UP Fintech: Strong Revenue Growth, But There Is A Devil In The Details
- TIGR’s Australian operation is projected to face a steep challenge in customer acquisition.
- Execution and Clearing Cost as a percentage of commission increase despite progress being made in self-clearing.
- Marketing and Branding Costs as a percentage of commission revenue doubled.
- Financial modelling projected a huge upside for TIGR’s share price and EPS growth.
Since my last coverage of UP Fintech‘s Q3 result, the share price has tumbled 28% as the broader market fell 8.05% due to inflation and rate hikes anticipation. There are several operating expenses that have increased rapidly as a percentage of revenue despite progress being made by TIGR in the past few quarters. This will be a troubling trend if it persists and if it does not reverse. The share price currently presents an asymmetric risk to reward ratio (according to my valuation model below) and an even better outlook for those who missed out last month when the share price spike. TIGR has recently launched its Australian operations, which are expected to grow its revenue due to the demand for innovative trading platforms in a market that is “underserved by traditional financial service institutions.” However, its Q4 results present multiple risks that might impair its valuation if the trend continues:
- Increased execution and clearing (“clearing”) cost as a percentage of commissions
- Marketing and branding (“marketing”) cost as a percentage of commissions.
- Declining financing income (as a percentage of commissions).
- Increase in doubtful accounts.
- Delayed integration (due to COVID-induced labour shortage).
TIGR’s FY21 EPS has decreased by more than 15% compared to FY20, primarily due to increased clearing and marketing costs.
This article will also model TIGR’s FY22 financials based on a bull, bear and base case scenario for valuation and risk-reward purposes. Most of the figures are in US Dollars ($ or US$) and Australian Dollars are denoted by A$.
Australia might not be a huge revenue contributor
TIGR’s CEO, Wu Tianhua, viewed Australia as “having similar competitive dynamics of Singapore” due to high commission traditional brokers having a substantial market share. He also further states that TIGR is confident that the “distinctive features” of the app will “distinguish us from the pack.”
Although the Australian brokerage market is similar to Singapore, I believe it is highly unlikely that TIGR will have a few hundred thousand accounts within a year of operation, even though Australia’s population is more than 4 times larger than Singapore. This is due to the competitive and saturated nature of the market. TIGR has acquired over 200,000 funded accounts in Singapore, according to its Q2 2021 Earnings Call transcript since it first started onboarding clients during Q1 2020.
In my article, I discussed the potential of TIGR’s innovative platform and low brokerage business model in a market served by traditional brokerage companies operating with poorly-built apps. It is not unusual to see online brokers in Australia operating on technology and legacy I.T. systems developed twenty years ago. For example, the Commsec app only allows Australian equities trade and international equities are only accessible through the desktop version because it uses a third-party platform. As a result, Commsec users need to transfer money to a third-party custodian (i.e. Pershing) to trade U.S. and international stocks.
Despite the competitive edge of TIGR’s app, I believe TIGR’s Australian operations are unlikely to contribute more than US$20m and contribute more than 10% of TIGR’s annual revenue in FY22. This is because there are currently more than 4 low commission fintech brokers in Australia on top of 4 traditional brokers. Although their technology and platform are not as sophisticated as TIGR, they are still respectable competitors due to the sticky nature of brokerage services (e.g. switching costs and hassle involved in transferring to another broker).
Traditional banks mainly dominate the Australian brokerage industry, and their market share has been slowly eroded by new non-bank brokers entering the sector in recent years. The recent industry study published in 2021 indicates that the Big 4 market share decreased from 84% in 2019 to 74% in 2020. The Big 4 Banks’ brokerage fees range from A$20 to A$30, and they are the highest among the non-bank brokers. Nevertheless, Commsec charges a flat A$10 brokerage fee for trades below A$1000.
