Futu Holdings: China's Robinhood Equivalent

Dec. 18, 2020 12:10 AM ETFutu Holdings Limited (FUTU)32 Comments
Eric Weiss profile picture
Eric Weiss
1.6K Followers

Summary

  • Futu Holdings Limited, a Hong Kong-based digital brokerage and wealth management platform, has become the “Robinhood” of China.
  • As of June 2020, China had 167 million retail investors - 12% of the country's total population. They also held a combined 1.3 trillion yuan of stocks, or 28.6% of the total market value.
  • Tencent Holdings is Futu’s largest financial backer.
  • FUTU has maintained strong returns, revenue growth, and technical indicators since it IPO’d.

It is no surprise that the novel coronavirus pandemic has driven an increased dependence on mobile technologies. Of particular note has been the pandemic's impact on the adoption of financial technologies. One of the most interesting micro-trends that has tagged along with the overall macro-trend tailwinds has been the increase in retail investors' participation in capital markets. The coronavirus pandemic has driven market participation by retail investors to all-time highs. Overall market volatility, a decrease in sporting events (and sports betting), stimulus checks, increases in free time and the need for alternative streams of income have all driven this rapid increase in retail participation.

Here, in the United States, Robinhood has become a household name as the go-to brokerage firm for millennial retail investors looking to easily gain access to the capital markets. Abroad, there have been a handful of companies that have enjoyed similar COVID-19 tailwinds.

In China, the Robinhood equivalent is a Hong Kong-based, publicly traded brokerage firm - Futu Holdings Limited (NASDAQ:FUTU). FUTU operates a reliable, commission-free, and user-friendly brokerage platform named Futu NiuNiu (FutuBull). New users can open an account remotely in as little as 3 minutes and begin trading immediately thereafter. Futu also offers wealth management, margin financing, and financial information services. Futu Holdings primarily generates revenue through fees and margin financing. Given its geographic market, combined with its services, backers, and financials, FUTU is primed for continued robust growth over the near-term and long-term future.

China Has Long Been A Leading FinTech Innovator And Adopter

While emerging markets such as China have traditionally been underbanked, as a result, these same markets have, in many ways, led the way in embracing newer and more cutting-edge financial solutions through the adoption of innovative FinTech. While America has spent the past decade or so upgrading its bank-based magnetic stripe cards with chips, China has built a revolutionary financial ecosystem through digital wallets and QR codes.

For years, China has led the world in building a cashless society, both in terms of total users and penetration rates. As of June 2020, more than 765 million people in China completed at least one mobile transaction annually, with 802 million mobile payment users in the entire country. For perspective, that equates to roughly 57% of the country using mobile payments, with roughly 37.1% of these users making at least one mobile payment per day. With only 125.48 million people in China making mobile payments in 2013, the growth to this point has been parabolic and astounding.

Figure 1. Number of mobile payment users in China from 2013 to June 2020 in millions. (Source: Statista)

It is no wonder that China scored 87% in Ernst & Young's 2019 fintech adoption index - nearly 30% higher than the global average of 64%.

China's Retail Investors Are Rapidly Shaping Its Markets

According to data published by China Securities Depository and Clearing, in the first five months of 2020 alone, China added 6.44 million new traders. This exceeds the total population of Singapore and is almost equal to that of Hong Kong. As of June 2020, China had 167 million retail investors - 12% of the country's total population. Retail investors also held a combined 1.3 trillion yuan of stocks, 28.6% of the total market value, while accounting for 70% of stock transactions across China's exchanges. Additionally, according to data from Goldman Sachs, the rise in online trading has caused the daily turnover on China's stock market to exceed $129 billion in 2020 and rise 60% from the five-year average. Other estimates say that retail investors make up more than 80% of the turnover on China's stock exchanges.

As a result of this surge in trading by China's retail investors, online brokerage stocks have become some of China's best-performing stocks for the year. In fact, many of these brokerages now tout valuations in line with some of the best-known banks in the world. East Money, for example, another large Chinese broker, now has a market cap greater than that of Credit Suisse (CS).

