“I have heard many banks saying they will lend more to small and medium-sized enterprises. I have been hearing this for five years but how many banks are actually doing this? If the banks don’t change, we will change the banks.” So said Alibaba founder Jack Ma at a business forum back in 2008 (see WiC181), talking up his firm’s ambitions to take on China’s state-owned banking giants.
Not many took the remark too seriously at the time, seeing it as another example of Ma’s bold predictions (like his claim that Alibaba would last 102 years). In 2008 Alibaba’s online payments platform Alipay was only four years old. But 12 years later, Ma’s promise looks a lot more credible, with Alipay’s holding firm Ant Group on the verge of a mammoth initial public offering set to give it a higher valuation than ICBC, China’s largest bank.
How big is this Ant?
The world’s biggest unicorn will be selling 1.67 billion shares on Shanghai’s STAR Market and the same amount in Hong Kong.
The dual listing is expected to raise about $35 billion, making it the world’s largest ever IPO.
This is the second time that a Jack Ma company has pulled off such a feat (Alibaba’s 2014 listing in New York was the world’s biggest IPO – till last December when Saudi Arabia’s Aramco grabbed the title). And Ant’s debut also marks another rare occasion: one in which there is no role for the New York stockmarket in the listing of a tech major.
Ant might also become the world’s biggest listed financial services provider. Its Shanghai IPO was priced this week at Rmb68.8 per share, giving it a market capitalisation of Rmb2.1 trillion ($313 billion) pre-greenshoe. That compares with JPMorgan Chase’s $300 billion and ICBC’s $250 billion (as of Thursday), which are respectively the most valuable banks in the US and China. It is also set to take the crown as the most valuable A-share stock from Kweichow Moutai, which produces China’s most famous liquor. Analysts working with the investment banks that are sponsoring Ant’s IPO claim that this is just the start and that investors are yet to see the six year-old firm’s true value, with one putting a $460 billion price tag on Ant.
How did Ant grow so big?
Ant’s origins date back to Alipay, a payment service launched in 2004 – which was just a year after Alibaba had created Taobao. It was viewed initially as an ancillary product that supported sales on Ma’s new e-commerce platform. When Taobao started there wasn’t much activity on its consumer-to-consumer marketplace as buyers were worried that they wouldn’t be sent the goods they had paid for online.
The company soon realised that it needed to resolve this problem if it were to unlock the potential of China’s e-commerce market. It came up with Alipay. Operating in a way similar to a law firm in a real estate transaction, the buyer was asked to deposit the agreed amount for an online purchase in Alipay’s bank account. However, Alibaba would only transfer the money to the seller once the goods were delivered and deemed in good condition by the buyer.
This pioneering escrow arrangement reduced settlement risk and unleashed a boom in Chinese e-commerce. By 2008 Alipay’s active users exceeded 100 million and daily transaction volumes were topping Rmb450 million. But outsiders really started to grasp that Alipay was a hidden gem in the Alibaba ecosystem when a high profile spat broke out with the internet firm’s shareholders, including Yahoo, over Alipay’s ownership. The row was finally settled in 2011, largely in Jack Ma’s favour (see WiC118).
Operations-wise, Alipay reported more than a billion annual active users this August and it is one of the two apps that most Chinese citizens cannot live without (the other, of course, is Tencent’s WeChat, which claims 1.4 billion users).
And very deliberately, Ant’s chairman Eric Jing turned back to the company’s origins in digital payments in his letter to potential investors in the Ant IPO. “Solving trust issues is at the core of what we do,” he told them. “We always ask ourselves, what should we leave for the world if one day our company were no longer in business? We hope that it would be a system of trust.”
What is Ant’s core revenue source?
