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Lufax IPO a bright spot among battered digital lender stocks

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Lufax IPO a bright spot among battered digital lender stocks

Lufax Holding Ltd. may have had a rocky public debut, but the Chinese company is unlikely to join the growing list of underperforming digital lending stocks in the U.S. The company's subsequent recovery and premium valuation compared to Chinese peers reflect its strong fundamentals and close ties with a large Chinese financial conglomerate: Ping An Insurance (Group) Co. of China Ltd.

The Chinese fintech began trading on the NYSE on Oct. 30 at $11.75, 14% below its offering price of $13.50, amid the underperformance of technology stocks in the U.S. The drag on Lufax's listing could also be a reflection of investor skepticism about digital lenders as most large online lenders are trading below their initial public offering prices. Lufax has since bucked the trend and is now hovering above its offering price.

Lufax operates an asset-light lending marketplace, generating revenue by matching institutional investors with borrowers, who are primarily small business owners. Originally a peer-to-peer lender, Lufax pivoted toward institutional funding in 2020 as the Chinese government clamped down on the P2P lending sector. The company also runs a wealth management unit, distributing 8,600 products from 429 financial institution partners.

Between 2017 and 2019, Lufax's revenue grew at a compound annual growth rate of 31.1% to 47.8 billion yuan. In 2019, fees from credit facilitation services formed 82.2% of its revenue, while wealth management transaction and service fees contributed 5.4%.

The imperfect peers

With the backing of Ping An, Lufax enjoys many competitive advantages, including user acquisition and access to proprietary data and technology.

As such, we have opted to compare Lufax against 360 DigiTech Inc. and Yirendai Ltd. Both firms are U.S.-listed Chinese digital lenders sourcing users from affiliated internet companies in China.

Before Lufax's listing, 360 DigiTech was the largest Chinese online lender listed in the U.S. by market capitalization and is perhaps the closest comparison to Lufax. It is affiliated with 360 Group, a large Chinese internet company that also provides the lender with technology support.

Yirendai is owned by CreditEase Holdings (Cayman) Ltd., a Chinese fintech conglomerate, and bears a similar revenue structure to Lufax. Yirendai derived 75% of its top line from digital lending with the remaining 25% from wealth management services in 2019.

Similarities aside, the scale of both lenders by loan originations and revenue pales in comparison to Lufax.

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Lufax sought a higher valuation than its peers. Its implied market capitalization based on its offering price was roughly 4.3x its projected 2020 revenue and 10.9x its pretax profit, per our estimates. In comparison, 360 DigiTech's market value at the end of Oct. 30 reflected a multiple of 1.0x its 2020 estimated revenue and 5.7x its pretax profit, while Yirendai registered a multiple of 0.4x and 4.1x respectively.

Lufax's premium valuation may be justified given its superior economics. Lufax generates more value from its loans than 360 DigiTech and its expenses per unit loan are substantially lower than Yirendai's. Of the three digital lenders, Lufax was the most profitable in 2019.

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The Ping An advantage

Lufax's affiliation with Ping An has helped enhance its competitive position in many ways.

Through the Ping An ecosystem, Lufax has access to 210 million customers and a key user acquisition channel for both its digital lending and wealth management business. Borrowers from Ping An accounted for 36.9% of loans facilitated by Lufax in the first half of this year and investors acquired through Ping An contributed to 45% of total client assets at the end of June.

Users sourced from Ping An are also likely to be more profitable than those acquired through other channels. Borrowers from Ping An tend to take on larger loans and are generally more creditworthy, and investors acquired from the Ping An ecosystem appear to be more affluent and invest more with the platform. On average, investors from Ping An have 32,228 yuan with the platform, whereas clients acquired through online marketing and member referrals hold assets of 30,387 yuan and 12,658 yuan respectively.

Financing guarantee support from Ping An Property & Casualty Insurance Co. Of China Ltd. enables Lufax to maintain a scalable capital-light business model as it pivots toward institutional funding. Like Lufax, many digital lenders in China have been pursuing institutional capital to navigate regulatory restrictions in the P2P lending sector. To attract institutional financing, online lenders have been offering credit guarantee services, but this often comes at the expense of their balance sheets. For Lufax, Ping An P&C guarantees 91.2% of its loans with the Chinese digital lender bearing credit risk for just 2.8% of its outstanding loans at the end of June. In contrast, 360 DigiTech retains risk for 76% of its loan balance even as it attempts to move toward a capital-light model.

Lufax's relationship with Ping An has also given it an edge in access to data and technology, both of which are core attributes of a digital lender. By leveraging analytics and insights from Ping An, Lufax has managed to develop a credit risk model that can assess borrowers' ability and willingness to repay loans of larger sizes, a key factor that sets Lufax apart from other Chinese online lenders. Loans facilitated by Lufax average 146,513 yuan for unsecured loans and 422,398 yuan for secured loans. Most other digital lenders originate loans of below 10,000 yuan.

