China's fintech insurgents march towards IPO

Disruptive startups have China’s state-owned banks on the back foot. Now they are seeking capital to build on their initial success.

When China Premier Li Keqiang visited internet bank WeBank in Qianhai, Shenzhen, in January and granted a Rmb35,000 ($5,549) loan to a truck driver at the push of a button, it signaled political support at the very top for the country’s burgeoning fintech sector.

WeBank is looking to raise $1 billion in capital, valuing the company at $5 billion, according to venture capital investors. A WeBank spokeswoman declined to comment.

Other relative newcomers such as Ant Financial, Lufax and Zhong An have made great strides in recent years to attract new customers and capital at the expense of the relatively dowdy, bricks-and-mortar banking establishment. 

Zhong An, for example, is China’s first online insurance provider. It attracted more than 150 million clients in its first 14 months and market sources say will likely raise more capital from an IPO in the coming years.

Other success stories include Yuebao, which has grown into the country’s biggest money market fund in terms of assets under management, and Alipay, China’s version of PayPal, which already handles half of all China’s online payments, according to Beijing-based internet consultant iResearch. Both Alipay and Yuebao are owned by Ant Financial.

As mobile technology supplants other online conduits, that force for change is reinforced.

China’s middle class – now bigger that the US’s at 109 million, according to Credit Suisse – are increasingly using the platforms of these financial insurgents to make payments on their smart phones, manage their wealth, transact peer-to-peer lending, and for crowd funding.

“These cashless payments systems continue to substitute money and the mobile phone has enhanced the speed of change,” said Stephen Pagliuca, managing director at Boston-headquartered private equity firm Bain Capital, which bought a minority stake in fintech firm China PnR in June.

The relentless march of fintech inevitably brings with it a growing hunger for capital – something private investors appear only too willing to satisfy. 

Many of the largest Chinese fintech firms have already tapped the deep pockets of local investors via private placements for billions of dollars, a mode of funding highly adapted to privately run, unprofitable, and fast-growing firms.

“Private funding is extremely efficient and still widely available for us,” Gregory Gibb, chairman of peer-to-peer platform Lufax, told FinanceAsia.

Lufax has started talking to potential investors about a second round of funding, seeking to raise the valuation of about $10 billion set by its Series A financing, according to people familiar with the matter.

Lufax, which launched in 2012, raised Rmb3 billion ($483 million) by selling stock in a March private placement. Investors included Zheng He Capital Management, private-equity firm CDH Investments, Morgan Stanley and mainland investment bank China International Capital Corp, according to people familiar with the matter. 

Going Public
A handful of fintech firms are now also gearing up for initial public offerings such as Ant Financial, as well as Yuebao and Lufax. If valuations hold up it could create the biggest fintech companies in the world by market capitalisation.

Gibb, a former McKinsey Partner, said listing Lufax is a long-term ambition of Chinese financial conglomerate Ping An, which owns 49.99% of the firm.

“Lufax is open to any listing venue depending on the market conditions,” he said.

Peer-to-peer lender, state-owned card issuer and clearing house China UnionPay, plus China Rapid Finance, the country’s largest consumer lending marketplace, are also likely IPO candidates in the coming years, according to various financial sources.

“These companies are growing fast, they obviously need funding, and an IPO is one of the tools in the toolbox, as well as private placements and fixed income financing,” said Marie-Soazic Geffroy Dernoncourt, head of Morgan Stanley’s Asia financial institutions group, who has advised on many of the largest fintech deals in Asia to date.

Potential investors and advisers are excited about the revenue growth on offer but are grappling with myriad business models, worried about the impact of regulation on the sector and how to value such disruptive, usually unprofitable upstarts.

One senior investment banker in Hong Kong told FinanceAsia  that recent fintech fund raisings had been priced to perfection with many competing business models all valued as winners.

Some investors are safeguarding their deals by bringing in expertise from overseas.

“The key to China is to take the approaches and experience from elsewhere and adapt them to the local market – no question fintech is a big, big growth area,” said Bain’s Pagliuca in an interview with FinanceAsia.

Bain has invested in other fintech companies outside of China such as WorldPay, formerly the credit card processing division of Royal Bank of Scotland, Denmark’s Nets and Italy’s ICBPI.

From the Bay Area to Beijing, the finance-technology hybrid model is captivating global capital. San Francisco-based Lending Club’s IPO, for example, raised a tidy $1 billion in December last year.

Japan’s SoftBank said it would invest $1 billion in the Korean ecommerce startup Coupang on June 3. The deal valued Coupang at around $5 billion according to a person familiar with the matter, marking it as one of Asia’s highly prized unicorns and the only one in Korea.

But China is where the biggest opportunity will be for investors going forward, say consultants, financial services providers, and entrepreneurs contacted by FinanceAsia.

P2P lending volumes in China, for instance, hit $40 billion in 2014 versus $5 billion in the United States. The market is likely to swell to $550 billion by 2019, according to Wandaizhijia and consultancy Oliver Wyman.

Former Lending Club employee Soul Htite has gone on to found Dianrong, a peer-to-peer lender in China, raising $207 million from a consortium of investors including Standard Chartered in August.
China is turning out to be a hotbed for fintech, given a huge online population of 700 million netizens fascinated with all-things digital.

