Please note, this report was first published and sent to the DeanVest newsletter subscribers on 10/01/2021 — For more research reports or to subscribe to our newsletter please visit www.deanvest.net
QFIN — 360DigiTech
Buy up to price: $13
Recommended platform — Interactive brokers
https://ibkr.com/referral/dean417
Holding period — 12 to 24 months
DeanVest Price target — $20+
What they do
360DigiTech is a Chinese Fintech company. It uses it’s platform to connect consumers with financial institutions and offer targeted financial products. It also offers standardized risk management service via SaaS modules to institutional clients.
360 DigiTech’s core product is an affordable, unsecured, digital line of credit which borrowers typically utilize for consumption spending and often as a supplement to credit card debt (similar to AFTERPAY). To apply, potential borrowers complete a simple online application and, for approximately 95% of recent credit applications, a fully automated credit decision is rendered. Approved borrowers are provided access to funds typically within five minutes and may select the loan structure best suited to their consumption needs.
The company has developed a proprietary technology platform supporting the full transaction lifecycle from credit application through settlement. The platform has a simple and agile credit decision process which allows risk management, in particular around Fraud identification and prevention. The company employs a robust and highly automated identity authentication process based on facial recognition to filter fraudulent credit applications. Further, the Company’s advanced analytical capabilities help translate data into actionable insights, where it has found statistical significance leveraging behavioural and social data sets to assess a potential borrower’s ability and willingness to repay a loan.
What we like
The company at current market cap of just under $2 billion USD fits within our definition of small cap and represents plenty of growth runway. In Aug 2020, 360 Group, which is the holding company associated to 360 Finance successfully acquired 30% Stake in Kincheng Bank of Tianjin. Post-acquisition, 360 Group will become the largest shareholder of the bank, and Kincheng Bank will become the third Chinese private bank to be backed by an internet giant. This is significant because, the acquisition of Kincheng Bank provides 360 DigiTech access to banking licences in China, which are difficult to attain.
The partnership will allow 360DigiTech to achieve operating leverage through lower funding costs and help to increase its addressable market from 3.5 Trillion to over 15 Trillion, which is a 329% growth, as illustrated below:
Furthermore, this will allow 360DigiTech to compete with the likes of Alibaba backed Ant Financial and Tencent backed Webank. Both Webank and Ant Financial are considered large cap stocks and have a Mcap of $21 and $300 Billion respectively.
The opportunity
360 Digitech’s past revenue has been growing over 65% per annum and we expect this trend to continue. Analyst forecast annual revenue growth is tipped at 9.3% with forecasted annual earnings growth of 15.5% (according to Stock Rover). However, this does not adequately take in to account the possible market share growth due to greater access to new addressable markets, through the group’s newly established synergies (via Kincheng bank). Furthermore, we believe the earnings growth could possibly be more significant due to the companies operating leverage.
Revenue growth
This expected growth is further illustrated by Zacks recently placing QFIN in its Rank #1 (Strong Buy), and the consensus estimate for 360 Digitech’s current year earnings has risen 19% over the last 60 days.
The company’s Gross margin is in excess of 80%, and it’s 9 month trailing Operating margin is 22% which is down from last year’s annual operating margin of 32% however, we believe slowdown is temporary and Q4 earnings could be strong enough to close some of the gap. Furthermore, with the recent acquisition of Kincheng Bank, we believe 360 Digitech could possibly achieve greater operating and net margins in the future. At current stock price of $12.97, the forward PE ratio is sitting at 3.6. In contrast, the PE ratio for 3600DigiTech in July 2020 was over 7. Reaching those highs again represents a possible med-term growth opportunity in excess of 90%.
The team
A company is only as good as the people behind it. We believe the team at 360 Digitech has the experience and incentives to drive its growth plans for the foreseeable future. Haisheng Wu was appointed CEO and Director of 360 DigiTech in August 2019. However, Wu was the president and co-founder of 360 DigiTech since its inception. Before working on the establishment of the Company’s business, Mr. Wu worked as a product director at 360 Group start page department from March 2011, in charge of 360 Start Page, 360kan and 360 Mobile Browser. Prior to that, Mr. Wu worked with the user product department of Baidu Inc. (NASDAQ: BIDU) as a product manager, leading the management of Baidu Space, Baidu Map and Baidu LBS from June 2008.
Hongyi Zhou is a Chinese Billionaire Entrepreneur, the Chairman of the board of Qihoo 360 Technology Co. Ltd. and the successor of its business, 360 Group. Prior to founding Qihoo 360 Technology Co. (360 Group), Ltd., Mr. Zhou was a partner at IDG Ventures Capital since September 2005, a global network of venture capital funds, where he assisted small to medium-sized software companies in sourcing funding to support their growth. Mr. Zhou was the chief executive officer of Yahoo! China from January 2004 to August 2005. Of note, QIHU (360 Group) was delisted from NASDAQ and taken private in 2015. The shareholders at the time were compensated a premium for their shares valuing the company over 9 Billion.
