) and Connected Homes (which is further amplified with a wider penetration of 5G technology). In a connected home, brands matter much more. If you are already using the Mi-Home app (Xiaomi) to control your security cameras and A/C, and you’re looking for a water purifier - it makes much more sense to buy it from Xiaomi as well and skip the price comparison process. If you’re furnishing an entirely new home, it makes an even greater sense to buy all of your smart appliances from the same brand - and specifically one with an easy-to-use mobile app. It would be quite inconvenient to have one app for your refrigerator, another for the air purifier and a third one to remotely open the A/C (think of a scenario where you left your house in a hurry and want to make sure that everything is turned off). The benefit of having a centralized interface is clear even before we go deeper into the future with cyber-security layers, or an embedded eCommerce solution for consumables and services (filters, light bulbs, service chat). In a way, software is eating the home appliances industry too (which makes sense since software is eating the world and appliances are part of the world).   

The move towards DTC is what enables the brands to take that path and what speeds up the process of obviating the middleman. This is already happening in China, online and especially offline. It might take some time to get out of China but expect your future appliance store to look much more like the pictures below than the one I’ve shown above. 

You might ask yourself, do I really need a smart refrigerator? A smart stove? Why would I even want my entire house to be connected? This is a valid question and one that we’ve been battling with too over the past year or so. We don’t have a definite answer but want to provide you with some food for thought: 

First, mainstream applications always lag the introduction of new platforms. Samsung came out with the first smart TV in 2008, but it was mainly used to watch linear TV and surf the internet so made little sense for consumers at the time. Smart speakers still lack that “killer” app but penetration rates have already crossed 20% in some markets and are above 10% in most Western countries (in a way, the existence of smart appliances in your home could very well end up being that exact “killer app”). Second, China is different. Chinese consumers love gadgets and consumer electronics - smart TVs penetration in China is now above 90%, and smart refrigerators are expected to account for 37% of refrigerators sales in the country in 2020. This phenomenon could be attributed to the fact that most incremental consumer spend in China comes from newly established middle-class, who are usually young (early 30’s) and live in the big cities (also China is well ahead of most countries in terms of 5G penetration). Third, there’s a network effect or at least some kind of inertia involved. If you own smart water purifier and refrigerator, it’s more likely you’d buy a smart A/C over a “dumb” one even if you don’t really “need” the extra functionality. Fourth and most importantly, the numbers say so - the smart home appliances market has been growing rapidly over the last couple of years while the overall home appliances will see declining sales in 2020 for the second year in a row. Industry research reports expect the smart appliances market to continue to grow at a 21% CAGR in the 2020-2024 and reach RMB 78b in sales by then, vs. LSD growth for the overall appliances industry. 

For a better understanding of what I’m referring to in Smart Appliances I’d recommend reading this blog post about Midea’s wide (and impressive) range of smart kitchen appliances (with Google Translate), and watching this YouTube review of Viomi’s flagship refrigerator  

Viomi is well positioned

The short version for this is that Viomi was built “right from the start”. It was founded with IoT in mind to produce only smart appliances and invested in 5G from the early days. Founder and CEO (and 36% owner) Xiaoping Chen left a senior executive role in Midea and partnered with Lei Jun from Xiaomi to start Viomi in 2014, in a move that surprised many in the home appliance industry in China. The Xiaomi partnership paved the way for Viomi to grow rapidly without outside capital - their first product, the Mi Water Purifier, launched in 2015 and turned out to be such a huge success that the company was profitable in its first year of operations. Cash flows from the water purifiers, and especially the associated high-margin consumables (filters), funded Viomi IoT platform which was built over the next 3 years and the company started launching a series of new smart products in 2018 and 2019, including refrigerators, washing machines, air conditioners, stoves, robot vacuum and plenty more.

In the meantime, revenue and user base has been growing exponentially. From a base of RMB 313m in 2016, revenues have grown 179%, 193% and 81% in 2017, 2018 and 2019. A CAGR of 146% (not a typo). 2020 growth should be considerably lower at 20%-25% but this comes on the heels of the COVID-19 which is expected to send industry-wide sales around 10% to 15% lower for the full year. User base over the same period has grown from 120k in 2016 to 3.7m in Q1-20, and perhaps more importantly - the number of households with at least 2 connected Viomi products has gone from 304k in Q1-19 to 681k in Q1-20 (we like this data point as it further validates the general thesis of increasing brand loyalty and improved prospect for the industry in a connected home world). Our view is that a CAGR of 20%-22% in 2020-2024 is achievable, with a bit of a “catch-up” in 2021 due to pent-up demand.  

