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The Ant IPO: Why it failed, and why it matters

Duncan Lam


Introduction

As October drew to a close, the financial world was in a frenzy as Ant Group prepared to raise USD$34.4 billion in what would have been the largest IPO in history, easily surpassing the previous record of $29.4 billion raised by Saudi Aramco last December. [1]. With Ant looking to sell 11% of its total shares, the IPO was expected to value the company at a remarkable $312 billion in the world’s first simultaneous listing on the Hong Kong and Shanghai markets [2]. Investors rushed to secure a share of the world’s most valuable FinTech company, with the Shanghai side of the deal drawing more than $2.8 trillion in bids from retail investors [3], a ludicrously high oversubscription of 872 times [4]. In fact, underwriters were even preparing to exercise an option to sell additional shares that could have brought the total funds raised to $39.6 billion [5]. The whole world watched with bated breath – but just 2 days before the planned launch date of 5 November, the IPO was suddenly called off by the Chinese government.


In an unprecedented move, the Shanghai stock exchange announced that it had suspended the IPO following the intervention of Chinese regulators, citing “significant issues such as the changes of the financial technology regulatory environment” and explaining that “these issues may result in the company not meeting the conditions for listing or meeting the information disclosure requirements.” [6]. In fact, it was reportedly Chinese president Xi Jinping’s personal decision to suspend the IPO, ordering regulators to summon and interrogate Alibaba founder Jack Ma [7]. Ant consequently suspended its listing on the Hong Kong market as well, putting a premature end to the IPO before it even began. As a result, Alibaba’s shares plunged 8.1% in New York on the day of the suspension, its biggest drop in nearly 6 years, while its Hong Kong listed shares fell by 9.6% the next day, causing its valuation to drop by a whopping $76 billion [8]. Nearly a month has passed since then, and while Alibaba’s shares have recovered to some extent, they still remain about 10% below its pre-suspension prices on both the Hong Kong and US markets. However, to fully comprehend the implications of the suspension and the underlying reasons that caused it, we need to fundamentally examine Ant’s identity as a FinTech company by looking into its past and identifying its key revenue drivers.



Graph 1: Alibaba’s share price following the suspension of the IPO [28]


What is Ant?

In 2004, Ant Group was officially founded under the moniker Alipay, a 3rd party online payment tool created by Alibaba that acted as an escrow service to connect buyers and sellers on its digital marketplace Taobao, in response to eBay entering the Chinese market [9]. It quickly grew into the dominant digital payment platform in China, and now has over 1 billion active users annually and over 80 million active merchants monthly, with its total annual digital payment volume exceeding $17.9 trillion [10]. Alipay was spun off from Alibaba in 2011 and rebranded as Ant Financial Services Group in 2014 [11], with Alibaba acquiring a 33% stake in Ant in 2018 [12].


However, Alipay’s market share has been gradually eroded by Tencent’s WeChat, its fiercest competitor in the digital payment market. In the first half of 2020, Tenpay, which owns WeChat Pay and QQ Wallet, occupied 38.8% of the Chinese mobile payment market while Alipay occupied 55.4% [13], a clear paradigm shift from 2015 when it occupied more than three-quarters of the market [26].


Graph 2: The Chinese Mobile Payment Market, 2014-2016 [26]


Graph 3: The Chinese Mobile Payment Market, 2019-2020 [29]


Ant’s transition into a FinTech company

Although Alipay has experienced a stable increase in market share over the last five quarters, Chinese consumers are increasingly favouring WeChat Pay for retail payments. In fact, WeChat Pay amassed over 800 million monthly active users in the fourth quarter of 2019 [30], even exceeding Alipay’s total of 711 million [10]. Indeed, Alipay’s continued dominance of the mobile payment market can mostly be attributed to its earlier introduction in 2004, a full nine years before Tenpay. Conversely, WeChat Pay’s surge in popularity likely stems from its seamless integration within the WeChat app, China’s largest social media platform. WeChat Pay comes pre-installed as part of the WeChat app on the majority of smartphones in China, allowing users to access a plethora of complementary services. In 2018, Walmart stores in Western China even replaced Alipay with WeChat Pay, explaining that “WeChat Pay is widely accepted and trusted in China”, exemplifying the sheer influence that WeChat possesses in the region [31]. Additionally, the Chinese government implemented new regulations requiring Alipay to deposit their funds in a low-interest custodial account, preventing them from reinvesting funds in idle accounts for capital usage [14].


