CELLPHONES: Xiaomi Courts Midea, Qihoo Eyes Shenzhen

Bottom line: The target of Qihoo’s rumored smartphone purchase could be Coolpad, while Xiaomi’s new tie-up with Midea could be followed by similar pairings in a broader drive to develop smart appliances.

Qihoo eying Coolpad?

A couple of big deals are bubbling around in the smartphone space today, led by yet another new tie-up involving smartphone sensation Xiaomi, this time with home appliance maker Midea (Shenzhen: 000333). But the hyperactive Xiaomi is having to share the spotlight with the edgier security software specialist Qihoo 360 (NYSE: QIHU), which is reportedly eying a deal for its own major smartphone acquisition worth up to $1 billion.

Each of these deals has slightly different motivating factors, but the central theme is that companies like Qihoo and Xiaomi increasingly see smartphones as a central element of larger suites of product and services rather than just a stand-alone product. In Xiaomi’s case, the company already counts smartphones as its core central product and is trying to build up an ecosystem of related products and services like smart TVs and air conditioners. Qihoo is eying smartphones as a vehicle for propagating its core software and Internet services.

To some extent, both of these deals also reflect the overheated state of China’s smartphone space, which has seen companies’ profits evaporate and margins rapidly erode. In Xiaomi’s case, the company is looking to develop more profitable businesses based on smart devices to avoid too much reliance on smartphones. In the Qihoo case, the deal is almost certainly being driven by razor-thin margins at the company it’s looking to acquire.

Let’s begin with Qihoo, which is reportedly eying a deal to buy a major Shenzhen-based smartphone maker for 5 billion yuan ($800 million) or more, according to a media report citing unnamed sources. The report’s wording is somewhat vague, saying only that Qihoo has “decided” to make the purchase. Still, the fact that the investment figure is so specific, and so is the manufacturer’s location, appear to indicate that talks are already advanced.

There are certainly plenty of smartphone makers in Shenzhen to choose from. Telecoms giants Huawei and ZTE (HKEx: 763; Shenzhen: 000063) are both based in Shenzhen, though neither is a likely candidate since both are quite intent on building their own businesses. The report also names recently launched OnePlus and Meizu as possible targets.

But I would put my money on Coolpad (HKEx: 2369), which is one of the larger and better established players and whose current market value also happens to be around $1 billion. Others may be thinking  the same thing, since Coolpad’s Hong Kong-listed shares rose 6 percent in Monday trading, and are up more than 40 percent over the last 5 weeks.

Next let’s look at Xiaomi, which has been making a wide range of relatively small strategic investments over the last couple of months in its broader effort to build up a suite of Internet-based products and services linked to its core smartphones. This new investment in Midea looks like a continuation of that effort, with Xiaomi investing a relatively modest sum of up to 1.266 billion yuan ($200 million) in Midea, which is best known for its home appliances like refrigerators and air conditioners. (Chinese article)

Xiaomi is making the investment by purchasing Midea stock for 23.01 yuan a share, representing a discount of about 7 percent to Midea’s share price before trading was suspended 2 weeks ago pending the announcement. After the deal closes, Xiaomi will hold a relatively modest 1.3 percent of Midea shares.

The fact that Xiaomi could buy the shares at a nice discount reflects the fact that traditional appliance makers like Midea are eager to make such tie-ups to develop smart devices that can be operated remotely using Internet-connected smartphones. We saw Haier (HKEx: 1169) sign a similar tie-up a year ago with e-commerce leader Alibaba (NYSE: BABA), and it’s quite likely we could see more similar tie-ups involving Internet giants like Tencent (HKEx: 700) and Baidu (Nasdaq: BIDU) in the year ahead.

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