Is Ant an overvalued giant?

Such severe restrictions imposed on investors are rare; restrictions are usually imposed instead by investors to safeguard their investments. At most, some companies may impose minimum holding periods. But in Ant’s case, the restrictions attempt to limit potential investors’ investments in other online players. Even then, not all are Ant’s competitors, except for Tencent, whose WeChat Pay is a major rival to Ant’s Alipay payments system. The rest are e-commerce competitors to Alibaba, Ant’s parent.

With such severe restrictions in place, investors must be expecting Ant to be worth several times more than its current US$150 billion valuation. Can this be possible?

Ant offers online payments, consumer loans and asset management services in China, with 622 million Alipay users. Its wealth management business has US$356 billion in assets under management, of which three-quarters are under Yu’e Bao, a money market fund that allows Alipay users to stash their idle cash. It also offers small consumer loans via its Huabei and Jiebei units. It is also expanding to India and Thailand.

Ant is, no doubt, a giant, and will continue to grow, but is it overvalued?

Ant made an estimated pre-tax profit of US$890 million in 2017. In terms of valuation at US$150 billion, it will be slightly smaller than Bank of China, which has a market capitalisation of US$174 billion and a pre-tax profit of US$32 billion; and Citigroup (market cap of US$178 billion and pre-tax profit of US$22 billion). It will also be about three-quarters the size of HSBC Holdings (market cap of US$199 billion and pre-tax profit of US$21 billion) and about half that of Industrial and Commercial Bank of China (ICBC), China’s and the world’s largest bank (market cap of US$329 billion and pre-tax profit of US$54 billion).

In other words, Ant’s valuation is equivalent to major global banking groups, which make about 20 times more in profits (see Table 1).

Many would argue that Ant will become the financial equivalent of Amazon.com. However, there are limits to growth in the financial sector, which is tightly regulated, unlike the retail and other sectors. There are limits to the ability to disrupt existing business models if Ant tries to encroach more into the space of traditional banks, which are highly regulated and capitalised, and largely state-owned in China.

Indeed, Ant is already coming under increased regulatory scrutiny. According to reports, regulators are mulling new rules that may force companies involved in at least two financial sectors to obtain licences from China’s central bank and maintain minimum capital requirements. To manage liquidity risks, Ant has announced steps to reduce by 75% the daily transfer withdrawal limit for its Yu’e Bao fund from June. Last year, it limited the size of the fund by imposing a ceiling of RMB100,000 ($21,057) per individual, down from RMB1 million. China’s central bank has also reduced the quota for the sale of asset-backed securities to fund Ant’s consumer loans.

If Ant were to encroach into the space of traditional banks, it would be subject to more stringent rules and capital requirements. That will surely alter its return on equity and growth prospects — and value it closer to banks. Moreover, if Ant is expected to disrupt existing business models, then surely, banks must be severely affected. But this is not apparent in most analysts’ expectations of bank earnings, or their positive views on banking stocks.

These concerns aside, what are investors expecting of Ant quantitatively at US$150 billion?

Predicting earnings for “new economy” companies is an impossible science. Instead, we will evaluate what the current valuation implies for investors in terms of future earnings expectation. In other words, how much will Ant’s earnings have to grow to support this valuation, with the stream of earnings discounted back to present value?

Our model assumes the US$150 billion valuation is the present value of a stream of net earnings over the next 20 years. We have used three different discount rates — of 6%, 8% and 10% — to find the required compound annual growth rate (CAGR) and earnings to support this valuation. One could argue that this may not be the best valuation method since Ant is an ongoing entity. However, this is the same rationale behind according a stock a price-to-earnings multiple of, say, 20 times — it tells you how many years in terms of payback even if earnings stay constant.

The results are in Table 2:

• Scenario 1: With a discount rate of 10%, earnings would have to grow by a CAGR of 31.5%, with pre-tax profit climbing from US$890 million to US$212.8 billion by Year 20.
• Scenario 2: With a discount rate of 8%, earnings would have to grow by a CAGR of 29.1%, with pre-tax profit reaching US$147.2 billion by Year 20.
• Scenario 3: With a discount rate of 6%, earnings would have to grow by a CAGR of 26.7%, with pre-tax profit reaching US$101.2 billion by Year 20.

• The other question is, of course, even if Ant can achieve these numbers in the future, what do they mean today? One way would be to use figures adjusted for inflation, which runs at 2% to 3% a year in China, to adjust back to today’s value. To be conservative, we will use the same 6% discount factor to adjust future values back to present value. Using this, we arrive at the following:
• Scenario 1: Future value: US$212.8 billion; present value US$66.4 billion;
• Scenario 2: Future value: US$147.2 billion; present value US$45.9 billion; and
• Scenario 3: Future value: US$101.2 billion; present value US$31.6 billion.

How do these numbers look in perspective? Under Scenario 1, the present value pre-tax profit of US$66.4 billion would be JPMorgan plus Bank of America combined. Or HSBC plus Bank of China plus Goldman Sachs combined. It will also be 1.2 times that of ICBC.

Even under Scenario 3, the present value pre-tax profit of US$31.6 billion would be the equivalent of Bank of China, JPMorgan or Bank of America; or two-thirds of ICBC, or 1.5 times HSBC.

Can Ant become the size of these global banking giants combined, or even bigger than the world’s biggest bank? We cannot say it is not possible, but it will be very difficult, given the regulatory and capital constraints.

This is just to give a perspective of what it means for Ant to be valued at US$150 billion. However, investors at this stage will surely want a much higher return on their investment in the future, perhaps a multiple of three to five times? Can a valuation of US$450 billion to US$750 billion be possible? And if one invests in Ant, one will have to miss the opportunity to invest in other key Chinese online players.

Finally, the total financial services simply cannot grow so fast. Thus, investors should either (1) invest in Ant and sell the other financial stocks, or (2) invest in other financial stocks and give Ant a miss. The reality is either one or the other is undervalued; it cannot be both.

Tong Kooi Ong is chairman of The Edge Media Group, which owns The Edge Singapore

Disclaimer: This is a personal portfolio for information purposes only and does not constitute a recommendation or solicitation or expression of views to influence readers to buy/sell stocks, including the particular stocks mentioned herein. It does not take into account an individual investor’s particular financial situation, investment objectives, investment horizon, risk profile and/or risk preference. Our shareholders, directors and employees may have positions in or may be materially interested in any of the stocks. We may also have or have had dealings with or may provide or have provided content services to the companies mentioned in the reports.