Chinese fintech company OneConnect Financial Technology (NYSE:OCFT) has released pricing details in what appears to be a rare downgrade. The company stated in its amended SEC report that it would be selling 36 million American depository shares (ADSs) at a price range of $12 to $14, which will raise about $500 million. According to Bloomberg, OneConnect will be valued somewhere between $4.4 billion to $5.2 billion after this IPO. Major banks working on this IPO include Goldman Sachs (NYSE:GS), Morgan Stanley (NYSE:MS) and JP Morgan (NYSE:JPM).
This represents a significant drop-off compared to earlier valuations, as OneConnect was valued at $7.5 billion and there were signs that OneConnect had been chasing an initial IPO valuation of $8 billion. But investors have become more skeptical in the wake of the WeWork debacle, which forced OneConnect to reevaluate its plans.
OneConnect is certainly a better investment at the lower price compared to initial expectations, but there are concerns about this company’s plans and finances which should worry investors. The numbers indicate that this remains an expensive stock even at the lower price which investors should avoid.
Financial Growth Opportunities
The case for OneConnect is simple. Chinese companies are appealing. Fintech companies are appealing. Therefore, a Chinese fintech company must be greatly appealing. OneConnect provides technological solutions to Chinese banks and financial institutions. These solutions include digital retail banking, insurance management, and blockchain solutions that help these institutions generate revenue and save costs. Its SEC report states that OneConnect “has supported Chinese financial institutions in serving RMB1.8 trillion (US$0.3 trillion) of transactions for their end-customers.”
Furthermore, its customer base includes all of China’s major banks and 99% of its city commercial banks. OneConnect has been to accomplish this in part due to its relationship with Ping An, China’s largest insurance company. Ping An is OneConnect’s primary shareholder and will hold over 35% of shares after this offering. Ping An has also consistently made up around 40% of OneConnect’s revenue since 2017, including 43% over the first nine months of 2019.
This dependence on a single supplier is a concern, especially as OneConnect has made no effort to move away from this dependence. On the other hand, investors should be tempted by the possibility of investing in the important Chinese fintech industry. Paolo Sironi with American Banker observed that China has even leapfrogged the United States in fintech, with Chinese mobile payments absolutely dwarfing an America still using cards and cash.
OneConnect cites third-party projections which state that the technology spending market for Chinese financial institutions “is expected to grow at a CAGR of 21.4% to RMB400.8 billion in 2023.” On a global scale, other estimates predict the demand for fintech to have a ridiculous CAGR of 25 to 30%. And OneConnect has set up moves to expand into other Asian countries such as Hong Kong, Singapore, and Indonesia.
A Low Enough Valuation?
The above factors means that OneConnect promises rapid growth, and that is exactly what we see from its financial numbers. Revenue rose from RMB902 million in the first three quarters of 2018 to RMB1.55 billion ($217 million) in the same timeframe in 2019, a growth rate of 72%. This is a significant decline compared to a 143% growth rate from 2017 to 2018, though some decline in the growth rate is to be expected.
While the growth rate is high, OneConnect is unprofitable and reported operating losses of RMB575 million in 2018 and RMB 1.1 billion ($156 million) in 2019. Cash flow losses via direct payday loans have also risen. OneConnect had a negative cash flow of $206 million in 2019 and has just $128 million in cash and cash equivalents as of September 30, 2019.
The increasing losses are caused by the fact that OneConnect’s expenses, especially in research and marketing respectively, are rising faster than its revenue growth. This portends poorly for OneConnect’s ability to become profitable, a poor indicator in an environment where investors are willing to tolerate losses for years on end.
So is OneConnect worth $5 billion? With $128 million cash on hand and $700 million in total liabilities, we are looking at an enterprise value of over $5.5 billion. As revenue over the first three quarters was $217 million, assuming a yearly revenue of about $300 million seems reasonable. We are thus looking at an EV/sales ratio of over 18. We can look at Alibaba (NYSE:BABA) and Tencent (OTC:TCEHY) as somewhat comparable companies in the same sector, and both of them are a little over 8.
That ratio is certainly not the final answer, as those companies are far larger and OneConnect is growing much more quickly. But investors should also remember that they could be investing at an even higher price post-IPO, pushing the valuation and ratio even higher. And at the very least, OneConnect remains an expensive stock despite the lower valuation.
Too Many Problems
A final note is that Chinese IPOs in American markets have historically performed very poorly, and so any such company going public needs to show that it stands out from the pack. Aside from being part of the interesting and innovative Chinese fintech sector, OneConnect does not have any strong cards to play. It is growing well like many tech companies but has other problematic financial indicators and is an expensive IPO.
If OneConnect can prevent its revenue growth from decelerating so rapidly or a path towards profitability, it could be a decent stock over the long run. But if investors are truly interested in the Chinese fintech sector, it is better to look for a more established company.