Deep Value QFIN

360 Digitech

Investment Time Horizon: Up to 3-5 years for today EPV estimate.

Disclaimer

I have been following this company and the industry since 2021. This position makes up x>10% of the portfolio. Investments do have risk and the valuations presented here may not come to fruition and also cause loss of principal.

My view:

It is my view that 360 Digitech is deeply undervalued. I believe the businesses equity value should be closer to 6.7 to 7 billion given the most recent stream of data on the business. This is the with regards to the Earnings Power of the Business. I do think there is also value beyond Earnings Power as well in the brand/growth.

Business:

QFIN is a loan service FINTECH company based out of China. They offer SaaS for credit driven services through their capital light model. In addition to that they have a capital heavy model where their business extends loans as well. The business earning streams are split 38% cap light 61% cap heavy as of 2021 annual report.

They are a strong brand as seen below Well positioned for continued success with a long runway that I believe China has to offer.

Source: Q3 QFIN presentation 2022

Investment Thesis:

QFIN is, as well as the majority of the FINTECH industry in China, in the bucket of misunderstood and unloved securities this time today. This has caused a large disconnect in the valuation of the securities that I believe, given the current events, is set to adjust course.

Competitive Advantage:

QFIN has a solid competitive advantage as seen with their software. It is also scalable as well.

Some of the information I’m talking about is, for instance during the first round of COVID.

They saw the lowest default rates as seen in the photos below relative to competitors.

As you can see this has spurred them to transition with a cap light model as well to offering SaaS model.

This in edition with a partnership Kincheng bank offers a competitive advantage.

Lastly, As seen in presentations 360 Digitech offer strong branding in China.

This coupled with ratios that indicate they get high returns on investment tell me they are solid tech franchise there.

Source:Q2 QFIN presentation 2022.

Valuation:

A potential upside of 140%+

Target share price of $58

Brief explanation:

I believe my estimates are conservative in nature I personally don’t want to over embellish the outcome. That said I do think the economic profits to the company could be much larger than the Earnings Power Value estimate depicts given the recent restart of China. As well as what I perceive as smoother go forward regulatory environment for FINTECH brands.

That said, I would much rather under promise and have some inclination that my estimate of economic profits could in fact overdeliver.

To reiterate, the reasons for a beyond expected outcome would be inherent in cyclicality post COVID lockdowns. In the end, I really want to stay away from overexaggerating the returns.

My timeframe for all this is 3-5 years. That said, as things stand this is a business I would be willing to see the story play out over time. Lots of opportunity to grow their moat and the business over the next decade. I look forward to seeing what else will transpire for the company going forward.

As you saw in my write up of “Becoming a Bargain Hunter” sometimes those things can take far longer to come to fruition so deferred gratification is key to seeing such a thesis come to fruition.

Why the discrepancy between Market value and EPV? What can drive Value fulfillment?

Past regulatory environment and an overdramatic reaction to

Changes going on

Geopolitics- HFCAA

In short, a laundry list of data has kept the valuations suppressed for some time. Since coming to the public markets, the FINTECH industry in China has been going through regulatory changes. Also more recent is the broader tech regulatory events. The news likes to call this, in its most extreme nature, "Crackdowns" these changes haven't been so extreme especially for business like QFIN that have stayed in regulatory compliance through the transition.

In fact, they haven't had a material effect on how a business like QFIN operates as well. All the drama has caused high uncertainty in the industry. While there is regulatory shaping of the industry still to go, the worst of it seems to be in the rearview mirror from how I’m interpreting the data. I think moving forward there will be better days to come for the businesses/industry.

To reiterate in my opinion there is a long runway here that has left QFIN in a solid position to continue delivering for consumer and shareholders. I could be wrong but my research has led me to such conclusions, currently.

Geopolitics

In relation to politics the HFCAA which will be in fruition come 2024. Some primary concerns I think have been mitigated by them relisting on the HK exchange. The reason why is if a company is delisted it hurts their liquidity as well as pension, mutual funds and other institutions can’t invest due to mandate reason. I believe the relisting has kept my valuation thesis alive.

Overall, my answer to geopolitics…. Well, I'm an investor in businesses. Throughout history there have been wars, pandemics, and all other chaotic events. This still doesn’t stop one business from continuing operations and growing their value.

To add further if Warren, Charlie, and Berkshire had worried about such things with BYD would we have seen them reap the benefits of those returns today? The principle of investing in a business is timeless.

Oddly Mr. market tends to eventually recognize these situations and brings value to fruition. In such case patiencegets rewarded when there are such disconnects in value.

Go forward basis for value fruition

Moving forward I think the stage is set for a smoother and full valuation to these companies from a regulatory perspective. In addition, coming off COVID lockdowns will also be a good boost to these companies’ valuation as well. Having shares on HK exchange also helps mitigate domestic risks associated with HFCAA here in the US.

Risk I primarily see note there will always be some sort of market risk. Or external risks to the business. That said when investing there you cant rule out Geopolitics. I still believe the offering on the HK exchange of QFINS shares helps mitigate some price volatility for when such events arise. When all else fails I still believe the long-term economics of a business and fundamentals will surpass the short term and noise. These things are hard to see as those are more macro-oriented and speculative in nature but the ones, I worry about are more centered to the business.

Risks I saw in relation to the business were loss of strategic relationships. 360 Group, Kincheng Bank relationship becoming impaired in any way.

This could be a scenario if Mr. Zhou((75.1% owner) left the company. Or if regulations came about stopping certain relationships. That said I also give low odds of these risks becoming huge issues in the future. They are still things I as well as any investor should be aware of.

If this occurred this would be my primary basis for selling the investment. I don’t think it will. Why? This business makes solid returns. It seems to be a successful partnership as you can see from the economic profits the business has produced. It is in the best interest of all parties to keep things moving forward given, based on my research, what looks to be good success as measured by the resiliency of the business through COVID scenarios and the economic profits. They also split ownership rights in other companies for instance

Last Update: Feb 23, 2023

updated Company statistic snapshot. Updated above: Wed Feb 8, 2023. Changes= adding company name. and correction net cash not net debt.