Initially all eyes were on the service fees generated via the transactions made through the payments platform. However, it soon became evident that Alipay’s other key advantage was that it allowed Ma’s behemoth to establish a new system for evaluating creditworthiness – one that was based on Big Data instead of bricks-and-mortar collateral. This enabled Ant to tap a vast market that traditional lenders had typically avoided – hundreds of millions of unbanked individuals and small businesses. It now offers comprehensive financial services including loans, investments and insurance.
One of the comparisons might be Amazon Lending, although, as The Economist points out, Ant offers additional services similar to those provided by the likes of “ApplePay for offline pay, PayPal for online pay, Venmo for transfers, Mastercard for credit cards, JPMorgan Chase for consumer financing, iShares for investing, with an insurance brokerage thrown in for good measure”.
Digital payments and merchant services have been Ant’s most reliable revenue generators. Yet its IPO prospectus describes the highest revenue contribution last year as another business line: the ‘Digital Finance Technology’ segment, which accounted for 56% of Ant’s Rmb120 billion in revenue. This unit oversees the provision of loans, investments and insurance services. And inside this digital finance unit, the largest single contributor is described as ‘CreditTech’. In the first six months of this year it accounted for 39.4% of Ant’s total income, more than the 35.9% attributed to payments services (i.e. Alipay) during the same period.
Ant’s CreditTech service, according to the company’s definition, “addresses the unmet credit demands of unserved and underserved consumers and small businesses in China”. Ant points out that up to 75% of Chinese over 15 years-old still lacked a credit card last year, and its payment tool’s popularity means that it has accumulated a deluge of credit data that allows it to assess credit risk in a way that traditional banks have been unable or reluctant to do.
Ant’s CreditTech business is growing rapidly, reporting an 86% rise in revenue for 2019, powered by an ever-deepening understanding of its customer base.
Ant’s Big Data expertise and AI-powered algorithms (which assess factors like a customer’s purchase history) are said to be able to identify default risks much more accurately: between 1% and 2% of its CreditTech loans sour in general. Moreover, its digital platforms allow Ant to compress lending costs so significantly that it can arrange micro-loans to the unbanked at profitable levels (in comparison, traditional banks must rely on more traditional due diligence, making it harder to lend profitably in more rural or remote areas).
That’s why Jack Ma was unable to resist the temptation of firing another salvo against SOE lenders during the Bund Forum in Shanghai last week.
“Chinese banks nowadays still operate with a ‘pawn shop’ mentality,” he said, referring to the typical request for collateral before giving out loans. “There is no systematic risk in China because there is not a system,” he also joked, referencing the extensive use of collateral cushions in state banks’ lending practices.
Ma also called for Chinese regulators to move away from their reliance on the “rules from yesterday” as a means to nurture future financial innovations. A case in point: Ant has been given a private sector banking licence but the company is still largely prevented from taking deposits. This curtails its ambitions to expand its micro-loan business more aggressively.
Is Ant’s IPO fairly priced?
Assuming a Rmb2.1 trillion market value for Ant, the company will be valued at almost 100 times its net profit last year.
In comparison, China’s biggest bank ICBC is trading at 4.8 times its 2019 earnings.
Ant’s main growth driver has been microloans – an immense market. But does it really justify a valuation so much higher than China’s banking majors? Unsurprisingly Ant itself doesn’t even want to be benchmarked against the banks. As Bloomberg reported in September, it has told investment banks that it wants their research department’s technology analysts to provide the coverage on its stock.
Warming to the theme, sell-side analysts have argued that Ant offers more than Alipay and micro-loans, pointing to the business potential in other areas such as blockchain. The same repositioning is reflected in the renaming of the company as Ant Group from Ant Financial last year, partly in preparation for next week’s stock market debut.
Of course, if Ant is valued as a tech or fintech play rather than a financial services firm it can expect to get a much higher earnings multiple. Conversely the company is also keen to play down any sense of direct competition with traditional financial services firms, identifying them instead as partners.
Its current model uses its ecosystem to identify and assess potential customers for loans but it then brings in a selection of 2,000 financial partners – mostly banks – to provide the funds for the loans, based on Ant’s vouching for the borrower’s creditworthiness.
