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CNinsure

|Includes: Fanhua Inc. (FANH)

(June 1, 2011)

1) Board of Directors approved a share repurchase program on Dec 3, 2010

2) As of Dec 31, the company had repurchased 331k ADS, or US 5.6 million

3) On Mar 25, in the conference call after the Datong sales, managements said that it was because of this deal that the company could not execute the repurchase and it would resume the repurchase thereafter. 

4) As of May 23, the date of 1Q11 release, the repurchase was 486k, or US 7.7 million. In the two months between the Datong sales and 1Q release, the company only purchased 155k ADS, or 2.1 million, while average trading volume is about 400k-500k ADS per day. 

The pace of the repurchase is extremely slow and it is almost certain that most of the money won't be used by the expire date.

I cannot figure out why is that. So I decided to sell out and stand in sidelines. 


(May 24 2011)

1) Management, together with CDH and TPG, launched a proposal to take the company private. Offer price is 19 per ADS. 

The officer price is low compared to CISG's potential. Because management is part of the consortium, I don't think the offer price has much room to improve. Also, due to the same reason, I think the due diligence will be fast and the deal might complete within this year. 

I was a bit surprised that stock price stays 10-15% lower than the offer price. Maybe people think that offer price has little to improve while the probability that the deal does not complete is not zero. 

2) The company announced 1Q11 result today. It's not bad, but not great, either. I think it reflects the nature of CISG's business: stable growth. 2Q guidance is set at a 18% net income growth. It is kind of weird for me. Why not give a range? Why supply such a precise number? 

2Q guidance is a bit low to me, though still acceptable. In the conference call thereafter, CEO said that investors should tune down their expectations about the company's operating margin in the coming quarters because more insurance companies ramping up their own tele-marketing business which will squeeze out CISG's business. 

Also, CEO said that expense related to e-commerce would incur mostly in 3Q and 4Q, which means, given current momentum, year on year profit growth rate might slow down dramatically in the second half. 

3) Share-repurchase is very slow. It is very likely that most of the money won't be used before the expire date. This is the only thing that concerns me. Repurchasing the stocks at current price is good for everyone, including management, shareholders, even the coming TPG. Why not pursuing it aggressively?

Conclusion: Sell when price near 19, or for better case

1) Chance is very high that the privatization completed this year, at 19. 
2) Underlying business is good. So that, even the privatization fails, the stock still is attractive. 
3) Low upside potential because of the privatization, but low risk. 

(March 2011)

Key reasons that I believe CISG is real

1) a business model that makes sense 

2) influential position in the industry (can easily verify by reading industry publications, etc)

3) financial results are consistent and make sense

4) high quality institutional investors: CDH is one of Chinese's top VC firms and sticks with CISG since 2005; Fidelity is largest institutional owner

5) high quality independent directors, including former CIRC chairman and at least one trustworthy American businessman. 

6) Management remains largest shareholder and does not cash out much ever since IPO

Acquisition risks 

CISG expands its business mainly through acquisitions, which brings at least two potential risks: 

1) it is hard for outsiders to verify the business of a newly-acquired business. Hence it is possible that the owner of the acquired business may be cooking its book (and cheating CISG's management), or, CISG's management may deliberately pay a high, off-market price, benefiting from some kick-back or un-disclosed ownership. 

2) the growth of CISG's business may be too quick if the company's execution capability cannot keep up with the business, especially a substantial portion new business is from acquisitions. By the end of 2010, the company had 660 sales outlets and 50,000 sales agents across 23 provinces in China. It is possible (even inevitable) that some subsidiaries or sales agents may have some fraudulent activities while  the company might not even notice. 

Business model

More than 80% of CISG's revenue is from independent insurance agency. Less than 20% is from insurance broker, claims service and others. So basically CISG is an insurance agent. Other business units have upside potential if execution is excellent, but downside is limited as long as the company stick to its role as an intermediary with no balance sheet exposure to insurance risk. So we may just analyze its agent business.  

In short, CISG's business approach consists of attracting top sales agents away from insurance companies and preventing them from defecting to other agency companies. 

 

There is a universal principle of 80-20. In insurance industry, 20% of sales agents produce 80% of the business. Every insurance company tries to make those 20% top sales agents very happy. To lure them away, CISG must offer a better payoff as well as a robust supporting system for them to conduct business. It is relatively easy for the first part but not so easy for the second part. 

