CAPI AL WA CH
FUTU HOLDINGS LIMITED
PREPARED BY
HONGLAN CHENG, CFA | PETER FRANK | MINGYI XU FUTU HOLDINGS LIMITED
Futu Holdings Ltd. Contents
Forward ...... 3 Sector: Financial Services Industry: Investment I. Industry Overview ...... 3 Sub-Industry: Online Brokerage A. General Introduction ...... 3
B. Global Investment Channels Increasing ...... 4
C. The U.S. Remains a Dominant Market ...... 4
D. China’s Rise in Investable Assets ...... 6
E. Chinese Investors Going Global ...... 8
II. Futu Holdings Ltd ...... 9
A. Futu’s Business Model ...... 9
B. Extraordinary Growth and Profitability ...... 10
C. Key Milestones ...... 12
D. Tencent As a Major Partner ...... 12
E. Futu’s Competitive Strengths ...... 14
F. Shift of Revenue ...... 18
G. Faith in “Good Products” ...... 20
H. Considerable Public Attention ...... 21
I. Diverse Profile of Futu’s Users...... 23
J. Incredible Trust between Futu and Users ...... 24
K. Risks...... 26
L. Industry Insiders’ Opinions ...... 27
CapitalWatch Research and/ or one of its affiliates does and seeks to do business with companies covered in its research reports. As a result, investors should be aware that the firm may have a conflict of interest that could affect the objectivity of this report. Investors should consider this report as only a single factor in making their investment decision.
2 CapitalWatch Research - Futu Holdings Ltd. Forward
This report is the outcome of a months-long investigation, research, and analysis of Futu Holdings Ltd. and China’s online brokerage industry by 27 professional journalists and analysts from JPM Media Group across its Beijing, Silicon Valley and New York offices. It differentiates from investment banks’ reports by focusing on media reports and providing analysis from the perspective of the media.
It collected and isolated relevant information from an extensive range of reports on Futu Holdings and China’s online brokerage industry, conducted in-depth analysis through investigations, verified the information authenticity from multiple channels, and analyzed data from unique media perspectives.
We hope this report will provide you with sufficient and reliable information to understand Futu Holdings and serve as a useful factor in making decisions about your investments.
I. Industry Overview
A) General Introduction
The global securities market, estimated currently to exceed $100 trillion per year, is expanding rapidly as new technology and new economic opportunities continue to develop around the world. The market, which includes trading in stocks, bonds, equity and bond funds, derivative securities, and other investments, has seen a 20 percent increase in just six years through 2018.
New technology, including rapidly growing digital channels, is leading much of the increase with new investment vehicles being made available for populations in all parts of the world. Indeed, online trading alone – as a percent of overall trading volume – is estimated to have grown from less than 16 percent of the entire market in 2012 to more than double that penetration, to 35 percent in 2018. During that time, the online securities market, also aided by a change in consumer preferences, has seen a compound annual growth rate of more than 20 percent during those years.
While much of this growth has been brought by an expansion of organic growth in global capital markets and concomitant trading volumes overall, an increasing component of the larger securities trading activity stems from a greater receptivity and appetite for online services. By bringing traditional trading capabilities into the hands of digitally-aware consumers, the industry has seen an aggressive expansion of new entrants in every continent.
Underpinning this customer receptivity are the developments of new technologies, including heightened and sophisticated internet security, which frees consumers to utilize these services with more confidence; the development of artificial intelligence, which assists in guiding and securing transactional information and preferences among consumers; and, new cloud capabilities, which integrates an infrastructure that permits the storage of big data with a global accessibility.
As a result, operating and transactional completion costs continue to decrease, lowering consumer costs and the hurdles that traditionally limited micro- or small-investment thresholds. Efficiencies in all areas have opened these securities markets not only to new companies and facilitators, but to new customers and trading platforms.
CapitalWatch Research - Futu Holdings Ltd. 3 FUTU HOLDINGS LIMITED
B) Global Investment Channels Increasing
We see several trends emerging worldwide within the securities industry.
Among the most impactful is the shift from the traditional bricks-and-mortar business model to online services. While this trend has accompanied the growth of the internet overall for the past 20 years, the speed of growth and the increasing acceptance of online and mobile trading platforms has accelerated in recent years.
As such, various new industry players are entering the online brokerage market, primarily large internet operators that are able to fund the significant investments necessary to enter the industry. Although the cost of entry is relatively small, the security needed to build out infrastructure, as well as operate within the various and strict international regulatory requirements, remain a serious barrier to many smaller firms.
In addition, the increasingly complex level of asset classes, capital requirements, customer identity security measures, and flow-of-funds restrictions require significant management expertise and experience.
Notwithstanding those substantial requirements, as consumers become more accustomed and familiarized with various alternative investment channels, the user experience becomes increasingly paramount in the development of the industry. Each of these components require changing and newly developed strategic revenue-driven business models that augment the user experience and combine to ensure a platform that can deliver long-term value.
This rapid development and maturation of the industry is not likely to slow any time soon. With each new capability and furtherance of technological developments, increased competition will continue. In addition, customers will become increasingly expectant of new alternatives, which in turn, will continue pressure among competitors to develop and offer additional ancillary services that serve to differentiate products and value-added services.
C) The U.S. Remains a Dominant Market
With securities markets expanding around the world, the United States remains among the top destinations for capital.
Technological advances, primarily driven by development within, and pioneered by, corporate research inside the U.S., has translated into vigorous growth within that market.
Today, the U.S. is among the leaders in the rapidly growing online securities markets. According to iResearch Report, the market size of online brokerage services was expected to reach nearly $7 trillion last year, representing roughly 15 percent of overall volume on the market. And the market is expected to continue expanding, increasing by nearly one-third in the next five years.
