Hexindai: Has A Long Way To Go

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About: Hexindai Inc. (HX)
by: Annual Report Reader
Summary

Hexindai needs to work hard to comply with regulations.

The company transitioned to different channels to attract both borrowers and investors.

Financial results still did not look good.

Micro lending business needs risk control.

Hexindai (Nasdaq: HX) recently reported another net loss for the third fiscal quarter of 2019, following their first net loss in the second quarter. The company has a long way to go to revive, while the P2P online lending industry in China continued its turbulence under enhanced regulation.

Regulatory Compliance

China started enhancing the regulation on the P2P online lending industry in a large scale in 2018. The market had been shaking especially since June 2018. Further in August 2018, the regulation authority published a guidance of 108 requirements for all P2P online lending platforms to comply by the end of 2018. Firms in the industry either have been working hard to meet the requirements or were weeded out due to problematic issues. In December 2018, another notice referred to as “Guidance 175” was published indicating that only a limited number of large platforms should stay in the game.

HX stated in the third quarter presentation that it was compliant with online lending industry guidelines. However, according to 01caijing, a leading informative website in the industry, HX was recently ranked 101th out of 120 platforms in terms of compliance progress, the lowest of its peers that trade in the US stock market.

Feb. 28. 2019

Ranking

Weidai (NYSE: WEI)

6

Yirendai (NYSE: YRD)

11

China Rapid Finance (NYSE: XRF)

30

Xiao Ying Wang Jin (1)

50

Juzi Licai (2)

51

PPDai (NYSE: PPDF)

53

Hexindai (Nasdaq:HX)

101

Source: 01caijing

Note 1: Xiao Ying Wang Jin, subsidiary of X Financial (NYSE: SYF)

Note 2: Juzi Licai, subsidiary of LexinFintech (Nasdaq: LX)

01Caijing publishes similar rankings monthly and the most recent one was published on February, 28, 2019. For this February ranking, the website selected 130 largest platforms, and followed the guidelines of both the 108 requirements and the “Guidance 175”. The fact that HX was ranked 101th did not necessarily mean that the company is in trouble, but means it was relatively behind its peers in terms of progress. It may take longer for HX to regain order of business. Particularly, HX received a low score regarding risk management and investor protection. I think we should raise at least a yellow flag here.

Operations

Overall, the net loss was due to low transaction volumes.

Loan Volume (billion RMB)

Oct - Dec

Market share

Change from prior quarter

July - Sept

Market share

Change from prior quarter

April - June

Market share

Change from prior quarter

Jan - Mar

Market share

Industry

268.50

-11.68%

304.00

-38.34%

493.00

-10.85%

553.00

HX

0.20

0.07%

-12.55%

0.23

0.08%

-92.18%

2.94

0.60%

8.89%

2.70

0.49%

Source: industry: 01 caijing

HX: quarterly reports

The loan transaction volume sharply dropped 93.2% in the quarter of July – September, which was full of mysteries as I discussed in my previous article on HX. Fortunately, in the last three months of 2018, the loan volume of HX only decreased slightly more than that of the industry.

Let’s further check out the number of investors and borrowers.

2018 1Q

2018 2Q

2018 3Q

2018 4Q

2019 1Q

2019 2Q

2019 3Q

Number of investors

37,033

42,771

57,846

62,039

67,607

38,825

20,325

Number of borrowers

14,736

20,697

32,417

33,322

28,979

2,183

1,771

Source: HX quarterly reports

HX investor and borrower number

On the investor side, as we can see from both the table and the chart above, the change in the number of investors has been dramatic. In the past two quarters, the number of investors dropped by about 50% quarter over quarter. Such trend indicated that investors were losing faith in HX, not even HX spent millions of dollars distributing cash incentives to investors.

USD

2018 1Q

2018 2Q

2018 3Q

2018 4Q

2019 1Q

2019 2Q

2019 3Q

Cash Incentives

1,818,571

3,357,828

4,542,781

5,451,226

4,969,479

6,235,442

5,040,897

Source: HX quarterly reports

Clearly, cash incentives did not work in the recent quarters, or we can say that even if HX was losing money, it dared not to be thrift on incentives. I did not believe it was a smart strategy in the long run to lure investors simply with cash incentives, which I discussed in my previous article on HX. Now that they finally realized that they need to try alternatives. They have signed funding contract with Aotou, Bohai and announced equity acquisition of Phoenix Intelligent Group, as they announced in the third quarter conference call. These are good moves and we shall find out the execution in the next quarter.

On the borrower side, the number dropped to less than 10% of previous quarter in the second quarter and continued to decrease in the third quarter. HX claimed in the third quarter conference call that “the decrease of the borrower number is the most because of we have decreased our pass-through rate for implementing the more strictly risk control standard”. It could be true, but I have further observations. HX used to mainly rely on the related party Hexin Group to refer borrowers. According to the 2018 annual report, over 89% of the borrowers were referred from Hexin Group’s physical branches in the past few years. But in the third quarter of 2019, they switched to almost 100% online channels to acquire borrowers. Hexin Group was also closing stores.

.

