The latest ads from Cabot’s Global Stocks Explorer caught my eye with a “bypass the coronavirus” pitch. Here’s how the ad starts:
“Bypass the Coronavirus…with this hidden gem at the heart of ‘the biggest investment boom in history’
“Operating revenue increased over 70%.
“Gross profit surged 122%.
“Net income was up over 60%.
“Total bookings increased more than 150%.
“Total number of registered users was up 92%.
“No sales guys”
That sounds pretty good, right? So what’s being touted here by Cal Delfeld for his Global Stocks Explorer newsletter? Here’s some more of the lead-in that grabs our attention:
“Tapping into my intelligence network, I have found a company and stock that I have no doubt is the infrastructure play of the decade.
“This is no steel or construction company but rather is a leader in a special type of infrastructure, requiring much less capital and offering much more explosive growth than traditional infrastructure.
“This type of infrastructure is hardly mentioned by the financial media.
“Instead of cement or muscle, it requires brainpower.
“Instead of taking years to build, it moves at lightning speeds.
“Instead of steady, predictable returns for income investors, it is delivering real wealth.”
The ad highlights the importance of infrastructure in general, suggesting some traditional infrastructure investments like Brookfield Infrastructure Partners (BIP), Fluor (FLR) and Nucor (NUE), but the fun part is when he talks up the “modern” infrastructure that he thinks is much more exciting…
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“Boom Trend #3: FINTECH
“The Rise of Mobile Payments & Digital Financial Infrastructure….
“Because of the explosive leapfrog growth of cell phones, the rising young consumer middle class, and a willingness to bypass traditional credit cards and bricks and mortar banks, mobile payments and digital banking are soaring.
“One company I call the ‘Giant’ – stands tall in Asia. This company is private and not listed on U.S. markets but I will shortly explain to you how to invest in its growth.
“I’ll also explain how you can learn about a smaller company that is growing even faster and will likely be acquired by this giant.”
So it looks like we’ve got two different companies being hinted at here… this is what he says about the big one:
“… the giant has gotten even bigger with 900 million Chinese and about 300 million overseas customers using its payment platform. And its goal is a staggering 2 billion by 2030.
“The company’s value has gone from $50 billion in 2015 to $150 billion in 2020.
“The company is also starting to make loans to individuals and to small businesses, and it has set aside $1 billion to expand in India and Southeast Asia – a potential combined market of 2 billion alone.”
That’s almost certainly the company that is (arguably) the most powerful fintech company in the world right now, Ant Financial… which was spun out of Alibaba (BABA) about five years ago, is believed to be worth about $150 billion these days, and remains part of the “Alibaba community” of companies and fuels most of the transactions on Alibaba’s giant marketplace platforms. More than 90% of online financial transactions in China are reportedly handled by either Ant Financial and Alipay, or by Tencent’s WeChat WePay service. You can, of course, buy either Alibaba or Tencent if you wish to have exposure to almost anything internet-related in China, but those are also massive companies (each over a $500 billion market cap) so they aren’t exactly “pure play” investments on any one specific trend like fintech and electronic payments.
The spinoff of what was then called AliPay in 2004 and 2005, as Alibaba was going public, was handled in a strange way and may have resulted in Jack Ma owning much of Alipay and then selling it back to Alibaba in some way (honestly, I can’t figure out the chain of events, and it doesn’t seem worth the effort at this point), but Alibaba is reportedly now again a one-third owner of Ant Financial, which itself might have an IPO at some point… so yes, buying stock in Alibaba is probably the cleanest way to invest indirectly in Ant Financial’s growth if you’re interested, and I’d wager that’s what Delfeld is recommending here.
But the smaller one is a little more interesting, whether or not it ever gets acquired by Alibaba or Ant Financial… here are the clues we get about that one, similar to what he mentioned at the top of the article but now (helpfully) a little more specific:
“This smaller company has most recently posted some eye-popping numbers:
✓ Operating revenue increased 76%.
✓ Gross profit surged 122%.
✓ Net income was up 62%.
✓ Loans outstanding are over $7 billion – double that of a year ago.
✓ Total loan bookings increased 170%.
✓ Total number of registered users reached 62 million – up 92%”
And we get some other specifics, too:
“The company’s target market is 250 million educated young adults aged between 18 and 36 with high income potential, high educational background, high consumption needs, and a strong desire to build their credit profile.
“And because it begins serving them early in their career, they have a clear advantage in data and analysis. In fact, this company gets to these Chinese yuppies years ahead of the banks by about five years.”
And apparently the valuation is pretty compelling…
“Despite these stellar numbers, this stock sells for 14 times trailing earnings and between 5-6 times prospective earnings. Earnings could increase by as much as 40%-50% in 2020.”