4 CapitalWatch Research - Futu Holdings Ltd. With immense liquidity and transaction capabilities, securities markets in the U.S. continue to dominate for corporations and investors seeking capital placement. Much of that trading today has shifted, and continues to migrate, to the various online platforms.
ONLINE SECURITIES TRADING VOLUME IN U.S.
10
9
8
7
6
rillions 5 In $T 4
3
2
1
0 2012 2013 2014 2015 2016 2017 2018 2019 2020 2021 2022 2023 Retail 3.8 3.9 4.1 5.2 5.1 5.8 7.5 7.8 8.1 8.3 9.1 9.4 Institutional 1.7 2.1 2.6 2.9 2.9 2.8 4.2 4.4 4.6 4.8 5.3 5.5
Source: Company Data, CapitalWatch Research
In particular, the retail market for trading accounts in the U.S. is robust and growing, nearly two-thirds of online trading volume is initiated by retail accounts, which represent more than one-fifth of overall trading volume. That volume, and its size relative to the overall market, is expected to increase as new technologies and newly integrated products and services give rise to increasingly lower trading costs and market entries.
The New York Stock Exchange and the Nasdaq Stock Market are today among the top destinations for securities trading. The ease of capital inflow and interborder financial transactions has brought an increasing volume of capital from overseas markets to the United States exchanges.
CapitalWatch Research - Futu Holdings Ltd. 5 FUTU HOLDINGS LIMITED
D) China’s Rise in Investable Assets
Among the top originating countries for investors’ funds has increasingly been China, which has seen an explosive growth in recent decades among a burgeoning mass affluent class in the population.
China, as the world’s second-largest economy, is expected to see its gross domestic product jump from 61 trillion yuan in 2013 to an anticipated 108 trillion yuan by 2022.
At the same time, the country’s population has shifted dramatically to urban centers, which represent nearly 60 percent of Chinese inhabitants. The shift to urban centers has also led to a rise in disposable income, which has grown at a compound annual rate of nearly 8 percent over the past five years. Among the results of the urbanization has been a shift of household wealth to real estate holdings, which have become a substantial category of investment, representing more than 70 percent of the overall asset value.
NUMBER OF CHINESE-BASED INVESTORS WITH OVERSEAS INVESTMENT
70 66.3
60 51.2
50 41.6
40 33.1 In Millions 30 26.6
20
20 14.3 9.7 6.4 10 5.1 3.2 4.1
0 2010 2012 2014 2016 2018 2020 2022 2024
Source: Company Data, CapitalWatch Research
6 CapitalWatch Research - Futu Holdings Ltd. With this rapid expansion of wealth has come an equally rapid expansion in the desire for wealth management services as investable assets have been more than doubled to nearly $25 trillion over the past six years. That market, which is expected to increase an additional 80 percent in coming years, has meant an enormous opportunity for additional products and services in mainland China and Hong Kong.
This aim for diversification has resulted in an increasing desire for investment opportunities in markets outside the Chinese investors’ home country as investor allocations to foreign markets expands rapidly.
Much of these overseas transactions are facilitated increasingly by the online retail securities industry, which has seen rapid growth over recent years, reaching nearly a half-trillion dollars, and is estimated to continue growing more than 30 percent annually during each of the next five years.
Augmenting this push for investable assets in diverse markets has been the rise in the number of Chinese-based corporations seeking liquidity and exposure on stock exchanges in non-domestic geographies. In particular, the securities markets in the United States and Hong Kong have been favored locations for companies located within the PRC. Indeed, Hong Kong is of particular interest to Chinese investors, given its cultural similarities, geographic placement, and relatively large composite of Chinese-listed companies. Estimates are that nearly 80 percent of trading volume on the exchange are attributable to Chinese companies, according to figures from the Hong Kong Stock Exchange.
This broadening of geographies has coincided with government policies, including its Made in China 2025 and the Belt and Road initiatives, resulting in the internationalization of the Chinese yuan and investment that flows both inward and outward from the country’s borders.
CapitalWatch Research - Futu Holdings Ltd. 7 FUTU HOLDINGS LIMITED
E) Chinese Investors Going Global
Further, as the economics of the growing affluent class in China increases, the limited investment opportunities within China and the economic growth witnessed in other parts of the world continues to attract funds into global markets.
As these funds flow outward, securities including stocks, bonds, and mutual funds receive the bulk of investment, with more than $260 billion allocated currently in overseas investments.
Of these international markets, the Hong Kong market is positioned as a dominant destination and recipient of transactional funding behind the United States, while the exchange itself has seen market for initial public offerings place it second among exchanges. The market’s trading volume of more than $2 trillion, which has expanded by nearly one-third annually in recent years, is expected to approach $4 trillion by 2023. Transaction volume stemming from retail channels accounted for more than $1 trillion last year.
ONLINE SECURITIES TRADING VOLUME IN HONG KONG
2,500
2,000
1,500 In $Billions 1,000
500
0 2012 2013 2014 2015 2016 2017 2018 2019 2020 2021 2022 2023 Retail 138 199.8 286.2 694.8 503.6 795.5 1,170.4 1,325.4 1,510.8 1,705.9 1,918.9 2,169.7 Institutional 266.5 359.8 519.3 685 519.4 784.7 933.7 1,031.3 1,144.1 1,254.4 1,366.8 1,493.5
Source: Company Data, CapitalWatch Research
8 CapitalWatch Research - Futu Holdings Ltd. In similar ways to the markets in the United States, the rapid growth in the Hong Kong online securities markets is being driven by ease of market access and lower price points for trading accounts and transactions. The share of trading volume generated by the local population continues to expand with a nearly tenfold increase in volume generated from Hong Kong investors in the past six years. At the same time, with the introduction of “Shanghai-HK connect” easing transactional flow between the two exchanges, the volume of trading from the mainland is predicted to witness a nearly hundredfold expansion from 2012 to within the next five years.
