Futu Holdings Ltd Q3 FY2020 Earnings Call

Hello, ladies and gentlemen. Welcome to Futu Holdings' Third Quarter 2020 Conference Call. At this time, all participants are in a listen-only mode. After the management’s prepared remarks, there will be a question-and-answer session. Today’s conference call is being recorded; if you have any objections you may disconnect at this time. I would now like to turn the conference over to your host for today’s conference call, Mr. Daniel Yuan, Chief of Staff and Head of IR at Futu. Please go ahead, sir.

Thanks, operator, and thank you for joining us today to discuss our third quarter 2020 earnings results. Joining me on the call today are Mr. Leaf Li, Chairman and Chief Executive Officer; Arthur Chen, Chief Financial Officer; and Robin Xu, Senior Vice President. As a reminder, today’s call may include forward-looking statements, which represent the company’s belief regarding future events, which by their nature are not certain and are outside of the company’s control. Forward-looking statements involve inherent risks and uncertainties. We caution you that a number of important factors could cause actual results to differ materially from those contained in any forward-looking statements. For more information about the potential risks and uncertainties, please refer to the company’s filings with the SEC, including its registration statement. With that, I would now turn the call over to Leaf. Leaf will make his comments in Chinese and I will translate.

Hello everyone. Thank you for joining the earnings call today. I’m excited to share that we continue to deliver outstanding operating and financial results in the third quarter of 2020. Our net paying client addition was approximately 115,000, bringing the total number of paying clients to over 418,000, up 137% year-on-year. This marks our highest quarterly paying client addition. Our China mainland and Hong Kong paying clients both experienced triple-digit growth in the quarter, driven by a number of industry tailwinds including continued market volatility and the surge of high-profile Hong Kong IPOs. Organic growth continued to contribute over half of our new paying clients. During our second quarter earnings call, we guided for 280,000 net new paying clients in 2020. We are well on track to deliver this guidance. Besides total paying clients, we also witnessed robust growth in total client assets. As of quarter-end total client assets reached HKD 201 billion, representing 178% growth on a year-on-year basis and 41% growth on a quarter-on-quarter basis. Average asset balance for paying clients was HKD 481,000, up 17% year-on-year. Our quarterly paying client retention rates surpassed 98% for the seventh consecutive quarter. Total trading volume in the quarter surpassed the HKD 1 trillion landmark, an exponential 381% year-on-year growth. U.S. stock trading contributed about 56% of the total trading volume. In the third quarter, we launched Hong Kong securities lending and several derivatives trading offerings, including Hong Kong Stock futures and MSCI index futures. The market share of our derivatives trading products climbed meaningfully over the quarter. Going forward, we will seek to further diversify our derivatives trading offerings. The strong IPO market continued to play in our favor. In the third quarter, six IPOs recorded over HKD 10 billion subscriptions on our platform, including the U.S. IPOs of XPeng Motors and Beike and the Hong Kong IPOs of Nongfu Spring and Ming Yuan Cloud. To note, the Hong Kong IPOs of Nongfu Spring attracted over 110,000 retail investors to subscribe over HKD 35 billion on our platform. As for our wealth management business Money Plus, we established partnerships with nine reputable asset managers, including Morgan Stanley, Invesco, and BNP Paribas. We have over 30 wealth management partners as of quarter end. In the third quarter, the wealth management daily average asset balance reached HKD 8.15 billion, a record high since we launched the service. Over 29,000 clients held mutual fund positions as of quarter end. In September, we launched bond trading for professional investors. We now offer a diverse array of USD denominated bonds covering multiple industries, including technology, real estate, logistics, and finance. Money Plus is strategically positioned to offer more diversified products, catering to the different risk appetites of our users and retaining more user assets within Futu’s ecosystem. Our enterprise service, FUTU I&E, also made solid progress in the quarter. We obtained ISO 27701 certification for our ESOP SaaS system, the world’s highest level of Privacy Information System Certification. We are the first ESOP SaaS provider in China to receive such recognition. As of quarter end, we had 126 ESOP plans and 81 IPO and IR plans. FUTU I&E continues to be the go-to ESOP partner for industry-leading TMT, biotech, and consumer retail companies, including MINISO, Ocumension, and GEO Module Group. We have been reaching new milestones with internationalization. Futu Singapore Private Limited was officially granted the capital market services license from the Monetary Authority of Singapore. We aim to launch the Singapore business in the first half of 2021, and we are excited about our growth prospects in the country. Besides, I’m pleased to share that on November 13, Futu Futures Inc. application for National Futures Association membership was approved. Futu Futures Inc. is now a commodity futures trading commission registered futures commission merchant. Next, I’d like to invite our CFO, Arthur, to discuss our financial performance.

