Lufax Holding: Leading fintech platform with attractive long-term potential
(Reading time: 18 min)
Lufax Holding Ltd (NYSE: LU) is the leading financial service platform, operating in retail credit facilitation and wealth management segments.
Lufax is primarily addressing the large unmet demand of small business owners, and also provides personalized wealth management products to the fast-growing middle class and affluent population. Lufax is serving about 14.5 million borrowers and more than 14.9 million active investors in the wealth management business.
The company is backed by Ping An Group, which is a leading tech financial services group, operating in insurance, banking, and asset management. Through a close partnership, Ping An opens up for Lufax the ecosystem with more than 200 million retail clients.
History of Lufax
The history of Lufax dates back to 2005, when the leading insurance company Ping An Group set up a consumer loan business, to start building a presence in fintech and financial services. This part of the business was later acquired by Lufax.
Lufax was established as a separate entity in 2011 when Ping An Group set up the wealth management subsidiary under the name Shanghai Lujiazui International Financial Asset Exchange Co. Ltd (‘Shanghai Lufax’).
In 2012, Lufax launched an online peer-to-peer (P2P) lending platform Lufax.com, which was later upgraded to LU.com. Lufax became one of the leaders in the P2P market and was expanding the wealth management business.
Lufax received $485 million Series A financing in 2015. Just one year later in 2016, the company completed Series B financing and raised $1.2 billion, with a company valuation at $18.5 billion. Lufax then went on and acquired several companies, including Shenzen Qianhai Financial Assets Exchange and Chongqing Financial Assets Exchange. Since 2017, Lufax started expanding internationally and set up operations in Singapore and Hong Kong.
The P2P market was rapidly growing but the market was loosely regulated. Many of the platforms operated as pyramid schemes or with insufficient risk assessment, resulting in a large number of defaults. The authorities started tightening the regulations in 2016, which included caps on the lending amounts and full disclosure on the use of payments. Around that time in 2016, Lufax was looking to go public on Hong Kong exchange as the first P2P platform, but the investors aware of the new regulations and risks were turning away from this market. According to new regulations, P2P firms had to transform to loan companies and meet minimum capital requirements. Lufax’s IPO was postponed, and the company decided to transform its business and discontinue its P2P operations as of 2019.
Lufax in the end didn’t list on the Honk Kong exchange as was originally planned. The company eventually went public on the New York Stock Exchange in October 2020. The shares sold at $13 and Lufax raised $2.36 billion. The company was valued at $32.9 billion.
What is important to mention is that Lufax IPO was planned around the same time as two other competitors, Ant Group and JD Digital Technology. The Ant Group was preparing for a record-breaking IPO, looking to raise $37 billion with double listing on Hong Kong and Shanghai exchanges. JD Digital Technology, the fintech arm of the e-commerce giant JD.com was preparing for IPO on Shanghai’s Star Market, seeking to raise about $2.9 billion. Both of these IPOs were halted, as China’s regulators stepped in with stricter regulations on online micro-lending practices.
After the IPO, the two companies with the highest ownership in Lufax are Ping An and Tongjun Investment, with 39% ownership each.
Lufax operates as a holding company as was incorporated in the Cayman Islands in 2014. The figure below shows the member companies of Lufax Holding Ltd.
Lufax (LU.com) is a wealth management platform and online marketplace for the origination and trading of financial assets.
Ping An Puhui is the retail credit facilitation business that was first set up under the Ping An Group. Puhui was later in 2016 acquired by Lufax, and now is part of the core business.
Chongqing Financial Assets Exchange and Shenzhen Qianhai Financial Assets Exchange. The financial assets exchanges are institutions that operate as electronic auction houses and fundraising platforms. They are used by loan companies and investment companies to raise funds, most commonly by selling fixed-income products. The exchange is also a place where companies that are not listed on stock exchanges can market and auction equity.
