Xiaomi Corp

HKEX:1810

Earnings Call Transcript 2019-Q3

[Steve Lin, executive]

Good evening, ladies and gentlemen. Welcome to the investor conference call hosted by Xiaomi Corporation regarding the company's 2019 third quarter results. I am Steve Lin, the Director of Corporate Finance and Joint Company Secretary.

Before we start the call, we would like to remind you that this call may include forward-looking statements, which are underlined by a number of risks and uncertainties and may not be realized in the future for various reasons.

Information about general market conditions is coming from a variety of sources outside of Xiaomi. This presentation also contains some unaudited non-IFRS financial measures that should be considered in addition to, but not as a substitute for, company's financial prepared in accordance with IFRS.

Joining us on the call today are our Founder, Chairman and CEO, Mr. Lei Jun; our Senior Vice President and CFO, Mr. Shou Zi Chew. To start with, Mr. Shou will review the business and financial performance for the third quarter of 2019. Following that, we'll move on to the Q&A session.

I will now turn the call over to Mr. Chew.

[Shou Chew, executive]

Hi. Good evening, everybody, and thank you for your continued support of Xiaomi. This is Shou here. I'm the CFO of the company, and I will begin by giving everybody a brief overview of our Q3 2019 results.

Now before we go into the detailed numbers, I would like to share some good news first. The first is Xiaomi was ranked #7 on Fortune's Future 50 list. And this is an indication that at least media believes that we have a lot of room to grow for our smartphone and AIoT business in the future.

We were also ranked #57th in Forbes Top 100 Digital Companies in 2019.

Now a very important thing in Q3 this year was that we have officially entered the new 5G era. We released our first 5G smartphone in China in September 2019 called Xiaomi 9 Pro. And this phone has been very well received by the market.

We believe that 5G will -- in the next couple of years, will bring new growth opportunities to Chinese smartphones, and in the future, will also capitalize a global smartphone shipment change.

Apart from investing in 5G, we have also continued to invest in other innovative technologies. For example, in the third quarter of this year, we launched the futuristic Mi MIX Alpha. This phone is the world's first surround screen display phone with a 180% screen-to-body ratio. We believe that this is a breakthrough in screen technology for smartphones.

On top of that, we also launched Xiaomi CC9 Pro, also known as Mi Note 10 globally, and this is the first smartphone in the world to support a 108-megapixel penta camera. This is, again, a breakthrough in the camera technology for smartphones.

As a result of this, we were ranked by DxOMark as tied #1 for overall camera performance for CC9 Pro Premium Edition. And in terms of video, zoom and texture, we were ranked #1. The reason why we can continue to deliver such innovative technologies is because we have continued to invest in R&D. Our cumulative R&D expense from 2016 to Q3 2019 has reached RMB 16.3 billion, and in the third quarter of 2019, our R&D expenses has increased almost 33% year-on-year.

In terms of AIoT, we have maintained our leading position as a consumer -- global consumer IoT platform. As of the end of Q3 2019, we have 213 million non-smartphone, non-laptop connected devices on our IoT platform. This number has grown 62% year-on-year. The number of users with 5 or more connected Xiaomi devices has also grown to 3.5 million people, and this number has grown 78.7% year-on-year.

As a result of this, we were listed on China's National Open Innovation Platforms for next-generation AI, and we believe that this is a significant recognition of our contribution to the new IoT era.

In terms of our financials. If we want to summarize our Q3 performance, it will be that we have chosen to operate prudently. And the reason we have done this is because we are preparing in advance to capture the 5G opportunities that are coming in the future.

Our total revenue was RMB 53.7 billion in Q3. This is a quarterly historic high for the company, with a year-on-year growth of 5.5%.

Our adjusted net profit is RMB 3.5 billion with a year-on-year growth of 20%.

Now if we were to dive into each of the individual business lines, we'll first talk about smartphones. Our smartphone revenue reached CNY 32.2 billion in Q3 2019. We sold 32.1 million units of smartphones in Q3 2019.