So who is it? Well, we’ve got lots of pandemic projects going on here at Gumshoe Manor, so I had to scooch the skid steer aside and climb over a pile of mulch to get to it, but the Thinkolator did fire right up on the first pull… and after feeding in a few shovels of those hints I did get our answer: This tease is pointing right at LexinFintech (LX).
Here’s how the company describes itself in its corporate profile (which seems also to be the source of much of the Cabot ad’s info and wording):
“We are a leading online consumption and consumer finance platform for educated young professionals in China. We provide a range of services including financial technology services, membership benefits, and a point redemption system through our Fenqile ecommerce platform and Le Card membership platform. We work with financial institutions and both online and offline brands and retailers to provide a comprehensive consumption ecosystem catering to the needs of young professionals in China. We utilize advanced technologies such as big data, cloud computing and artificial intelligence throughout our services and operations to better serve our customers. The use of these technologies encompasses our risk management and loan facilitation systems, which allow for the near-instantaneous matching of users’ funding requests with offers from over 100 potential funding partners.”
I must say, that “comprehensive consumption ecosystem” is perhaps a little too much on the nose — like “we’re just managing the herd and making sure they eat right.” Which I suppose is what happens globally with giant ecommerce and finance companies, we’re all sheep being herded by someone, it’s just that the wording here is a bit more impersonal.
What that really means is that LexinFintech does consumer lending by using AI to screen for creditworthiness (in young adults who don’t much of a credit profile yet, they use frightening amounts of data, including social media presence, browsing history and GPS data in addition to traditional banking and employment info), and then use their proprietary systems to match borrowers with lenders, and that lending creates installment loans and lines of credit that are hooked right in to both a virtual credit card system and to LexinFintech’s own Fenqile e-commerce business, so a lot of borrowers can also buy what it is they’re trying to finance (computers, furniture, appliances, travel, etc.) directly through Fenqile with installment plans from dozens of different retail partners, effectively letting LexinFintech double-dip a bit on fees and commissions for making all these connections.
Their primary focus seems to be building a financial relationship with young professionals early on, helping them with installment loans and creating repeat customers, and also building a rewards program which will help them build data on customers and retailers and help them “own” these financial relationships as these consumers grow gradually wealthier. And it doesn’t have to be e-commerce transactions that get financed, they might provide a loan/line of credit of $1,500 for someone to take a training class, for example, or $5-10,000 for a wedding or a move to a new city for a job.
Those numbers from the tease are a bit old, the 62 million registered users and 92% year over year user growth number is from the third quarter of 2019, as is the 170% increase in loan origination, but the business remained on a similar trajectory for the fourth quarter (they’re now at 73 million registered users, for example, and total loan originations grew 90% for the full year 2019).
If you’re interested in the back story, there’s an interesting Wealth & Society article about the company here that goes into their founding and the details of the business in an understandable way — worth a read if you’re interested in maybe investing.
And yes, LX does screen very nicely when it comes to profitability — analysts are penciling in $2.40 in earnings per share in 2021 (after $1.80 this year), so the PE ratio is very, very low with the stock below $10. And trailing EPS is equally strong, at about $1.83, so that sends up a green “cheap stock” flag.
Stocks are rarely as obviously cheap as this without a pretty big reason, though, so why does LX look so cheap? Is it just that we’re all worried about the creditworthiness of the increasingly overlevered young Chinese consumers, or the dangerous “not quite bank accounts” financial products that many in China use to earn a decent interest rate (and which fuel the “lending” side of this busienss)? Is it just that we’re worried about a real crash coming in China? Is there something specific about the company that engenders fear?
That I can’t tell you after just a few minutes of research, but part of this might be largely reputational — LexinFintech started out on much shakier ground as more of a peer-to-peer system, with individual investors providing most of the capital for loans, but the current situation seems much more sustainable and scalable than that (more than 60% of loan funding was from individual investors when LX went public in 2017, but that has now flipped and more than 85% is now from institutions, including cooperation agreements with a lot of big national banks). At the same time, they’ve been gradually moving away from holding loans themselves, so much more of their revenue comes from fees on loans that are off of their balance sheet than in previous years. (And incidentally, the stock price now is almost exactly where it was when they had their IPO in December of 2017).
There are also some smaller companies in the consumer installment credit space, with often terrible stock market performance thanks to the rough turn in the credit cycle in China in the last year or two, so perhaps investors are afraid that LexinFintech will go the way of Qudian (QD), which describes itself in terms very similar to LexinFintech, or the more peer-to-peer focused Hexindai (HX) and China Rapid Finance (XRF), which also went public in the 2017-2018 time period (each of those three has fallen roughly 95% over the past 2-3 years). There was a big regulatory shift for online lending in China late in 2017, so it hit a lot of these companies pretty hard (capping fees and pushing back against aggressive or illegal collections practices, as well as restricting the launch of new peer-to-peer systems), so part of the relative outperformance is just that Lexin came public after this change instead of before (though it did cut into their IPO dramatically, they had hoped for a $500 million IPO and only ended up raising about $100 million).
