Extra Buzz #16: JD Digits Joins the IPO Train
Dear Extra Buzzers,
Hope you’ve had a chance to listen to our most recent podcast episode on Ant Group (fka Ant Financial), Alibaba’s fintech affiliate and poised to be possibly the largest IPO in history. We’d done a previous episode back in 2018 on Ant that was fairly critical -- its spinoff from Alibaba is still considered a blemish in Jack Ma’s legacy, some of its efforts in social networking have been tasteless and ludicrous. However, two years on, we are much more bullish. The transition from payments to multidisciplinary technical platform services provider is well under way and progressing as predicted, no easy feat for such a large company. Today, Ant’s strengths shine through, its trajectory is clear and logical, and its greatest weakness might be that it is altogether too successful, bringing upon itself unwanted scrutiny and worse, regulation. Anyway, it’s our longest scripted episode ever at nearly an hour and we tried to give some different context than what’s typically covered, especially regarding the origins of the Chinese credit system, and the potential for abuse (a well known fact in China that plagues many marketplaces and inflates GMV, sometimes quite substantially). Take a listen and let us know what you think!
It’s also super relevant to the topic of today’s newsletter, which is the upcoming IPO of JD Digits (fka JD Finance). Since unveiling its prospectus last week on 9/11, a flood of analyses have come out dissecting the business, especially since “former competitor” Ant’s mega-IPO is also around the corner. I read these analyses for you and summarize them below, because I was also curious -- what does a “digital finance” business in China look like, without the data input from the vast Alipay payments business? Can it be just as compelling? Or must it evolve into something very different? Please send me your reactions!
Best,
Rui
PS One new thing I'm doing is to follow hyperlinks in Chinese with an asterisk (*) so you can decide for yourself whether or not you want to read the underlying source. English sources will not have an asterisk. Let me know if this makes it easier for you to decide what to click through to!
JD Digits Joins the IPO Train
It’s been known for a while that JD.com’s fintech spinoff, JD Digits (“JDD”), was planning to go public this year in mainland China, and the news was confirmed in early July,* before Ant. The company began independent operations in October 2013 and was originally named JD Finance, the primary goal being to accelerate ecommerce consumption by offering credit and asset management products to both consumers and small businesses. In January 2016, it would raise nearly $1Bn from the likes of Sequoia, Harvest Global and China Taiping Insurance for a post-money valuation of nearly $7Bn, usually referred to as its Series A. Each of its successive three fundraisings would also be in the $B of dollars, the last publicly disclosed amount at nearly $2Bn in 2018. All in all, the company has raised at least $5Bn, and it is looking to raise another $3Bn or so in its upcoming IPO, at an expected valuation of at least $30Bn, at least in part because that’s what parent JD.com paid for this summer in an equity transaction. Richard Liu, by the way, controls 74% of the voting power, and JD.com now owns 37% of JDD after a transaction swapping profit sharing for a pre-negotiated equity stake. All of these are ways in which the analogy JDD : JD :: Ant : Alibaba holds up well.
JDD’s revenue will probably be somewhere north of $3Bn this year. Like many Chinese companies, JDD’s topline growth is robust, although not extraordinary. Revenue growth from 2017 to 18 was 50%, but slowed down to 34% last year, lower than the (more than 6x as big) Ant over the same period. Gross margins have been increasing, to 67%, but profitability is where the two companies really differ. Ant, if you will recall, has reached 30% net margins this year, while JDD dipped into negative income territory after barely reaching profitability the last two years. Its highest net margin was 5% in 2017*.
2017-1H2020 revenue in '00mm RMB for Ant (orange) vs. JDD (blue).
2017-1H2020 profit (loss) in '00mm RMB for Ant (orange) vs. JDD (blue).
But that’s because JDD is fundamentally unlike Ant in many ways. First, it is not branding itself as (just) a fintech company. Yes, like Ant, it has removed the word “financial” from its name in 2018, because grouping oneself with financial institutions is like attaching a bulls-eye to one’s back asking for further regulation. But it’s also because the mission of the company has shifted from its initial pretty exclusively finance focus to be inclusive of other sectors of the “real economy.” In addition to digital finance and digital asset management, JDD also lists intelligent cities, digital agri-husbandry (bringing AI to “animal breeding”, for example) and digital marketing in its suite of services. In marketing pieces, JDD makes sure it’s referred to as the “biggest digital technology IPO,” versus Ant’s “biggests fintech IPO.” It seems obvious that the company both wants to benefit from the momentum and excitement Ant is bringing to the space, but does not want to enable an easy, direct comparison. Why? As we'll see, probably because it’s kind of a hodgepodge of things with no obvious connections to each other.
