Xiaomi’s Patent Strategy Crucial to Boost Market Share, Profit

• Licensing fees could rack up as Xiaomi competes globally, experts say
• Chinese smartphone maker to go public in Hong Kong

Xiaomi Corp.’s patent portfolio is under investor scrutiny as the Chinese smartphone maker gears up for its stock market debut.

Xiaomi’s initial public offering in Hong Kong July 9 could value the company at $54 billion, according to Bloomberg Intelligence data. After that, the company’s intellectual property strategy will play a critical role in shaping its fortunes. Investors closely watch patent licensing fees and litigation expenses of smartphone makers like Xiaomi to see whether they eat into device sales and shrink profits.

“They can have great phones, but if all their revenue from phones goes directly to the Qualcomms and Samsungs of this world, there would be no margins left for them,” Tim Pohlmann, chief executive officer of market intelligence firm IPlytics, told Bloomberg Law.

The company, founded in 2010, has the fourth-largest market share among smartphone makers in the world as of March 31, after Samsung, Apple and its older Chinese rival Huawei Technologies Co. Ltd., according to Bloomberg Intelligence data sourced from research firm IDC. Xiaomi’s executives have told investors that the company is trying to forge an international brand and has aggressive expansion plans across emerging markets like India and Indonesia, as well as Europe and North America. Xiaomi reported a net loss of 43.9 billion yuan ($6.6 billion) for 2017.

A global expansion for a smartphone company such as Xiaomi comes with litigation threats and the need to pay for country-specific licenses to use technologies, Pohlmann said.

Xiaomi spent 3.4 billion yuan ($512 million) in licensing fees, including royalties to Qualcomm Inc., Nokia Corp. and Microsoft Inc., and posted smartphone sales of 80.6 billion yuan ($12.14 billion) in 2017, its IPO prospectus shows. Xiaomi’s larger rivals do not disclose smartphone licensing fees.

Xiaomi’s gross margin — its revenue minus basic costs of goods sold — on smartphones and products such as smart TVs was 8.7 percent of total revenue in 2017, according to Bloomberg Intelligence data. Apple’s gross margin was 38.5 percent of its sales in the fiscal year ended September 30, 2017, the data show.

Xiaomi had 7,100 patents as of March 31, according its prospectus. Chinese patents make up about 51 percent of Xiaomi’s portfolio, according to its prospectus. By contrast, Huawei had 74,307 granted patents worldwide in 2017, according to that company’s annual report.

Patent Portfolio Expansion

Xiaomi plans to continue investing in cloud, big data and artificial intelligence, it said in its prospectus. Future investments will include “continued building of our patent reserve around the world,” it said.

The company needs to grow its patent war chest to fend off infringement litigation threats, Pohlmann said. He said the company could take a page from Alphabet Inc.’s Google’s patent playbook, noting how Google, after it grew into a public company, acquired Motorola Mobility’s patent portfolio in 2012 to push back against Android technology licensors.

Xiaomi has 5,800 pending patent applications overseas including in the United States, France, Germany, India, Japan and Russia, according to its prospectus.

If another smartphone company tells Xiaomi that it’s infringing a patent and should pay licensing fees, Xioami could leverage its own assets to negotiate a cross-licensing deal, Pohlmann said. “You always need something to fight back,” he said.

Xiaomi sold 93 million smartphones compared with Apple’s sales of 216 million iPhones last year, according to Bloomberg data drawn from IDC. Licensors charge smartphone makers fairly similar fees but dominant players can negotiate volume discounts, according to Bloomberg Intelligence analyst Matt Larson.

Xiaomi has also bought patents from companies such as Nokia and Microsoft in the last two years to tackle potential licensing and litigation fights. It acquired some standard-essential patents, which underlie technology on standards set by industry standard groups and are often at the center of high-stakes patent litigation, from Nokia Corp., on cellular technology, according to IPlytics.

Xiaomi will need standard-essential patents, including those in emerging areas such as internet-connected devices and next-generation 5G wireless technology, Erick Robinson, director of patent litigation at Beijing IP East Ltd. told Bloomberg Law.

Most importantly, “what they need are patents that read well on folks on that would sue them and they would sue,” Robinson said.

Litigation Threats

Xiaomi is facing patent-related lawsuits in China and other countries, according to its prospectus. Yulong Computer Telecommunication Scientific (Shenzhen) Co. Ltd. sued Xiaomi claiming patent infringement in January 2018 in the Shenzhen Intermediate People’s Court. Its India expansion is threatened by a court fight with Ericsson AB, which has asked the Delhi High Court to permanently block Xiaomi from selling devices after accusing Xiaomi of infringing its technologies.

One strategy used by Chinese smartphone makers who are sued in other countries is filing counter-suits in China where rivals manufacture phone components, Robinson said. Chinese courts render quicker judgments and issue orders blocking certain business activities, such as imports and exports, that are harder to win in U.S. courts, legal experts say.

“It’s worked out so that Chinese companies can now go abroad because they have this protection back home that if the U.S. or another foreign company wants to sue them abroad, their retaliation can be back home,” Robinson said.

Xiaomi could look to making strategic patent purchases to win legal tangles in China and overseas, Robinson said.

“In the early days, every patent is a good patent,” Robinson said. “Now the only patents they need are those they think will be useful for them five and 10 years down the road.”

To contact the reporter on this story: Malathi Nayak in Washington at mnayak@bloomberglaw.com

To contact the editor responsible for this story: Rebecca Baker at rbaker@bloomberglaw.com