With the rise of investor interest and activity, the universe of online brokers – as is apparent in the U.S. and Europe – has also expanded in local markets in recent years, more than doubling to nearly 300 brokerage participants by 2016. As is seen elsewhere, the typical online broker business consists of operations from within existing commercial banking institutions, entities that provide both online and offline sales and transaction-fulfillment channels, and dedicated online firms.
Given the expansion of investment opportunities as well as investor access, the online brokerage industry in Hong Kong is anticipated to increase dramatically, accounting for roughly $150 billion in total trading volume last year.
II. Futu Holdings Ltd.
A) Futu’s Business Model
Futu Holdings Ltd. is an advanced FinTech company transforming the investing experience by offering a proprietary cloud-based brokerage platform, primarily serving the emerging affluent Chinese population through its fully licensed securities brokerage firm from its headquarters in Hong Kong.
According to the company’s prospectus filed with the U.S. Securities and Exchange Commission, some of Futu Holdings’ subsidiary companies hold SFC type 1, 2, 4, 5 and 9 licenses and is registered as a broker-dealer with the SEC and is a member in good standing of U.S. FINRA.
Similar to other online brokers, Futu Holdings, through its fully digitized brokerage platform, Futu NiuNiu, provide users with trade execution for stocks, warrants, options and exchange-traded funds, margin financing, market data and information, and social networking services for three major markets including Hong Kong, U.S., and Chinese A-share listed stocks through Shanghai and Shenzhen Stock Connect.
Apart from its main business of serving as a securities and options brokerage, Futu Holdings also provides corporate services to institutional clients, which includes establishing and administering the platforms of their employee stock option plans (ESOP) and providing IPO subscription services to many listed companies.
The platform’s interface is specially designed to fit Chinese investors’ preferences and it provides free live stock trading data to China-based investors that is only available to VIP clients on other platforms. Users can open an account online in five minutes and begin trading and reading live market information that is available on the NiuNiu platform.
CapitalWatch Research - Futu Holdings Ltd. 9 FUTU HOLDINGS LIMITED
The live data is not restricted to the Hong Kong stock market. Starting in 2019, investors in China who trade U.S. equities can use Futu’s NiuNiu app to access Nasdaq TotalView for free, which displays real-time traded prices and full order book depth for market participants.
Over recent years, Futu has launched several new services to satisfy clients’ needs, including one-click new share subscription, after-hours trading, mainland cross-border stock trading, and IPO subscription using collateral. In addition, Futu rolled out a series of discounts and special offers during holidays, including zero-commission, zero-deposit IPO subscriptions, and low margin fees.
These improvements, though relatively minimal, are seen as critical to Futu staying ahead of big traditional brokerage firms and banks, like Bank of China and Haitong International Securities, that are lowering fees to compete, as well as other startups offering zero-commission mobile or online trading.
“Futu provides one-stop service for clients’ all investment needs, and unlike our competitors, Futu has developed front-end stock trading software, customer management system and back-end clearing and settlement system all by ourselves,” said Hua Li, founder of Futu Holdings. “We have developed full-chain closed loop infrastructure.”
In short, the company aims to build an app that enables clients to get everything they need for their investment without walking into a local bank or brokerage firm.
B) Extraordinary Growth and Profitability
Most investors are interested in the Futu IPO because of the extraordinary growth in its business and its profitability.
Benefiting from the emergence of a mass affluent class in China that has strong demand for overseas wealth-management services, Futu’s user base (including those who opened trading account but have not yet deposited any assets) has grown from 3.2 million as of Dec. 31, 2016, to 3.9 million as of Dec. 31, 2017, and further to 5.6 million as of Dec. 31, 2018. The company’s monthly average users (MAUs) have increased from 175,383 in December 2016 to 304,660 in December 2017, and further to 374,692 in December 2018. Its average number of daily average users (DAUs) jumped from 45,733 in December 2016 to 151,700 in December 2018.
Although the growing number of users are not fee-paying clients, they remain a critical source of data for the NiuNiu platform, a pipeline for growing the company’s fee-paying client base and serving as the foundation of its NiuNiu social community.
As of Dec. 31, 2018, the company had more than 502,000 registered clients and more than 132,000 clients with assets in trading accounts. For the year ended Dec. 31, 2018, the company recorded HK$907 billion ($115.8 billion) in total trading volume for client. According to research by Oliver Wyman, the company ranks fourth among Hong Kong online retail brokers in terms of online brokerage revenue for the six months ended June 30, 2018. Also, Futu held HK$50.9 billion (US$6.5 billion) in client assets at the end of the period.
10 CapitalWatch Research - Futu Holdings Ltd. FUTU NET INCOME (LOSS) VS UP FINTECH NET INCOME (LOSS)
30,000
20,000
10,000
0
-10,000 US$ in thousands -20,000
-30,000
-40,000
-50,000 2016 2017 2018 Futu Holdings ($12,801) ($1,053) $17,689 Up Fintech (Tiger Securities) ($10,811) ($7,927) ($44,294)
Source: Company Data, CapitalWatch Research
Among the more interesting aspects of the company is that Futu has succeeded in turning a profit while its direct rival Tiger Securities, which filed for an IPO with the U.S. Securities and Exchange Commission a month after Futu, is far from breaking even.