FUTU Has The Backing Of An Internet Giant

Chinese internet behemoth, Tencent Holdings (OTCPK:TCEHY), controls a 33% stake in Futu, representing one of the firm's largest bets on the FinTech space. With Tencent's help, Futu Holdings has created arguably the most unique and user-friendly trading experience in the marketplace by implementing a social media aspect to its platform. Futu created a network that connects its users to other investors, companies, analysts, and key opinion leaders. With the backing of a company like Tencent, in combination with trending tailwinds, the potential for Futu to become China's largest mobile and online brokerage is immense.

After Strong Q3 Earnings, Futu Continues To Exceed Expectations

FUTU was already experiencing solid earnings growth prior to the pandemic, and COVID-19 has only accelerated this growth pattern. FUTU has continued to beat revenue estimates every quarter since its IPO and has beaten earnings estimates in each of the last 4 quarters. By Q2 of this year, Futu already exceeded its full-year growth target for total active paying clients. FUTU's Q3 earnings were more impressive, shattering expectations as a result of an influx of Hong Kong IPOs and the continued increase in retail investors.

Revenues for the quarter also rose 272.1% year over year to $122.1 million as a result of a 136.5% growth in total active paying clients, easily beating consensus estimates of $96.73 million. Earnings per ADS were $0.39 per share crushing the consensus estimate of $0.04 per share.

FUTU revenue streams also rocketed upwards with brokerage commission income increasing 356%, interest income rising 140%, and other incomes surging by an eye-popping 555%. Additionally, client assets increased 178%, daily average client assets rose 152%, total trading volume vaulted 381%, daily average revenue trades shot up 273%, and margin financing and securities lending balance increased 171%.

Summarizing The Financials And Valuation Level

While Futu has been scorching hot since it IPO'd in March 2019, with over 400% in gains since March 2020 alone, this is not some speculative Chinese tech stock. There are serious fundamentals behind the returns.

Although Futu is seriously levered, which is concerning at a 537.5% debt-to-equity ratio, Futu appears capable of meeting its short-term obligations with a current ratio of 1.1x. However, unlike many other tech startups, Futu is already a profitable company. Futu boasts a gross profit margin of 83.0% and an ROE of 20.4%.

As far as the company's valuation is concerned, the stock certainly has enjoyed a boisterous hot streak. While a near-term pullback would not be the most surprising thing in the world, considering the stock is trading nearly 20% higher than its 50-day moving average, the firm is profitable and has a strong position in a growing industry. In addition to analyst upgrades and forecasts, Futu's net income is projected to grow by 449.6%. Although Futu's trailing P/E ratio of 52.3x is high, as well as its forward P/E ratio of 55.6x, this just goes to show that investors believe in this company and are willing to pay more of it. FUTU is considerably more overvalued than other American retail brokerages, however, these American competitors are not comparable given China's favorable growth metrics.

For the case of FUTU, I decided to use a residual valuation methodology, an approach used most frequently to value brokerage firms. I like to use this methodology because it is a more conservative approach that accounts for the income a firm is able to generate after accounting for the cost of capital. While this is a strong company, it certainly seems overvalued, and thus, I'd like us to account in some form for the opportunity cost of betting on FUTU to further accelerate, versus putting our cash in another equity. Residual valuation method is also considered a form of absolute valuation versus relative valuation, allowing us to look at FUTU independently of the market as a whole. Lastly, I like residual income for this case as it gives us a better look at true economic profitability versus its accounting probability. For my fair valuation model, I will consider a growth rate of 12% and a cost of equity of 9%. I modeled net incomes of $102.6 million, $134.4 million and $204.1 million from 2020-2022E, respectively, accompanied with returns on equity of 27%, 27.2%, and 30.8%, respectively. This yields a fair value of $38/share, translating to FUTU being roughly 10% overvalued at its current price of $42/share. As a bull case, I would use a relative valuation method and compare FUTU with East Money as the clear market leader in the space. With FUTU currently trading at 53x P/E and East Money trading at 72x P/E, it would imply a bull price target of $57/share for FUTU. Lastly, as a bear case, I will look at a comparative price to book valuation model of its U.S. competitors, Charles Schwab (SCHW), T. Rowe Price (TROW) and TD Ameritrade (AMTD) (before it merged). FUTU's US competitors have price/book values of 3.59x, 4.70x, and 2.26x, respectively, for an average of 3.52x. With a price/book value of 7.54x, FUTU is relatively on par with its Asian competitor East Money (7.23x), but over double its American counterparts. As a bear case, based on a comparative price/book valuation with mature American counterparts, FUTU has a price of $20.49/share.

