The 3nm Xring O1 SoC marks a key step of Xiaomi’s brandpremiumisation strategy
　　Xiaomi (1810 HK/TP: HK$75.25, BUY) released the Xring O1 SoC based on the TSMCsecond generation 3nm process (N3E) and has equipped it in two new products -Xiaomi 15S Pro and Xiaomi Pad7 Ultra. The chip's release progress has exceededmarket expectations as the street was originally expecting a 4nm Xring chip releasethis year and a 3nm chip in 2026. Meanwhile, Xiaomi launched Xring T1 SoC forXiaomi smartwatch S4 which incorporated in-house designed 4G modem. We believethe SoC launch will have a positive impact on the stock momentum subsequently.
　　We believe this in-house designed SoC will enhance the company's technological andbrand image, in particular narrowing the gap in brand and technological perceptionwith Huawei, which is still the leading domestic consumer electronics brand in China.
　　Meanwhile, Xiaomi's current chip adoption strategy is relatively flexible, via using bothdomestic and overseas chips in parallel, effectively reducing the risk of overseassanctions. Qualcomm CEO Cristiano Amon stated at COMPUTEX 2025 in Taiwan lastweek that it is not uncommon for manufacturers to develop their own chips, citingSamsung (Exynos series SoC) as an example, which also adopts a strategy of usingboth in-house chips and Qualcomm SoCs. He said that the cooperation with Xiaomi isa long-term and stable relationship, and Xiaomi's future flagship models will still useQualcomm's technology and chips. We believe that Xiaomi's future chip strategy willfollow a dual-track approach of both outsourcing and in-house development: futureflagship Xiaomi smartphones will still be initially equipped with outsourced flagship SoCs(such as Qualcomm Snapdragon and MediaTek Dimensity), while the interim flagshipsmartphone models will be equipped with Xiaomi's in-house Xring SoCs.
　　Cost-benefit analysis of Xring: we see 4% smartphone GPMupside in long term assuming 20% adoption rateIn-house SoC is a comprehensive long-term development requiring heavyinvestment. According to Chairman Lei, Xiaomi has incurred over RMB13.5bncumulative expenditure up to April 2025 for the R&D of Xring and will spend aboutRMB6bn in R&D in 2025 with a huge team of over 2,500 engineers. Xiaomi hascommitted RMB50bn investment for chip development over ten-year time span. Afterperforming a cost-benefit analysis, we believe Xiaomi’s Xring SoC could uplift Xiaomismartphone’s GPM by 4ppts and OPM by 2ppts in the long run provided smooth Xringadoption in Xiaomi smartphones.
　　Qualcomm's group gross profit margin is around 55%. Considering that Xiaomi hasno IP licensing revenue and has extra expenses such as the external MediaTek 5Gmodem IC and corresponding 4G/5G/ARM core royalties, we assume that theequivalent GPM of Xring is around 40% with an average selling price of US$80 (theaverage price of a mid-up range SoC), resulting in a cost saving of US$32 per chip.
　　Assuming Xiaomi ships 190m smartphones and tablets annually, with a 20%penetration rate for the in-house Xring chip (so totaled 38m units), the total COGSsaving would be US$1.22bn (or RMB8.8bn). With an estimated long term annual R&Dexpenditure of around RMB5bn, the net annual cost saving would be RMB3.8bn,representing approximately 4ppts increase in Xiaomi's smartphone GPM and 2pptsincrease in OPM. If comparing with the upfront investment in Xring of approximatelyRMB20bn (RMB13.5bn cumulative investment plus RMB6bn expected investment thisyear), Xiaomi’s Xring initiative would achieve a return on investment (ROI) of nearly19% (net annual cost savings RMB3.8bn/ total investment RMB20bn). Our calculationeven does not yet consider the positive side effect of the enhancement of the brandimage and the synergies brought about by the integration of software and hardware.