Just Like Ant ...
JD Finance got its start in 2014 with the JD Baitiao product, which translates into “white strip,” and in accounting refers to unofficial, unreimbursable receipts. Very similar in concept to Ant’s Huabei (a credit card-like product), Baitiao actually launched a full year before Huabei, in February 2014*. It was an obvious market opportunity that everyone was ready to pounce on. In 2013’s China, consumer credit for short-term consumption was just 4% of bank lending, mostly in the form of credit cards that had 18% or higher APRs. Everyone was working on a more competitive product.
However, Ant’s late entrance wasn’t because it was slow to the concept; in fact, Ant had been rumored to be testing the unnamed credit product almost a year earlier in April 2013*. The delay was blamed on the fact that the product alarmed Ant’s many banking partners, with whom they had to work closely for payments. (This was when Ant was still mostly Alipay, and was already pissing off banks with Yu’EBao, its wildly successful money market fund product.) JD, of course, had no such qualms. Yes, it also has its own payment product, and is technically the fourth largest, but its market share (as of 2019) is just 0.7%*, and it will be a hard climb up.
Baitiao, like Huabei, was initially meant to spur consumption on its own platform, and so could only be used on JD.com. You could unlock it after making a minimum of 6 purchases on the platform. You could use it in one of two ways -- a 30-day delay for payment, or pay in installments over 3-12 months, the latter of which was by far the more popular option. Since JD.com sold primarily higher-value consumer electronics, the credit limit was set at 15,000 RMB or roughly $2,000. When your Baitiao payment came due, you could pay it off using your credit card, which gave you almost two months of interest-free consumption. Of course, as a growth hack, JD would heavily promote Baitiao every 618 Shopping Festival, its annual equivalent of Singles Day.
As an aside on just how early the entire personal credit situation is in China, which we covered in our recent episode, I want to alert you to the recent alarm of Chinese citizens when Baitiao began to report its data to the Central Bank last year*. If you listened to our episode, you would know that they were similarly outraged when Ant’s Huabei did the same. This is because banks are also often suspicious of such “microloan” behavior, believing users who resort to them to be short of money, an attitude which will take time to reshape / prove wrong, as digital consumer finance is definitely here to stay. They also often require all debts to be cleared before giving out a large loan, such as a mortgage. And it didn’t help the situation that Baitiao has been accused of reporting the full credit limit* instead of actual spending amount to the Central Bank, making it seem like the user was more indebted than they were and affecting their creditworthiness. As you can see, it will take some time for all the stakeholders to iterate their way to a satisfactory conclusion. The system is being built as we speak.
Finally, while Baitiao was taking a risk on you, the benefits were substantial too. All Baitiao users had to undergo real name verification, and of course you had to link your bank card and thus your bank account directly. This was so much more and higher quality information than JD was used to getting from its users in the past. And Baitiao users would, of course, spend more on JD. By 2015, that amount was about twice as much. That same year, Baitiao would venture beyond the JD platform into the real world in the form of branded credit cards with major banks. It is now available for use in many platforms outside of JD, including offline merchants who accept JD’s payments system. In 1H2020, active users amounted to over 55mm* and revenues were nearly $300mm, or 17% of total revenues. More importantly, Baitiao users had double the retention of JD users who did not use Baitiao, as well as 50% higher order volume, and 80% higher order amounts. The original vision of Baitiao, it seems, has been more than fulfilled.
If Baitiao is JDD’s answer to Ant’s Huabei, then Jintiao (“gold slip”) is the analogue of Jiebei, Ant’s “short-term digital unsecured consumer credit product for larger consumption transactions.” Together with Baitiao, just these two products account for 43% of total revenues. Just like not everyone qualifies for Jiebei, Jintiao requires a Baitiao account and a clean credit history on JD. While certain customers can get up to $34,000, most are only going to qualify for $8,000 or less, and approved amounts on the platforms tend to be similar, although many users report getting a higher limit on JDD. In all other respects of the loan terms -- length of contract (up to twelve months), interest rate, penalty fees -- the two products are virtually identical. Again, traditional banks were grossly undeserving this market -- it is no wonder that Jintiao is growing so quickly. Active users for 1H2020 is 14mm, and total loans outstanding is $38Bn, representing about $2700 borrowed on average and accounting for nearly $400mm in revenue, which is 25% of total. I should note that the pandemic has brought more business but also more risk. As you might expect, 90-day delinquencies were fairly steady at 0.80% for the past three years, but more than doubled in 1H2020. The good news is that they are showing signs of declining again.
