In a remarkable turn of events, the Hong Kong stock market witnessed its largest initial public offering (IPO) in three years, marking a significant milestone for the investment communityOn September 16, Midea Group, a prominent player in the home appliance industry, announced its share distribution resultsThe company offered around 566 million shares of H-shares globally, with 5% allocated to public offerings in Hong Kong and a substantial 95% in the international marketThe final offering price was set at HK$54.8 per share, successfully raising approximately HK$30.67 billion in net proceeds from the global sale.

Midea Group's shares experienced a robust debut on September 17, rising by 7.85% to close at HK$59.10. The stock continued to gain traction on September 19, adding another HK$5.15. Over the course of two trading days, the cumulative increase reached an impressive 16.56%, contrasting sharply with the mere 2.79% rise in its A-shares

This stark discrepancy raises intrigue: Are the H-shares undervalued or are the A-shares merely being overlooked?

The successful “A+H” listing is indeed commendable, but it comes with a note of cautionThe issue price of the H-shares equated to approximately RMB 49.96, representing a more than 20% discount compared to the closing price of Midea's A-shares at RMB 63.51 on September 13. This international venture not only signifies a strategy for diversification but also seems to equate to a sizeable discount for global investorsThe distinct trajectories of the A-shares and H-shares highlight a pressing need for reflection on Midea's valuation across different markets.

In August of the previous year, Midea Group laid out its vision to deepen its global strategic footprintAccording to its prospectus, the company intends to utilize the funds raised for global research and development, the continuous enhancement of its smart manufacturing systems, improvements in supply chain management, and the expansion of its global distribution channels and sales networks

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These efforts aim to bolster overseas sales under its proprietary brand while providing operational funds for general corporate purposes.

The overseas market indeed presents enormous potential for growth, yet the critical question remains: Will Midea be able to sustain this investor enthusiasm and live up to the high expectations set by this capital influx?

Is a Discounted Offering Indicative of Financial Stability?

The trend of issuing H-shares at a discount has been a contentious issue for Chinese companies listing in Hong KongA pertinent example is Tianqi Lithium, which faced a similar scenario of launching at a "half price". This reflects broader realities of liquidity constraints and lower valuations faced by companies in the current climateIn September 2023, the Hong Kong government established a dedicated task force aimed at evaluating factors affecting liquidity in the stock market.

While Midea’s decision to go public in such challenging market conditions reflects admirable courage, it is imperative to remain vigilant regarding potential profit dilution and the associated impact this may have on A-share valuations.

From 2021 to 2023, Midea Group displayed fluctuations in its revenue growth rates, with figures of 20.18%, 0.68%, and 8.1% respectively

Net profit growth followed a slightly different trend: 4.96%, 3.43%, and 14.10%. This indicates a notable volatility in profitability growth, although projections for the first half of 2024 suggest a return to double-digit increasesRevenue reached RMB 217.27 billion, reflecting a 10.30% year-on-year growth, while net profit stood at RMB 20.8 billion, with a commendable 14.11% increase year-on-year.

On the surface, the company doesn’t appear to be in a financial pinchDuring a shareholder meeting in April 2024, executives indicated that the move to list in Hong Kong was not primarily for fundraising, as Midea’s annual dividends exceed RMB 20 billionRather, the strategic decision boiled down to the need for breakthrough opportunities, convenience, and speed.

As of the end of June 2024, Midea's cash balance stood at RMB 101.95 billion, with accounts receivable at RMB 43.86 billion

Meanwhile, the total liabilities reached RMB 330.35 billion, including accounts payable, short-term loans, and long-term debtThe company's debt-to-asset ratio has steadily increased, averaging around 65% over the identified timeframe, a stark contrast to its competitor Haier Smart Home, which rested at approximately 58%.

Industry analyst Wang Tingyan pointed out that the debts held by appliance manufacturers like Midea often include significant operating liabilitiesWhile this cannot simply be taken at face value to assess overall financial health, it remains a critical indicator, particularly in times of sluggish consumer marketsAdequately managing the growth of liabilities in relation to assets is a fundamental aspect of a company's prudent operational strategy.

Moreover, the upwards trajectory of accounts receivable also raises some eyebrows, increasing from RMB 28.24 billion in 2022 to RMB 43.86 billion by mid-2024, showcasing growth rates that exceed revenue increases

Such trends not only occupy necessary working capital but also introduce challenges for cash turnover, operational efficiency, and financial costs, thus highlighting potential risks associated with bad debtsThis paints a picture of a company that must enhance its market influence and product competitiveness.

By evaluating these financial indicators collectively, it becomes evident that Midea Group does not enjoy a position of absolute security; it too must navigate through rugged terrainIts future hinges on how effectively it leverages the advantages of the Hong Kong market to transform into an internationally minded enterprise.

The Urgency of Establishing a Second Home Base

The journey towards capital internationalization is merely the first step on a long road, with product competitiveness being paramount for broader international business integration.

The core of Midea's operations revolves around two principal sectors: smart home technology (B2C) and industrial solutions (B2B). The former includes household appliances like air conditioners, refrigerators, and washing machines, which form the cornerstone of its business

Meanwhile, the industrial solutions segment encompasses new energy technologies, advanced manufacturing, smart building technologies, and robotics, signifying Midea's ambition to transition toward high-end manufacturing and establish a secondary growth trajectory.

In the first half of 2024, the industrial solutions segment generated revenue of RMB 46.7 billion, reflecting an increase of 7% year-over-yearNotably, the contributions from new energy technology, smart building technologies, and robotics were RMB 17.1 billion, RMB 15.7 billion, and RMB 13.9 billion respectively, although the robotics segment experienced a decline due to ongoing inventory reductions and insufficient demand.