Lufax also operates subsidiaries abroad, Lu International Financial Asset Exchange in Singapore, and Lu International Limited in Hong Kong. While Lufax’s priority is still a domestic market in China with a lot of potential for growth (as will be discussed in a later section), the company is laying down the foundation for expansion in South East Asia, which is another high growth potential market.
Lufax is currently led by two Co-CEO’s, Gregory Dean Gibb and Yong Suk Cho. They both previously worked at Ping An, and their experience, knowledge about the Ping An ecosystem, and close partnership with Ping An are some of the key factors for Lufax’s potential.
2. Qualitative Analysis
Lufax is a financial service company that is targeting large, attractive, but underserved segments of retail credit facilitation and wealth management. Lufax’s mission is to make borrowing and wealth management easier, safer, and more efficient. To do so, Lufax combines financial expertise with purpose-built technology.
Lufax operates the so-called hub-and-spoke model, which connects individual customers with financial institutions. Lufax takes full advantage of the advanced IT technology, big data, and AI for account verification, loan application processing as well as risk assessment.
What is distinguishing Lufax is the personalized service and superior user experience. The investors come to Lufax because of the broad product offering and the fast processing time of the applications, which is allowed by the technology and AI.
With the vast amount of data about consumers, their risk profiles, and preferences, Lufax also helps the asset owners to structure and price the assets for investors.
Let’s look closer at two core business areas of Lufax.
Retail Credit Facilitation
In retail credit, Lufax is targeting small business owners and facilitating credit access. The size of this market is estimated to be RMB 43.1 trillion ($6.1 trillion) and is expected to grow at 12.2% CAGR between 2014-2024, to reach RMB 76.6 trillion in 2024.
However, the total credit demand of small businesses was estimated to be RMB 90 trillion ($12.7 trillion) in 2019, which means that currently only about half of the market is served, according to Oliver Wyman’s report commissioned for Lufax’s IPO prospectus.
The small business owners are often unable to get loans they need from the traditional banks, because of required collateral. Lufax fills this gap by using technology to better assess the risk of the borrower and provide loans in a short time. Small business owners have convenient access to affordable funding, and financial partners are able to access the fast-growing market in a cost-effective way.
As of June 2020, Lufax has connected 13.4 million borrowers with more than 50 banks, trusts, and insurers. Lufax has facilitated the loans with an outstanding balance of RMB 519 billion ($80 billion), and its credit risk exposure is only 2.8%.
The estimated size of personal investable assets reached RMB 192 trillion ($27 trillion), but only about RMB 49 trillion ($7 trillion) has been placed in wealth management products, according to Oliver Wyman’s report.
With the fast-growing Chinese economy, the high savings rate of the middle class, and the affluent population, the wealth management market is expected to grow at 19% CAGR by end of 2024, to reach RMB 118 trillion ($18 trillion). This represents a significant opportunity for Lufax.
To source the customers, Lufax is leveraging the marketing team, on-the-ground agents, member referral programs, as well as Ping An ecosystem.
As of June 2020, Lufax served 44.7 million users and 12.8 million active investors that are connected to more than 400 product providers with more than 8600 wealth management products. Lufax is targeting clients with high-profit potential. The high-value investors with assets above RMB 300,000 ($42,462) make up more than 75% of the total assets invested.
Strengths of Lufax
There are several key strengths of the Lufax’s business model:
Capital-light business model. Lufax operates a technology platform and connects the customers with partner banks and investors. This model requires relatively little capital and is highly scalable, allowing for fast growth.
Offline-to-online channel integration. Lufax operates a hybrid model, where all loan applications are processed online, but more than 56.000 agents are on the ground ready to advise clients. The agents are able to better understand the needs of the borrowers and develop relationships with many middle-class and affluent investors. Better service allows underwriting larger and longer-term loans, which is different from other players, such as Ant who focuses mainly on short-term microlending.