On the other hand, fintech trading platforms are more appealing to the middle class and active investors due to their low brokerage pricing model. As a result, multiple fintech companies have been gaining traction recently in the Australian share brokerage market- Superhero, Stake, Selfwealth and Sharesies. The following table below illustrates a list of Australia’s brokerage, brokerage fees and products offered:
|Brokerage Name||ASX Stocks Brokerage Fees (A$ 1001 trade size)||US Options Minimum Brokerage Fees per Order||Products offered|
|Tiger Brokers||A$6.49||A$2.99||ASX, US Stocks, US options, HK Stocks|
|Commsec (traditional)||A$19.95||A$65.00||ASX, US Stocks, US options and international stocks|
|Westpac (traditional)||A$19.95||A$38.95||ASX, US Stocks, US options and international stocks, Germany stocks and UK stocks|
|ANZ (traditional)||A$19.95||A$34.95||ASX, US Stocks, US options and international stocks|
|NAB (traditional)||A$19.50||A$34.95||ASX, US Stocks, US options and international stocks|
|Superhero||A$5||N/A||ASX, US Stocks|
|Selfwealth||A$9.50||N/A||ASX, US Stocks|
|Sharesies||A$5||N/A||ASX, US Stocks|
|Stake||A$3||N/A||ASX, US Stocks (Platform doesn’t offer all stocks available)|
Interactive Brokers is excluded from the table above due to its requirements to have a US$20,000 liquid asset requirements and a US$10,000 upfront deposit which indicates that it is mainly catered to high account deposit investors.
It is evident that TIGR offers the most value when the fees charged and the financial products offered are considered. TIGR enable investors to invest in low-cost options and stocks with instant transfer between different accounts.
TIGR is expected to capture a segment of the Australian market by waiving 3 months of brokerage fees along with free-market data (including level 2 market data) and welcome gifts (e.g. free Apple shares). TIGR’s competitive advantage lies in free access to level 2 market data, constant app updates (every two weeks) and the capability to offer extended hours of trading, according to TIGR Australia’s Chief Strategy Officer, Michael McCarthy. It is important to note that TIGR is the only low-cost online broker in Australia to offer free access to level 2 market data. Those offers and functionality are a huge selling point for day traders and active traders.
However, it is essential not to be overly optimistic about TIGR’s Australia operations as the industry is highly competitive. The brokerage industry is very sticky, and users are usually reluctant to switch brokers. For example, ASX listed low commission broker, Selfwealth has reported revenue of A$5.37 million and 123,523 active traders for the third quarter of 2022 ( for the quarter ending 31 March 2022) according to its Q3 FY22 Quarterly Cash Flow and Activities Report (“Selfwealth’s Quarterly Report”) published on 12th April 2022 (Australia’s financial year ends on 30th June). That translates to an annualized ARPU (Average Revenue Per User) of A$174.86 (U$124.9) at a conversion rate of 1 USD to 1.40 AUD. Selfwealth has been operating since 2018, and it is one of Australia’s first low-cost brokers. Selfwealth’s active accounts exceeded the 100,000 mark after three years of operations is indicative of the enormous challenges confronting Australian brokers in acquiring customers. The other Fintechs are not listed, and public data lists their number of users instead of accounts with deposits. Therefore, I do not believe TIGR will acquire more than 100,000 accounts, as demonstrated in Singapore in its first and second years of operation.
TIGR did not provide any paying clients guidance regarding its Australian or global operations, citing the uncertainty and volatility of stock market activity in general. TIGR also cites that guidance might be provided in the coming quarters after the market and Australian client activity have stabilized, according to its Q4 earnings transcript.
According to Selfwealth’s Quarterly Report (for the quarter ending 31 March 2022), its active account has increased by 37,529 on a year-on-year basis. Assuming TIGR is able to add 50,000 Australian accounts with the same FY21 ARPU of $336.80. I expect TIGR to have a higher ARPU than Selfwealth due to the wider offerings of financial products offered (e.g. options) and financing revenue from margin accounts. The formula I used is total revenues less other revenues (as they originate from TIGR’s investment banking activity) divided by 637.4 thousand accounts with deposits. That will translate into a revenue of $16.84 m which is less than 10% of TIGR FY21 Total revenues less Other revenues.
Cost savings from self-clearing capabilities are not being reflected
TIGR has been emphasizing its gradual transition and investment to achieve self-clearing capabilities to reduce its operating costs since its Q2 Quarterly Result. Its Q3 Quarterly Result also cites that “we made more progress during the third quarter and over 70% of clients were having their U.S. cash equities trades cleared by TradeUP Securities Inc (TIGR’s subsidiary).” TIGR currently self-clear more than 80% of its U.S. cash equity, according to its Q4 earnings transcript.