Now the most important subject in our industry today for smartphones, in particular, in China, is the upcoming 5G opportunity. It is true that from 2017 to 2019, the Chinese overall smartphone market has declined year-on-year. And this is especially true in the first 3 quarters of 2019, where the overall Chinese smartphone market has witnessed a challenging environment.

We believe there are many reasons that make up for this. And one of the important ones is that consumers are waiting for the 5G era to come, in particular, after the commercial license of -- the commercial use of 5G licenses was issued in June this year. We have prepared for -- we have prepared our R&D resources for 5G for a number of years already. In particular, in February 2019, we launched our first 5G phone, Mi Mix 5G, in Barcelona.

In September this year, we launched our first 5G phone in China called Xiaomi 9 Pro 5G. And of course, the Mi MIX Alpha.

In 2020, we have planned more than 10 5G devices that we launched into the market. Now in particular, on the 10th of December, which is not very -- which is a few weeks from now, we will be launching the launch event of Redmi K30, which will be the first 5G phone under the Redmi brand. This is a phone that supports both SA and non -- and NSA. We believe that this is a significant moment for 5G technology to be brought to the mass market. And we do hope that everybody can give us their support during that day.

Now over the course of our 9 years, Xiaomi's mission has always been to relentlessly build amazing products, have honest prices, to let everybody in the world enjoy a better life through technology. There are many examples of us doing this over the course of our 9 years. I will pick a few.

The first is our Xiaomi first-generation phone, where we launched a flagship phone at a RMB 2,000 price range, bringing flagship smartphone technology to the mass market.

In 2016, we launched a Redmi Note 3, which was the first fingerprint technology phone that we launched in the market under RMB 1,000. In 2019 -- in February 2019, we launched the first 48-megapixel camera smartphone at under RMB 1,000 to the market, and this Redmi Note 7 was very, very well received.

Recently, we launched our first 5G smartphone in China at a price starting at RMB 3,700. Now the reason why I raised this examples is to display that Xiaomi is very, very good at making use of our industry-leading operating efficiency to bring the best technologies to the mass market as quickly as possible.

We believe that at the beginning of the 5G era, the cost of producing 5G phones will initially be high.

Now because the cost of producing 5G phones will be high, we believe that this will enable us -- enable our superior operating efficiency to shine even better as we bring 5G phones quicker to the mass market.

Now in preparation for this, in the third quarter of 2019, our focus was on healthy operations. This has led to continued margin expansion as our gross margin for smartphones increased from 6% in Q3 2018 to 9% in Q3 2019.

Our net income margin has also increased as a result. Also, very importantly, our inventory turnover days has gone down to 52 days, reflecting a very healthy inventory level as we prepare to capture the 5G technology -- the 5G opportunities, especially in the Chinese market, in the few quarters ahead.

Now on top of this, we have continued to execute our smartphone multi-brand strategy with Xiaomi establishing itself in the mid- to high-end and diversified user market and Redmi continuing to offer products at the ultimate price-to-performance ratio across a lot of major price points.

Moving on to our AIoT business. We have maintained our leadership in the global consumer IoT market. Our IoT and lifestyle product revenue stream reached CNY 15.6 billion in Q3 2019. This represents a year-on-year growth of 44%, maintaining a high growth rate.

Now in particular, our smart TV shipments reached 3.1 million units in Q3 2019, with a year-on-year growth of 59.8%. This is a high growth rate on a large base. We were also ranked #1 by shipments in mainland China and #5 globally, last quarter. We launched a Mi TV 5 series on November 5, 2019, which is an all-round upgrade at better price points for the future home.

Now outside of televisions, we have also further expanded into home appliances. We launched our Mi Refrigerator on the 11th of October this year, completing our wide goods offering of refrigerator, air conditioning and washing machines.

We also launched a very important device on the 5th of November, which is our Mi smartphone. If I were to summarize what this product does, it is basically a small smartphone that you can wear on your wrist. Because it supports eSIM, it is extremely convenient to use and has received a very strong fanfare from our Mi fans.

Our AI assistant monthly active users also reached 57.9 million, representing a year-on-year growth of 68.6% in the third quarter of this year. Our AI touch screen speaker won the 2019 Red Dot Design Award, the U.S. Industrial Design Award -- the U.S. IDEA award and the Good Design Award.

