The case for HMI

Huami is a China-based technology company known for its fitness wristbands and smart watches.
Ticker: HMI (Mktcap: $1,033M, EV: $784M, Total debt: $15M, LTM sales: $873M, 2019 FCF: $58M)

Price as of 7/14: $15.59 ($8.52-$18.20)

Top holders: Huang Wang (CEO, 35.6%), Xiaomi (strategic investors, 15%), Gaorong (VC, 9.85%), Wells (US inst. 9.73%), Shunwei (Xiaomi-affiliated VC, 6.9%).

HMI management, together with its biggest Chinese investors (Xiaomi/Shunwei/Gaorong), should take HMI private and seek relisting in mainland China. The reward for key holders will be much higher multiples on China's stock market. Another option for higher valuation is dual-listing in Hong Kong, where the process takes less time (less than 6 months).

Privatization and relisting in mainland is a very arduous and historically has been done once by Qihoo 360. Back in 2015-2016, more than a dozen Chinese ADRs in the US announced going private deals but most of them failed to go through. Another factor making privatization a low probability event is a comment made by the founder of Gaorong, which he stated that going private deals are the kind of short-term, fast money he does not intend to make.

That said, HMI will be a much better investment (for insiders) if listed in the mainland, for the following reasons:
- US investors give significant valuation discount to consumer hardware pure plays. Their taste for such companies have been soured by likes of GPRO and FIT. Even for more profitable companies such as HEAR, valuation is still punishing. HMI is perceived similarly to GPRO and FIT, and gets punished with low multiple even though the company is more successful at growing, R&D, and cost management.
- HMI's investment in in-house silicon is largely overlooked by US investors. But such effort will guarantee a major valuation premium in mainland market, where any company touching on semiconductor themes get a valuation boost. More importantly, HMI has been developing and investing in RISC-V ecosystem, an open source silicon architecture that pose smaller geopolitical risk to future roadmap.

Speculation on privatization aside, HMI's core business is still attractive. Despite fearsome competition from Apple, I believe HMI has a shot at building a niche for itself in the already competitive and increasing competitive wearables. The on-going trend in consumer wearable is that all handset OEMs will try to emulate Apple by building their own wearable accessories family, ranging from smart watch to wireless earphones. 

Conventional wisdom will tell us that HMI will have no shot at all, due to OEM competitors' integration benefits ("ecosystems") and more direct (often cheaper) access to end users. However, when it comes to execution, even formidable powerhouse like Xiaomi has troubles. Xiaomi Watch was released in late 2019 and Xiaomi relied on a leading ODM in China, Longqi, for manufacturing. The product, which seems copied pixel by pixel from Apple Watch, was a major failure comparing to the overwhelming positive reviews received by HMI's Mi Band family. Xiaomi Watch Color, released in early 2020 and made by another Xiaomi ecosystem company Shanghai Xin An, is another failure. The product looks and feels half finished and reviews reflect the poor quality.

Longer term, HMI will need to build a strong brand for itself in its post-Xiaomi growth stage. That means more opex, and potentially margin compression in the near-term. Its chip development will be another costly endeavour. Its gen 1 Huashang chip is basically bought through its investment in Abee. Now that Abee's founder and CEO has left the company, it remains to be seen how Huashang 2 and its future iterations will perform. If successful, it provides substantial upside to HMI's enterprise value.

Escape Technology

Technology is a major democratic force, a powerful equalizer for the unprivileged. A billionaire cannot use a better phone than an average user of the latest generational of iPhone. In fact, many of the luxury items and experience today are noted for their lack of a technological touch. Luxury highlights direct customer service with real human beings face-to-face, products that cannot be manufactured at scale with the "cutting edge", food that can only be consumed at limited time at a specific place. Luxury can also mean abundance of time. Time itself is a luxury goods.

The problem with technology is that the consumer-facing products are too good at providing instant gratification: video games, porn, movies, TV shows, and music. Any one of the entertainment genres are touches of fingertips away. Removal of burdens to access to those content also means it is more difficult to control one's natural tendency for enjoyment. The hard work and thinking required for achievement are grounded in reality. But technology is pulling us away from reality at a faster speed and more variety than ever. I am probably the last one voicing concerns for the abundance of technology. Apple recognizes that people can be addicted to screen time, hence the release of Screen Time in iOS. That's hardly enough. In fact, the pessimist in me believe that screen time is almost impossible to control by some optional third party tools. One has to change from within to get away from the addiction to screen time.

