Ant Group & Alibaba – Up from zero.

Ant Group’s digital powerhouse becomes a bank.

• While the original Ant Group proposition was dealt a fatal blow (see here) by the Chinese regulator, Ant Group has been granted a license that will see it become a 50% shareholder in a bank.
• While the value of this to Ant Group is a tiny fraction of the once mooted $300bn, it is more than zero which is what I think the current valuation of Alibaba is assuming.
• The new “bank” is called Chongqing Ant Consumer Finance (CACF) in which Ant will hold a 50% stake with a series of other financial institutions and investors holding the rest.
• The entirety of Ant’s $344bn (RMB2.2tn) consumer loan portfolio (Huabei (credit card) and Jiebei (loans)) will be shifted to this unit which under the new regulation will almost certainly need to raise a lot of capital to back these loans.
• As a bank, the best way to raise capital is to take deposits from consumers but CACF will have great difficulty in doing this meaning that it will need to issue bonds or borrow from the established banks.
• This means that its net interest margin will be a lot lower than that which can be achieved by the state-controlled banks making it much easier for them to compete on price.
• Furthermore, now that this lending business will be split off from Alipay, the intelligence from payment patterns will no longer be available to assess the creditworthiness of applicants.
• Essentially, Ant Group has gone from a deeply threatening digital financial powerhouse to a 50% owner of a commercial bank but critically, this is worth a lot more than zero.
• Given the size and valuation of its competitors, I would estimate that CACF is probably worth around $80bn – $100bn which is worth $45bn to Ant Group and $13.5bn to Alibaba.
• This is positive for both Alibaba and the Chinese banks and I have a position in both.
  • First, Alibaba: where my valuation assumes no value accruing from whatever Ant Group becomes.
  • With Ant Group at zero, I can still get to HKD320 without an enormous amount of difficulty given the outlook for the Chinese economy, Alibaba’s dominance of all things retail, and the very light punishment that was metered out by the competition regulator (see here).
  • Hence, any value salvaged from Ant Group adds upside to the value of Alibaba.
  • Second, Chinese banks: These are the biggest banks in the world by assets, but they are also very slow-moving and state-owned.
  • As digital payments emerged and transformed into lending, the banks have been under enormous threat of being disrupted and gently declining into oblivion.
  • However, now that the regulator has crushed Ant Group and is now turning its attention to Tencent, this threat has been greatly reduced.
  • As a result of this threat the banks have underperformed since 2018 and this has taken their valuations to very low levels.
  • For example, ICBC (1398 HK) trades at 0.5x 2021 price to book value, a 2021 PER of 4.5x and pays a dividend of 6.7%.
  • The dividend yield is a reasonable return on its own but there is also the possibility of a rerating as the digital upstarts are neutered by the regulator and turned into banks.
  • This is further reinforced by the fact that I suspect that the last thing the Chinese government wants is to lose control of consumer banking to the private sector.
• Hence, the Chinese banks have been given plenty of time to copy Ant Group and Tencent which could allow them to rerate somewhat.
• Furthermore, it is becoming clear that there is some value in Ant Group although much less than the market previously expected.
• This is why I own Alibaba and three of the four largest Chinese banks which I think also gives good exposure to the Chinese economy which I see as being in much better than much of the rest of the COVID-ravaged planet.