However, its execution and clearing expenses as a percentage of commission revenue have increased 30% on a year-on-year basis despite related party commission and related party execution and clearing expenses as a percentage of commission revenue decreasing in the same period. TIGR’s related party commissions account for 45.81% of total commissions in FY20 and 20.68% in FY21. TIGR cites that there are delays in their system development and testing, according to its Q4 earnings transcript.
In FY21, TIGR execution and clearing costs have increased to 21.16% of commission revenue from 16.29% in FY20. Although TIGR has made progress in its self-clearing capabilities during the year, the cost synergy arising from those capabilities did not materialize and might have been overestimated.
Marketing and Branding
Marketing and Branding Expenses will be calculated as a percentage of Commissions because page 88 of the 2022 Annual Report indicated that the Marketing and Branding expenses are mainly “Internet search engine results and advertisements on websites focused on trading and finance” and “conducting marketing for our trading platform through APP stores.” The section made no mention of the institutional clients or marketing for its investment banking business. Therefore, the marketing and branding expenses in the financial model below will be a percentage of the commissions instead of total net revenues (which include its investment banking revenue from Other Income).
Marketing and Branding costs have increased from 20.45% of commissions revenue in F.Y. 2020 to 40.26% in F.Y. 2021. This increase is primarily due to TIGR’s internationalization strategy. I expect the Marketing and Branding cost to revert to around 20% of commission revenue once it has met its market share objectives. The financial model below will use 20% for its bull case, 40% for its bear case and 30% for its base case.
Financial Model and Assumptions for Projections
The estimated Employee Compensation and Benefits, General and Administrative, and Occupancy Depreciation and Amortization are modelled using the percentage average of F.Y. 2021 and FY2022 as the percentage variance of those items between those two financial years are less than 10% except Occupancy, Depreciation and Amortization. Occupancy, Depreciation and Amortization expenses decreased by 33% on a YoY basis but accounted for less than 4% of the total net revenue. Therefore, the model will use 3.09% of Net Revenue (the average of FY20 and FY22) for the bull, bear, and base cases.
The financial model assumes the projected FY 22 commission to be 60% of total net revenues for all three cases, as the figure hovers around 60% (with less than 1% variance) for FY 20 and FY 21. The estimated tax rate percentage will be 25%, China‘s standard corporate tax rate. This figure is close to the 22.9% of NPAT in FY21 after adjusting for deferred tax assets and liabilities.
For the bull case of TIGR, the projected net revenue will be modelled on its 3 years CAGR and clearing costs that account for 15% of its commission revenue. The clearing costs were 16.29% of net revenue in FY20, and this projection is also consistent with Futu’s execution and clearing costs (listed under brokerage commission and handling charge expenses in its Q4 financial results) of 14.62% in FY21. The marketing and branding costs as a percentage of commission will be 20%, assuming the figure revert back to F.Y. 20 figure once its expansion and market share objectives are met.
The Bear case will be modelled on a revenue growth rate of 47.14%, a 50% drop in the 3-year CAGR of 94.28%. Its clearing costs will remain at 40%, assuming COVID-related labour shortages and headwinds delay its self-clearing development. The marketing and branding costs will maintain at 40%, assuming TIGR is spending aggressively in new markets.
All the figures in the base case will be a midpoint between the estimations used in the bull and bear case except those figures aforementioned in the general assumption.