In 2018, Futu’s revenue reached HK$811.3 million (US$103.6 million), representing a 159 percent increase from the year before. Net income for the year was $17.7 million, or 1 cent per share, compared with a net loss of $1 million for the same period in 2017.
By comparison, Up Fintech Holding Ltd., which operates under the name Tiger Securities, saw its revenue nearly double year-over-year to $33.6 million in 2018. However, the company’s net loss reached $44.3 million compared with a loss of $7.9 million for the prior year. The company’s management has said it did not expect Tiger Securities to break even any time soon.
“We may also continue to incur net losses in the future due to changes in the macroeconomic and regulatory environment, competitive dynamics and our inability to respond to these changes in a timely and effective manner,” Up Fintech said in its prospectus.
CapitalWatch Research - Futu Holdings Ltd. 11 FUTU HOLDINGS LIMITED
C) Key Milestones
2018
July 2018 – Became the first licensed brokerage company to provide completely online-based trading account opening services among leading players in Hong Kong.
January 2018 – Registered in the U.S. as a broker-dealer, became a FINRA member, and opened an office in Palo Alto, California.
2017
May 2017 – Completed series C round of venture capital financing.
2016
October 2016 – Became one of the first brokerage companies globally to offer free real-time Level II Hong Kong stock quotes to China-based clients.
2015
May 2015 – Completed series B round of venture capital financing.
2014
October 2014 – Completed series A round of venture capital financing from Tencent, Matrix and Sequoia Capital.
September 2014 – Integrated with the U.S. capital markets and began offering real-time stock quotes on major U.S. exchanges.
2012
October 2012 – Obtained a Type 1 License for dealing in securities from the HK SFC and commenced the operation of its online brokerage business.
2011
December 2011 – Launched its proprietary Hong Kong securities trading system supporting the execution of securities trades within 0.0037 seconds.
D) Tencent As a Major Partner
Futu has raised millions of dollars in its most-recent funding round from Tencent, Sequoia Capital, and Matrix Partners China, which occurred in May 2017. Among these top three investors, Chinese tech titan Tencent is the largest shareholder holding a 34.2 percent stake in the unicorn after the offering.
In addition to being a primary investor in Futu, Tencent is also a key supporter of the company. Leaf Hua Li, founder and chief executive officer of Futu was Tencent’s 18th employee. He joined Tencent in 2000 and was an early and key research and development participant in Tencent QQ and the founder of Tencent Video. Futu’s chief technology officer, PPchen Weihua Chen, also came from Tencent. He was the former head of Tencent QQ’s back-end services and led multiple system restructuring projects of Tencent QQ with hundreds of millions of simultaneous online users.
12 CapitalWatch Research - Futu Holdings Ltd. According to the prospectus, in December 2018, Shenzhen Futu, one of the company’s operating entities in China, entered into a strategic cooperation framework agreement with Shenzhen Tencent Computer System Co. Ltd., a subsidiary of Tencent. Pursuant to the agreement, Tencent agreed to cooperate with Futu in traffic, content, and cloud areas through Tencent’s online platform. In addition, Futu and Tencent agreed to further explore and pursue additional opportunities for potential cooperation in the area of fintech-related products and services to expand both parties’ international operations.
SALES AND MARKETING EXPENSES AS A PERCENTAGE OF REVENUE 900,000 90
811,343 800,000 80
68.00% 700,000 70
600,000 60
500,000 50
400,000 40
311,663 300,000 30
200,000 20 13.30% 12.10% 98,062 100,000 87,015 10 59,198 41,446
0 0 2016 2017 2018 Selling & Marketing Expenses (in thousands, and HKD$) 59,198 41,446 98,062 Total Revenue (in thousands, and HKD$) 87,015 311,663 811,343 Expenses vs. Revenue Percentage 68.00% 13.30% 12.10%
Source: Company Data, CapitalWatch Research
Leveraging on its efficient online trading system and support from Tencent, Futu’s sales and marketing expenses as a percentage of its revenue have dropped significantly as the firm has scaled its operations.
Looking ahead, the involvement of Tencent could be invaluable. According to the chart below, WeChat, a social networking app developed by Tencent, has over 1 billion monthly active users (MAU) worldwide as of August 2018, and the number is approaching 1.1 billion.
CapitalWatch Research - Futu Holdings Ltd. 13 FUTU HOLDINGS LIMITED
NUMBER OF MONTHLY ACTIVE WECHAT USERS
1,250
1,082 1,057.1 1,040 1,000 989 963980 938 889 849 806 762 750 697 650 600 549 500 500 468 438
Number of accounts in millions 396 336 355
250 235.8 209.6 194.4 151 160.8 100 50 0 14
1 1 2 2 2 2 3 3 3 3 4 4 4 4 5 5 5 5 6 6 6 5 7 7 7 7 8 8 8
Q3’1 Q4’1 Q1’1 Q2’1 Q3’1 Q4’1 Q1’1 Q2’1 Q3’1 Q4’1 Q1’1 Q2’1 Q3’1 Q4’1 Q1’1 Q2’1 Q3’1 Q4’1 Q1’1 Q2’1 Q3’1 Q4’1 Q1’1 Q2’1 Q3’1 Q4’1 Q1’1 Q2’1 Q3’1
Source: Statista
As a result, depending on the scope of the overall collaboration, Futu could benefit immensely by using WeChat as a channel to reach billions of potential Chinese clients in a very cost-efficient manner.
Tencent founder Pony Ma speaks highly of Futu. “The Futu team all born with Internet genes with high technological innovation capabilities,” said Ma. “They continue to pursue its mission to re-define traditional investing with proprietary technologies and a relentless focus on user experience.”