2019 3Q

2019 2Q

2019 1Q

2018 4Q

2018 3Q

Online

99.60%

27%

16%

11%

24%

Offline

0.40%

73%

84%

89%

76%

Offline branches

233

242

253

244

205

Offline cities

127

127

130

128

119

Source: HX quarterly presentations

This change might be because the regulation stated that P2P platforms should not use offline branches, of either own or third party, to conduct business other than risk management functions. If so, HX faces a big challenge to enhance its ability to acquire customers through their online channels.

By the way, Hexin Group was owned by the chairman of HX, Xiaobo An. In March 2017, they also signed an agreement (with infinite term) that Hexin Group provided such referral service without charging HX. However, according to the quarterly presentations, borrowers paid a 6% referral fee, which was pretty high. Here is the economics illustration chart from the presentation of the third quarter of 2019.

HX economics

Source: Presentation of the third quarter of 2019

Apparently, Xiaobo An earned big money in this related party transactions for the past few years. 6% was a large chunk out of borrowers and hence also a hidden high customer acquisition cost for HX. If HX truly stops such cooperation with Hexin Group, it maybe a good cost cutting measure for HX, as long as the company is capable of acquiring more customers online.

Financial Results

We further move to analyze the financial results of the quarter.

USD

2019 3Q

QoQ

2019 2Q

QoQ

2019 1Q

Net Revenue

1,911,225

-47%

3,621,162

-93%

51,651,497

Income from Operations

-11,141,784

-36%

-17,452,572

-148%

36,093,754

Net Profit

-9,592,789

-45%

-17,400,575

-159%

29,678,615

Source: HX quarterly reports

Overall, both revenue and net loss were down by half of prior quarter, which was a lower speed than the previous quarter. There have been quite a few optimistic comments that net loss was narrowed. I am afraid that I cannot agree. When net revenue was down by half, there was no good reason that the net loss should not narrow. We should only applaud if the net loss decreased more than net revenue.

Here are more details on the revenue.

USD

2019 3Q

% of Revenue

QoQ

2019 2Q

% of Revenue

QoQ

2019 1Q

% of Revenue

Revenue

Loan facilitation service

2,510,689

35.60%

-48%

4,870,258

49.29%

-91%

54,051,878

94.55%

Post-origination service

3,484,551

49.41%

-19%

4,328,279

43.81%

83%

2,364,879

4.14%

Interest income

1,054,519

14.95%

55%

681,599

6.90%

-9%

749,727

1.31%

Others

2,169

0.03%

100%

0.00%

0%

-

0.00%

Total revenue

7,051,928

100.00%

-29%

9,880,136

100.00%

-83%

57,166,484

100.00%

Business and sales related taxes

99,806

1.42%

324%

23,532

0.24%

-96%

545,508

0.95%

Cash incentives

5,040,897

71.48%

-19%

6,235,442

63.11%

25%

4,969,479

8.69%

Net Revenue

1,911,225

27.10%

-47%

3,621,162

36.65%

-93%

51,651,497

90.35%

Source: HX quarterly reports

The revenue from the loan facilitation service (paid by borrowers and recognized up front) decreased by 48% from the second quarter. One reason was that the loan volume decreased by 12%, per the table in the early section of this article. The other reason was that the billing ratio decreased from 14.4% to 9.1%. This is the lowest billing rate since the third quarter of the fiscal year 2018.

The revenue from post origination service (paid by investors and recognized at the end of the investing period) decreased less, only by 19%. Since the number of investors dropped sharply in the third quarter, it was probably due to the timing issue as the fee is charged at the end of the investing period. If so, we should anticipate even less post origination service revenue in the next quarter.

Interest income increased by 55%, which came from the micro lending business. I will discuss this business later.

Cash incentive paid to investors ate 71.48% of total revenue, and it was still a lot more than the post origination service revenue earned from investors. Ever since the fiscal year 2017, cash incentive has always exceeded post origination service revenue, by large percentage. The management claimed in the 2018 annual report that it was “due to the timing difference in bookkeeping”. Wow, this is such a large time lag! I suspect such timing difference would ever turn around.

Next, we discuss more details of expenses.

USD

2019 3Q

% of Revenue

QoQ

2019 2Q

% of Revenue

QoQ

2019 1Q

% of Revenue

Sales and marketing

7,175,816

102%

-39%

11,749,563

119%

1%

11,665,104

20%

Service and development

2,246,516

32%

3%

2,177,233

22%

60%

1,364,568

2%

General and administrative

3,247,121

46%

45%

2,236,523

23%

-3%

2,313,793

4%

Share-based compensation

383,556

5%

-92%

4,910,415

50%

2192%

214,278

0%

Total Revenue

7,051,928

100%

-29%

9,880,136

100%

-83%

57,166,484

100%

Source: HX quarterly reports

Finally, HX was cutting down the sales and marketing expense, but it was still more than the total revenue of the quarter. It seemed to be a dilemma for HX. The company was losing customers so it needed advertisement to attract more business. However, as it was earning less revenue, it faced pressure to cut cost.

