Xiaomi needs money, but is a $40 billion valuation justified?

An ambitious sales target, plans for expansion to new markets, and building a brick and mortar presence in existing markets may have prompted Chinese smartphone maker to begin funding talks, which are reportedly taking its valuation to more than $40 billion.

Forbes has reported that the smartphone maker, that defines itself as 'a software and e-commerce company that just happens to manufacture hardware', is negotiating with Russian investor DST to raise $1.5 billion. YourStory reached out to Xiaomi for a comment, and we will update you as soon as we have one.

A $40 billion plus valuation will put Xiaomi ahead of both Sony and Lenovo combined in terms of worth. The $1.5 billion funding will also be the largest tech financing round in the history equaling that of Facebook from 2011. At its last financing round in August last year, Xiaomi was valued at $10 billion.

Xiaomi's meteoric rise has been a case study of sorts for hardware developers the world over. Four years after Lei Jun launched the first flagship device Mi One, Xiomi has beaten Samsung to become the largest smartphone maker in the world’s biggest handset market – China.

Xiaomi shipped more than 15 million devices in the second quarter of 2014 – a marked 1.8 million more devices than Samsung, and looks set to achieve its ambitious target of selling 60 million devices this year. The target for 2015 is an ambitious 100 million phones, Lei has said.

To achieve this target, Xiaomi will need to go beyond its initial strategy which has thus far worked brilliantly. A direct-to-consumer selling approach through e-commerce (which cut overheads), shunning traditional styles of marketing, and relying instead on social media and word-of-mouth have brought Xiaomi this far.

Detailed read: How Xiaomi sells its high-end phones at low prices: a short lesson in the Economics of Pricing

But there are quite a few challenges ahead. Competition is heating up with several lower cost phones set to enter the growing markets, such as Google’s Android One and Motorola’s Moto series which offer more value for money.

Xiaomi is currently operating in very few markets outside China – India, Philippines, Singapore and Malaysia. Future plans include forays into Indonesia, Thailand, Russia, Turkey, Brazil and Mexico.

A look at this list shows that other than India and China, the other current markets are tiny and intended markets are large but also have higher entry barriers with plenty of competition.

Even in India, despite the dazzling publicity surrounding its sales, in terms of numbers, it still lags behind other makers. If Xiaomi manages to make a dent in these markets like it did in China, the high numbers may be justified. But it is too early to tell.

Xiaomi has rightly recognized the need to have brick and mortar presence for customer support and after sales service. In the newer markets, Xiaomi wants to build a native presence and aims to give itself a local flavour and character.

The company also plans to set up a global R&D centre in India, Vice President Hugo Barra told YourStory in September.

Related read: What India taught Xiaomi: On Flipkart, lessons and future plans with Hugo Barra, VP Global

All of which will require capital, and it’s no big surprise that Xiaomi has gone out looking for it. But is a $40 billion valuation at this stage justified is something that remains to be seen.