Smartphone penetration is roughly similar in the US and China at 56.4% and 46.9%, respectively. But at 90%, China’s citizens score highest among a range of nationalities in terms of their willingness to share personal data in exchange for lower prices, according to a survey jointly conducted by consultancy BCG and Morgan Stanley in 2014.

China’s government is encouraging fintech to flourish partly because it complements the policies of premier Li’s administration, which is seeking to defend economic growth by funnelling more credit to small- and medium-sized firms, which are relatively underserved by the country’s large banks.

In a 2013 interview with People’s Daily, Alibaba founder Jack Ma noted the opportunity: “China’s financial industry, especially the banking industry, only serves 20% of clients.”

SMEs in China represent about 60% of China’s GDP but less than 30% (23.2% precisely) of loan balances, according to a 2014 report by China Banking Regulatory Commission, the industry watchdog. But with fintech things are now changing.

Mobile and online lender China Rapid Finance’s founder Zane Wang Zhengyu estimated China’s untapped market at 500 million creditworthy people. To fund the pursuit of these potential clients the firm closed a $35 million series C round of financing in July, valuing the company at $1 billion, it said in a statement. The financing was led by private equity firm Broadline Capital and UBS was a placement agent of the transaction.

As a result, China’s big-four banks – Bank of China, China Construction Bank, Industrial and Commercial Bank of China, and Agricultural Bank of China – are beginning to feel the pressure to lend more actively to the small but vibrant private companies as they seek to raise fund through the innovative fintech companies that offer market-friendly loans to them. Last year they had a 68% market share of primary banking relationships in China’s largest cities, said a McKinsey report in January. In 2011 it was 75%.

To be sure, the use of technology in finance is not new; globally banks have long run research and development teams, which have tended to focus on making incremental improvements to back-office and middle-office processes.

What is new and more disruptive currently is that nimble start-ups are increasingly seizing some of the initiative from incumbents by pursing recent software innovations such as apps that larger, more lumbering rivals have ignored. They are also adapting faster to consumers’ changing behaviour.

“The rise in fintech companies in China is due to the country’s inefficient financial system,” Fan Bao told FinanceAsia.

Bao is the founder of investment banking firm China Renaissance, which invests in and advises some of the country’s largest technology companies.

As a result, talent is draining away from many of China’s major financial institutions and heading to these entrepreneurial start-ups.

Yang Jun, for one, joined Lufax this year as its chief risk officer after spending more than 20 years with mid-sized lender Shanghai Pudong Development Bank.

Meanwhile, WeBank, which was established in July 2014 by Tencent, raided Ping An Bank for its secretary to the board of directors Li Nanqing and chief risk officer Wang Shijun.

Risks and Rules
However, the fintech sector’s rise to prominence has also not been untrammelled and the risks for potential investors in equity offerings remain high.

Some of China’s big financial institutions have dusted off their own IT credentials and are fighting back either through licencing-in or acquiring technology developed by start-ups, or by incubating their own fintech innovation. Their reach should not be underestimated.

ICBC, China’s largest lender by assets, launched its online lending platform Yi Loan in 2013, offering loans to individuals and small business owners. China Construction Bank and China Merchants Bank followed online in January.

Regulators have also beefed-up protection for fintech users after several cases of fraud and a surge in bankruptcies.

Fanya Metals Exchange, an online platform that traded rare metals, said in April that it had a liquidity problem. Clients were consequently unable to access the Rmb40 billion in their accounts, leading to protests outside the offices of the China Securities Regulatory Commission in Beijing on September 21, according to state-run Beijing News.

So on July 18 the People’s Bank of China, in conjunction with the nation’s banking, securities and insurance regulators, issued stricter fintech guidelines. These stipulated that client funds be held at recognised banks and that traditional bank accounts be used to channel large payments.
In addition, the disclosure requirements for online lending and crowdfunding platforms were increased.

“Mobile device payments and the ubiquity of the internet mean electronic payments are growing rapidly. If you translate that into China, where there aren’t as many credit cards, you can see it will go grow in the same direction,” said Bain’s Pagliuca. “The issue is understanding the regulations as China will want to maintain control over money flows.”

Potential investors need to identify and back the industry survivors: those with a strong brand, a scalable platform, as well as credit expertise in lending and underwriting finesse in insurance.

“A lot of small fintech companies have a short history in credit management and do not understand the liquidity risk created by running businesses with duration mismatches,” said Gibb, whose company Lufax has benefited from the credit expertise and platform of its parent Ping An. “In fact, by nature, capital-light P2P companies should not create liquidity risk. But many do and that’s one of the main problems in China.”

Another company with strong backers is Zhong An, which was co-founded by Jack Ma, Pony Ma, and Ping An’s chairman Peter Ma. It successfully raised $931 million in its first round of private fundraising in June this year, valuing the company at $8 billion, according to people familiar with the transaction.

The changes in regulation mean the industry is likely to see weaker players going to the wall and early movers with well-established protocols building their market shares.