As a result, Ant diversified their services, and has instead reclassified themselves as a FinTech company rather than a financial services company, encapsulated by its decision to drop the “Financial” from its name and officially rename as Ant Group in May this year [15]. With the tightening of financial regulations in Beijing, which will be explored in more detail later in the article, Ant has attempted to reduce its reliance on its own financial products, instead opting to offer payment gateways and sell digital infrastructure to financial institutions rather than competing with them. This is exemplified by the decreasing importance of digital payments as a revenue driver for Ant. Digital payment was Ant’s major source of revenue between 2017 and 2018, but only constituted 36% of total revenue in the first half of 2020 [16]. Conversely, Ant’s digital finance technology platforms (CreditTech, InvestmentTech and InsureTech) contributed to 63% of Ant’s revenue in the same time period, up from 44.3% in 2017 [16]. Since 2019, these platforms have formed the bulk of Ant’s revenue by charging commercial partners such as banks, insurers and fund managers termly fees. In June, Ant CEO Hu Xiaoming even claimed that he expected technology service fees to constitute 80% of Ant’s revenue within the next 5 years while also anticipating the revenue share of its pure financial services to decrease as a result [23].

Graph 4: Ant’s revenue drivers in the first half of 2020 [17]


CreditTech is Ant’s consumer credit business, comprising Huabei and Jiebei. The former functions similarly to a virtual credit card, while the latter is a short-term consumer loan provider that helps finance a variety of big-ticket purchases [18]. It is currently Ant’s largest revenue driver, with total lending balance amounting to 2.1 trillion RMB at the end of June. InvestmentTech is Ant’s wealth management arm, facilitating a whopping 4.1 trillion RMB in investments as of June through its flagship money market fund Yu’ebao [16]. Ant’s smallest revenue driver is InsureTech, Ant’s insurance range. These three FinTech units propelled Ant to earn 18 billion RMB in net profit on 120.6 billion RMB in revenue last year, and is expected to easily surpass that figure this year, having already generated 72.5 billion RMB in revenue while remarkably retaining 21.9 billion RMB as net profit [10].



Graph 5: Ant Group’s revenue breakdown from 2017-2020 [19]


Ultimately, it is clear that Ant’s transformation from a mere provider of consumer loans to the largest unicorn company in the world was supposed to herald a new age of FinTech solutions for China, while also re-establishing investor confidence in Hong Kong following the civil unrest it experienced last year due to Beijing’s introduction of new security laws. This was supposed to be China’s opportunity to demonstrate that it had the capability to rely on fully intrinsic financial services, with minimal reliance on the US capital markets for financing. With the Trump administration’s belligerent approach to international relationships and their commitment to waging trade wars with China, China has risen to prominence as a global technological superpower driven by its strong emphasis on domestic manufacturing. Hence, this IPO seemed like the perfect way to showcase China’s development via unique and homegrown technology. We have now returned to the question at hand: Why did China suspend the IPO?


Reasons for IPO suspension

Unsurprisingly to some, the writing may have been on the wall for some time prior. At a summit in Shanghai on 24 October. Jack Ma slammed traditional financial institutions, claiming that the regulatory system was “stifling innovation and must be reformed to fuel growth” [20], even calling banks “pawn shops” [17]. He also argued that China desperately needed new and ambitious entrants who could extend credit to those with low collateral [19]. This tirade was apparently the catalyst that ultimately led to the demise of the Ant IPO, leading state regulators to compile reports on Ant to be submitted to President Xi – including one on how Ant had used Huabei to encourage young and poor people to accumulate debt [20]. Regardless, the suspension was a clear display of power by the Chinese government, seemingly reminding Ma, and the world watching, that they were in charge and they would not tolerate misbehaviour. However, it is likely that the suspension was primarily driven by factors that are less politically charged, which we will delve into now.


Recently, Chinese regulators have become concerned with the rise of FinTech companies like Ant Group that provide bank-like services despite not being a bank [6]. In 2018, the Chinese central bank identified Ant as a risky financial holding company, putting them under increased scrutiny due to their growing role in China’s money flows and financial plumbing [29]. It is arguable that despite Ant’s claims of being a FinTech company, its operations closely resemble that of a bank, receiving deposits and issuing loans with the pooled money. Thus, it is easy to see why regulators were concerned, given that while Ant operated like a typical bank, it was attempting to flout the standards required of one by declaring itself a FinTech company, essentially allowing it to charge higher fees for transactions while state-run banks absorbed most of the risk. For instance, Ant has much lower capitalisation compared to its banking counterparts with a capital ratio of below 3%, well below the China average of 8% and dramatically lower than the 12% to 15% that most financial institutions adhere to globally [21]. Furthermore, Ant uses a private credit scoring system, Sesame Credit, that is unverified by external parties and has not undergone stress tests, meaning that the capabilities of its complex algorithm are otherwise unknown.