Ping An Group ecosystem. Lufax has a close partnership with Ping An Group and can leverage a vast amount of credit and financial data, to develop highly sophisticated risk assessment tools.
Technology. The loan facilitation process is highly automated and the platform is convenient to use for customers, who get product recommendations tailored for their financial goals, and they can use features as automatic repayment of the loans, tracking all transactions, and automatic transfer of balances into investment. The customers are verified with AI facial and voice recognition tools, making the verification time efficient. The superior user experience contributed to a 93.3% retention rate among wealth management customers in 2019.
Leading player in the attractive market. Lufax is the leading player among non-traditional financial service providers. It is ranked number 2 in retail credit facilitation and number 3 in wealth management, and both sectors are expected to see double-digit growth between 2019-2024.
E-commerce is booming in China and so is the fintech, with all the internet giants providing online financial services – e.g. Ant Group, WeBank, JD Digital Technology (formerly JD Finance). These companies leverage their large user base from e-commerce and provide a range of financial services, from microlending to wealth management. As the scale of these players is growing, the authorities are watching to keep up with the appropriate regulations.
The advantage for Lufax is a narrower but high-quality customer base and a more focused service offering. This could make it somewhat easier to keep up with the regulatory changes, although this is by no means guaranteed as new regulations may be introduced! But the fact is that Lufax IPO went smoothly last year, while both Ant and JD Digital Technology had to postpone their IPOs and make necessary transformations to comply with the regulations.
The two companies that operate similar platform models to Lufax and are also public on the Nasdaq exchange are 360 Digitech and LexinFintech Holdings.
360 Digitech is a digital platform that facilitates access to credit, by connecting borrowers and funding partners. The difference is in scale and target group. This company offers affordable credit typically for consumption spending as a supplement to a credit card. In terms of the outstanding loan balance, Lufax has about 10x higher figures (RMB 519 billion vs RMB 58 billion).
LexinFintech operates a similar platform for loan facilitation, matching consumers with over 100 funding partners and investors. The competitive advantage for Lufax over these companies is the wealth management business besides credit facilitation, as well as a high-quality client base and access to Ping An ecosystem.
 Oliver Wyman: Fintech in China: Hitting the Moving Target. https://www.oliverwyman.com/our-expertise/insights/2017/aug/fintech-in-china-hitting-the-moving-target.html
3. Quantitative Analysis
First, let’s look at Lufax’s income statement over the last few years 2017-2020. The majority of the revenue, about 70-75% comes from the retail credit facilitation fees. The income from wealth management represents only about 3-5%.
The total income in 2020 grew by 9% and reached $7.97 billion. The growth rate slowed down compared to previous years with a growth of 46% in 2018 and 18% in 2019. What we have to consider is that over this period Lufax was transforming their business and discontinued their P2P business in 2019, and the company still managed to grow at reasonable rates.
The largest expense components are sales and marketing with more than 50% of total expenses, and operations expenses with about 20%.
The net profit in 2020 was $1.8 billion, which implied a healthy profit margin of 24%.
The balance sheet shows that Lufax almost doubled the assets from 2019 to 2020, from $23 billion to more than $38 billion. The increase comes from the loans to customers, which represent about half of the assets. Correspondingly, on the liabilities side, the payables to investors doubled as well.
Now let’s look at some valuation metrics! The table below shows a comparison with the parent company Ping An Group.
Lufax’s market cap is about $37 billion, which is not as much as China’s e-commerce or other giants, but it’s still ranked in the Top 70 biggest companies. Ping An is ranked in the Top 10, and as was already discussed, for Lufax it is a great advantage to be backed by Ping An and have the access to their ecosystem.
In terms of the P/E ratio, Lufax is trading at 17.5 and Ping An at 9.98. This suggests that investors are expecting higher growth from Lufax, but the ratio is not too high.
Lufax is generally trading at higher ratios than Ping An, except for EV/EBITDA. The profit margin of 24% is double as much as Ping An at 11.5%.