“The team is focused to enhance its product and try to create its own core competitiveness. In fact, Futu is very similar to Tencent, designing good products is the most crucial element for our success,” said Ma.
E) Futu’s Competitive Strengths
Headquartered in Hong Kong, Asia’s financial hub, Futu is no stranger to competition. Traditionally, top players in the brokerage market were large financial institutions, like HSBC and Bank of China, and established brokerage houses, like CHIEF and Bright Smart Securities. Today, however, online brokers – those exchange participants that offer online trading services to retail investors – are growing so quickly that they are expanding from 30 percent to 54.7 percent of the total number of brokers from 2007 to 2016.
14 CapitalWatch Research - Futu Holdings Ltd. Moreover, according to iResearch Report, with the increasing need to trade efficiently, the customer base that chooses to trade through online brokers will grow at a faster pace than that through traditional brokers.
Despite the keen competition in the securities, futures, and options brokerage industry, we believe that the competitive strengths of Futu will enable the company to compete effectively. The reasons for this include: i. Futu’s Subsidiary companies hold SFC type 1, 2, 4, 5 and 9 licenses and a broker-dealer with SEC and FINRA member.
Futu, ranked fourth among Hong Kong online retail brokers in terms of online brokerage revenue for the six months ended June 30, 2018, is one of the few pure-play online brokers with its own license in Hong Kong. This means Futu has its own clients, assets, and clearing abilities. Many other popular internet brokers have no “real” clients. For example, newly released Snowball Securities and Futu’s direct rival Tiger Securities both rely heavily on collaboration with their primary clearing agent, Interactive Brokers, to execute, settle, and clear a substantial portion of the trades in U.S. and Hong Kong stocks and other financial instruments. This is their biggest challenge. They do not actually hold client assets.
The result is that all these other firms can do is to serve as an agent, which does not permit a substantial pricing power, arguably the single-most important decision in evaluating a business.
“We believe that our relationship with Interactive Brokers is critical to our business. If we need to enter into alternative arrangements with a different clearing agent to replace our existing arrangements, we may not be able to negotiate a favorable alternative arrangement,” Tiger Securities warned in its latest prospectus. “Transitioning to a new clearing agent is time-consuming and may affect the user experience or, if our platform becomes inoperable, may result in our inability to facilitate trades through our platform.” ii. Futu has its proprietary execution and clearing system, which represents extensive know-how and a high technical barrier for entry.
Designing a system that includes proprietary execution and clearing comes with additional risk and large costs. Regulatory scrutiny from the Hong Kong Securities and Futures Commission and the U.S. Securities and Exchange Commission are both high, and the more Futu brings in-house, the more security work it must do.
Over the past eight years, Futu has made significant investments in its technology platform, which has evolved into a highly automated, multi-market, closed-loop technology infrastructure that drives every function of its business, including trading, risk management, clearing, market data, news feeds, and social functions.
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This proprietary system has a significant cost. As of Dec. 31, 2018, approximately 65 percent of Futu’s workforce was dedicated to research and development, and the majority of them have work experience at leading internet and technology platforms. Research and development expenses grew more than 50 percent to HKD$95.5 million in 2017 from HKD$62 million. It jumped nearly an additional 60 percent in 2018 to more than HKD$151 million.
However, as the company grows, Futu’s research and development expenses as a percentage of its total revenues, which measures the percentage of sales that is allocated to R&D expenditures, dropped to 30.7 percent in 2017 from 70.8 percent in 2016. It dropped further to 18.6 percent in 2018, illustrating a driving factor behind its expanding margins.
RESEARCH AND DEVELOPMENT EXPENSES AS A PERCENTAGE OF REVENUE 900,000 90
70.80% 811,343 800,000 80
700,000 70
600,000 60
500,000 50
400,000 40
311,663 300,000 30 30.70%
20 200,000 18.60% 151,097
100,000 87,015 95,526 10 61,624
0 0
2016 2017 2018
Research and Development Expenses 61,624 95,526 151,097 (in thousands, and HKD$)
Total Revenue (in thousands, and HKD$) 87,015 311,663 811,343 Expenses vs. Revenue Percentage 70.80% 30.70% 18.60%
Source: Company Data, CapitalWatch Research
16 CapitalWatch Research - Futu Holdings Ltd. In comparison, Tiger Securities listed no R&D expenses on its financial statements, only growing marketing and branding expenses. It has explained in an interview that Tiger Securities focuses on continuously improving UI (user interface) design amid Chinese customer feedback. UI design is important in terms of attracting more clients, but it can be easily copied by its competitors. Designing in-house systems might seem unnecessarily costly at first, but it could bring massive cost-savings in the long run.
Although spending on R&D is not directly linked to growth in sales or profits in the short-run, it does demonstrate the company’s unique positioning and increased innovation, which could potentially boost Futu’s reputation and income in the long run. Moreover, since Futu is not depending on a third party, it can control its own destiny.
We believe Futu will continue to make investments in research and development and technology to create a higher technical barrier for entry and to enhance its platform to address the diverse needs of clients and improve operating efficiency. As a listed company, it will also be easier for Futu to attract talented IT professionals globally to join the R&D team with different share-based compensation programs. iii. People prefer to do business with like-minded people.
Apart from Tiger Securities and Snowball Securities, which are designed by mainland companies, there are some major online retail brokers based in Hong Kong that have a long history and have served the diverse community of Hong Kong retail investors. According to research by Oliver Wyman, below are the top seven online retail brokers in Hong Kong, based on estimated online brokerage revenues derived from retail investors for the six months ended June 30, 2018. The ranking only shows exchange participants with trading seats in the Hong Kong Exchange.
