China is coming to Wall Street, as a host of Chinese companies have either gone or are looking to go public. Chinese Internet search engine SOGOU Inc (NYSE:SOGO) went public a week ago, and micro-lending specialist Qudian Inc (NYSE:QD) debuted a month ago and reached a high of above $34 before it fell to its current value of over $26.
Now another Chinese micro-lender named LexinFintech Holdings has also filed for an IPO, indicating in its filing that it plans to raise a maximum of $500 million. No word has been released on how many shares it plans to sell nor the share price, but the company’s financial numbers appear to be heading down the right path.
Despite Lexin’s current success so far, Chinese micro-lending as a whole has no direct U.S. equivalent, and a look at Qudian indicates that the stock has suffered from various scandals and news reports on shady loan practices. While Lexin itself has not been subject to such scrutiny, the lack of stability and regulation in this sector means that investors should stay away.
Lexin and Chinese micro-lending
Lexin says that it is “a leading online consumer finance platform in China” which focuses on serving the credit needs of educated young adults in China. It states that it had 3.3 million active consumers in the nine months ending September 30, 2017, of which 90 percent are between the ages of 18 and 36.
As China has grown wealthy, its youth have grown more used to conspicuous spending as they look to buy the latest electronics and consumer goods. Young Chinese citizens are not afraid to borrow money to get these items, but Chinese banks are unwilling to loan to them as they have a limited credit history.
This is where Lexin steps in with its online consumer finance platform called Fenqile. Lexin does not loan money directly to consumers, but connects them to funding partners and investors who help consumers buy the item through installments.
The result is a growing business. Lexin’s revenue has risen from 2.5 billion RMB to 4.3 billion ($652 million) from 2015 to 2016, along with a revenue of almost 4 billion in the first nine months of 2017. It should be noted that Lexin only made a profit in the first nine months of 2017 at just $794,000, with much larger losses in the previous years. But the losses were the heaviest in 2015, which indicates that Lexin’s financial numbers are on the right path. And given the size of the Chinese youth market, there is no doubt that Lexin has plenty more room to grow.
A Crackdown on Micro-lending?
While these numbers look good, investors should be able to pick up how lending money to young Chinese citizens so they can buy iPhones can go horribly wrong. This is especially so once you realize that Lexin states that its APR for 2017 was a staggering 25.3 percent, along with 25.7 percent in 2016.
Chinese micro-lenders are under serious scrutiny from the Chinese government, and a look at Lexin competitor Qudian should indicate why. The South China Morning Post reports horror stories of young students who find themselves having to beg relatives for money to pay back a friend’s loan from Qudian. Household debt in China has surged, and there very could be either a crackdown from the Chinese government or a financial crisis caused by high levels of debt.
There are some reasons why these concerns may not apply to Lexin. Qudian charges a significantly higher interest of 36 percent and is bigger, which means that it may be targeted by the government, just like Bitcoin companies, while Lexin is free to operate. Lexin also emphasizes that “we have not been subject to any inspection” in regards to excessive interest rates or other malicious financial activities. It could argue to investors that it may be able to be in a strong position if China cracks down on its competitors.
But there is a colossal level of risk here, and Lexin is nowhere near large nor profitable enough to justify that risk for investors. And while others may disagree, there is the moral quandary of investing in a company which profits off of the financial naivety of young Chinese people.
Moral and Financial Problems
Lexin has certain things going for it, such as an expanding market and financial numbers which suggest that it is well on the road towards profitability and growth. But there are major moral and financial justifications to stay away from this company completely. And unlike other firms which can prove they are worthy investments over time, the problems with Lexin will not go away. Chinese household debt will continue to be a problem in the foreseeable future, and there is no way to confidently declare that a Chinese government crackdown will not happen in the months or years to come. Investors should take a serious look at Chinese businesses going public and consider their potential. But in Lexin’s case, there is no reason to take the risk.