Next our Internet services business. Our Internet services revenue reached CNY 5.3 billion in Q3 2019, representing a year-on-year growth of 12%.

Our advertising revenue, excluding pre-installations, achieved a positive growth of 6.9%, reflecting a few trends: one, the shift in preference for a lot of advertisers to more advanced advertising platforms outside of pre-installation, which we have diversified and captured; and also, the overall challenging advertising market in China today.

Despite this, our advertising revenue has increased quarter-by-quarter in 2019 from CNY 2.3 billion in Q1 to CNY 2.5 billion in Q2 to CNY 2.9 billion in Q3 2019. We believe that this is the result of our increased efforts to diversify our advertising base and to strengthen our overall advertising offering.

On top of this, we launched MIUI 11 recently. MIUI 11 focuses on a few things, including minimalistic design, efficiency and connectivity, especially with IoT devices and also smart travel.

As a result of all this work, we have experienced a strong monthly active user growth on our handsets.

Our global MIUI MAU has reached CNY 291.6 million, globally, while our mainland China MIUI MAU has remained flat year-on-year at CNY 112.8 million.

Our Internet service revenue stream is also increasingly getting more diversified. Today, 37.2% of our Internet service revenue is from Internet services outside of advertising and gaming from mainland China smartphones. This, if you recall from last quarter, includes Youpin, our Fintech business, our overseas Internet services revenue and also Internet services revenue from our IoT products, including television.

This increasing diversification is also experiencing fast growth. These revenue streams that I just mentioned experienced a year-on-year growth of 87.8% in Q3 2019.

In particular, we have continued to strengthen our overseas Internet services. Just as an example, our major Internet services in India, including our App Store, our browser, our security center, video and music are ranked #1 or #2 on our smartphones in India today.

We believe this serves as a very strong base for future monetization opportunities.

But speaking of overseas, our overseas revenues continued to grow year-on-year with a growth rate of 17.2% in Q3 2019. Today, our overseas revenue represents 48.7% of our total revenue. For example, in India, we have maintained our leading smartphone position for 9 consecutive quarters. Our Q3 2019 market share in India, for smartphone, remained at a very high 27.1%. Another big highlight for us is our growth in the Western European markets. We are ranked #4 by smartphone shipments in Western Europe in Q3 2019, with a year-on-year growth, according to Canalys, of 91%. Our Spain smartphone market share has increased to #2 in the country with a market share of 22.9%, experiencing a 64% growth.

Now if we look outside carriers, and only look at the open market, we are now ranked #1 in the open market in Spain.

Moving on to a few key financial highlights. First, we'll start with gross margins. As mentioned just now, due to our focus on healthy operations in Q3, while we are waiting for the new 5G opportunities ahead, we have increased our smartphone gross margin from 8.1% in Q2 to 9% in Q3 2019.

Our IoT and lifestyle products gross margin has also gone up from 11.2% last quarter to 12.8% in Q3. Our Internet services gross margin is at a strong 62.9%. The reason why it marginally declined from Q2 2019 is because of the greater proportion of Fintech business as a total -- as a percentage of our total Internet services revenue, and the Fintech business has a slightly lower gross margin profile than the advertising business.

The second is we are pilot testing an advertising network business, and at the initial stages of this pilot test, the margin profile is not as high as our traditional advertising business.

We believe that this gross margin will continue to be stable for the foreseeable future.

In terms of our operating expense. As mentioned just now, our R&D expenses has increased 32.5% year-on-year in Q3. And as a percentage of our total operating expenses, it has gone up to 3.8% versus 3% in Q2 2019.

Now despite this, we are still at a very efficient operating expense ratio of about 10%.

We believe that R&D efforts will pay off as we capture future 5G growth opportunities. And we believe that we will continue to have industry-leading operating expense ratios.

In terms of inventory management, as mentioned just now, our inventory turnover days has gone down from 65 days in Q1 to 52 days in Q3 2019. This is, again, due to our focus on healthy operations before the new 5G era, and we believe this puts us in a very favorable position as we have very healthy inventory levels today.

