Kakao Bank, the first purely digital bank to launch in Korea, is headed for a domestic listing that is expected to start trading on August 5. Independent analysts at Smartkarma aren’t convinced by the heady valuation being attached to it: they like what Kakao Bank has done, but they note that Korea’s incumbent banks are now scrambling to figure out how to compete against it.
First, the IPO. Book-building for institutional investors begins on July 20.
Kakao Bank is offering 65.45 million shares at W33,000 to W39,000 per share, which gives it a deal size of $1.9 billion to $2.3 billion, giving it an expected market cap of up to W18.6 trillion (about $16 billion). At the high end, this would make Kakao Bank the 22nd largest stock on the broad KOSPI market index.
The three lead underwriters – KB Securities, Credit Suisse, and Citi Global Markets – relied on US and Brazilian tech companies as comparables, and then derived a hefty price-to-book ratio of 7.2x.
Premiums for profits
Such a high P/B is unusual. Ratios for Korea’s four major financial holding companies range around only 0.5x. The valuation suggests a premium of up to 4.3x versus KB Financial, says analyst Sanghyun Park of Clepsydra Capital, writing on Smartkarma.
A $16 billion market cap would make Kakao Bank’s stock worth that of the top four incumbents combined.
Kakao Bank has an impressive track record as a consistently profitable digital bank. It was launched in 2016 by local messaging-app company Kakao, a fast-rising conglomerate whose Kakao Talk created enough traction to then launch mobile wallets, gaming, and then a virtual bank. It’s been profitable since 2018.
Analysts are generally bullish about Kakao Bank.
Brian Freitas, an analyst on Smartkarma’s platform, says the stock has a “high probability” of inclusion in the blue-chip KOSPI 200 Index and a “moderate” chance of getting fast entry to the FTSE All-World Index. These will attract valuable passive flows. He is doubtful, however, on Kakao Bank getting fast-tracked to MSCI’s global index.
Douglas Kim, another analyst, says Kakao can justify its premium because of its lean, asset-light operating model, its low-cost and effective open-source operating system, a super-slick loan approval process, and the fact that it has been generating profits since 2018. This “is a testatment that the company has already gained significant economies of scale”, he said.
Sanghyun Park adds that unlike other digital banks, Kakao Bank is based on a market-dominant mobile platform.
Another arm of the conglomerate, Kakao Pay, is also now slated to IPO. (Kakao Pay is loss-making.) Kakao Corp. may also list affiliated gaming and lifestyle companies in 2022.
Heightened headwinds
Nonetheless, analysts are not convinced by the degree to which the underwriters are asserting a premium against incumbent banks.
The punchy valuation assumes that Kakao Bank is on a very different growth trajectory compared to incumbents.
Park says the premium is based on iffy comparisons. He says WeBank (Tencent), MYbank (Alibaba), Seven Bank (from Japan) and Rakuten Bank, as well as UK-based digital banks, were not included in the bankers’ analysis. (To be fair, of these, only Seven Bank is listed.)
The peer group is instead Rocket Companies (retail tech from the US with a digital mortgage business), Pagseguro Digital (a Brazilian fintech), Sweden’s Nordnet, and TCS Group, a Russian digital bank. Park says these are inaccurate and perhaps overly bullish comps.
Another Smartkarma analyst, Douglas Kim, says he is positive on the IPO but notes headwinds that suggests caution. While Kakao Bank has performed brilliantly at consumer lending, it has yet to prove it can compete in the more lucrative mortgage market. That’s a future unknown. Its current challenge is slowing growth. From 2018 to early 2021, it doubled deposit market share to about 2.3 percent, and loans to 9.1 percent. But of late, arch-rival digital bank K-Bank has been adding more new customers, particularly among young people, who are drawn to its connection to a local cryptocurrency exchange.
The biggest challenge to Kakao Bank’s strong premium is that it faces new competition. So far its only digital rival has been K-Bank (a unit of Korea Telecom). A third digital bank, Toss, has recently won a license. There is a good chance regulators will authorize two more this year.
Incumbents iterate
This leads us to our second theme: Korea’s big incumbent banks are fighting back. Kakao Bank and K-Bank have enjoyed the digital banking field to themselves over the past five years, and that luxury is coming to an end.
Six banks have already told their regulator, the Financial Services Commission, that they plan to launch digital-only extensions (including KB Financial, Shinhan Financial, Hana Financial, BNK Financial, and JB Financial). Other big financial groups may follow.
Kim outlines several plans in the works by incumbents to develop platforms to attract or retain consumers, and generate data off their non-banking activities. These include a food delivery app that Shinhan Bank is cooking, NH Bank’s blooming plans for a flower delivery service, and Woori Bank’s packaging a parcel delivery business.
“It appears that many financial companies in Korea have a lot of data related to consumers’ wealth formation but not enough information about their consumption patterns,” Kim wrote.
If any Korean incumbent is able to transform itself, then Kakao Bank’s mid-term prospects look weaker, and its huge premium difficult to justify. But no one knows whether incumbent banks can actually run platforms well. They have a steep learning curve and many internal barriers. There is no independent digital bank in Korea owned by a financial institution, so the launch of purely digital businesses is also a gamble for incumbents.
The fiercest battle may be in mortgages. Kakao Bank needs to grow into this segment if it’s to cement its position as a leading consumer bank. Its digital rival K-Bank has already started offering mortgages from 2020, and as of June 2021 had sold W700 billion of product. Woori Bank has just launched a digital service for remote sales of home loans – no branch visit required.
We won’t really know how successfully Kakao Bank transitions to a new, more competitive environment for at least another year or two. We do know it’s a good business, in part because it’s awakened traditional banks to the opportunities and threats of the digital platform. Is it 4.3x-KB-Financial-good? That’s the question facing fund managers.