Bottom line, at the current price point, if you hold FUTU, I would continue to hold. If you do not hold FUTU, I would wait until the price dips down closer to its fair value price. There is certainly a lot to be excited about with FUTU, and I would not necessarily second guess buying at the current price. I think the firm will continue to enjoy favorable growth metrics and deeper market penetration. That said, the market is incredibly frothy right now, and I believe there are a handful of other opportunities that are likely to yield more substantial returns with relatively the same risks.

Risks To Consider

Chinese Government: China's government plays a large role in regulating industrial development. Additionally, China's banks are state owned and heavily regulated. It is worth paying close attention to mainland regulation around both capital investments in foreign securities and remote investing, in general. If the Chinese government begins to see an uptick in cases of overleveraged retail investors (similar to Robinhood), I would not be surprised if they put regulations in place that could hurt FUTU's revenues.

Geopolitical Tensions: Despite the opportunities that China has to offer, there are always geopolitical risks. In fact, it is more likely to continue or worsen - especially with recent news. The Trump administration added China's SMIC (OTCQX:SMICY) and CNOOC (CEO) to the Defense blacklist, President-elect Biden said that he would not ease the Trump tariffs, and the House of Representatives unanimously passed a bill that would mandate Chinese companies to adhere to U.S. auditing standards if they want to be listed on American exchanges.

Accounting Risks: Are Futu's numbers too good to be true? It's possible. Accounting risks and auditing transparency is something investors should always be worried about with Chinese companies. This year alone, two major, publicly traded Chinese companies, TAL Education (TAL) and Luckin Coffee (OTCPK:LKNCY), were caught up in major accounting scandals. Luckin essentially fabricated their entire sales and, as a result, was completely delisted from the NASDAQ.

Key Takeaways For Investors

It is always better to be cautious with Chinese companies. Especially if the stock has overheated and the financials seem a little bit too good to be true. However, FUTU is very unique, and there's a very realistic shot that it goes on to become the largest online brokerage in China. China is simply too large of a FinTech powerhouse, with too large of an active retail investing population (and population as a whole), to simply blow off Futu as the latest Chinese scam. I love its business model, I love the tailwinds, and I hope it pulls back from its current price. With the way that the world is changing, this company has never been more relevant or favorably positioned. The opportunity is seemingly too enticing to pass up altogether, and if the stock pulls back below $38, it may be worth the gamble. That said, keep in mind the risks mentioned above, and ask yourself whether you believe this boom in customers and revenue is simply because of the pandemic. After all, this influx of trading participation could be nothing more than temporary.

Authors Note: Thanks so much for reading! As always, please feel free to message me with any further questions or concerns. If you enjoyed this article, please click the like button right below this note, then scroll back up to the page and give the follow button a click.

This article was written by

Eric Weiss profile picture
1.6K Followers
Analyst at several large banks for my earlier years before switching over to the hedge fund space as a trader. After about 8 years doing that, have been running my own hedge fund for 23 years now. Have done a lot of work with emerging markets as well as event driven investing and bond arbitrage.

Disclosure: I/we have no positions in any stocks mentioned, but may initiate a long position in FUTU over 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.

Additional disclosure: Should FUTU dip into the 30's I would consider a long position.

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