Our operating cash flow has also performed strongly in Q3. Our adjusted operating cash flow, adjusted for Internet Finance is a positive RMB 3.6 billion in Q3 2019.

As a result of this, our cash resources has increased to RMB 56.6 billion by the end of the third quarter. If you include the book value of our investments, the book value of our office and other real estate and deduct our financial debt, our total -- the cash assets is now at RMB 80.7 billion, and this has increased CNY 5.1 billion -- this has increased by CNY 5.1 billion in just 1 quarter. This number was at about CNY 75 billion in Q2 2019.

This concludes my very short presentation before we go into questions.

In summary, the focus in Q3 for Chinese smartphones was on healthy operations as we prepare ourselves for the new 5G opportunities ahead. Our AIoT operations continue to grow strongly, our overseas business continues to expand at a rapid pace.

Thank you for your attention, and this concludes my short presentation. We will now move on to Q&A.

[Operator]

[Operator Instructions] Our first question comes from Grace Chen with Morgan Stanley in Hong Kong.

[Grace Chen, analyst]

My question is about the 5G smartphone replacement cycle. Can the management share with us about -- what's the status now? And how much do you expect the 5G smartphone will be by end of next year, actually? And what are the key successful factors to contribute to the replacement cycle? And what's Xiaomi's competitive edge in this 5G upgrade?

[Shou Chew, executive]

Thank you, Grace. Let me translate for management here. [Foreign Language]

[Jun Lei, executive]

Okay. [Foreign Language]

[Shou Chew, executive]

[Interpreted] Next year is the first year of proliferation of 5G smartphones, and we will be launching more than 10 models of 5G smartphones next year.

[Jun Lei, executive]

[Foreign Language]

[Shou Chew, executive]

[Interpreted] We believe that the 5G total penetration for the market in China could be between 40% to 50% next year.

[Jun Lei, executive]

[Foreign Language]

[Shou Chew, executive]

[Interpreted] Once we enter the 5G era, the 5G cost of production is higher than 4G phones.

[Jun Lei, executive]

[Foreign Language]

[Shou Chew, executive]

[Interpreted] Because of our superior, industry-leading operating efficiency, we are very well positioned to launch 5G phones at a very, very attractive price. And we believe that this will be very attractive for a lot of users.

[Jun Lei, executive]

[Foreign Language]

[Shou Chew, executive]

[Interpreted] Within the next 3 to 4 years, almost everybody's smartphone should become a 5G smartphone.

[Jun Lei, executive]

[Foreign Language]

[Shou Chew, executive]

[Interpreted] This is a very massive market demand.

[Jun Lei, executive]

[Foreign Language]

[Shou Chew, executive]

[Interpreted] Also, very importantly, over the last 2 quarters -- a few quarters, we have emphasized on healthy operations. This means a few things. It means that our cash results are very, very adequate. It means that our inventory levels are very healthy, both inventory levels on our balance sheet and also within our channels. This will give us a very big advantage in capturing the opportunities when the 5G era begins very, very shortly.

[Operator]

Our next question comes from Leping Huang with CICC in Hong Kong.

[Leping Huang, analyst]

So my question is also about 5G. So when we will see that your RMB 1,000 5G phone -- [Foreign Language]

[Shou Chew, executive]

Let me translate the question first. The question is when will 5G phones be at RMB 1,000 price point?

[Jun Lei, executive]

[Foreign Language]

[Shou Chew, executive]

[Interpreted] In order for smartphones to reach RMB 1,000 retail price, and for this to be pushed to the mass market, this could be something that will happen in 2021.

[Leping Huang, analyst]

The second question is about your overseas development of -- around these smartphones. So what's the progress of -- since we see a lot of opportunities, I think, especially in the overseas operator market, so when we can see -- what's the latest progress in Xiaomi sector? [Foreign Language]

[Jun Lei, executive]

[Foreign Language]

[Shou Chew, executive]

[Interpreted] We have only been in the Western Europe market for roughly 2 years. And today, we are already #4 in the market, experiencing very high growth at 70-plus percent year-on-year. For example, in particular, in Spain, we are now #2 in the overall market, with about 22.9% market share and #1 in the open market. Now this is a relatively incredible achievement to have been achieved in only 2 years. Now regarding the carrier market, this is a to-be-business, and we will need a bit of time to expand and scale.