So maybe it’s just that everybody hates this broader “Chinese fintech” sector these days and fears either Chinese lending and finance companies themselves, or more changes in the Chinese regulatory framework that could hurt these businesses… I pulled all the names I could think of that might loosely match that “small fintech” sector in China into a chart covering the past year and a half or so, and it ain’t pretty… even if Lexin has perhaps been the best of a sad bunch (that’s them at the top in grey, only down a few percent since late 2018):
I’m sure there’s a hefty amount of risk in this system as we wait to see how young consumers hold up during China’s slowdown/recession, so the chargeoffs and delinquencies will probably climb for a while (they were already rising at the end of last year, before the global coronavirus recession really got going, and Chinese growth was faltering before the latest coronavirus cessations and trade war reheating). On that front, the risk is probably that this AI-powered system for assessing credit risk hasn’t yet been tested in an ugly recession — and as we saw during 2008-2009, sometimes consumer credit can be a lot worse than the financial models expect.
In reviewing their latest investor presentation, I come away liking that they’re largely fee-focused and are trying to be the middleman in these consumer/lender relationships, with relatively limited direct loan exposure (though they do carry some of the debt), I haven’t looked over the full annual report to see what they state as their risk factors or look for other things to worry about.
We don’t know a lot about what the impact of the current economic disruption in China will be for Lexin — as of their fourth quarter update (in late March), they said they had seen some impact from the coronavirus business cessation, and expected their delinquencies to get a bit worse, but that everything was in the range of their expectations and they reiterated their loan origination guidance for the full year of RMB170-180 billion (more than 30% growth), despite what will probably be a soft first quarter. I haven’t seen confirmation of their date for releasing first quarter 2020 financial results, but it will probably be later this week or early next week (it was May 17 last year).
There is a nice optimistic take on the stock from a Motley Fool writer (the stock is not a recommendation of any Motley Fool newsletters, to be clear),
with the compelling title “Investors Could Double Their Money from LexinFintech” — and certainly that possibility exists for a company with this low a valuation, the author concludes that…
“All things considered, if Lexin can grow its business by at least 50%, and multiples improve from 5x to 8x earnings in the next three to five years, investors will more than double their money.”
And big moves wouldn’t be all that shocking – LX shares have seen a high of $16 and a low of $7 already this year, and the company is still quite small, with a market cap of about $1.7 billion. This seems mostly to be a situation where you have to decide how risky it is to bet on the creditworthiness of young unbanked workers in China… and whether you think it’s likely that Tencent or Alibaba or Ant Financial might just want to buy Lexin to wrap its services up in their larger fintech systems (or, alternatively, push their own competing solutions and try to squash Lexin).
If we’re betting on takeovers, incidentally, I’d put Tencent ahead of Ant Financial in any line of acquirers that may form — most of LexinFintech’s leadership team worked at Tencent, so they’ve presumably still got connections to that goliath… and when Lexin went public a lot of the initial backing was from JD.com (JD), which also allies somewhat with Tencent as a counter to Alibaba (I don’t know if JD.com or Tencent currently own Lexin shares)… but that’s just speculating, we should probably assume that LexinFintech will have to continue to make it on their own.
Going just from the financials, there’s a lot to like and what looks like a pretty wide margin of safety built in given the very low valuation — but that doesn’t mean the business can’t get a lot worse, or that there might not be some uglier skeleton in the closet that I haven’t run across yet, and I’ll color myself intrigued here but haven’t invested. Whether or not the risk of being a middleman for consumer installment loans to Chinese yuppies is something that appeals to you or not, well, I can’t say… it’s your money, so you get to choose. Please do let us know what you think with a comment below.
P.S. We haven’t received a lot of feedback regarding this Cabot “emerging markets” newsletter since it changed editors a couple years ago (it was run by Paul Goodwin for a long time, and was both one of the better international stock newsletters for many years and one of the few that didn’t close up shop after the Chinese market implosions of 2007 or 2015 — China’s flat decade from 2010-2020 probably caused a lot of subscribers to give up, and a lot of publishers to pull the plug on China-focused newsletters), so if you’ve subscribed to the Cabot Global Stocks Explorer letter under Carl Delfeld please do click here to share your experience.
Disclosure: of the companies mentioned above I own BIP partner Brookfield Asset Management. I will not trade in any covered stocks for at least three days, per Stock Gumshoe’s trading rules.