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.