The shares of Xiaomi, the world's third-largest maker of smartphones, were slammed in Hong Kong trade on Friday after the U.S. Department of Defense labelled it as having ties to China's military. Xiaomi stock lurched lower as soon as trading started, and ended the day down 10.3%.
Xiaomi, which specializes in mass and mid-range phones, now sells more smartphones than Apple (AAPL) . It has been one of 2020's success stories. Xiaomi's shares tripled in value over the course of the year, as it won business from its main mainland competitor Huawei Technologies, the primary initial target for U.S. sanctions.
The Pentagon on Thursday named Xiaomi as one of nine new names on its list of "Communist Chinese military companies," which now contains 44 Chinese corporations. Other notable additions include COMAC, or the Commercial Aircraft Corp. of China, which counts General Electric (GE) among its suppliers. GE makes engines for COMAC's passenger jets.
Xiaomi moved ahead of Apple in Q3 2020 to become the world's third-largest smartphone seller, with 13% of the market in Q3 2020, according to Counterpoint Research, to Apple's 11%. Only Samsung, at 22% of the market with 80.4 million phones, and Huawei, with 14% market share, sell more phones around the world. Xiaomi's market share has increased by five percentage points in a year, while Huawei's share has fallen.
Xiaomi issued a statement on Friday that it "provides products and services for civilian and commercial use." The company "confirms that it is not owned, controlled or affiliated with the Chinese military," and shouldn't therefore be on the list. Xiaomi says it will "take appropriate course of actions" to protect the company and its stakeholders.
The confusion in China is that many private companies have links to the state. Even shareholder-owned companies have at times written the Communist Party into their charter as the ultimate controller. Any Chinese company would serve the central state if ordered to do so. And telecoms are always going to be of interest to military users.
The U.S. Department of Defense said that it "is determined to highlight and counter" China's military-civil fusion development strategy, which supports the modernization of the People's Liberation Army "by ensuring its access to advanced technologies and expertise acquired and developed by even those PRC companies, universities, and research programs that appear to be civilian entities."
Putting Xiaomi and COMAC on the DoD's list means that they are now covered by a November 12 executive order from outgoing President Donald Trump. The order states that U.S. investors, whether individuals or funds, can no longer buy the shares of these companies. The order went into effect on January 11 for the initial list of 35 companies, which included Huawei, and will apply to any newly added companies such as Xiaomi 60 days after their inclusion. U.S. investors have until November 11 to sell the shares they hold in the first set of companies.
Huawei, which makes telecom network hardware and chipsets as well as phones, is on a more-significant Entity List established in Washington that prevents companies worldwide from supplying it if they use U.S. parts or technology. That is far more expansive than the current designation slapped on Xiaomi, which makes consumer products rather than network systems. The Entity List ban is making it extremely hard for Huawei to source chips for its phones, so it is important to watch if Xiaomi is also added to that.
Xiaomi has ADR shares listed in the United States under the ticker (XIACF) , and U.S. investors own about 15% of its stock. BlackRock (BLK) , Vanguard and State Street (STT) own large blocks of stock for their funds.
Xiaomi has its primary listing in Hong Kong, where it at the start of December set a record in terms of a follow-on offering by selling US$3.9 billion in stock as a top-up share sale. It went public with a US$4.7 billion IPO in Hong Kong in June 2018. The U.S. pressure is magnifying the importance of Hong Kong as a stock market for Chinese companies.
Beijing-based Xiaomi offers Apple-like phones at a budget price, and with an open-source system that allows users to customize how their phone operates. Its top of the line phones sell for around US$400, but its cheapest fall below US$100. So far, it has made its biggest inroads in Asia, particularly India, Indonesia, Hong Kong, Singapore and Taiwan. But it is most recently making headway in Europe.
Xiaomi sells hardly any phones in the United States. But it does rely on Qualcomm (QCOM) to supply chips for two-thirds of its phones, so an Entity List designation would be devastating, cutting off that supply.
The New York Stock Exchange has made the drastic decision of de-listing China's three main phone companies after they were slapped with the same military designation.
The NYSE flip-flopped but decided after pressure from U.S. Treasury Secretary Steve Mnuchin to de-list China Mobile (CHL) , China Telecom (CHA) and China Unicom (CHU) , which have a combined market capitalization of US$157 billion. That has caused index providers to also strip the phone companies and other similar stocks from their indexes, since the Trump order forbids U.S. investors from trading in any securities offered by those companies, as well as derivatives based on those securities.
The U.S. investment banks J.P. Morgan (JPM) , Morgan Stanley (MS) and Goldman Sachs (GS) have de-listed derivatives in Hong Kong as a result. They have removed 500 callable bull/bear contracts, derivative warrants and inline warrants in Hong Kong that were based on those companies, or indexes that contain them such as the Hang Seng, the most-followed index in Hong Kong, and the CSI 300, the main index for following mainland Chinese shares.
The action on COMAC demonstrates the confusion sown by some of Trump's orders. Trump stepped in last February to prevent the U.S. Department of Commerce from denying a license to allow GE to sell jet engines to COMAC.
Trump at that time denied there were any national security concerns for U.S. companies supplying Chinese airplane makers. "We're not going to be sacrificing our companies ... by using a fake term of national security. It's got to be real national security. And I think people were getting carried away with it," he told reporters. He also said in a Twitter post that "I want China to buy our jet engines, the best in the World."
GE also has a joint venture with the Chinese aircraft maker AVIC, the Aviation Industry Corp., which is also on the DoD's list of military Chinese companies.
The state-run Global Times newspaper, often used to communicate China's foreign-policy stance, runs a story today quoting an academic as saying the latest orders could be the "final frenzy" of the Trump administration. Some Chinese netizens joked that Xiaomi should be congratulated, because the company is successful enough to come to the attention of the U.S. Department of Defense.
Xiaomi and Huawei, as well as the teen-friendly app TikTok, are some of the most-recognized Chinese brands internationally, where few Chinese companies have generated much if any recognition. All have been targeted by Trump orders.
The problems facing Huawei have encouraged China to funnel funding toward the creation of a domestic semiconductor and telecommunications industry. The Global Times quotes an unnamed "telecommunication analyst" as saying it is time for ZTE (ZTCOF) , Huawei and Xiaomi to work together to "reshape the industry chain in China and create a completely domestic supply chain."