Ant has adapted aspects of its model over time as regulations have evolved. For instance, in early 2019 the rules were changed for payments platforms like Alipay and WeChat Pay, requiring them to put all of their customer deposited funds into centralised, interest-free accounts. In the past, the payments firms were allowed to hold pre-paid sums for a short period, allowing them to earn interest by depositing customer money into bank accounts. Such was the scale of the cash transfers that the government started to see the practice as a new source of financial risk.
Those changes led Ant to re-emphasise how it saw its role: declaring that it was a technology provider for the wider banking system. But they also highlighted how Ant will need to retain the confidence of the Chinese government as its influence spreads across the broader financial sector.
Major internet firms such as Alibaba and Tencent continue to be regarded as beneficial to the wider economy, not just in improving efficiency and transparency, but also in compelling slower-moving SOEs to change their own business practices for the better. For instance, Sesame Credit, which tracks individual credit scores according to behaviour on Alibaba’s various platforms, has become a key plank in Beijing’s rollout of a social credit rating system. Ant is also one of the companies participating in the government’s trials for its new digital currency (see WiC502).
Yet Ant’s business activities remain exposed to changes in China’s regulatory regime, something which is made plain in the risk factors listed in the prospectus. For evidence of the (sometimes) existential danger just ask the executives who ran China’s P2P lending businesses, which were decimated by a complete government clampdown over an extended period after 2016.
How has the IPO been received?
Ant’s debut is the most anticipated IPO in Hong Kong in recent memory. The pricing strategy has also been designed to be retail investor friendly in its 50 shares per lot, so an individual needs to spend just HK$4,040 ($517) to take part in the offering. The retail tranche of the Ant IPO was already 54 times oversubscribed by the first day of the offering this week.
According to Hong Kong Economic Times, many Hongkongers new to stock trading have opened brokerage accounts to apply for shares. More than a million people in the city (about a seventh of its population) are likely to subscribe (another record) and there are reports that Ant will try to allocate each investor with at least one lot. The previous subscription record in Hong Kong was set by ICBC in 2006 when more than 970,000 investors took part in its share sale.
Interest in the Ant IPO is expected to freeze up more than HK$1 trillion in liquidity, shattering another record (the previous one was held by Nongfu Spring’s IPO, which froze up HK$678 billion in funding), until trading starts on November 5.
Ant’s shares are priced at HK$80 each in Hong Kong. That is around the same value that its A-shares will start trading at in Shanghai after factoring in currency exchange rates. Yet given that retail investors in the A-share market are typically more enthusiastic about IPOs and tech counters, Ant’s A-shares are expected to surge to a premium over their Hong Kong equivalents. SMIC offers a precedent for that view: China’s leading semiconductor maker was trading this week at Rmb60 in Shanghai’s STAR Market compared with HK$21.55 in Hong Kong (i.e. almost triple the value).
Ant will be making its debut just days ahead of Alibaba’s landmark Singles’ Day sales extravaganza on November 11. That looks like perfect timing to drum up interest in Ant while also showcasing the group’s role in reinforcing the government’s ‘internal circulation’ economic strategy (see WiC508) to boost consumer demand.
However, the timing of the IPO has left it open to a major uncertainty: the outcome of the US presidential election on November 3. The impact could be magnified because of the huge amounts of liquidity tied up in Shanghai and Hong Kong this week by the IPO, which could create wilder swings should something unexpected happen in the presidential vote.
A plunge of about 7.5% in the Dow Jones between Monday and Wednesday this week indicated growing concerns (partly over an uptick in US Covid-19 cases) but may also signal that investors on Wall Street are bracing for potential turbulence on November 4, especially if the election result is unclear or contested. Ant’s shares will start trading the following day. Enthusiasm for the stock notwithstanding, even the mighty Ant may find that a major headwind if markets around the world are plunging.
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