Conversely, Midea's smart home business faces its own challenges amid intense market competitionIn the first half of 2024, domestic market revenues amounted to RMB 126.2 billion, marking an 8.37% increase, albeit slower than the previous year’s 11.09%. On the international front, revenue surged by 13.09% to RMB 91.1 billion, providing a strong rationale for Midea’s accelerated international expansion strategy.

Segment analysis reveals a decline in the market shares for core products such as home air conditioners, dryers, and refrigerators, with contractions of 2.5%, 0.3%, and 2.2% respectively

Given that Midea does not produce televisions, these traditional staples represent critical strengths; thus, their decline serves as an unfavorable signal.

By June 30, 2024, Midea's inventory surged dramatically to RMB 40.33 billion, reflecting a significant 19.7% year-on-year increase, indicative of a persistent trend of inventory growth over the years.

However, this is not an isolated concernData from GfK shows the domestic white goods retail market size shrank to RMB 2,319 billion in the first half of the year, a decline of 7% year-on-year.

Confronted with this challenging market landscape, Midea's Chairman and President Fang Hongbo declared at a management meeting in January 2024 that achieving global breakthroughs is one of the organization’s core strategies, emphasizing the need to establish a second stronghold in overseas markets while prioritizing the autonomy of their brand.

The global market is vast, but competition is equally fierce

A report by Frost & Sullivan revealed that the compound annual growth rate (CAGR) of global appliance market sales hovered around 3.5% from 2017 to 2023. Consequently, enhancing product strength is essential for Midea's aspirations to build a second market stronghold.

Industry analyst Wang Yanting insists that the internationalization of products hinges not only on high-quality offerings but also on efficient channel strategies, exceptional after-sales services, and product designs tailored to local demands, along with comprehensive market analysis and adaptabilityCollectively, these dynamics influence Midea's potential for generating a second growth curve and securing a pivotal position in new markets.

Brand Value Exceeding RMB 29.9 Billion: Globalization Is More Than Just Acquisitions

When reviewing Midea's global strategic initiatives, KUKA Group stands out as a key component in its portfolio.

Public records indicate that KUKA is among the world's top four industrial robotics manufacturers, and in 2017, Midea acquired the company for RMB 30 billion

However, KUKA's fortunes rapidly changed the subsequent year, with order revenues dropping by 8.5% to €3.3 billionRevenue further declined by 6.8% to €3.2 billion, and net profits plummeted by 85% to just €10 million.

By 2020, KUKA posted a staggering loss of €80.89 million, only to show signs of recovery in 2021. By 2023, Midea reported that KUKA’s order volume and revenue reached historic highs, particularly in China, where its contribution to revenue increased from 15% in 2020 to over 22% in 2023. KUKA has promoted the localization of overseas production facilities and currently operates three factories in China, boasting an annual robot production capacity exceeding 100,000 units.

Analyst Sun Yewen argues that the rejuvenation of KUKA's business in China highlights the potential of leveraging foreign technological advantages for domestic market expansion

Yet, this does not wholly align with Midea's goal of outpacing competitors on the international stage, which partially diminishes the intended strategy of building a second stronghold abroad.

As of the end of June 2024, Midea's goodwill stood at RMB 29.9 billion, with KUKA accounting for nearly 80% of this figureThe company set aside RMB 546 million for goodwill impairments in the first half of the year.

Aside from KUKA, Midea made significant acquisitions in 2016, including an 80.1% stake in Toshiba's appliance business and completing the acquisition of 80% of the Italian company ClivetBy 2023, the Original Brand Manufacturing (OBM) segment accounted for over 40% of Midea's overseas smart home revenue, driven by brands such as Toshiba, Midea, and Comfee, showing substantial competitive strength in various overseas markets.

In mature markets in Europe and North America, brand recognition and channel barriers are formidable, leading most local companies to adopt a dual strategy of maintaining autonomous brands alongside acquiring local brands

This model elevates the OBM ratio significantly.

The inherent advantages include accelerated market penetration while retaining complete control over products, which significantly boosts R&D and brand managementHowever, challenges remain as this strategy demands substantial resources for R&D, manufacturing, marketing, and channel developmentFor instance, in the first half of 2024, Midea's selling expenses reached RMB 21.46 billion, reflecting a 25.23% increase year-on-year, which analysts attribute to global expansion efforts.

It is evident that Midea's journey toward globalization commenced early on, predominantly through acquisitionsThis approach, while seemingly efficient, harbors difficulties and liabilitiesThe disparities in management practices between domestic and foreign enterprises complicate the integration process post-acquisition, creating alignment challenges

If the acquired entity underperforms or external market conditions fluctuate, these investments can become liabilities, adding pressure on Midea's operational development.

Articulating an Effective Internationalization Narrative

This development has led to speculation that He Jianfeng’s departure, although unforeseen, may signify strategic transitions within MideaHistorically, he represented family interests on the board; his exit could indicate Midea's shift towards a more professional governance structure that embraces modernization and greater openness.

The new board features first-time directors such as Guan Jinwei and Zhao Jun, with several independent directors also newly appointedOut of the ten board members, six are fresh faces—marking a notable overhaul in governance.

Xiao Geng, now the practice professor at The Chinese University of Hong Kong (Shenzhen), and Xu Dingbo, the EMLYON Business School professor at CEIBS, exemplify the caliber of new board members