Can China fintech IPOs sizzle after 2018 fizzles?

The valuations on initial public offerings in Hong Kong of mainland China’s fintech companies reflected a lot of hype. The reality has been brutal, with the prices of Huifu Payments, 51 Credit and VCredit trending downward.

It’s not clear whether this will impact pricing prospects for more companies in the queue. On the one hand, analysts point to the obvious: the first batch of companies cratered in the secondary market, so of course, investors won’t accept heady IPO prices again.

On the other hand, the reason for these companies to enjoy outsized valuations was because they lacked comparables. And while the first batch may be setting some kind of benchmark, the next set of companies is also quite distinct. Investors may decide that a poor showing by the likes of Huifu won’t have bearing on a fintech with a different profile.

There’s another factor that could support strong valuations for these upcoming names: they are profitable, with most of them turning the corner last year. Analysts and investors must parse whether the happy results of 2017 mark a peak, or the start of something great.

There are circumstantial reasons to think 2017 was an exceptionally good year and not an indicator of future prospects. Combined with newly relaxed rules on Hong Kong Exchanges and Clearing designed to attract trendy tech names, it has created a fertile environment for fintech players, some of which may have made an effort to dress up their 2017 numbers in anticipation of cashing in this year.

Small fintechs in China rushed to embrace the lack of traditional requirements on reporting profits. “Many companies grabbed market share through marketing and developing sales channels in 2017,” said Michelle Li, head of research at AMTD Group in Hong Kong.

“Potential growth rates are what attract investors,” said Edward Au, co-leader of national public offerings at Deloitte in Hong Kong. Companies didn’t need to be especially big; they could be quite small, in the mainland Chinese context. “Even a 5 percent market share is a lot,” he noted.

Fintechs also took advantage of novelty. There aren’t listed comparables for many of them, particularly among that first batch. Huifu is a tiny, SME-focused payments company that competes with Alipay and Tencent Pay – how do you put a valuation on that? So these companies, and their underwriters, went IPO with steep valuations (based on aggressive price-to-sales ratios, as they weren’t profitable and therefore could not apply a price-to-earnings metric).

The result was ugly: Huifu Payment’s stock was trading at half of its June IPO price. Vcredit is trading at 2/3 of its IPO price. The Hang Sang Index has also fallen in that two-month period, but only by 10%.

Upcoming companies face other challenges that Huifu, 51 Credit and Vcredit avoided, including a Sino-U.S. trade war, China’s regulatory crackdown on P2P marketplaces, and intensifying competition in their niches.

Chang Gefei, an analyst at Guoyuan Securities, says the P2P shakeup will allow the truly good players to stand out.

But it could also hurt reputable players. Hong Kong-based mobile lending platform WeLab notes in its filing with HKEx that the regulatory tightening for P2Ps reflects harder conditions in consumer markets, which might impact business volumes, drive up defaults or make funding scarce.

We look at WeLab and three mainland-based companies now in the HKEx pipeline: Finup Finance, a peer-to-peer network; Canaan Inc., which mines crypto-currencies, and VTeam, a network for supply-chain finance.

WeLab
Hong Kong-based WeLab, a money-lending network evolving into a full financial services player (it’s applying for a virtual banking license), is in the pack, thanks to its large mainland business under the Wolaidai. Morgan Stanley and J.P. Morgan are its joint sponsors.

The company is an exception in that it has turned profitable. In 2017 it reported an operating profit of $14.9 million and total profits, net taxes, of $17.6 million. Its revenues show plenty of growth, reported up from $2.1 million in 2015 to $155.1 million in 2017, mostly from facilitating loans and credit on its platforms. The amount and number of loans originated in both Hong Kong and China show similar trends.

Set against this are risks, which are speculative: WoLaiDai’s funding depends on third parties, whose terms may not “commercially reasonable” and which could be disrupted by regulatory changes.

Finup Finance
Finup’s joint sponsors are Goldman Sachs, China Merchants Securities and Huatai Financial. The company is the fourth-largest online lender in China, with 2.6% market share, as of 2017.

In its filing with HKEx, it reports it also finally turned a profit last year, thanks to revenues from information and consulting services, rather than facilitating loans; its net profit margin (profits divided by revenues) was 11.6x. Among the risks it faces: failing to obtain a license. (The ‘risks’ section of Finup’s filing is incredibly vague.)

Canaan Inc.
Canaan Inc. is among the more intriguing companies in the queue, as a pioneer in designing chips designed specifically for mining bitcoins (the company ranks second worldwide as a fables ASIC designer of bitcoin mining machine). Its joint sponsors are Morgan Stanley, Deutsche Bank, Credit Suisse, and China Merchants Securities. The company is using the IPO proceeds to support its plans to design chips for other crypto-currencies and for uses in artificial intelligence.

Unlike others in the IPO queue, Canaan has been profitable for several years, although its growth has been spectacular: from Rmb1.5 million in 2015 to Rmb360.8 million last year. The risks in its HKEx filing focus on the outlook for bitcoin: the rate of acceptance of bitcoin or a major fork in bitcoin’s code, increasing competitiveness in mining, and whether China adopts blockchain. The other risk is how well the company can diversify into new areas.

VTeam Financial Service
This Cayman-based company’s sole sponsor is Dongxing Securities. It is creating a supply-chain financing ecosystem for small businesses in China – a crowded space. VTeam has been around since 2001, making it far more established than others in this IPO story, and 70% of domestic commercial banks and commercial factors in the People’s Republic have at some point used its services, according to an Oliver Wyman report. It now uses tech to connect SMEs to large corporate and government buyers.

Despite having been around for 17 years, the company reported a steep pickup in profits and margins from 2015 to 2017, including an eye-popping net profit margin in 2017 of 70.6%.

VTeam cites risks out of its ability to control: a change in regulation, including new licensing requirements; the termination of vital partnerships; and the inability to source adequate funding for the business via its factoring activities.