Thanks, Leaf and Daniel. We continue to deliver outstanding financial results. Let me walk you through some key financial details for the third quarter. All currencies are in Hong Kong dollar terms. We recorded total revenues of HKD 946 million, up 2.7 times year-on-year and 38% quarter-on-quarter. To break it down, brokerage commission and handling charge income was HKD 563 million, up 3.6 times year-on-year and 38% quarter-on-quarter. This was primarily due to the 3.8 times growth of our total trading volume. Our blended commission rate this quarter was 5.8 basis points, down from 6.6 basis points in the last quarter. This sequential decrease was primarily due to the increase in trading volume per DART for clients that used the flat rate pricing package option we offer. Brokerage income accounted for 60% of our total revenue in the quarter. Interest income was HKD 276 million, an increase of 140% year-on-year and 33% quarter-on-quarter. Both margin financing interest income and IPO financing interest income achieved strong growth. Margin financing interest income increased primarily on the back of a significant 142% year-on-year increase in daily average margin financing balance. IPO financing interest income increased significantly due to the hot Hong Kong IPO market and our clients increasing appetite to subscribe to high-quality IPOs on margin. Interest income contributed about 29% of our total revenue. Other income was HKD 107 million, up HKD 5.6 million year-on-year and 52% quarter-on-quarter. The growth was primarily due to an increase in our IPO subscription service charge income, currency exchange service income, and underwriting fee income. Other income contributes about 11% of our total revenue. On the cost side, total costs were HKD 182 million, up 161% year-on-year and 18% quarter-on-quarter. To break it down, brokerage commission and handling charge expenses were HKD 101 million, an increase of 3.1 times year-on-year and 31% quarter-on-quarter. The growth was roughly in line with our total trading volume growth. Interest expenses were HKD 47 million, an increase of 151% year-on-year and 18% quarter-on-quarter, primarily due to higher IPO financing interest expenses. Processing and servicing costs were HKD 34 million, an increase of 27% year-on-year primarily due to an increase in cloud service fees to support the growing number of trades. As a result, total gross profit increased to HKD 764 million, up 3.1 times year-on-year and 43% quarter-on-quarter. Gross margin was extended to 81% versus 73% in the same period last year. Total operating expenses were HKD 323 million, an increase of 111% year-on-year and 22% quarter-on-quarter. To break it down, R&D expenses were HKD 150 million, an increase of 111% year-on-year and 28% quarter-on-quarter; the increase was primarily due to an increase in R&D headcount to support our business expansion. Selling and marketing expenses were HKD 111 million, an increase of 184% year-on-year and 15% quarter-on-quarter. The increase was primarily due to higher branding and marketing spending. Although we are more aggressive in our marketing strategy to take advantage of the favorable market conditions, our client acquisition costs per each unit continue to trend down this quarter. G&A expenses were HKD 62 million, an increase of 45% year-on-year and 22% quarter-on-quarter; the increase was primarily due to an increase in headcount for G&A personnel. As a result, our net income increased to HKD 402 million. Non-GAAP adjusted net income increased to HKD 408 million, up over 16 times year-on-year and 68% quarter-on-quarter. The significant bottom line growth was primarily due to robust revenue growth and strong operating leverage. Also in this quarter, we completed our $314 million equity follow-on financing. This placement has doubled our equity base and significantly strengthened our balance sheet to support our future growth. That concludes our prepared remarks. We would now like to open the call to questions. Operator, please go ahead.

Certainly sir. Ladies and gentlemen, we will now begin the question-and-answer session. [Operator Instructions] We have the first question coming from the line of Ivy Liu from HSBC. Please go ahead.

Thank you. It’s Ivy Liu from HSBC. I have two questions today, mainly on the financial numbers. So first one, in the balance sheet, loans in advance, and also we’ve seen a very big difference between this number and margin balance. So could management explain the reason for this discrepancy? And the second number is on the short-term borrowings, because we see a sharp increase in this number, so could management give us guidance on the source of that funding and also the funding cost trend going forward? Thank you.