[Operator]

Our next question comes from Donnie Teng with Nomura in Taiwan.

[Donnie Teng, analyst]

My first question is regarding to smartphone gross margin in third quarter. So the gross margin in third quarter improved from 8.1% to 9%. Could you quantify how much percentage is from like foreign exchange or product mix being pulled to overseas market? And my second question is regarding to our smartphone gross margin next year. If we, at the same time, want to regain some market share in China with more 5G smartphone shipment, what kind of reasonable gross margin for smartphone business would be? And my third question is regarding to our Internet business. So if we assume like the Internet sales from China smartphone-related business to be flat, what kind of sales percentage would be from non-China smartphone business going forward? So in the third quarter, we have already around -- close to 40% is from non-China smartphone-related Internet business. So what kind of percentage we should expect going forward?

[Shou Chew, executive]

Give me a moment, please.

[Jun Lei, executive]

[Foreign Language]

[Shou Chew, executive]

[Interpreted] So for your first question on gross margins. We believe that the 9% gross margins that we have in this quarter, it's actually a reflection of normal operations. And this is a normal gross margin for us to have. In normal conditions, our gross margin should be at around 8% to 9%, and we believe that this should be stable over time, including for next year. So your question on how much of it is ForEx, how much of it's overseas market? How much of it's product mix? We think it's just -- this is just a -- this number just reflects the normal gross margin profile that we should have. So that's the first question.

And the second question. Regarding your Internet question. So your question was: What percentage of -- in the future, what percentage of our Internet services revenue will be from smartphones outside of China? Now today, our Internet services revenue from Fintech, from Youpin, from overseas phones and from TV is increasing at 88% year-on-year and is already at 37.2% of our total revenue. Now although this is quite some distance from the majority, the growth rate is very fast. The work we are doing right now in certain geographies, for example, in India and Indonesia, is to make sure that we are building very strong Internet services for our users. For example, our App Store, our browser, our video, our music apps in India are already at the #1 or #2 position in terms of DAU on our smartphone platform. Now once you have the users using all these services, you create the inventory and the opportunity to monetize. So I think we're on the right track. Now we won't give a forward-looking statement on exactly what percentage it is, but I think you can look forward to a bigger percentage of our Internet services revenue coming from the overseas market in the future.

[Operator]

Our next question comes from Kyna Wong with Crédit Suisse in Hong Kong.

[Kyna Wong, analyst]

I would like to talk about the R&D investment or the CapEx investment for 5G in the future because we see that in terms of R&D spending, actually, run-up in third quarter, this kind of level will be sustainable or not? Should we like also consider like more R&D effort in next year in preparations for like 5G or like even a CNY sub-1,000 price point of 5G phone in 2021? So -- and also the CapEx because we also know that some factory in Beijing does some testing or like some -- I mean, preparation for the 5G. So I want to see if there's any further CapEx investment for 5G phone as well. This is first question. The second is about the Internet business. In terms of the Fintech business, we see as a high growth, but is this sustainable? What should we expect in the future? Is this -- because there's some kind of uncertainty in the market, maybe related to regulations and all the things. So should we like also expect this would be one of the key driver in 2020 Internet business?

[Shou Chew, executive]

Okay, Kyna, give me a second, please.

[Jun Lei, executive]

[Foreign Language]

[Shou Chew, executive]

[Interpreted] Okay. For the first question, our R&D expense for Q3 this year was -- had a year-on-year growth of more than 30%. And Lei Jun expects that by the end of this year, our total R&D expense for the year should be at around RMB 7 billion. Now he believes that for 2020, it will be at a reasonable level. And our R&D today is appropriate for our current business plan. And of course, we will plan and adjust our R&D cycle according to our business needs. So this is something that he believes is appropriate at this level, and we will increase appropriately over time. So that's the first question.