• Hongkong and Shanghai Banking Corp. (HSBC)
• Haitong International Securities (0665.HK)
• Bank of China (Hong Kong)
• Futu Holdings
• Interactive Brokers
• Bright Smart Securities (1428.HK)
• Huatai Financial Holdings
Among the seven, HSBC and Bank of China are the major international banks that offer comprehensive full banking and investment services to high net worth clients. Standard trading fees for HSBC, for example, typically range from 0.25 percent to 0.4 percent of the transaction amount per transaction, depending on whether trading is conducted through manned phone-banking and branch or through mobile banking. There is usually a minimum charge of HKD$100.
CapitalWatch Research - Futu Holdings Ltd. 17 FUTU HOLDINGS LIMITED
Large securities house like Haitong International Securities and Huatai Financial Holdings have lower rates than big banks, typically 0.15–0.25 percent of transaction amount per transaction, but still the same minimum charge of HKD$100.
Bright Smart Securities, a locally well-known securities brokerage house, generally has low brokerage commission rates and primarily focuses on providing online brokerage services in Hong Kong. It covers services from its securities, futures and options brokerage in Hong Kong to a wide range of financial products traded on the U.S. and Singapore exchanges. It charges Hong Kong clients a rate of 0.0668 percent (with a minimum charge of HK$50) of transaction value for online securities trading, and 0.085 percent (with a minimum charge of HK$50) of transaction value for securities trading through telephone orders.
To compete with newcomers like Futu and Tiger Securities, Bright Smart Securities just announced that it will lower its commissions to zero for new customers from mainland China. Also, for the first year, mainland clients will be credited with HKD$5 per each Hong Kong stock and A-share transaction.
“With this promotion, we hope to attract 200,000 new mainland customers in the near future,” explained the chairman of Bright Smart.
Although the promotion is large and unusual – no commission plus extra rebate, we believe mainland clients would still prefer mainland-developed trading apps like Futu, Tiger, or Snowball. People prefer to do business with like-minded people.
Eventually, all brokers are likely to be offering zero commission as costs become less of a concern. It’s the user experience (simplified Chinese interface instead of traditional Chinese interface in Hong Kong), and online chatting community functions that could eventually win the heart of mainland users.
F) Shift of Revenue – From Commission to Margin Interest
Futu had a user base of 5.6 million with more than 502,000 registered clients and more than 132,000 clients with assets in trading accounts as of Dec. 31, 2018. For the year 2018, the company recorded HK$907 billion (US$115.8 billion) in total trading volume for clients. It held HK$50.9 billion (US$6.5 billion) in client assets at the end of the period.
Currently, Futu receives most of its income from brokerage commissions, handling charges and interest income.
For all of 2018, the company generated total revenue of HK$811.3 million (US$103.6 million), representing a 159 percent increase from the year before. Over the past three years, Futu’s gross profit margin has grown significantly. Driven by the increase of financing income for applications of shares in connection with IPOs and other handling charges income, Futu’s gross profit margin grew from 48.2 percent in 2016 to 69.24 percent in 2018, signaling that a more efficient management push is generating more profit for every dollar of labor cost involved.
18 CapitalWatch Research - Futu Holdings Ltd. FUTU’S GROSS PROFIT MARGIN
900,000 90
811,343 800,000 80
700,000 70 69.24% 600,000 65.00% 60 561,749
500,000 50
48.20% 400,000 40
311,663 300,000 30
202,561 200,000 20
100,000 87,015 10 41,946
0 0 2016 2017 2018 Gross Profit (in thousands, and HKD$) 41,946 202,561 561,749 Total Revenue (in thousands, and HKD$) 87,015 311,663 811,343 Gross Profit Margin (in thousands, and HKD$) 48.20% 65.00% 69.24%
Source: Company Data, CapitalWatch Research
In addition, Futu Holdings disclosed in its recent prospectus that it will continue to maintain and enhance its relationships with Futu’s funding partners for its margin financing business. It said it also plans to expand its service offerings from online brokerage services to margin financing services and to other new service in the future.
Faced with growing competition in the online brokerage service industry, we expect every company to be offering zero commission trading eventually, and even traditional brokerage houses that have broader range of services are rolling out a series of promotions. Relying only on brokerage fees to support the business is not only unrealistic but also risky in the long run.
Currently, Futu derives a significant portion of its revenues from commissions and fees paid by clients for trading securities, but the percentage in relation to total sales is decreasing. In 2016, 2017, and 2018, Futu’s brokerage commission income and handling charge income amounted to HK$74.5 million, HK$184.9 million, and HK$408.0 million (US$52.1 million), representing 85.6 percent, 59.3 percent and 50.3 percent of its total revenues during the three years, respectively.
CapitalWatch Research - Futu Holdings Ltd. 19 FUTU HOLDINGS LIMITED
In 2016, 2017, and 2018, Futu’s revenue from interest income derived from margin financing and securities lending businesses amounted to HK$1.8 million, HK$65.5 million and HK$226.1 million (US$28.9 million), representing 2.0 percent, 21.0 percent and 27.9 percent of its total revenues during the same years, respectively. For the same years, Futu’s interest income derived from bank deposits were HK$4.0 million, HK$34.1 million, and HK$123.8 million (US$15.8 million), representing 4.6 percent, 10.9 percent and 15.3 percent of its total revenues during the same years, respectively.
Futu’s shift of revenue is apparent from the following chart.
