INTERNET: Xunlei Swings to Loss, Where’s Xiaomi?

Bottom line: Xunlei’s performance and stock price could come under pressure over the next year due to stiff competition in China’s consolidating online video market and lack of support from struggling strategic partner Xiaomi.

Xunlei swings to quarterly loss

As rumors swirl of a potential merger between the online video services of Tencent (HKEx: 700) and Sohu (Nasdaq: SOHU), smaller rival Xunlei (Nasdaq: XNET) has just announced its latest quarterly results that show why it may be difficult for the company to remain independent in the rapidly consolidating sector. Xunlei swung to a loss in the quarter and saw its revenue contract — hardly encouraging signs for a company that’s already quite a small player in China’s fiercely competitive online video market.

The big “elephant in the room” in this instance is struggling former smartphone sensation Xiaomi, which purchased 30 percent of Xunlei around the time of its 2014 IPO for a reported price of about $200 million. Xiaomi went on to form a content distribution service with Xunlei last summer, leading me to predict that it could make an offer to buy the company outright. (previous post)

Fast forward to the present, when Xiaomi’s chief Lei Jun said earlier this week his company still has more than $1 billion in cash, which would be more than enough to buy out Xunlei, based on its current market value of $400 million. But Lei isn’t in a big spending mood these days. He said Xiaomi won’t be doing anymore fund raising this year, possibly fearing a significant drop in his company’s own value if he tries to raise more cash. That would seem to indicate that Xiaomi may not come to Xunlei’s rescue anytime soon, though perhaps it may be forced to make such a move to protect its earlier investment.

All that said, let’s take a closer look at Xunlei’s latest results, which aren’t really quite as dire as I might be implying. The company did indeed swing to a loss in the fourth quarter, ending up $4.3 million in the red. (company announcement; Chinese article) The trends certainly weren’t encouraging, since Xiaomi reported a nearly $1 million profit a year earlier, and the latest result also represented a widening of the $3.6 million loss Xunlei reported in the third quarter.

The top line didn’t look much better, with Xunlei’s net revenue dipping slightly to just over $35 million for the quarter. That’s certainly not a good sign for such a small company, and hints at the intense competition that has led most of Xunlei’s rivals to seek refuge with larger, cash rich rivals. Leading that group was former industry leader Youku Tudou, which last year sold itself to e-commerce giant Alibaba (NYSE: BABA).

As I’ve said above, Xunlei’s weak results come the same week that media are reporting that Tencent and Sohu may be close to a deal to combine their video services. (previous post) That would leave the industry with 3 major players: Alibaba-owned Youku Tudou, alongside Baidu-linked (Nasdaq: BIDU) Qiyi.com and LeEco (Shenzhen: 300104), formerly known as LeTV. It’s hard to see where Xunlei fits into that equation, unless of course it can find its own cash-rich backer.

Sinking Shares

Reflecting its ever-weakening position, Xunlei’s shares have tumbled over the last 9 months and now trade at half their IPO price. Xiaomi certainly can’t be too happy about that, since that means its initial $200 million investment is now just worth $100 million.

On a more positive note, Xunlei doesn’t seem to be burning through its cash too quickly and probably has the resources to survive for at least another year as an independent company. Xunlei said it had $432 million in cash at the end of last year, roughly the same as a year earlier.

But it may have to start using that cash to fund its operations if it continues losing money. If the company is smart, it will turn to Xiaomi and try to negotiate a sale of itself that can help to ensure its future. It’s unclear if Xiaomi would be interested in making such a purchase due to its own tenuous situation, which could put further pressure on Xunlei’s performance and share price for the rest of this year.

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