 

One of the most important methods CISG uses to pay more to the agents is to help them capitalize their gains. CISG sets up JVs with those sales agents so that they can share business profits and CISG promises to buy out their shares at 7x PE or so. It is almost impossible for sales agents to win similar agreements with insurance companies. 

 

To help generate more new business for the agents is at least as important giving more incentives for the same business to the agents. In order to achieve this, CISG invests heavily in support systems, helping those top sales agents to recruit and train new members, and build its reputation. How can we measure CISG's capability to help agents generate more new business? I think that the most important index is CISG's organic growth rate. In 2008, 64% of its growth was organic while 36% was from acquisitions. Unfortunately, it no longer breaks out this number. Since CISG did most of its acquisitions after 2008, my guess is that CISG may score poorly in this regard. But is it likely to have deteriorated enough to void the overall business model? I don't think so. The business model works as long as the total payoff (business incentive x new business) for those top agents is greater than their old payoff. 

 

To prevent top sales agents from defecting to competitors is the other requirement of CISG's business. Economies of scale plays in favor of CISG in this regard. First, CISG is by far the largest insurance intermediary. It has many corporate-to-corporate arrangements with insurance companies while most other competitors who conduct business in certain area can only do business with the local branches of insurance companies. Hence, CISG is able to earn better commission rates, and can roll out business into new areas easily. Also, CISG’s support facilities are highly scalable. 

 

Tailwinds

 

The insurance penetration rate is still quite low in China while premium generated by independent intermediaries is even lower. On top of that, CISG's business is especially useful in the current competitive landscape of China's insurance industry. There wass only one insurance company -  PICC -  two decades ago. Now three players PICC, Ping An and China Pacific dominate the property and casualty industry while China Life and Ping An are quite dominant in life insurance. PICC, China Life and China Pacific are all state-owned enterprises. The whole industry remains heavily regulated. SOEs are not famous for their efficiency and new players have every incentive to increase business before they develop in-house army of sales agents. CISG and other intermediaries can attract top sales agents from dominant SOEs and place more business in favorable rates for new, smaller players.

 

Acquisitions

 

CISG accelerated its pace of acquisitions following its Oct-07 IPO. Its goodwill increased from RMB 9 million in 2007 to RMB 38 million in 2008, RMB 536 million in 2009, and further increased to RMB 1,154 million in 2010. Insurance agency is a capital-light business. The goodwill reflects the high price CISG pays to attract top talent. Insurance agency is not a high-tech business, nor is it subject to technology disruptions. As long as the return from acquisitions is high enough and sustainable, I don't think it is a problem. Furthermore, acquisitions are a good way to build up size quickly, hence increase the leverage of CISG over insurance companies and deter competitors. 

 

How to evaluate its acquisitions? How to judge the sustainability of its acquisitions before the scandal broke out? Besides the undisclosed organic part of its business, I think ROA, Return of Total Assets is the most important indicator. For an outsider, the major concern is that the new acquired business may show good profits in year 1 or year 2, but then collapse in year 3 or 4. If this happens, even a 5x PE acquisition price is way too high. And if it does happen, the company will have to make more new acquisition to cover old failures. 

 

CISG’s ROA is 9.3% in 2007; 9.4% in 2008; 11% in 2009; 10.8% in 2010. So far it is consistent. But four years are still too short to draw a clear conclusion, especially for major acquisitions done since 2009. What we can say safely is that those business acquired in 2009 did not collapse in 2010. But considering most of CISG's acquisitions are in life insurance (CISG was basically a P&C agent company before IPO), which has recurring revenues and rarely show profits in the first several years, I would say that so far CISG's acquisitions are successful. 

 

Valuation

 

On a fully diluted basis, CISG has 52 million ADS. It has USD 290 million cash with no debt (or Net Cash $5.6 per ADS)and earns USD 1.29 per ADS. The company expects to grow net income 20-23% in the first quarter of 2011. 

 

If CISG's number are real, its business model viable and its competitiveness endurable, given its market leading position (NO.1) and growth potential, I would say 20x PE is a reasonable valuation. This would translate to a price of $26 (based on 2010 earnings) or higher. 

 

Current price of $14 per ADS suggests the ex-cash value of the company's business of only 7.4 per ADS, or 6.5x PE. 

 

Conclusion: CISG is a leading company in a fast growing industry, with a solid and conservative balance sheet, enjoying sustainable competitive advantages while trading at very depressed price. 

 



Disclosure: I am long CISG.