… But Also Not Like Ant At All
If we were to stop at 2015, JDD would basically look like Ant’s CreditTech arm, with its own version of Huabei and Jiebei. It wouldn’t be a bad thing -- Ant has managed to transform that into a $8Bn revenue run rate business this year. But that’s when the two companies start to diverge. Recall that Ant has managed to convincingly separate its 4 major business lines into 2 revenue categories: payments (about one-third of revenues) versus the rest (credit, investment, and insurance tech platform services, all fairly intuitive). JDD, however, categorizes its revenue streams by end consumer: 2B, 2F and 2G. 2B, the largest, stands for “selling to businesses (and consumers)” and comprises 52% of revenues, including Baitiao. 2F, or 41%, is “to financial institutions,” which includes Jintiao, and 2G, or 6%, is “to government,” which is really where all that intelligent cities stuff comes in.
In 2015, JDD issued the first consumer finance ABS (asset backed security) on the Shenzhen Stock Exchange. It’s a practice that’s since been copied by internet fintech companies all over China and is in overdrive this year, with nearly $3Bn* of issuances in the first 2 months alone. After ABS, there were ABNs (asset backed medium term notes) and of course there emerged a suite of services to help financial institutions do the same. Last year, JDD launched JT^2, which is a one-stop shop for asset managers to do everything from getting an app up and running to internal risk management. These “2F” services, if we take away Jintiao, is only about 16% of revenues. Not nothing, but a lot less diversified away from its own offerings compared to Ant, who has successfully built platforms around each of its superstar proprietary financial products.
The 2B and largest segment is less dominated by JDD’s own Baitiao product, which is only about one-third of the segment’s revenues, but that might be because it also includes many offerings you might not expect. For example, it includes the entire advertising suite of products, and that’s both online and offline advertising. It also includes “AI services,” which refers to both software as well as physical robots for transportation and logistics. Of course, the agribusiness I mentioned earlier also falls under this category. Saving feed for your pig breeding to the tune of $11 per head? That’s part of JDD’s 2B business as well. (Alibaba does it too, just not Ant.)
Screenshot of JD’s AI pig farming system, which includes porcine facial recognition. (From Kr-Asia.)
Optimistically, you could say that yes, JDD is remaining true to its new name of “Digits,” because it’s not entirely focused on the financial sector. I mean, by sheer volume of product offerings*, it barely looks like a fintech firm. But its revenues are still highly dependent on just two financial products, Baitiao and Jintiao. Both of these are, in turn, highly dependent on parent company JD.com, who contributes 30% of revenues, compared to just 15% for Alibaba to Ant. Sure, it’s no easy feat to have built a $3Bn revenue business with over half the revenues coming from selling software and services to other businesses, but a pessimist would point out that these products are so wide-ranging it’s difficult to see how the same staff could support them all. That’s probably why the R&D expense for JDD is so high -- nearly 16% of revenues, twice that of Ant and second only to domestic chipmaker SMIC on the STAR stock exchange. But then it makes sense -- how can you support so many disparate business lines without devoting 42%* of your employees to R&D? By the way, that is where most of the IPO proceeds will be going.
The industrial internet, as Pony Ma is fond of saying, will be the next big wave in Chinese tech. But is that something JDD, with its fintech roots, going to be able to capitalize on? I’m not convinced. But I suppose it has no other choice, with nemesis Alibaba and ally-and-competitor Tencent in the way. A $30Bn spinoff, though, is a decidedly good first win for Richard Liu, who has JD Logistics and JD Health waiting in the wings. What do you think? Let me know!
PS Now you should be able to answer in the final question I pose in the tweet thread below!
Rui Ma 马睿同学
@ruima
你能人脸识别多少位？How many of these (all male) Chinese tech players can you recognize?
(Also, note the seating order.)
PS It's from a while ago, so before certain folks started publicly going at each others' throats, lol. https://t.co/tBa4pymBap
1:53 PM - 15 Sep 2020