But Lufax's reliance on the Ping An ecosystem may be a double-edged sword. While it has provided the lender with many competitive advantages, it also raises the question if Lufax's growth can be sustained without the support of Ping An Group. Post-IPO, Ping An retains a 38.9% stake in Lufax, which may be reassuring to investors for now.

Potential headwinds

Among small business owners, Lufax's primary customer segment, early repayment is common. Loans are largely used to supplement the borrowers' working capital and they typically apply for the maximum loan tenor to reduce repayment pressure but tend to repay loans early once their short-term liquidity needs are met.

This may affect Lufax's loan income substantially due to its revenue structure. While 360 DigiTech and Yirendai register more upfront revenue from loan facilitation services, Lufax derives the bulk of its loan revenue from post-origination services. Although this setup may provide more recurring revenue for Lufax under normal circumstances, early repayment will impact Lufax's loan income to a larger extent as the period over which post origination services are rendered shortens. By Lufax's estimates, early repayment by a month from its projected effective loan tenor will cost the lender 3.5 billion yuan, roughly 8.7% of the credit facilitation service fees expected at the end of June.

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As a countermeasure, Lufax began charging early repayment fees in November 2018 and has seen a modest improvement in borrowers' behavior, though it is unclear if the effect on borrowers' behavior is sustainable. Since September 2020, Lufax has also started to front-load its fees by charging service fees as a proportion of outstanding loan balance instead of a fixed monthly figure based on the loan principal. This will likely increase revenue per loan even if early repayment continues to be a persistent issue.

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Over the last three years, Lufax's borrower acquisition costs have been rising. This was largely due to a shift in user acquisition efforts from online and telemarketing campaigns toward a direct sales network and the use of channel partners to bring in higher-quality borrowers. But borrower acquisition costs may stabilize over the longer term as Lufax's sales agents, its largest user acquisition channel, have been showing improving productivity. Agents are equipped with an artificial intelligence-driven mobile application that helps to optimize their efforts by identifying regions with higher sales potential. Consequently, new loans sourced per agent on an annual basis rose from 2.9 million yuan in 2017 to 4.0 million yuan in 2019.

Lufax's loan take rate — defined as income generated from facilitating credit, including service fees and interest income, as a percentage of the average outstanding loan balance — has been declining over the years due to its growing shift toward an asset-light business model. While less capital is at stake now, the change in the funding mix has led to a drop in net interest income and guarantee income.

Regulatory changes pose another threat to Lufax's margins. China's Supreme Court revised the interest rate ceiling in August, limiting annualized interest to 4x the one-year loan prime rate. As of October, the one-year LPR was 3.85%, which means that the annual interest rate would be capped at 15.4%, down from the former limit of between 24% and 36%. Lufax has since trimmed its annual percentage rate for loans facilitated from September onwards and may be compelled to reduce rates further should there be future declines in the one-year LPR.

As Lufax does not engage in any joint lending or loan facilitation partnerships with funding partners through its microloan subsidiaries, it is largely unaffected by the new draft rules on online microlending that may have contributed to Ant's stalled IPO. But the lender cautions that the regulatory environment is still developing and a re-evaluation of its position may be required in the future.

Investors unimpressed with digital lenders in the U.S.

Most of the large digital lenders by market capitalization on major U.S. stock exchanges have been trading below IPO prices, and at least four of them have seen their value plunge by over 50% since their listing.

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But if the past track record of Ping An-backed IPOs is any indication, a bumpy listing may merely be a slight blip. In 2019, Ping An-backed OneConnect Financial Technology Co. Ltd. had downsized its IPO offering and trimmed its target price to below its indicative range, valuing the firm at less than half its last private valuation of $7.4 billion. Its stock price has since doubled, propelling its market capitalization to $7.9 billion at the end of October.

Overall, Lufax's growth prospects look promising and should be able to sustain a positive reaction from the public market. By focusing on larger-sized loans, Lufax has built a moat that limits direct competition. It has also demonstrated business resilience by maintaining steady growth in its loan book amid funding mix changes and disruptions from COVID-19. Between December 2017 and June 2020, Lufax's loan balance grew 80% to 519.4 billion yuan. At June's end, the lender had only utilized 49% of its credit facility from banking partners and 31% from trust companies, which should leave it with plenty of room to grow originations when demand for credit improves with a gradual economic recovery.

As of Nov. 18, US$1 was equivalent to 6.56 Chinese yuan.

This article was published by S&P Global Market Intelligence and not by S&P Global Ratings, which is a separately managed division of S&P Global.

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