China's Rising Star Might be Why Samsung is Struggling

Last week, Samsung  CFO Lee Sang-hoon warned that the Korean tech giant's upcoming earnings report would not "look too good." Management offered nothing in the way of an explanation, but given the company's dependence on profits from its mobile division, weak handset sales may be to blame.

If Samsung's handset business is indeed struggling, it could be due to the growth of one of its major competitors. Earlier this week, China's Xiaomi said that its handset sales for the first half of 2014 were up a whopping 271% from the same period of last year.

Xiaomi's rapid growth may even challenge Apple as it looks for growth in emerging markets.

Xiaomi: China's rising star
Xiaomi was founded just four years ago, but it has attracted some big-name executives -- most notably Google's Hugo Barra --, and has taken the Chinese handset market by storm. Kantar Worldpanel reported that Xiaomi in April sold more smartphones than Samsung -- this is notable, as Samsung has been the top-selling smartphone vendor in China in recent quarters.

Xiaomi's success has largely been a byproduct of its budget handsets: Its flagship Mi3 is a high-end smartphone that retails for roughly $300 in China. To Chinese consumers, with an average family income of only a few thousand U.S. dollars, Xiaomi's devices are understandably attractive.

Poaching Samsung's customers
As TechCrunch noted, many of Xiaomi's customers are first-time smartphone buyers, but almost a quarter were former Samsung handset owners. Like Samsung, Xiaomi's smartphones use the Android operating system.

Xiaomi's version of Android is heavily modified, but that's not particularly relevant. Few Chinese consumers actually use the official Google Play -- the majority of Chinese Android apps are downloaded through third-party app stores.

Apple looks to China for growth
With its monopoly on the iOS operating system, Apple is less likely than Samsung to lose customer to Xiaomi, in China or anywhere else.

But Xiaomi is still a competitive threat to Apple's emerging-market ambitions. Although the Cupertino-based company has a firm grip on developed economies such as the U.S. and Japan, analysts have looked to China and other markets to provide incremental iPhone demand.

To a large extent, that has happened. Last quarter, Apple sold more iPhones than analysts had anticipated, mostly due to record emerging-market demand. In China, for example, Apple's revenue increased 5% sequentially, and company management noted that revenue from the BRIC countries collectively was at an all-time high.

Investors may be tempted to write off Xiaomi's phones as low-end budget devices, stepping stones for Chinese customers who will one day (if they can afford it) purchase Apple's iPhone. In reality, Xiaomi's phones are fairly high end -- the Mi 3, for example, has specs comparable to Apple's top-of-the-line iPhone 5s.

If Xiaomi can continue to capture first-time Chinese smartphone buyers, Apple may have a difficult time prying them away. As Xiaomi expands into other emerging markets, it could prove to be a major competitive threat.

Investors should be mindful of Xiaomi
Unfortunately, Xiaomi is a private company, leaving investors unable to take advantage of its rapid growth. Yet shareholders in the space, particularly Apple and Samsung investors, should be mindful of Xiaomi's rapid expansion.

When it comes to China, and emerging markets more broadly, Xiaomi could prove to be a major thorn in the side for these two tech majors.

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