Okay. Thank you, Ivy. I will answer your second question first. For the short-term borrowing, actually since the beginning of this year, we started to further optimize our funding source. Besides the equity follow-on and also the bank borrowing, we also started to use the repo and equity repo to further lower our financial costs and further support our balance sheet growth. So the items you can see from the short borrowing is more due to this equity repo instrument. And for the first question, I think basically these two things, the loan balance and also the margin balance is still quite in line. Actually, I see the number is not too far away. So just wonder, could you further clarify your questions.

Hi, Ivy. Maybe I will chime in a little bit on your first question regarding the discrepancy. So I just want to clarify that for our margin financing and securities lending balance, that number does not include our IPO financing balance. The line item, loans and advances includes our IPO financing balances. So actually in the third quarter there were two IPOs that extended from September to October. If I remember correctly, these were the two Hong Kong IPOs that started their IPO subscription process in September but eventually got lifted in October. So that is about HKD 25 billion of IPO financing included in our loans and advances balance on the balance sheet, whereas it’s not included in the margin financing and securities lending balance. So I think that kind of explains the discrepancy here.

Thank you. We have the next question, this is coming from the line of Daphne Poon from Citigroup. Please go ahead.

Hi, evening management. Thanks for taking my questions. So my first question is regarding the IPO subscription business. Just wondering if you can help break down the contribution in this quarter led to interest income, other revenue, and commission? And related to that is that recently, we saw the news from Hong Kong EX saying that they’re planning to revise the IPO subscription routes to basically shorten the subscription period from T+5 to T+1. So just wondering if the management has done any analysis in terms of the revenue or earnings impact from this? And second, I just want to quickly check on the new customer, new paying customer mix this quarter between the Hong Kong and China clients? And lastly, regarding your sales and marketing costs, as you mentioned earlier, the unit customer acquisition costs per new paying client are meaningfully lower. I think now it is less than HKD 1,000. So just wondering if that will be the sustainable level going forward, basically what’s the outlook here? Thank you.

Okay, thank you, Daphne. I will answer your first question about IPO margin and I will partially answer your second question in terms of the breakdown of new paying clients. I will leave the acquisition cost outlook to my colleague Robin. We noticed this consultation paper issued by the Hong Kong Stock Exchange earlier this week. You’re right, the IPO processing timeline may be cut from the current T+5 days to T+1 day under this new arrangement. From our second perspective, our IPO margin revenue will be negatively impacted, similar to all our retail broker peers. I expect we may see a low middle single-digit revenue impact if we implement this new policy in the first three quarters of this year. From a forward-looking perspective, I think this loss may be significantly offset by the demand increase and also the industry consolidation we anticipate in the retail brokerage business in Hong Kong. Despite our near-term financial loss, which I think is fully manageable, we strongly support this initiative advocated by the Hong Kong Stock Exchange. As we believe, this reform will improve overall market efficiency and eliminate unnecessary transition costs for all market participants. This will make the overall market more accessible to the main street. So we think every participant, including Futu, will be better off in the long run. And for your second question, in terms of the new paying clients we achieved this quarter, 53% came from the Hong Kong local market and the remaining 47% came from mainland.

Right. So this year, the percentage of our new paying clients from organic growth continued to climb meaningfully quarter-after-quarter. And you can see that our paying client acquisition costs have therefore come down quite a bit this year. This – in terms of our overall market spending, I think we attach more importance to the ROI of our client acquisition as opposed to the total marketing expenses.

Thank you. Shall we move to the next question? We have the next question coming from the line of Yiran Zhong from Credit Suisse. Please go ahead.

Thanks for taking my questions and congratulations on a strong quarter. I have three questions. One is, in Q3 you have further gained trading volume market shares, both in Hong Kong and U.S. How is the trend looking for Q4 thus far? And also more specifically on U.S. volume, we noticed that the China ADRs trading volume had significantly picked up in November, and could you share any color on the kind of stock distribution of your U.S. volume? What are the top traded U.S. stocks on your platform and how concentrated are the China ADRs traded through Futu? Secondly, we calculated that the overall commission and handling fee rate was 5.5 bps in Q3, lower than before – 6.4 bps in the last quarter. Could you share kind of the underlying drivers for the quarter-on-quarter change? Any color on how it’s trending going forward? And thirdly, on customer acquisition, can you break out the contribution from say IPO related promotional events? Just trying to understand how we should think about U.S. acquisition growth related to IPOs and also how should we consider the trend going forward, beyond Q4, beyond this year into next year and beyond? Thank you.

