Futu Holdings Ltd., a Hong Kong–based online brokerage that is backed by Chinese internet giant Tencent Holdings Ltd., is expected to be one of the first big Asian initial public offerings of 2019.
The company filed for an IPO in late December with the stated aim of raising up to $300 million and listing on the Nasdaq exchange under the ticker symbol “FHL.”
Goldman Sachs, UBS and Credit Suisse are underwriters on the deal. Proceeds will be used for general corporate purposes, including research and development, to fund working capital and to cover increased regulatory capital requirements in Hong Kong and other jurisdictions, according to the preliminary prospectus.
Futu has enjoyed strong growth in recent years, growing its staff to 561 employees at the end of September. It has close ties to Tencent
: Chief Executive Leaf Hua Li, Futu’s founder, was the 18th founding employee of Tencent, while Chief Technology Officer Ppchen Weihua Chen was a senior technology expert at Tencent. The company had revenue of HK$584 million ($74.6 million) in the nine months ending in September, up from HK$178 million in the year-earlier period. It posted its first profit, of HK$100 million, for the period, after a loss of HK$38 million in the year-earlier period.
The company generates revenue in the form of commissions and handling charges from its online brokerage, and interest income from its margin financing and securities lending services, interest income from bank deposits and interest income from IPO financing, where it arranges the financing for clients. The company is benefiting from the emergence of a mass affluent class in China that has driven strong demand for wealth-management services.
The U.S. market was popular with Chinese companies in 2018, when 32 of them listed, the highest number in nine years, according to Kathleen Smith, a principal at Renaissance Capital, a provider of IPO exchange-traded funds. Many turned to the U.S. because their home stock market was faring badly, she said. The Shanghai Composite ended the year down about 25%, its worst annual performance since 2008, the peak of the financial crisis. The Shenzhen Composite fell 33%, and the Hang Seng declined about 14%.
But the average return for the 32 U.S.-listed companies was negative 12%, underperforming the broader IPO market, which was showing a negative return of 1.9%.
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“This poor relative performance of Chinese IPOs in the U.S. market in 2018 and weak performance of brokerage stocks in general could make investors valuation sensitive about the Futu IPO,” said Smith. “However, investors will likely be interested in the Futu IPO because of the extraordinary growth in its business and its profitability.”
Since it was launched in 2012, Futu has grown its user base to 5.3 million and boasts more than 457,000 registered clients, defined as users who have opened trading accounts, and more than 124,000 paying clients, defined as clients with assets in their trading accounts. The company allows mainland China investors to trade stocks in Hong Kong and the U.S.
In the first six months of 2018, the company brokered HK$478.2 billion in client trades, according to its prospectus.
The company’s platform, called FutuNiuNiu, can be accessed on a mobile device such as a smartphone, tablet or desktop computer and offers news, data, research and analytical tools and social media.
Here are 5 things to know about Futu ahead of its IPO:
It has a young and loyal customer base
Futu says its average client is 34 years old and is typically a high earner, with 45% working in the IT, internet and financial services fields. Since the beginning of 2017, it has retained about 97% of its paying client base, according to its prospectus.
Futu designed its platform with the aim of allowing access to low-cost investment for everyone, including customers with little or no market experience. Its commission rates are about one-fifth of the average rate offered by the leading players in Hong Kong, according to its prospectus, citing an industry report that it commissioned from Oliver Wyman Consulting (Shanghai) Ltd. That same report found that Hong Kong is the world’s fourth biggest online securities market, with annual trading volume growing to $1.6 trillion in 2017 from $404.5 billion in 2012, equal to a compound annual growth rate of 31.3%. The market is expected to grow to $3.1 trillion by 2022.
The company is expecting to benefit from China-based investors deploying more of their overseas investable assets in online securities trading, especially in Hong Kong and the U.S. The market for overseas online retail securities reached $297.5 billion in 2017, according to Oliver Wyman. It’s expected to grow to nearly $1.4 trillion by 2022, equal to a CAGR of 35% from 2017 to 2022.
It’s operating in a market that is still evolving — with an uncertain regulatory outlook
The Hong Kong online-based brokerage service industry is in the early stages of development, and regulations and other requirements are still in flux and may change over time.
“We are subject to extensive and evolving regulatory requirements in Hong Kong, noncompliance with which, may result in penalties, limitations and prohibitions on our future business activities or suspension or revocation of our licenses and trading rights, and consequently may materially and adversely affect our business, financial condition, operations and prospects,” reads the IPO prospectus. “In addition, we are involved in ongoing inquiries and investigations by the HK SFC.”
The investigations in question related to anti-money-laundering laws, practices relating to protection of client assets and handling and monitoring of client orders and trading. The company is also involved in regulatory inquiries relating to client onboarding, and it concedes that it does not strictly follow the steps set out by the Hong Kong authorities when dealing with clients from mainland China.
“If our online account opening procedures are deemed to be not in compliance with the applicable laws, regulations, guidelines, circulars and other regulatory guidance, we may be subject to regulatory actions, which may include, among other things, reprimands, fines, remediation, limitations or prohibitions on our future business activities and/or suspension or revocation of Futu International Hong Kong’s licenses and trading rights,” says the prospectus.
It has a risky corporate structure that is typical of Chinese IPOs
Like other Chinese companies with listings outside of China, such as Alibaba Group Holding Ltd., Futu is a variable-interest entity, or VIE, a structure created in the 1990s as a workaround for Chinese companies not allowed to have direct foreign ownership.
Under the VIE structure, the Chinese company creates two entities, one in China that holds the permits and licenses needed to do business there and the other an offshore entity, in this case in the Cayman Islands, in which foreign investors can buy shares. The Chinese entity, which is usually owned by top executives, pays fees and royalties to the offshore company in contractual arrangements. The risk is that foreign investors don’t actually own stock in the company, and local management or even the Chinese government could force a split with the listed company, leaving U.S. investors high and dry.
“You may face difficulties in protecting your interests, and your ability to protect your rights through U.S. courts may be limited, because we are incorporated under Cayman Islands law,” the prospectus cautions.
It’s not planning to pay dividends any time soon
Like many newly listed companies, Futu is not planning to pay dividends for the foreseeable future. That means shareholders will have to count on share-price gains for returns.
It’s exempt from certain disclosures
Futu has applied to list as an emerging-growth company, a category that exempts it from the full disclosures required of big public companies. But it has its accounting challenges and has already identified a material weakness in its internal controls dating back to 2017 and acknowledges that, as a private company, it did not have the accounting expertise and resources needed to address the issue.
“If we fail to establish and maintain adequate internal controls, we could suffer material misstatements in our financial statements and fail to meet our reporting obligations, which would likely cause investors to lose confidence in our reported financial information. This could limit our access to capital markets, adversely affect our results of operations and lead to a decline in the trading price of the ADSs,” says the prospectus.
The Renaissance IPO ETF
was up 3.5% Friday and has fallen 17% in the last 12 months, while the S&P 500
has fallen 8% and the Dow Jones Industrial Average has fallen 7%.
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