Valuation is reasonable. Governance is not.
- There is no doubt that Ant Group is a powerhouse of digital financial services and while the valuation is reasonable, little if any attention is being paid to the great governance risk being taken by smaller shareholders.
- Ant Group was founded by Jack Ma and from a very strong position in e-commerce payment processing has branched out into a range of other financial services.
- In 2019 Ant Group posted revenues of $17.5bn (RMB120.6bn) of which 43% came from AliPay payment processing with consumer loans making up the bulk of other revenues.
- Investment services and insurance make up the rest of the revenue mix.
- Essentially, AliPay has brought users onto the platform and Ant Group has done an excellent job at leveraging that engagement to cross-sell users other financial products.
- This is why the engine of growth is here where lending increased 87% YoY compared to 17% growth at the core AliPay service.
- Overall growth in revenues in 2019 was 40.7% YoY and I see no reason for this not to continue albeit at increasingly lower rates as the business gets bigger.
- On the RMB120.6bn of revenues, Ant Group made RMB24.1bn in EBIT (19.9% EBIT margin) and RMB18.1bn in net profit (15% net margin).
- However, H1 2020 profitability has improved markedly with a net margin of 29.3% despite more modest YoY revenue growth of 28% YoY.
- This has been largely achieved through slower growth in fixed costs of which marketing had the biggest impact falling 42% YoY despite 40.7% revenue growth.
- Ant Group put this down to reduced advertising as a result of COVID-19, but the timing of the IPO works very nicely as many will base their forward estimates and valuation off this artificially low number.
- Hence, I expect that marketing expenses will rise again which will put pressure on the net margin that the company can earn.
- General and Administrative expenses also fell by 11% YoY to 5% of sales but to be completely fair to Ant Group, 5% of sales is where GNA should be in any well-run technology company.
- Hence, I think that H1 2020 overstates the profitability of the company and that the real figure should be somewhere around a net margin of 25%.
Valuation
- This brings us to the valuation of the company where 2020 and 2021 might see revenue growth of around 40% and net margins of 25%.
- This means that in 2020, net profit could be around RMB42bn ($6.9bn) and in 2021 around RMB60bn ($8.6bn).
- With a market capitalisation of $225bn (mid-point of the mooted range), this means that Ant Group is asking investors to pay 32.6x 2020 earnings and 26.1x 2021.
- By contrast, Visa has a PER of 40x 2020 PER and Mastercard is on 48x 2020 PER.
Corporate governance
- However, one also needs to take corporate governance into account and here Ant Group ends up in the same boat as Baidu and Facebook where one person (Jack Ma) controls the company despite not holding a majority of the economic interest.
- Bloomberg estimates that Jack Ma’s economic exposure to the company is just 11.1% despite having overall control.
- I have long advocated that while these sorts of situations are advantageous in small private companies, they have no place in large public corporations.
- This is because these structures disproportionately punish smaller shareholders for bad decisions over which they have no say.
- What smaller shareholders can do is vote with their feet which is why while these structures are allowed to persist in large public companies, I put a discount to fair value on any company that uses them.
- To compensate smaller investors for the added risk I use a discount of between 10-30% depending on how egregious the breach of fair corporate governance appears to be.
- In this case, with one shareholder holding an 11.1% stake and controlling the whole company, I think the full 30% discount is warranted.
- As usual, no-one is going to take any notice of this until it becomes a problem and when it becomes a major issue, the share price will have already collapsed and it will be too late.
Take-Home Message
- Ant Group is doing extremely well in China and there is no reason why this should not continue, but I suspect the geopolitical tension is going to clip its wings overseas.
- Consequently, I think that the assessment of Ant Group should be made on this basis which is by and large what I have done above.
- On the current numbers, the valuation is not unreasonable given its growth rate and medium-term trajectory.
- However, I do not think that the valuation incorporates the corporate governance risk that is being taken by smaller shareholders when they buy the shares.
- Hence, shareholders will need to be clairvoyant and get out before Jack Ma makes a decision for the company to the detriment of smaller shareholders.
- He has done it before (in 2011 when AliPay was spun out from Alibaba) and it is quite possible he will do so again.
- The valuation is acceptable, but investors need to be very aware of the extra risk they are running.