Okay, thank you. I will answer the first two questions and I will also leave the third question to Robin for your inquiries about client acquisitions. Number one, as we mentioned in our last earnings call, we see significant spikes in our market share gains in Hong Kong since July. And the situation in Q3 has seen overall our Hong Kong trading volumes increased a lot. In terms of market shares, we continue to keep our market shares over 2%. I think the situations in October are still well on track. So, I do expect there will be some structural positive improvements going forward. In terms of the U.S. trading volume, actually I think our U.S. trading is not very concentrated on these Chinese ADR names. If my memory is right, our Chinese ADR trading volume accounts for roughly 10% to 15% of our total U.S. trading volumes overall. So despite we are benefiting from Chinese ADR trading volumes recently in the U.S., I think the overall impact is not very meaningful. Secondly, regarding your question on the commission rate, I actually addressed this in the opening remarks. On a like-for-like basis, our commission rate is very stable. You can see our blended commission rate dropped down this quarter compared with last quarter, mainly due to the increase in trading volume per DART for clients who used the flat rate pricing package options we offer. I will leave the third question to Robin.

I’ll take the third question on our paying client breakdown. It’s very difficult for the U.S. to break out why clients specifically come for IPOs because it’s really hard to trace other activities like they may invest and then subscribe to IPO. So it’s very hard to do that breakdown, but overall, we have seen that when these general IPOs get listed in Hong Kong, we see a pickup in our client acquisition for one to two weeks beforehand. For IPOs, for example, two weeks before an IPO, we have seen a meaningful pickup in our paying client numbers. And as we mentioned, these jumbo deals in Hong Kong will definitely be a positive contributor to our paying client growth. But again, it’s very hard to break down the specific percentage, but we think the Hong Kong IPO in general just attracts a lot more attention to the market. Well, it may bring some clients that are interested in IPOs at first, but then they will be converted to other trading clients. So overall, we have not seen a meaningful change in our planned asset balance or their trading behavior.

Thank you. [Operator Instructions] We have the next question from the line of Kelvin Chu from UBS Investment Bank. Please go ahead.

Hi, it is Kelvin Chu from UBS. So thank you for taking my questions. Two questions from me. First, you have delivered very strong brokerage business this year, with decent market share gain. So at this point, what is your long-term strategic vision for your business model? How do you prioritize your transitional business versus wealth management fund product distribution over the long term? And secondly, can we have an update on the U.S. settlement system? Any disruption due to COVID-19? Just in terms of timing, when should we expect the migration of the trading account to take place? And when will the financial impact come through in terms of potentially higher interest income from the settlement cash? Thank you.

Okay. Thank you, Kelvin. Let me answer your second question first. I will leave the first question to my colleagues Leaf and Robin. You are right, our progress in the U.S. sales clearing was negatively impacted by this COVID-19 pandemic. Now, we currently expect we will start the trial migration to our self-clearing house in the first half of next year. It is still too early to expect the financial impact. I think overall speaking, next year’s financial impact will still not be too significant, but just to give you a rough idea, based on our current U.S. stock positions, if we complete this full process of the sales clearing, I think we will at least generate an additional $50 million operating profit.

Our strategy is composed of five different elements to our business. Number one is our retail brokerage business, number two, our financial business that provides a lot more earnings visibility by nature, thirdly is our enterprise service Futu I&E with ESOP system and IPO distribution services. Fourth, is our international expansion. We want to expand our client base, and we think the overseas market will contribute to a meaningful share of our overall paying client base in the mid to long run. And number five, we want to create Futu into an ecosystem that is centered around users and provides connectivity to different stakeholders like the investors, TLLs, media, etc., and we want to construct a self-reinforcing ecosystem. Regarding the relationship between our brokerage and wealth management business, our strategy is to become a one-stop financial services platform for our clients, catering to the various asset allocation needs of our clients. I believe wealth management is a very important step toward this strategy.

Thank you. We have our next question, which is coming from the line of Hanyang Wang from 86Research. Please go ahead.

Good evening, management. Thank you for taking my questions. My first question is about our margin financing business. Our successful secondary offering last quarter helped boost some more margin financing demand and significantly improved the margin financing balance. So we have impressive growth; will this be sustainable given the leverage restrictions on the business in Hong Kong, and how should we project the future growth of our margin financing balance? Do we need to keep raising money from the capital markets to meet the leverage requirement? My second question is on our user acquisition strategy. In the third quarter, I think the number of Hong Kong paying users surpassed the mainland users. What will be our strategy in the future to acquire and manage China users, which seems to have a larger user base that we could explore into? My final question is about Ant’s IPO suspension. Will there be any impact on our IPO financing business in the fourth quarter? Thank you.