“It has become harder for smaller players to survive as regulations have become more complex. We expect consolidation in the industry,” said Morgan Stanley’s Dernoncourt.

Click on Page 2 for how to value these fast-growing firms heading towards IPO and information on where Ant Financial may list

Ant On The March
Among the IPO frontrunners is Alibaba affiliate Ant Financial, which raised an undisclosed amount in a private placement in June, valuing the company at $45 billion, according to a person familiar with the matter.

The implied value of Ant Financial, which was spun off from Alibaba in 2011, is eight times bigger than Lending Club’s $5.6 billion market cap as of November.

Ant Financial, known formally as Zhejiang Ant Small & Micro Financial, sold stakes to large state-backed investors including China Development Bank and the China’s National Social Security Fund, according to a company filing in June.

In addition, China’s National Social Security Fund, the country’s pension fund, acquired about a 5% stake in Ant Financial and became a strategic shareholder, according to Wang Zhongmin, a vice-chairman of the fund.

“We would like to make more strategic investments [in fintech] in the future,” said Wang at an industry conference in June.

Under the hood Ant Financial owns profitable assets including Alipay, which has become synonymous with online shopping in China. Payment systems still involve banks but are customer facing.

It also owns Yuebao, the country’s biggest money market fund in terms of assets under management, which was launched in June 2013. The number of investors in Yuebao jumped to 226 million in  June,  up from 185 million in the end of 2014, representing a sixth of China’s population, according to its interim results.

Shen Guojun, the former chief executive of Alibaba’s logistic unit Cainiao, who remains close to Ma, said in September that the listing of Ant Financial should take place next year if everything runs as planned. That follows comments in November 2014 by Alibaba’s founder, in which he offered no timetable but said Ant Financial would eventually be listed on the domestic A-share market.

A spokeswoman for China International Capital Corporation, which has been hired to advise on the prospective listing of Ant Financial, declined to comment when approached by FinanceAsia for an update.

Valuing Fintech
Often fintech companies prefer to stay private in order to experiment with business models without the pressure of hitting quarterly earnings targets.

Share placements also tend to suit smaller companies, as was the case with P2P lender Dianrong and the $207 million it raised in August.

These entrepreneurs are adhering to the classic technology model: invest for top-line growth, drive revenues, drive users, and then worry about profitability. That makes some potential investors and advisers worry that the hype around fintech in China is vapour in an expanding tech bubble.

“I think the valuation of lots of fintech companies in China is pretty peaky and dangerous,” China Renaissance’s Bao said. “The problem is China has too much capital without enough formal investment channels, leading part of the money to fund fintech companies.”

For now private placements are more suitable for many of China’s young fintech firms and investors seem to understand that building a business takes time.

Investors in Zhong An’s $931 million placement included Morgan Stanley, CICC, CDH Investments, Keywise Capital Management, and SAIF Partners, sources said.

“If a company is unprofitable but driving a huge business – that may be the time to do a private placement,” said Morgan Stanley’s Crawford Jamieson, co-head of global capital markets, Asia Pacific. “The importance of private placements as an asset class for investors has definitively grown,”

For entrepreneurs, their financial advisers, and investors the challenge is how to value companies that are young, have few peers, and may be selling a business plan that hasn’t fully been rolled out yet in a changing regulatory environment.

Investors often tend to rely on analyses of discounted cash flows to evaluate these businesses.
Private placements are usually sold by investment bankers rather than equity sales teams and analysts at brokers.

Entrepreneurs and bankers usually judge the right time to go public after a private placement at around two to three years, say financial advisers.

Some tip Lufax as China’s first fintech IPO. In Ping An’s interim results briefing in August, chief financial officer Jason Yao cited the potential benefits to the insurance group of listing Lufax . “Ping An is actively considering the plan to boost the company’s value,” Yao said.

Total transaction volume on the Lufax platform rose more than 10 times year-on-year to Rmb512.2 billion in the first half of 2015, Ping An’s interim report said.

Then the company has to decide where to list its shares.

A case in point is China’s largest crowdsourcing site Zhubajie, which raised Rmb2.6 billion in a round of Series C funding in June, valuing the company at Rmb10 billion, according to its chief executive officer Zhu Mingyue.

Zhubajie originally sought a New York listing in 2011 but has put its listing plans on hold for a domestic offering, Zhu said in an interview with mainland media.

A Beijing-based banker told FinanceAsia that Ant Financial may list on Shanghai’s planned Strategic Emerging Industries Board, which aims to bridge the funding gap between the main board and Shenzhen’s ChiNext.

“The launch date of the new listing venue in Shanghai should be in the first half of 2016,” said the banker, who declined to be named because the discussion is private.

The new  venue will offer an exit for private equity investors and may attract US-listed Chinese companies seeking to go private and then relist in China.

If Ant Financial does kick off listings in this new Chinese government-owned venue then premier Li would score a hat trick by developing China’s capital markets, keeping entrepreneurial companies in China, and developing fintech.

Additional reporting by Julie Zhu

This article has been corrected to show that The Postal Savings Bank of China did not participate in Ant Financial's series A funding but the lender is a strategic partner with Alibaba’s financial affiliate.

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