Ownership
Having insiders and/or managers owning the company alongside retail shareholders is always a positive sign — think Apple, Amazon, Facebook etc. It is important to note, that the Co-founder and Chairman of 360 DigiTech has ownership interest of 13.97%. This includes the recent purchase of over 21 million shares by Hongyi Zhou on 18 Dec 2020. This represents a 2.46% change in ownership interest. This further strengthens our conviction on the project, as he has substantial vested interest to see the project through and ensure its success. Furthermore, individual insiders own 25.1% of the company followed by a mix of Private companies, Hedge funds, Institutions and VC/PE firms. The proportionate ownership of 360 DigiTech is illustrated below. Hedge fund activity has also increased. According to InsiderMonkey, there are at least 13 hedge funds with active positions in 360 DigiTech (QFIN), which is a bullish sign.
Risk factors to consider
Organizational or business risk factors are quite low in our opinion due to QFIN’s proven track record and product execution thus far. However, we are somewhat concerned about the recent regulatory changes by the Chinese Government. Please see below excerpt, which was published by Seeking Alpha.
Recent regulatory changes prompted the Suspension of Ant Financial IPO, which was dubbed the biggest IPO offer ever. Ant Financial is a subsidiary of China’s largest E-commerce platform Alibaba (BABA), which has grown to a FinTech giant in only six years. However, the IPO was suspended and is rumored to be pushed out for “at least six months.”
Investors are rightfully concerned and are eager to understand the potential impact on other FinTech players like QFIN. We believe that the new FinTech Regulation in China will likely have minimal impact on QFIN.
The rules’ main focus is to raise the bar for micro-loan lenders who provide online loans directly to consumers or jointly with banks. A good example would be Ant Financial, which was the largest player in this field thanks to Alibaba’s support. QFIN, however, has minimal exposure in this area. As per their recent Q3 earnings call: “currently, the outstanding balance of the outstanding loans issued through our microlending subsidiary accounts for less than 1%”. Also, QFIN has virtually no joint lending business with banks (joint lending accounts for around 0.01% of the balance, according to the Q3 release). As a technology provider, QFIN supports their partner banks primarily with “technology-powered services” instead of joint lending activities.
The new rules set a new requirement for small online lenders to provide at least 30% of any loan with their own capital. This will hurt those online lenders badly, relying on higher leverage to grow loan volume rapidly. Ant Financial was operating on a leverage ratio of ~100x, allowing them to turn RMB 3bn ($449m) in capital into RMB 300bn in loans. For QFIN, the rising standard of operating leverage could be a good thing. The new standard will push some of the other online lenders to give up on some market share, bringing in more business for QFIN.
We think investors have all the reasons to be concerned about the suspension of Ant’s IPO and the new rules. But a more in-depth look into the details of the regulations and QFIN’s business leads us to believe that the impact is minimal. QFIN could even benefit from the changing competitive landscape brought by the regulatory movements.
On the other hand, another regulatory rule issued in May this year should be considered more applicable to QFIN’s business. In that rule, Chinese regulators put specific restrictions on banks’ online lending activities and work with online lenders that don’t have a proper license. Our previous article discussed that it’s a sage decision for QFIN to switch to a “capital-light” business model and focuses on being a technology partner with banks. More importantly, QFIN has acquired all the necessary licenses for doing the business, which will make it more attractive when banks are looking for partners in the market.
Asset Correlation
As illustrated below, the company has low correlation to the Large Cap Technology (FAANG) stocks. This indicates that the movement in price for the largest technology stocks has lower impact to 360DigiTech’s performance. Hence, any sudden and unexpected correction within the overvalued technology stocks in the US markets does not necessarily mean any potential significant adverse impact on QFIN, although some impact could be expected. It’s also important to note, that QFIN has near zero correlation with Gold or Silver spot price. Therefore, within Phase 1 of our investment cycle, we can expect the stock to perform well irrespective of the movements by the precious metals.
Fair value and price target
Based on the company’s fundamentals and accounting for current and future earnings potential, we believe 360 DigiTech is undervalued. And therefore, deserves an allocation within the DeanVest portfolio. In our opinion, the upside potential far exceeds its downside risk.
Below is a mix of different price targets expressed by various analysts. With an average price target of $25 we feel is fairly conservative within the next 12–24 months. The price targets are based on existing cashflows and discounts future growth potential. We believe 360 DigiTech could possibly grow even faster than it has already over the last 24 months.
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