This will never work (Vol 1, No 21)
“After a remarkable four-year journey of careful deliberation, HKEX’s new listing regime is finally open for business. We are now at the dawn of an exciting new era for Hong Kong’s capital markets,” said HKEX Chief Executive Charles Li.
What Chief Executive of HKEX was referring to was the introduction of weighted voting rights structure, the listing of biotech companies that don’t meet the Main Board’s financial eligibility tests and new concessionary secondary listing routes for Greater China and international companies.
As Kevin Costner heard in Field of Dreams, “If you build it, they will come”.
Sure enough, there’s lots of excitement that a bunch of high-tech unicorns are now stampeding to list in Hong Kong.
Among these mythical creatures is the Peer-to-Peer Lenders. On the surface, there is a certain logic to it. Make use of the internet to connect the providers and users of capital. Sounds exciting, right?
or Rainbow Dashed?
The funny thing is that the US leader in P2P lending has struggled mightily since the sixth day of its listing.
The P2P theme was really hot back in 2014. In December 2014, Lending Club raised nearly US$900mn and on the first day of listing, it surged 56%. It rose for another five days and hit an intra-day high of US$29.29 on December 18, 2014. The current share price of US$3.37 is down 89% of all time high and puts its market captialisation at US$1.41bn. Still a unicorn, I guess.
How do P2P Lenders make money?
As and when the Chinese P2P lenders come to market, they will certainly make a case that “it’s different in China, we’ve got 1.3bn borrowers and 1.3bn lenders”.
Maybe so, but let’s have a look at the “control group” first. Later, we can see if the China variable can materially improve the economics of the P2P-lending business model.
In 2017, Lending Club’s net revenues was US$575mn, up 15% y/y. Of this, three-quarters came from transaction fees and 14% came from investor fees.
But what are transaction fees?
“Transaction fees are fees paid by issuing banks or education and patient service providers to [the P2P platform] for the work [they] perform through [their] lending marketplace’s role in facilitating the origination of loans by [their] issuing bank partners”.
Ok, quite a mouthful but it seems to be a fee for passing loan demand to issuing banks. Expressed as a percentage of loans originated, the transaction fee seems to be around 5%.
But hang on, one of the other key metrics that Lending Club monitors is Customer Acquisition Costs as percent of loan origination. This is basically its sales and marketing expense. If one were to net off these two, then the net transaction fee earned has been hovering around 2.4% over the past three years.
So P2P lenders earn money by generating loans and then passing them over to the banks and taking roughly a 2.4% cut.
What are Investor fee?
But there is also an investor fee too. These seem to be service fees earned from investors who provide their capital to fund some of the loans. If expressed against the US$11.9bn of loans serviced on Lending Club’s platform, the investor fee works out to around 0.73%.
Okay, my head is starting to hurt but I think I still got this.
P2P lenders earn a fee based on the amount of loans originated and also from the amount of loans that it helps to service. So it seems that as long as the amount flowing through the pipes is increasing, the business should thrive, right?
Well, yes and no.
Over the past five years, the transaction and investor fee revenues (we are ignoring fair value changes and other one-off gains/losses) has grown more than five fold.
The trouble is that the higher volumes have not resulted in higher operating margins. For 2016 and 2017, even ignoring one-off expenses like goodwill impairment and litigation costs, operating income margins (after general and admin expenses and engineering and product development) were still -23% and -13%.
Let’s see how “We-” can tweak this equation
Maybe I’m missing something but can someone explain why investors are holding their breaths for the listing of Chinese P2P lenders.
If we use the US P2P leader as a control subject, to make the Chinese equation work, you will need the following:
- Loan origination in excess of US$9.0bn a year
- Loan servicing in excess of US$11.9bn a year
- Net transaction fee on loan origination in excess of 2.4% a year
- Investor fee in excess of 0.73%; and/or
- Overheads (i.e. SGA and product development) that is less than 58% of revenues.
Or failing that, just make sure you include “We-” in your name, then none of the financials matter.
The Kinki is very fresh indeed.