|BULL||YoY Growth||Base||Bear||YoY Growth|
|Total Net Revenue||$246,109,339||$478,141,224||94%||$430,691,343||75.00%||$362,125,281||47.14%|
|% of Total Revenue||59.81%||60.00%||0%||60.00%||0.32%||60.00%||0.32%|
|Execution and Clearing||$31,143,578||$43,032,710||38%||$45,222,591||45.21%||$43,455,034||39.53%|
|% of Commission||21.16%||15.00%||-29%||17.50%||-17.29%||20.00%||-5.47%|
|Marketing and Branding||$59,264,634||$57,376,947||-3%||$77,524,442||30.81%||$86,910,068||46.65%|
|% of Commission||40.26%||20.00%||-50%||30.00%||-25.49%||40.00%||-0.65%|
|Communications and Market Data||$22,121,263.00||$43,032,710||94.53%||$38,762,221||75.23%||$32,591,275||0.4733008385|
|% of Commission||15.03%||15.00%||15.00%||15.00%|
|Employee Compensation and Benefits||$87,160,214.00||$177,840,279||104.04%||$160,191,728||83.79%||$134,689,205||54.53%|
|% of Net Revenue||35.42%||37.19%||5%||37.19%||5%||37.19%||5%|
|General and Administrative||$22,705,839.00||$47,656,777||109.89%||$41,331,311||82.03%||$36,093,361||0.5896070061|
|% of Net Revenue||9.23%||9.97%||8%||9.60%||4%||9.97%||8%|
|Occupancy Depreciation and Amortization||$6,134,991.00||$14,777,749||140.88%||$13,311,232||116.97%||$11,192,084||0.8243032314|
|% of Net Revenue||2.49%||3.09%||24%||3.09%||24%||3.09%||24%|
|Total Operating Costs||$228,530,519||$383,717,172||67.91%||$376,343,524||0.6467976608||$344,931,026||0.5093433792|
|% of Total Net Revenue||92.86%||80.25%||-14%||87.38%||-6%||95.25%||3%|
|Income Before Tax||$19,054,472.00||$94,424,051||395.55%||$54,347,819||1.852234328||$17,194,256||-0.09762623652|
|Weighted Average of Diluted EPS||2,335,717,204||2,335,717,204||2,335,717,204||2,335,717,204|
|Net Income per ADS||$0.11||$0.455||309.72%||$0.262||135.83%||$0.083||-25.39%|
The projected net income per ADS (each represents 15) in 2022 are $0.455, $0.262, and $0.083 for the bull, base, and bear case, respectively. TIGR is currently valued at a trailing P.E. (from diluted earnings) of 41, and this figure range from 25 (March 2022) to 263.45 (June 2021). The table below will model TIGR’s share price based on a trailing PE of 25 (lowest P.E. recorded in 2 years), 41 and 60, respectively, for all three cases.
If clearing and marketing costs are brought to a level close to the bull case ratio, we will be looking at a huge EPS growth in the coming quarters. I believe this ratio will be achieved once TIGR’s internationalization strategy goals are met. In the case of TIGR’s Singapore customer acquisition strategy, it takes slightly over a year to acquire more than 200,000 accounts.
To put my outlook in perspective, TIGR FY21’s diluted EPS is lower than FY20 due to the significant increase in clearing and marketing costs. If we modelled TIGR FY21 clearing and marketing costs based on FY20 ratios (20.45%), it would have an additional $54.1m added to its FY21 income before tax of $18.43 million. Assuming all else equal, that will translate into a net income of $57.8m and a diluted EPS of $0.37, representing a nearly 300% EPS growth compared to FY20. Therefore, the reversion of those ratios would be crucial to investors’ interest because of the higher diluted EPS in the coming years.
Self-clearing capabilities could increase TIGR profit margins by at least 20% of commission revenue in the coming years when the commission revenue hits $ 200 million annually, which translates into a pre-tax profit of $40 million. In addition, the reduction in marketing and branding costs as a percentage of commission revenue will also translate into an additional pre-tax profit of around 40 million. Those aforementioned cost savings of $80 million are significant to its income in the coming years, considering its pre-tax income for FY21 is $19.1 million.
Assuming TIGR is valued at its current trailing P.E. multiple of 41, TIGR’s bull to bear case presents a 7 to 1 risk-reward ratio. I believe the trailing P.E. multiple will increase once the uncertainty about Chinese ADRs settles down.
|Net income per ADS||Bull||0.455||$11.38||178.80%||$18.66||357.23%||$27.30||569.12%|
This opportunity exists because low commission brokerages in the Asia Pacific are still in infancy, and there is an enormous market in multiple countries to capture. TIGR’s current revenue is minuscule compared to the size of the brokerage industry in the Asia Pacific.
Even in the absence of those bull case projections, TIGR remains cheap when its revenue growth and outlook in the Asia Pacific region are taken into account.
A fresh wave of positive progress towards Chinese ADRs by the Chinese government will present a significant upside to TIGR. TIGR’s current valuation is relatively cheap compared to its $29.93 peak last July, where its F.Y. 20 revenue is around half of its FY21 revenue.