Now in terms of the second question on 5G. We began our R&D in 5G starting on 2017. And he thinks that we are well prepared to take on all the opportunities that the 5G smartphone business will bring for the future. Just to clarify, this R&D expense is in our P&L, it's not a capital expenditure. Now in terms of the factory news that you heard just a few days ago, this is a pilot test where we are trying to push the industry to innovate in efficiency and automation. It will be a pilot test at a scale where we can continue to push the industry forward. And for the foreseeable future, we intend to continue to maintain very strong working relationships for the manufacturers who perform assembly for us at this point in time.

Now for your second question on the Fintech business. Our Fintech business is, generally speaking, you understand it as 2 pillars. The first is consumer finance business, which mainly revolves around our smartphone users. We provide it as an additional Internet service to our smartphone users, and we have the appropriate license and comply with all the rules and regulations in terms of this business. Now the future growth of this business is still something that we can foresee even after complying with all the rules and regulations locally. And this is because we have the resources to get all the licenses in place. But the second part of the business, which is very exciting for us is the supply chain financing business, where we are making use of our strength in the manufacturing space and also our deep relationships with our partners to build a Fintech business for our supply chain. Now sometime in the future, when it is the right time, we may further break down these 2 businesses to disclose appropriately. But I just wanted to give you a sense of what it actually is.

[Operator]

Our next question comes from Piyush Mubayi with Goldman Sachs in Hong Kong.

[Piyush Mubayi, analyst]

Thank you for taking us through your 5G opportunity. If you dig deeper through that, could you give us a sense of what you think your strength is as you roll out 5G smartphones in the country? First. And second, could you look at what the potential market share could be for you in the 5G smartphone business in China? And finally, what it implies for our user number for China, which has been flat year-on-year, 112 million, so we can get a better estimate of what it means with profitability for the overall business?

[Shou Chew, executive]

Okay. Give me a second, Piyush.

[Jun Lei, executive]

[Foreign Language]

[Shou Chew, executive]

[Interpreted] Piyush, let me try to take these 2 first. The first advantage in the 5G era is -- comes back to our operating efficiency. Our 9% gross margin means that we only need to add roughly 9% to the price for us to break even here, whereas some of our competitors need to add a lot more in order to break even. So we believe that our operating efficiency will allow us to very quickly bring 5G devices to the mass market because of our operating efficiency and the model that we have employed. Now the second advantage is we have prepared very early for this 5G transition. And actually, we talked about it in quite a bit of detail last quarter as well. Our inventory levels now are very healthy. And they should give an example for the single-day sales that happened recently, where we were very conservative. And some people didn't understand why we were so conservative. It is because we don't have unhealthy levels of 4G inventory. And there was no need for us to take massive losses for this. So because we are prepared earlier for this 5G transition, what we say internally is that and I quote, "This is -- we have basically cleared out our warehouses so that we can take off during the 5G era," loosely translated.

[Jun Lei, executive]

[Foreign Language]

[Shou Chew, executive]

[Interpreted] Okay. The third is we have a very innovative culture and a very sustained R&D investment and effort. This has led to a lot of technology breakthroughs for us. Now RMB 7 billion is actually a very large number for R&D expense in China. Now of course, you may be comparing us to one company, which claims to have a very big R&D expense. But what is also important is not just mere numbers, but you need to have a very innovative culture. Now he gave 2 examples. One is the same competitor has always been very proud of their camera technology. And they found a very authoritative third-party called DxOMark, and within 2 years of us innovating in this field, we are now tied #1 in terms of camera technology according to DxOMark. It took only took us 2 years to get there. In terms of wireless charging technology, we are now leading globally. So this R&D -- continued R&D investment and innovative culture is a very significant advantage that we have.

[Operator]

Next question comes from Gokul Hariharan with JPMorgan in Hong Kong.

[Gokul Hariharan, analyst]

So first of all, on the Internet service business. Could you talk a little bit about margin trends across the different businesses, ad versus Internet finance versus value-add services? And secondly, what is your outlook for advertising, given even ex pre-installs it's growing at single digit, what does the current building of your own ad network business, et cetera, do to recapitalize the market -- recapitalize Xiaomi's advertising growth in Internet services?

[Shou Chew, executive]

Okay. Give me a second, Gokul.

