Why You Should Invest Some ‘Can-Lose’ Money in Chinese Micro-lender Qudian Inc. (NYSE: QD)

Is Qudian Inc. (NYSE: QD) a bottom fishing opportunity, or a falling knife?

In one view, the stock of the October listed, Chinese micro- and online lender is reeling under the weight of adverse regulatory pronouncements, the resultant challenge to its hitherto highly profitable lending model and the prospect of much slower growth in the near future. This is a Chinese company in a new, risky market with ample scope for a sudden economic bust.

On the flipside, Qudian Inc. (NYSE: QD) is a profitable play on a nascent market with huge potential, and may benefit from the shakeout in the industry from recent regulatory restrictions.

What should you do as an investor?

Qudian Inc. (NYSE: QD) Overview

Qudian together with its subsidiaries, operates online consumer finance platforms in the People’s Republic of China. It offers small cash and merchandise credit products, and uses big data enabled technologies such as artificial intelligence and machine learning in its business operations. The company was founded in 2014 and is headquartered in Beijing, China.

In October, it issued 37.5 million American Depository Shares at $ 24 per share, raising $ 900 million. As a result of the offering, the net worth of the company’s the 34-year-old founder and Chief Executive, Min Luo surged past the US $ 1 billion mark.

The company is 11% owned by Ali Baba group affiliate Ant Financial and other Chinese online lenders.

During the third quarter 2017, revenue surged 308% year-on-year to RMB1,451.0 million (US$218.1 million), and the number of active borrowers leapt 174.7% year-on-year to 7.5 million. Sales commission was 20.3% of total revenue, up from 5.2% in the year ago quarter.

The company’s technology backbone allowed it to process 37,682 transactions on average per hour with 12,102 credit drawdowns and 25,583 payments per hour on average.

The company on average lent approximately RMB920 (US$139) for cash credit and RMB1,390 (US$209) for merchandize credit during the quarter, with credit terms being 2.4 months and 8.7 months respectively.

Adjusted net income vaulted by 329.9% to RMB663.3 million (US$99.7 million) from RMB154.3 million in the prior year period.  Basic and diluted adjusted net income per share was RMB9.24 (US$1.39) and RMB2.24 (US$0.34), respectively, compared with basic and diluted adjusted net income per share of RMB1.95 and RMB0.51, respectively, for the third quarter of fiscal 2016.

“The key to our success has been our strong technology and highly competitive operational efficiency,” said Min Luo, Founder, Chairman and Chief Executive Officer in a statement. “We continue to experience high demand from our customers and see exceptional growth opportunities, reflecting our leading market share position in online small consumption credit.”

Qudian Inc. (NYSE: QD) In a Perfect Storm

Investors who were issued shares at $ 24 apiece in the recent public issue of the company were briefly happy when the price touched $ 35. Unfortunately, the good times did not last, and the stock disintegrated under a barrage of bad news thereafter.

A Bloomberg report said last month that Chinese officials were probing allegations that data from more than 1 million students who were clients of the company was leaked and possibly sold online.

This incident is being investigated by law firm Kaplan Fox & Kilsheimer LLP, who claimed that “violations of protecting personal information carries possible penalties including shutdown of websites or cancellation of business licenses under China’s cyber Security Law.”

The stock was dealt another blow when Chinese regulators including the Central bank, directed local governments to cease approving licenses for online micro-loan companies and to disallow lenders from operating outside the province in which they are registered.

The regulatory action stemmed from a slew of factors such as public complaints about very high interest rates, the burgeoning debt levels in the economy and recent financial scandals such as those of Dada Group and Ezubao, which cost investors billions of dollars.

As a consequence of the regulatory blitz, Alipay, a subsidiary of Alibaba (NYSE: BABA), which originates about two thirds of Qudian’s loans, decreed that the online lender charge no more than 24% on loans that were backed with Alipay funding.

This is likely to be a huge earnings setback for Qudian, because it earned as much as 36% interest rate on loans passed through Alipay. Analysts were quick to downgrade and cut the price targets of the stock.

Unsurprisingly, the ADS nosedived from a post-listing high of $35 to $12 on Friday.

At the time of writing today, Qudian is trading at $ 14.33, up 4.98%.

So, the question: Is Qudian a bargain, or a stock to be shunned?

Qudian Inc. (NYSE: QD): The Loss of Earnings May Be Priced In

Granted that Qudian is taking a haircut on its Alipay-originated loans, but looking at it another way, the lower interest rates and better regulation would boost likely loan volumes, compensating for the loss of earnings.

On the other hand, earnings would be supported by the rapid growth in the merchandize sales from its ecommerce platform, as well as the commissions.

Meanwhile, the stock has lost 60% from its high, with the result that its PE ratio has not turned prohibitively expensive due to the Alipay hit.

According to this analysis, based on an estimated EPS of $0.40-$0.60 in 2018, PE ratio at the (then) price of $12 would be in the range of 20-30, which is not bad considering the market opportunity before the company despite regulatory restrictions.

Qudian Inc. (NYSE: QD) Market Opportunity and Plus Points

Here are the factors working in favour of an investment in Qudian:

  • Chinese household debt has risen rapidly, roughly doubling since 2012, according to the Bank for International Settlements, known as the central banks’ central bank.
  • This comes as a new generation of Chinese give up their traditional savings habits and instead take to credit to enhance the quality of life.
  • Smartphones have made it very easy for consumers to borrow cash in China, with e-commerce apps and mobile payment being widely used. According to an analyst this is an addressable market of about 400 million tech savvy millennials.
  • Online platform PPDAI has garnered 9 million borrowers. Qudian reported 7.5 million active borrowers during 3Q 17 – so there’s still a lot of headroom.
  • The current size of the Chinese micro-lending industry is estimated to be about 1 trillion yuan ($ 151.5 billion).
  • According to some estimates, online micro-lending could approach the size of credit cards by 2020, as Chinese rapidly transition from plastic to mobile loans. The online cash loan sector would burgeon to 2.3 trillion yuan by 2020, according to iResearch.
  • Alternative lending in China has reached a take-off point and is already about 85% of the global market size according to a report by the University of Cambridge.
  • There is a huge demand for small-ticket cash loans from individuals that are unable to approach banks and institutions.
  • Good management practices, adherence to screening procedures can make lending highly profitable, given rates of interest chargeable between 24% – 36%.
  • Qudian’s tie-up with Alibaba Group Holding Ltd (NYSE: BABA)’s Ant Financial would enable extensive borrower engagement and healthy risk management. In any case Qudian is also developing other channels and apps that would reduce its dependence on the Ant Financial arrangement.
  • Qudian has announced a share repurchase program worth US$ 100 million comprising its outstanding American Depository Shares. This program will bolster share prices.
  • “We view the company’s laser-like focus on small dollar, short duration loans and its partnership with Ant/Alipay as sustainable competitive advantages that should enable the company to keep its market leadership position and capitalize on the tremendous growth opportunity ahead,” said Stifel analyst John Davis in a recent note.

All these factors point to an excellent investment opportunity in the ADS of Qudian Inc. (NYSE: QD). However, given the increasing wariness of the US investor towards ‘boom-and’bust’ Chinese IPOs, it may be a good idea to invest only a “kiss-it-goodbye” amount. In years to come, however, it may turn out to be a multi-bagger.


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