Put a value on Xiaomi, then subtract some

[LONDON] Whatever you think Xiaomi Corp might be worth, it's probably less.

The Chinese smartphone maker is set to be the first prospective listing to take advantage of looser Hong Kong rules that allow dual-class stocks. With a valuation anywhere between US$60 billion and US$100 billion, it's also on course to be the world's biggest float since Alibaba Group Holding Ltd.

But with that kind of shareholding structure, investors should go in with their eyes wide open. Essentially, it's one that gives chairman and CEO Lei Jun and his co-founders majority control, leaving little say for minorities.

Mr Lei and Xiaomi's president Lin Bin will hold Class A shares that carry 10 votes each. Class B stock, the sort allotted to ordinary shareholders, will have one vote. So Mr Lei, with 31.4 per cent of Xiaomi, and Mr Lin, with 13.3 per cent, will have a lot more control than their combined interest suggests.

That power doesn't stop with the shares. Xiaomi's prospectus states that any meeting of directors "shall have no less than two directors, one of which shall be the company's founder, Lei Jun (or his duly appointed alternative director)", meaning a meeting of just Mr Lei and Mr Lin would make a quorum.

Mr Lei could turn out to be the executive who cements Xiaomi's future success, or the genius who needs to be shielded from analysts and their short-term financial projections.

Would-be investors also need to consider whether Xiaomi is more than a hardware company with razor-thin margins, or whether to avoid it altogether because its IPO may be a flop, a la Good Doctor.

Firms with dual-class share structures in the US tend to trade at a discount over the longer term.

Google owner Alphabet Inc paid existing shareholders compensation when it rolled out shares with weighted voting rights, while Facebook Inc, whose CEO Mark Zuckerberg has less than 1 per cent of the stock but 60 per cent of the voting power, backed down from selling shares with no say after investors revolted. Mr Zuckerberg's extraordinary control has raised red flags after it emerged the social media giant had allowed an outside party to collect users' data on a grand scale.

While Hong Kong does have some safeguards to protect minority shareholders, the most effective of them all - class action lawsuits - aren't possible in the city's legal system.

In some respects, investors in Hong Kong should be no stranger to a handful of interests having a tight grip over large swathes of the market. Family-owned companies are common, as are Chinese state-controlled firms. There's a greater chance of Xiaomi going bust than, say, a train maker with Beijing's implicit backing.

The buyer beware argument is often trotted out by proponents of the dual-class system, but that worked better at a time when passive and index funds didn't dominate global flows. And while activists are starting to descend on the region, it's early days.

Safe to say, Xiaomi's mega-IPO won't be winning many corporate governance fans any time soon.

Buyers should indeed beware: Of a backward step for governance, of key-person risk, and of stretched valuations.

BLOOMBERG