Gokul, I'll answer this question. So it's broken down into a few parts. Your first question on margin trend. I think the overall answer is that this current margin level of 62 point something percent, we believe, is a very sustainable number for the foreseeable future. Now the breakdown of amortizing Internet finance and value-added services can get very complicated. But you can think about it this way. Overall blended and based on what we can see for future growth, we believe that this kind of a 60% plus margin profile is sustainable for the foreseeable future.

Now in terms of the advertising outlook, I think it's fair to say that it has been soft for -- since the beginning of this year for the Chinese market. Now because it is soft, I think it has compelled us to start building sort of more sophisticated recommendation engines, and deliver better ROI for our advertisers, starting from very early this year and the back end of last year. And what you're seeing now with the growth of our ex pre-installation advertising revenue, especially the growth for 2 consecutive quarters on a quarterly basis, is the initial results of us strengthening these parts. So it is about building a stronger recommendation engine. It is a better use of the big data subject to other privacy compliance that we need to adhere to. And it is also about expanding our advertising base from Internet companies only, in the past, which is about a year ago to more sort of traditional advertisers, such as the traditional finance industry, such as small to medium enterprises, such as education, so on and so forth. Now we believe that a diversified strategy is the best way to make the business more robust. And because if you compare our advertising revenue to the entire advertising industry in China, the proportion and penetration is still very small. So as we diversify our base, this will allow us to continue a very sustained, powerful growth. And then as the advertising market turns as the economy sort of picks up in the future, we believe this puts us in a good position for even more accelerated growth.

[Operator]

And our next question comes from Donnie Teng with Nomura in Taipei.

[Donnie Teng, analyst]

I just have one follow-up question regarding to Chairman's smartphone gross margin target of 8% to 9% next year. Originally, I was thinking that Xiaomi's priority is to regain some smartphone market share in China. So to do that, Xiaomi may need to have a more aggressive pricing strategy when entering into 5G era next year. And also, considering that the BOM cost of 5G smartphone, may be like RMB 300 to RMB 500 higher than 4G smartphone, so I would be surprised if Xiaomi can regain market share in China, and at the same time, to maintain the gross margin at 8% to 9% next year. So could you elaborate more how could we do that by -- is there any specific strategy or reason behind?

[Shou Chew, executive]

Okay. Give me a second, please.

[Jun Lei, executive]

[Foreign Language]

[Shou Chew, executive]

[Interpreted] So our price-to-performance ratio is a relative metric. It means it is always relative to the pricing of our competitors. Now precisely because the BOM of 5G is going to increase, our competitors have a higher operating expense, and they basically have no choice but to increase their prices. So it is a relative metric. It's a relative measure in terms of us having better prices in the market. And this is a reflection of our superior operating expense. Now 8% to 9% gross margins is actually already not high. It is a low number. And because our business model focuses on more efficient channels like e-commerce, so at the end of the day, the consumers can still get a phone at a very good price, even if we sell our phones at 8% to 9% gross margin. So there is no contradiction in the way we look at it.

[Operator]

Our final question comes from [ Robert Cao ] with [indiscernible] Research in Shanghai.

[Unknown Analyst]

I also want to ask about 5G, but I'm interested in the implications that the transition to 5G is going to have on your IoT business. How are you thinking about IoT in the context of 5G era?

[Shou Chew, executive]

Okay. Give me a second, please.

[Jun Lei, executive]

[Foreign Language]

[Shou Chew, executive]

[Interpreted] So Lei Jun believes that the 5G -- new 5G era will actually have a very profound impact on the IoT sort of experience for users. And of course, initially -- 5G will initially sort of benefit smartphones first. But because the whole 5G technology is actually designed for the Internet of Things, so maybe in 2021, 2022, you can see how this technology will be brought to more and more IoT devices. And because we already have such a leading advantage in our IoT consumer, IoT platform today, we are very well positioned to capture these opportunities in the future.

[Steve Lin, executive]

Okay. Thank you all. This concludes the call today. Thanks, again, for joining us. Good night.

[Shou Chew, executive]

Thank you.

[Portions of this transcript that are marked [Interpreted] were spoken by an interpreter present on the live call.]