It was strange that service and development increased slightly, taking a third of the revenue. This line item covers related employee expense, custodian bank account management fee, and rental and property management fee. If it was hard for HX to cut cost on marketing, shouldn’t the company try to be lean at this difficult time?

General and administrative expense increased tremendously due to high provisions in the micro-lending business, which I will discuss later.

Share-based compensation was the main reason that operation expense was cut down.

Micro lending business

USD

12/31/18

QoQ

9/30/18

QoQ

6/30/18

QoQ

3/31/18

Loans receivable--Current

43,613,597

-23%

56,756,803

93%

29,469,103

3%

28,696,234

Loan receivable - noncurrent

29,735,615

82%

16,328,520

100%

-

0%

-

Total loan receivable

73,349,212

0%

73,085,323

148%

29,469,103

3%

28,696,234

Interest receivable

370,397

-59%

913,803

-16%

1,085,739

95%

555,502

Interest income from the quarter

1,054,519

55%

681,599

-9%

749,727

27%

590,122

Estimated quarterly interest rate (*)

1.44%

0.93%

2.54%

2.06%

General and administrative expense for the quarter

3,247,121

45%

2,236,523

-3%

2,313,793

36%

1,697,319

Source: HX quarterly reports

*: Quarterly interest rate = Interest income for the quarter/ the total loan balance receivable at quarter end

I compiled the above table using both quarterly reported information and my calculation, and I have the following observations.

1). The company changed its original plan on this micro lending business. In the 2018 annual report, HX stated that it would provide individual borrowers short -term loans, typically within 12 months terms. The interest rate would be 8% per annum and the maximum loan balance would be 200 million RMB. The loan receivable balance at 6/30/18 and 3/31/2018 roughly reached this balance cap, using the exchange rate of 6.7 approximately, and they were both short term.

However, starting from the second quarter of 2019, it seems that HX expanded to both short term and long term loans and the balance reached 500 million RMB. In the third quarter conference call, HX confirmed that “We will keep our loan balance for the micro lending business on the cap of RMB500 million. ” (The above minor difference in loan receivable balance was merely due to currency fluctuation)

2). Expanding to micro-lending business was not a bad idea, but it comes with higher risk. HX recognized provisions for micro lending in general and administrative expense, which increased significantly in both the first and the third quarter. HX explained that such increase in the first quarter was due to employee and professional expenses, but the increase in the third quarter was due to provisions.

3). Interest income fluctuated in a strange pattern. For the quarter ended on 6/30/18 and 3/31/18, the interest rate earned seemed reasonable, as they were about a quarter of the targeted 8% annum interest rate. However, interest rate sharply dropped to 0.93% in the following quarter and went back up to 1.44% in the third quarter, which was still low. The only reason to explain the 0.93% rate was that all incremental loans over the 6/30/18 balance was made on the last few days of the second quarter. Then it was hard to explain why the rate was still low in the third quarter, since the total balance didn’t change from the second quarter end. Whether short term loans were replaced by long term loans or extended to long term, quarterly interest rate should be larger than 2%, not to mention that long term loans usually bear higher interest rate. Therefore, I can only infer that there were bad loans.

“Others”

There are some “other” items in the financial statements that make people wonder.

1. Other Assets

USD

12/31/18

QoQ

9/30/18

QoQ

6/30/18

QoQ

3/31/18

Receivable, prepayments and other current assets

3,834,212

-81%

20,320,402

99%

10,211,490

718%

1,248,562

Other non current assets

7,272,198

100%

Total other assets

11,106,410

-45%

20,320,402

99%

10,211,490

718%

1,248,562

Other assets increased tremendously this year, and no reason was disclosed in the quarterly reports. As of 3/31/2018, per the annual report, the current balance was mostly rental deposit, prepayment to suppliers and staff advances, nothing too out of ordinary. As for the non current assets, it appeared for the first time on balance sheet. Probably it used to be the current assets and turned into long term in the third quarter. Without clear disclosure, I can’t help wonder, will these other assets turn into expenses or bad debts? Given that their net revenue was only 1.9 million dollars in the past quarter, these other assets were significant items.

2. Other income.

USD

2019 3Q

QoQ

2019 2Q

QoQ

2019 1Q

Other income

1,177,173

94%

608,187

25%

484,977

Net revenue

1,911,225

-29%

3,621,162

-83%

51,651,497

Source: HX quarterly reports

Other income jumped quarter over quarter, especially relative to net revenue. It significantly contributed to the net profit (loss). The so- called “narrowed net loss” would have been larger without this other income. Because other income is usually from non-core operation and not sustainable, the “narrowed net loss” was even less a good news.

Further more, investors need to know what built up the other income. It should not be penalty for late payment or fee for investors transferring their creditor rights, as they were included in the “other” item above the revenue line. The more unknown, the less confidence investors have.

Conclusion:

Hexindai had two rough quarters in a row. It does have improvement, such as cutting cost, expanding funding sources and diversifying businesses. However, it seems that it has a long way to go. It still needs to satisfy regulations, which is high priority, otherwise they might be weeded out due to small business scale. It also needs to revive their P2P lending business by both increasing revenue and cutting cost. Finally, expansion will only work with right executions.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.