To provide some context, the 2008 financial crisis resulted in unprecedented losses for banks across the globe, causing robust credit score models and strict capital risk criteria to be erected as defence mechanisms to prevent a similar occurrence in the near future. The Dodd-Frank Act was enacted in 2010 to protect consumers from the risks exacted by financial institutions by regulating credit cards and loans, establishing credit rating agencies and ensuring the financial stability of large firms [32]. Nuno Fernandes, professor of finance at the IESE Business School, had this to say about Ant: “The lack of capital buffers, or at a minimum the inability to see those buffers from the outside, is unacceptable in a multibillion-dollar balance sheet.” [21].


The suspension coincides with the new draft rules for online microfinance businesses issued by China’s Banking and Insurance Regulatory Commission on 2 November, which included higher capital requirements for loans and tightened lending controls [22]. Perhaps the most damning indictment of Ant was that its decision was to rush an IPO to cash out at its peak before the new regulations kicked in, which would have required Ant to fund 30% of their own loans. That figure currently stands at 2% [24]. This would have serious ramifications for the structure of its lending business and its balance sheet, which in turn would reduce its earnings and potential valuation. Furthermore, this also directly contradicts the Dodd-Frank Act, which requires issuers of securities to retain at least 5% of the risk associated with the relevant loans [32]. This therefore suggests that Ant has shifted almost all its risk to its borrowers and the 100 odd banks that underwrite their loans [33], and it is thus not surprising that they have attracted the ire of the Chinese government.


These regulations would prove particularly painful for Ant, given that lending has become their largest driver of revenue, underwriting about $253 billion in consumer loans and $64 billion in small business loans in the first half of 2020, with CreditTech revenue up by 59% [17]. Jefferies Financial Group estimates that it would have to set aside an additional $14.4 billion in capital to comply with the new regulations, which is 2.7 times the current capital for its two microfinance lending divisions – quite a substantial sum by all financial metrics [24]. In fact, considering that the IPO was supposed to raise about $34 billion, that figure suddenly represents a major obstacle that Ant must overcome, shedding light onto why Ma had so fervently pushed for the deal to happen. It thus becomes clear why the intervention was most likely needed: to protect the thousands of retail and institutional investors from billions of dollars of losses when the new regulations are implemented along with the inevitable fall in Ant’s share price. In fact, George Calhoun, Founder & Director of the Quantitative Finance Program and Hanlon Financial Systems Centre at the Stevens Institute of Technology (New Jersey) believes that Ant has accumulated a dangerous amount of systemic financial risk and is creating the conditions for a potential repeat of the sub-prime credit crisis that triggered the global recession in 2008 [34].


What does the future hold for Ant?

One month later, the outrage following the suspension of the deal has nearly dissipated, with the financial world watching on earnestly to determine the ramifications on consumers and firms alike. However, Alibaba is now expected to face a slew of lawsuits, with some investors claiming that Alibaba had allegedly made misleading statements to investors by failing to disclose that Ant Group did not meet the listing requirements [27]. At this point, it is hard to envision the IPO happening in the next year, with the new financial regulations and China’s willingness to take action against any firm that dares to challenge its rule. Ant will likely focus on ensuring they comply with the tightened lending restrictions to maintain their position as the dominant force Chinese digital payment market. However, it is also unlikely that the IPO will be permanently suspended, given its reputation among investors, huge market share and consistent growth trajectory.


Unfortunately for Ant, it must find some way to finance its capital and adjust its business model to suit the new regulations. There is a very real possibility that Ant will have to dig deep into their reserves to fund their loans, which would substantially harm their proposed valuation. Add this to the fact that investors will have lower expectations for the second IPO and we reach the conclusion that it is likely that the terms of the deal will look extremely different. Nevertheless, Ant still remains the most valuable FinTech company in the world and the new regulations by no means signal the end to Ant’s reign in China. I fully expect them to continue their diversification and eagerly await whatever new innovative product they unveil next. Given Jack Ma’s bullish nature towards the Chinese government, I have full confidence that Ant will continue forging their own path, regardless of outside influence, but only time will tell whether Ant will ever be free of the shackles of the Chinese Communist Party.


References

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