Achieving full self-clearing with a low ratio (to commission revenue) would undoubtedly increase TIGR’s pricing competitiveness and differentiate itself from many brokers in the Asia-Pacific. However, according to TIGR’s latest Q4 financial result, self-clearing infrastructure and systems development has been delayed due to COVID-19 induced factors. Therefore, TIGR’s upcoming Q1 2022 results will have investors anticipating the cost synergy arising from self-clearing and marketing costs.
In the Bull case, I estimated that TIGR clearing and marketing costs would be reduced to 15% and 20% of commission revenue, respectively, in the FY2022 financial statement. TIGR might not be able to achieve those ratios (in clearing and marketing costs) simultaneously in the next financial year. Those ratios might not be apparent in FY22 due to COVID-19 induced factors (mentioned in Q4 2021 financial results) which could make TIGR a multi-year play in the absence of other catalysts. A more immediate catalyst, in my view, could be a faster than expected account size growth (especially in Australia) in the coming quarters, complemented by lower operating expenses and higher earnings per share. TIGR has beat analysts’ revenue expectations in Q4 2021 by 22%, and I expect TIGR to beat revenue expectations due to its products’ competitive advantage in the Asia Pacific.
Despite Vice Premier Liu’s comments about supporting foreign listing, the market has not fully restored its confidence in Chinese ADRs. The Golden Dragon Index (an ETF that tracks mid to large-cap Chinese stocks) skyrocketed briefly upon the Vice Premier’s comments and then reverted to a downtrend. The Golden Dragon Index has fallen 15% since 16 March (the earliest coverage of the Chinese government’s position in Western media), while the S&P 500 has fallen by less than 2%. Most Chinese ADRs including TIGR also skyrocketed briefly and then reverted to a downtrend.
Although China reportedly considers sharing company audits and measures to support US-listed Chinese companies, there is still a lot of uncertainty surrounding the specifics. Further progress and details about improving China-US relations and ADRs will be another positive catalyst for TIGR.
TIGR’s Q4 report mentioned that its allowable balance for doubtful accounts had increased fivefold from $0.1 million as of December 31 2020, to $0.5 million as of December 31 2021, due to an increase in its user base and market volatility. However, it accounts for less than 1% and it accounts for a negligible part of its commission and financing revenue.
Volatile Market Conditions
TIGR’s CEO, Wu Tianhua, did not guide in relation to the number of paying clients in 2022 when asked by an analyst, citing the uncertainty arising from volatile market conditions according to its Q4 earnings call. IBKR and Charles Schwab’s Q1 2022 revenue has fallen short of analyst expectations. However, I do not think that TIGR’s revenue will follow the same trend as there is still enormous room for TIGR to grow in terms of capturing market share from traditional brokers in the Asia Pacific, which will offset the decrease in ARPU.
The Decline in Margin Balance and Financing Service Fees
TIGR has recorded an 11.3% year-over-year decrease in total margin financing and securities lending balance to $1.8B. As a percentage of commission revenue, financing service fees also decreased 26% YoY from 8.47% of commission revenue to 6.3%. This trend will likely continue in the upcoming quarters as equity market volatility is reduced in anticipation of multiple rate hikes from the Federal Reserve. However, financing service fees account for only 3.77% of Total Net Revenues, and any loss of financing service fees could be offset by commission revenue from Australia and Hong Kong.
Charles Schwab’s 2022 first quarter also results fell short of analysts’ expectation as it reported a 1 per cent drop in revenue for the three months ended 30 March compared to Q1 FY2021. Charles Schwab cited the weak equity market and low volatility as major contributors to lower securities lending activities and margin loan balances. Similarly, Interactive Brokers’ Q1 2022 earnings and revenue missed analysts’ expectations by 0.56% and 8.3%, respectively. IBKR cites decreasing customer stock volume from an “unusually active trading period last year” as a factor for the 15% drop in revenue. These trends are indicative that the revenue growth rate and appetite for margin lending are starting to slow down, and I expect TIGR’s financing revenue to decline to around 3% of Net Revenue.
In conclusion, I remain bullish on the outlook of TIGR, especially on its internationalization move in Australia and Hong Kong. I expect TIGR’s marketing and branding operating expenses to gradually reduce in the coming quarters once their targets are met. If TIGR is able to lower its operating costs (as a percentage of commission revenue or net revenue), assuming all else equal, that will lead to an enormous EPS growth based on my projections.
Author: The Big Spike, Seeking Alpha