Okay, thank you. I think I have already answered your third question before to another analyst. I will answer your first question about margin financing and I will leave the user acquisition strategies to my colleagues Robin and Daniel. For margin financing, you are right; after the equity placement we completed in the third quarter, our equity base has almost doubled. This will be very supportive for our balance sheet business going forward. I think, based on our current business expansions, we will have sufficient funds to support our margin financing in the next 12 to 18 months. If you look at our third quarter number, our total equity base now exceeds HKD 5 billion. Based on the regulations from the Hong Kong SE, each retail broker's leverage ratios in Hong Kong cannot exceed five times. Just to give you a rough idea about our further upside for margin business, it is very difficult to estimate the margin balance outlook going forward as many market conditions and volatilities will impact the clients' risk appetite. But I believe that long-term, as we have more clients, this balance will continue to grow down the road. Now, I will leave the second question to Robin. Thank you.

We have been quite aggressive with our Hong Kong marketing strategy, and that turned out to be quite effective because Hong Kong is a small place, and the existing client base is very prone to trading in Hong Kong and U.S. securities already. As for our mainland client acquisition, we are using different client acquisition strategies because of a number of constraints. For example, ESOP continues to contribute a very steady stream of high-quality clients, and word of mouth referrals are more meaningful in the mainland than Hong Kong in terms of our paying client contribution. So we have different client acquisition strategies for mainland growth, and we think the growth prospects in the mainland are very strong. Thank you.

Hi management. Thank you for taking my questions. And really congrats on the strong quarter. I’m really excited about Futu launching Hong Kong options products and other derivative instruments to expand your product portfolio, but my concerns are on the risk control side. I don’t know if you have anything to share at this moment about risk management regarding your burdensome derivatives business segment? Thank you.

Okay, thank you. I will let my colleague Daniel answer this question. Thank you.

With regards to our risk management procedures, we have always been quite prudent with our risk management approach. If you compare our LTV ratio for individual stock margin financing to those offered by traditional banks, we are more conservative. This cautiousness also applies to our derivatives trading risk management as well. To prepare for the launch of this business, we have actually recruited several finance personnel from traditional institutions that have rich experience in risk management for derivatives products. Overall, we have been prudent in our approach and we gradually rollout our derivatives trading products, as we mentioned late in the third quarter when we started offering the Hong Kong securities lending business. So far, we’ve only opened that service to 10% of our total paying client base and we plan to open it to 100% of our client base by the end of this year. So when we start new derivatives products, we approach it gradually and cautiously. To date, we have not experienced any material loss on margin financing or derivatives trading offerings since we launched the margin financing business in 2017. Thank you.

Understood. May I ask one more question on your brokerage fee and commission expense ratio? Is there a meaningful difference between the brokerage expense ratio of your U.S. trading volume compared to that of Hong Kong volume? And how should we expect the expense ratio to be in say, three years to five years, when your proprietary U.S. stock clearing system is fully developed? Thanks.

I think in terms of the commission – blended commission rate in Hong Kong and in the U.S., the U.S. rate is slightly higher than Hong Kong, but the difference is not so significant. Regarding the U.S. self-clearing capabilities, Kevin from UBS earlier raised this question. It will take a very long time for us to gradually migrate our U.S. clients' stock positions to our self-clearing house. There are a lot of technology aspects, and we need to ensure that all corporate actions can be conducted correctly. It will definitely take time, but just to give you a rough idea, if we migrate all these existing positions to our self-clearing house today, the cost savings in terms of execution fees and idle cash we can monetize alongside stock positions could generate an additional $15 million operating profit without considering any direct associated costs.

Got it. That’s really helpful. Thank you.

Thank you.

Thank you. [Operator Instructions] We do not have any questions at this moment. I would like to hand the conference back to our host, Daniel; please take over for any closing remarks.

Thank you. That concludes our call today. On behalf of the Futu management team, I would like to thank you for joining us today. If you have any further questions please do not hesitate to contact me or any of our Investor Relations representatives. Thank you and goodbye.

Ladies and gentlemen, that concludes our conference for today. Thank you all for your participation. You may disconnect your lines now. Thank you to all.