It is unproductive to argue that we need to dial back technological development, but it will be helpful to set more up-to-date boundaries for certain industries and certain companies by the government. It appears that all companies are in one shape or form technology companies, for technology is the interwoven fabric underlying all forms of business. The instant gratification part, however, seems to stem from only internet technology companies-the largest internet companies are all culprit in cultivating digital addiction. The benefits of their technology is clear. But it is also important that the right regulations and policies are in place to keep their vices in control.

Technology Diffusion - Notes on The Lever of Riches

The Lever of Riches, by Joel Mokyr is a fascinating book dense with quotable gems like the ones below:

"Like silk, worsteds were a delicate and relatively up-market fabric woven into patterns using the so-called Jacquard loom, one of the most sophisticated technological breakthroughs of the time. The Jacquard loom was perfected in 1801 by Joseph Marie Jacquard, a Lyons ilk weaver, following a century of efforts by French inventors to device a loom that could automatically weave patterns into fabric. The patterns were coded on cards by means of holes representing the information in a binary code. The cards were probed by rods connected to wires, transmitting the information embedded in them."

"What became known as the Jacquard loom was in fact invented by two Frenchmen in the late 1720s, One of them, Basile Bouchon, was the son of an organmaker, which is significant because the organ is the first direct application of the binary coding of information."

"The Jacquard loom inspired Charles Babbage in the design of his famous Analytical Engine and Richard Roberts in the design of a multiple-spindle machine..."

Netflix as an insurance

Guillermo del Toro is just one of the many beloved directors/actors/actresses/show runners that Netflix is backing for exclusive content. In many ways, a Netflix subscription works like an "insurance" for me - it makes sure that I will not miss those Netflix-exclusives involving people whose work I admire.

Also, I sense a general acceleration in Netflix' appetite for those high profile exclusives. It only make sense that Netflix eventually penetrate close to 100% of US households, up from 50% as of 3Q18. Amazon Prime, in comparison, is close to 100M (worldwide, but mostly US). Arguably it is not a one-or-the-other competitor of Netflix due to Prime's obvious benefits in online shopping, but it does show the potential for Netflix' remaining run-way as a must-have subscription for the US audience.

The monthly subscription is a little less than the cost of movie ticket which in comparison seems like a terrible deal for 1.5-2hr of immersive entertainment.

The first post of my weekly writing project

I will start writing my thoughts down as before. As a form of reflection and introspective summary of my thinking on finance and technology related topics. I will try to hone my writing skills as well. The older I am, the less tolerant I become of bad writing. I aim for concise delivery and hopefully, occasional insight on things that matter to a better life.

A few thoughts on career changes

optionality - asymmetric upside and downside - much higher upside than downside

individual growth - breaking out of the comfort zone and instill a healthy dose of discomfort and imposer syndrome

hard work is often overrated. Responsibility, ownership, and identifying the right problems to work on are more important

A few takeaway from MIT Sloan Investment Conference

Seth Klarman was the opening keynote speaker today. This is my first time seeing him in person. I was deeply impressed by the clarity of his thought and humility. A few nuggets from his Q&A with David Salern:

• people should go into investing if they love investing. It's important whether it's your own capital or someone else's. 
• investing is a pure meritocracy
• energy, hunger, humility, intellectual curiosity are all important characters of successful investor
• Stephen Mandel is a great investor, he has the great skills as an investor and as a manager of people
• current leadership has no thought on what makes America great, he would not last more than 5 minutes in a Baupost interview
• expected return on US large-cap are too low, valuation and competition are making it difficult to make money in today's environment
• as asset managers we are responsible to maintain clients' purchase power
• we need to institutionalized the lessons we learned, the biggest lesson I learned is about people, hence the "no asshole" rule at Baupost
• as asset manager, it is meaningful to be a trusted fiduciary of our clients and steward of capital
• $5-$10B is an ideal size for a fund today, it's big enough to be meaningful, and it is small enough to be nimble; if too small you cannot get into certain asset class such as commercial real estate

Pat Dorsey from Dorsey Asset Management gave a very interesting presentation on economic moats and capital allocation; an older form of his presentation is available online here: https://www.finect.com/file/download/blog/0027c9701db014bd186df047c9701db014bd186df04

He argued forcefully, with a healthy doze of humor, that maturing companies should prioritize capital return over revenue growth due to their lower than cost return on capital. His arguments resonate with quite a few other investors in that return on invested capital is a very important metric to measure management's ability to allocate capital rationally and ROIC is also an important metric to show how competitive a company is. 

As a side note, Pat emphasis the value of talking to industry people at trade shows or via LinkedIn. He believes in the value of primary research and he find that people love to talk about what they do.