FUTU’S CHANGING REVENUE SOURCE
5% 2018
7% 2017
7.73% 2016 6.70% Brokerage Income
Interest Income 34% Other Income 50% 59% 45%
85.62%
Source: Company Data, CapitalWatch Research
G) Faith in “Good Products” Underpinned by Independent Technology
Futu has attached great importance to its user experience and is committed to providing “good products” to users. As the company’s founder Mr. Hua Li said, “only users have the best sense of ‘good products’ and they totally understand what is good and what is bad.” With such a faith in “good products,” Futu has been making constant efforts and progress in improving its user experience by perfecting Futu NiuNiu, the flagship trading software of Futu. For example, to give users a better version of Futu NiuNiu, Futu updated the versions 52 times touching upon almost 1,300 functions in 2016 alone.
20 CapitalWatch Research - Futu Holdings Ltd. Another example is that Futu has taken the unusual step in successfully waiving commission fees for users on their birthdays. Although it seems to be an easy move, there were technical challenges about requiring data needed to match the users with their birthdays. With the strong belief and persistence in “good products” and “good user experience,” the tech team eventually overcame an array of difficulties and managed to waive the commission fees for users on their birthdays. Such a small, yet meaningful, move has been welcomed by users, who believe that Futu does care about them and has been truly making efforts to give them the best user experience and benefits as well.
The faith in “good products” and “good user experience” is also reflected in the delicate handling of Futu’s logo on its invoice. In the online brokerage industry, 99 percent of brokerage firms provide their invoices with logos that are not vector graphics. If the logos are magnified, they become blurry. However, Futu, which noticed this problem, made its logo on the invoice a vector graphic. Such a detail-oriented attitude gives Futu a better position to win users’ trust. It is no wonder that Futu has been awarded by KPMG with China’s Top 50 Fintech Firms for three consecutive years.
H) Considerable Public Attention
Futu has been receiving public attention in China with a peak in December of 2018. According to Baidu Search Index, which indicates how much attention is given to a particular company by the public, Futu’s search index is around the national average with fluctuations during the past half year. It appeared more in people’s researches at the end of 2018, but less in the early 2019. It indicates relatively less public attention to Futu. Also, if we look at the information index, which measures the popularity in the topics of people’s discussion, we can also find that Futu is less discussed by the public. One of the possible explanations is the decreasing public attention to the entire online brokerage industry in China, which can be proved by the fact that almost all online brokerage companies in China have decreasing search indexes.
Futu Search Index vs. National Search Index
Source: Baidu Search Index
CapitalWatch Research - Futu Holdings Ltd. 21 FUTU HOLDINGS LIMITED
Futu Information Index vs. National Information Index
Source: Baidu Search Index
At the same time, if we look at the media index that measures media coverage, Futu was widely reported at the end of September 2018, end of December 2018 and in January 2019. It is fair to conclude that Futu has been receiving significant media coverage, which further proves its importance and significance to the entire industry.
Futu Media Index vs. National Media Index
Source: Baidu Search Index
Also, if we compare the research index of Futu to that of Tiger Securities, another leading online brokerage company in China, Futu has been receiving less attention than Tiger Securities in the past half year. There are two possible explanations for the decreasing public attention of Futu. One could be the result of the rising Tiger Securities, which has been developing quickly in recent years and taking more market share. Another possible explanation is that Futu has already been a strong brand with cultivated and stable trust with users. This existing familiarity would explain why they do not search Futu as much as they did in the past.
22 CapitalWatch Research - Futu Holdings Ltd. Futu Search Index vs. Tiger Securities Search Index
Source: Baidu Search Index
I) Diverse Profile of Futu’s Users
It is useful to look at Futu’s user profile for both age and geographical distributions to better understand the company. According to Baidu Search Index and 360 Search Index, Futu has been popular among the three major areas in China, including Guangdong province, Beijing, and Shanghai. In particular, Guangdong province, the largest economic province in China and a neighbor of Hong Kong, has the largest number of Futu users.
If we dig further, we find that Futu has attracted a large number of young and middle-aged users with a breakdown of 75 percent men and 25 percent women. It is a good indicator for Futu’s growth potential since it is particularly attractive to the most dynamic group of people with higher income.
Futu’s User Profile – Geographical Distribution
Source: Baidu Search Index
CapitalWatch Research - Futu Holdings Ltd. 23 FUTU HOLDINGS LIMITED
Futu’s User Profile – Age Distribution
Source: 360 Search Index
J) Incredible Trust between Futu and Users
Futu’s dedication, commitment, and persistent efforts to provide “good products” are rewarded by incredible trust built through time between Futu and its millions of users. Not only does the company receive consistently positive feedback from new users, but it also builds on and strengthens the trust from existing users. The overall feedback and comments include reviews that focus on the company’s great “Tencent gene” with great technology, “amazing user experience” with friendly interfaces of the trading software, and low commission fees. The trust between Futu and its users is one of the crucial factors for Futu’s success in China’s online brokerage industry.
We have widely searched users’ comments on their experience with Futu Holdings from the major discussion platforms, such as Xueqiu, Zhihu, Baidu Zhidao and Options BBS.
Futu’s software is really great. We can feel and see the considerable efforts made by Futu, a company with Tencent gene, to provide a good trading software.
It’s so great to trade US, HK and A shares using just one trading software.
Futu Securities is an internet broker invested by well-known investors, such as Tencent and Sequoia. Its Tencent gene and technology enable it to provide the most timely market information which cannot be offered by common platforms.
24 CapitalWatch Research - Futu Holdings Ltd. I strongly prefer Futu, because it provides a more friendly interface which is easier to operate. This is particularly attractive to individual investors.
Which US stock broker is better, Futu or IB?
I have used both and I prefer Futu, because Futu has a more convenient way for users to open accounts and has no threshold for the initial funds. Also, its trading platform is user-friendly and offers a great user experience. Given the above advantages, it is particularly attractive to individual investors who are trading US stocks.