The DCF analysis can help us decide what is the potential value of the stock. Firstly, we have to make projections for EBIT and Free Cash Flow. Over the past few years, the EBIT has been stagnating, but with the new IPO funding, Lufax will be investing and strengthening the business, and we model the EBIT using the 8% growth rate.
The FCF projection is more complicated because of the significant changes on the balance sheet over the last few years. The value of current assets doubled as the loans to customers increased, but the corresponding increase on the liabilities side was for the non-current liabilities. As a result, the change in the net working capital was $13 billion and subtracting this from EBIT we get a negative FCF of about $12 billion. Going forward, the FCF is expected to stabilize and turn positive, as the non-current liabilities will turn to current liabilities.
To value the expected cash flows, we use the WACC of 7.6%. The perpetual growth rate beyond 2030 is set to be 5%. We estimate the terminal value of the company using two methods, one is the perpetual growth and the second is using EV/EBITDA exit multiple. We model three different scenarios for the terminal value and the implied share value based on our model is in the range of $27 to $29. With the current market price of $15.5, the potential upside is somewhere around 77% to 91%.
Peter Lynch’s stock category
According to Peter Lynch’s 6 stock categories, we would classify Lufax as something between Fast and Slow Grower.
Lufax has strong fundamentals and a high net margin, which is more typical for established companies. Over the last 2 years, the growth has slowed down as Lufax was transforming their business, but we believe the company has the potential to grow fast in the next years, as they are eying to foster their domestic business but also expand internationally.
Risk 1: Competitors in the fintech space
Fintech is a growing and attractive market in China. The competitors in the consumer loans market, as well as the wealth management, include internet giants Alibaba, Tencent, and JD.com, new startups, and also traditional banks.
To remain competitive, it is important for Lufax to focus on offering superior experience and personalized offerings. We believe Lufax is positioned well to serve their specific segment of small businesses and affluent clients.
Risk 2: Regulatory changes
The fintech market is fast-growing and Chinese authorities are keeping a close eye to have appropriate regulations in place. With easy access to loans via apps, concerns are growing about internet lending practices and potential defaults. The regulatory changes can have a significant impact on the business, as was the case for Ant and JD Digital with their postponed IPOs.
The authorities are also taking steps to allow traditional banks to be more competitive, for example by no longer restricting the daily interest rates for credit cards. This gives banks flexibility to lower interest rates in order to compete with online lenders or charge higher interest rates for higher-risk clients.
The proposed regulations are also expected to restrict the data collection so that the companies only collect data that is necessary. This may eventually impact the accuracy of the risk assessment models that fintech companies use, as they oftentimes also collect data that is ‘nice-to-have.
The risk of regulatory changes in the fintech market is high, but as of now, Lufax seems to be in a good position after the smooth IPO. Lufax also proved in the past that is able to pivot, as they did with the P2P lending business when they transformed the business model without taking significant hits on financials.
Lufax is a leading player in the fintech market, operating in the attractive segments of retail credit facilitation and wealth management, which are expected to grow at double digits rates in the years to come. Lufax has an attractive customer base, focusing on affluent clients with high customer lifetime value.
Following the IPO, we expect Lufax to continue investing in its technology and growing its presence in China. In the long-term, we can also expect a focus on international expansion, namely in South East Asia, where Lufax is already establishing a presence with a subsidiary in Singapore.
Lufax was trading at over $18 at the beginning of February, but after the recent drop in the stock market, the current price is at $15,5. Based on our model, this stock has an upside up to levels between $27 to $29.
We believe that Lufax has strong fundamentals and with the corporate backing from Ping An, the long-term outlook is positive. We, therefore, recommend this stock as buy and hold for the long-term.
Disclaimer: Our content is intended to be used solely for informational and educational purposes, and not as investment advice. Always do your research and consider your personal circumstances before making investment decisions. ChineseAlpha is not liable for any losses that may arise from relying on information provided.
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