One of the side effects of this explosive growth, and one that might have concerned some investors, is the erosion in gross margins over the period (from 31.5% in 2017 to 23.3% in 2019). It should be noted that Viomi remained FCF positive while expanding its product portfolio from 1 to over 25 in a little less than 2.5 years, but diversifying away from the highly profitable water purifiers (and especially the recurring filter sales), did take a toll on margins. For example, Viomi put a lot of efforts in entering the refrigerators market in 2019, where historically brands played a bigger role and entering at the right price point was crucial. 

The idea of “compromising” on lower margin products sales serves two main causes - one is to continue and build the Viomi brand, and the other is to expand the potentially monetizable user base. In both cases, this is very similar to the Xiaomi playbook, where marketing dollars are substituted by lower pricing and savings for the consumer. As for monetization, this is definitely still an open question (excluding the obvious consumables in some products), but if you watched the refrigerator review I’ve linked to above you can get a sense of where this is going (the giant touch screen comes pre-installed with a specific music streaming app, video streaming app, eCommerce app, Cookbook app, etc. - these companies pay for that real estate). It is not my game to try and speculate on the eventual ARPU from each household on these somewhat futuristic use cases, but I think that Viomi is currently well ahead of the competition in that area and I’ll be curious to see how this side of the business evolves over the next few years.  

Viomi’s battle for land grab in newer product categories seems to be paying off - in the most recent 6/18 shopping festival of JD.COM, Viomi was ranked #8 in refrigerators, #9 in A/C, #6 in dishwashers, #7 in washing machines, #7 in ovens, and with an overall y/y growth of 85%, according to the company’s release on WeChat.   

Viomi is currently the only “pure-play” on connected appliances in China, and it is inherently in a better position to capitalize on that trend vs. the incumbents who are still committed to legacy products and distribution channels. While the brand is admittedly not nearly as strong as Midea’s or Haier’s, it is growing rapidly among the young, tech-savvy new Chinese middle class (Viomi also has a more expensive sub-brand called coKiing which was launch in late 2019 and is designed to compete at the higher end of the market). Furthermore, the structural shift that is going through the appliance market sets the perfect environment for an emerging brand that can become the “poster boy” for this new age. 

Stock is cheap

Not too much to say on this one, but it does make a difference buying into this at 10x next year’s EPS vs. 30x. Despite exponential growth and the fact that the company has been FCF positive from day one, investors have not been buying into the story en masse in its ~2 years as a public company (quite the understatement). Why is this the case? We can think of a few reasons:   

1. This isn’t software, eCommerce, trading platform or anything that is “in” right now.

2. General fears from Chinese small caps (especially one that grows from 0 to $650m in revenues in 4 years?). 

3. Viomi/Xiaomi relationship is misunderstood and fears that over time Xiaomi will suck all the added value (sales to Xiaomi went from 84.7% of the total in 2017 to 45.4% in 2019). 

4. Viomi shares only trade in the US, whereas 100% of revenues/customers are in China. We estimate that over 95% of the customer base doesn’t have access to the US stock market.

5. Thin liquidy - the CEO, Xiaomi and Shunwei Capital (a VC founded by Xiaomi’s CEO Lei Jun) together own 69% of the company, which makes the float much smaller than in your average $450m company.  

6. Erosion in margins as the company diversifies from highly profitable water purifiers to a full catalog of smart home appliances. 

7. Fears from COVID-19 and its effect on offline sales (offline accounts for around 30% of the 55% non-Xiaomi related sales, but practically all offline stores are franchised).  

There are plenty of reasons to dislike or disbelieve parts of the story, which is exactly why the opportunity is so big. 

However, the opportunity is undeniably huge. A 5% market share in China should be worth around RMB 15b in revenues by 2024 vs. ~5.5b today. China is leading the world both in terms of 5G penetration rates and smart home adoption, and the relationship with Xiaomi also sets the stage for international expansion when the time is right. 

I haven’t provided you with a detailed review of the financial statements nor included a financial model. This is by design. The easy part would be to open your terminal and see that the company is very cheap on pretty much any metric. You don’t need a scale to tell that someone is fat, and you don’t need a sophisticated financial model to see the Viomi is cheap, especially if you come to the conclusion that selling hardware isn’t necessarily a bad business. I don’t know how future margins are going to look like, but I think that due to the trends I’ve described above, they have a good chance of being higher than what your average home appliance company has been earning in the past. The interesting part in my view is to gain a deeper understanding of the main trends that are reshaping this industry, and why Viomi can use them to emerge as a winner. In a “blue sky” scenario, this is the next Haier in a couple of decades (~$20b market cap, Midea is at $65b). In a more down to earth base case, this thing grows revenues at a nice 15%-25% CAGR for the next decade, with earnings growing a quite a bit faster than that. I’m not sure where the stock ends up under that scenario, but it should definitely be way higher than the current $450 market cap. 

Catalyst

Revenue growth accelerating in H2-20 and 2021

Better understanding of underlying industry trends

Improved sell-side coverage (at some point)