If I have to choose one, it must be Futu!
Futu has a much better interface and operation functions, which are more friendly than IB. I had bad experience with IB before. It was even very difficult for me to figure out how to open an account at IB. It was frustrating.
About commission fees: Futu just released the new commission fee structure. The adjustments about How is Futu Securities ? commission fees are incredibly considerate and beneficial for its users.
Futu Securities was established in Hong Kong in the year of 2012. It is recognized by Hong Kong Securities and Futures Commission (code: AZT137). It finished C round financing in June, 2017 with 145.5 million US dollars, and has become one of the unicorns in this industry.
Futu Securities has been a leading internet broker. It was awarded Best Hong Kong Broker in 2015, Top 100 Chinese Companies with Innovation and Growth in 2015, and Top 50 Hurun New Finance in 2016.
As one of the earliest users Is Futu Securities safe ? of Futu, I have witnessed its rapid growth and increasing competitiveness in this industry. Brand awareness and trust are not built in one day. I strongly believe that Futu will gain trust of more and more users.
I have been using Futu since I started trading stocks.
CapitalWatch Research - Futu Holdings Ltd. 25 FUTU HOLDINGS LIMITED
I am one of the earliest users of Futu. I am still using it now. It is absolutely safe.
Very professional trading software!
K) Risks
i. Competition in the U.S. market
The company plans to use the net proceeds of this offering for general corporate purposes, including research and development, working capital needs, and increased regulatory capital requirements of the HK SFC and regulatory authorities in other jurisdictions as a result of the business expansion.
Expansion in the U.S. to serve customers who reside in that country could face potential difficulties given the highly competitive environment. Although the company expects to target its products and services to the large investment community of Chinese nationals and immigrants, current offerings from online brokerages, including operations run by traditional banking and brokerages houses, are likely to make entry challenging. Much of the industry in the U.S. remains dominated by long-time and well-known institutions that increasingly offer no-fee trading options online with additional investment advisory services.
In addition, new technology has allowed the influx of many non-traditional competitors that offer mobile-based applications to a mostly younger, affluent population that has increasingly become a profit center for investment services.
Marketing and sales expenses, in addition to needed administrative and customer service operations in the U.S., are likely to make entry to the market risky in terms of penetration, brand recognition, and profitability. Identifying and catering products and services to a targeted population segment of U.S. investors could be successful, but carries many challenges that would need to be surmounted.
ii. Lack of license in China
Hong Kong-based Futu enables investors to see live data and invest in Hong Kong and U.S.-listed shares using funds deposited in overseas banks. While the company adheres to all regulations involving overseas markets, potential risk remains involving investors from mainland China.
Under PRC laws and regulations, the company explains in its prospectus, “no entity or individual shall engage in securities business without the approval of the securities regulatory authority of the State Council.” However, the company maintains that it does not conduct any applicable operations in mainland China as its services, through affiliated businesses, are not in the securities brokerage business.
26 CapitalWatch Research - Futu Holdings Ltd. Inquiries have been received from regulators in China, however, and the company “has taken measures” to resolve any questions of compliance, the company said in its filing.
Further questions remain regarding certain regulations pertaining to the need for all investment institutions to safeguard against money-laundering and illegal transfers of funds. Futu has received questions regarding its anti-money-laundering procedures as well as the methods employed for onboarding clients from mainland China.
Despite review of corporate counsel and measures taken to respond to regulatory concerns, uncertainties remain should the application of future laws and regulations change in fact or in interpretation.
L) Industry Insiders’ Opinions
“At the forefront of two dynamic and rapidly intersecting markets, Futu is well positioned to leverage an expanding affluent class in China with investable assets coupled with the new technology allowing global transaction funding into securities markets.
We expect Futu to be a leader in leveraging these burgeoning market opportunities through its proprietary trading platforms and low-cost structure for consumers.”
Yulin Song, Executive Director of Goldman Sachs China
“Futu has experienced a sharp revenue growth trajectory, likely a cause of its relationship with Tencent that results in greater capital efficiencies and stronger growth metrics. There is a significant market opportunity for garnering increasingly affluent Chinese investors who are interested in investing in overseas markets, especially in the wake of highly volatile mainland China stock markets in Shanghai and Shenzhen in the past few years.
FHL competes with another Chinese company seeking to go public, Up Fintech (Tiger Securities), which is much smaller and has unattractive financial metrics by comparison.
As to valuation, FHL management is asking investors to pay an EV/ Revenue multiple of 9.54x, which is a relative bargain compared to that of Interactive Brokers at 16.96x. However, the firm has half of Interactive Brokers’ EBITDA on an enterprise value basis and a fraction of its earnings per share.”
Donovan Jones, Senior Equity Analyst and the Founder of VentureDeal, a North America technology venture capital database.
“Futu Holdings Ltd., a Hong Kong-based online broker will debut Friday March 8, 2019 in the United States. They have a slick mobile centric tool aimed at global market participants, and offer a solid product with excellent graphics when I tested it compared to the TD Ameritrade product.
They also have pedigree which include Tencent, Sequoia Capital China and selected Goldman to deliver the IPO placement, note also, in 2017, they raised $145.5 million in a funding round at a valuation of about $1 billion which comes through in the tight technology the developers put together in the software package for users.”
Steve Kanaval, Trader/Portfolio Manager at Chicago Arbitrage Group. He ran the Morgan Stanley Derivative Prop Trading for the firm specializing in Index Arbitrage.
CapitalWatch Research - Futu Holdings Ltd. 27 CAPI AL WA CH
FUTU HOLDINGS LIMITED