Puyi and Fanhua in share swap

Separate shareholder groups from the two publicly traded companies will each acquire a majority stake in the other through an equity swap

Key Takeaways:

  • An equity swap will give a group of Fanhua shareholders 77% of wealth management firm Puyi, and a Puyi shareholder group 50.1% of Fanhua
  • The deal comes as Puyi struggles with shrinking revenue and ongoing losses


By Warren Yang

Wealth manager Puyi Inc. (PUYI.US) has pulled off a sort of shotgun marriage that will closely tie its fate – and ongoing quest for profitability – with the far larger and profitable insurance broker Fanhua Inc. (FANH.US).

Under a deal announced Wednesday, a group of Fanhua shareholders, including CEO Hu Yinan, will swap some of their stock for newly issued Puyi shares at a ratio of two Fanhua shares for each Puyi share they receive. The transaction will give the Fanhua shareholder group about 77% of Puyi, which in turn will hold a 50.1% of Fanhua.

The transaction, which is expected to close this week, will essentially allow Puyi to obtain a majority stake in Fanhua without spending a dime in cash. The Fanhua shareholder group, meanwhile, will maintain its control of Fanhua through its majority ownership of Puyi.

The deal comes less than a week after Fanhua agreed to transfer a 4.46% stake it held in Puyi back to the wealth manager, in exchange for a 10.5 million yuan ($1.5 million) in cash and 15.41% of Fanhua Puyi Fund Sales (Puyi Fund), a distributor of publicly raised funds that is one of Puyi’s key businesses.

Fanhua and Puyi co-created Puyi Fund in 2010, and Fanhua later converted its minority stake in the venture to a 4.46% stake of the parent company Puyi’s stock ahead of Puyi’s 2018 IPO. But that stake has dwindled in value since then as the profit-challenged Puyi’s shares lost about a third of their value amid falling revenue in its last three fiscal years.

The latest share-swap deal that effectively ties the two companies closely together looks somewhat curious, since the Fanhua shareholders paid a hefty premium for their new majority Puyi stake. Reflecting that, Puyi’s shares jumped 47% on Wednesday, while Fanhua’s rose by 1.7%. Puyi shares already commanded an inflated price-to-sales (P/S) ratio of nearly 15 before the announcement, and that figure rose to 22 after the big stock gains. By comparison the larger Noah Holdings (NOAH.US; 6686.HK), a much bigger player in China’s wealth management market, trades at a far more reasonable ratio of 2.

Perhaps Fanhua and Puyi are betting that synergies from their closer ties can lead to greater growth, especially for Puyi, whose revenue totaled just 114 million yuan for its latest fiscal year through June. That’s not too unreasonable, given that their businesses are highly complementary since both sell financial products. But Puyi would really need to post some astronomical growth to justify its latest valuation – a difficult challenge considering its recent record of shrinking revenues and China’s slowing economy growth.

Puyi is also quite low on cash, with just 164 million yuan at end of June, as it continued to lose cash from operations. A glaring problem for Puyi is its lack of investment in new growth engines, which is reflected in its nearly debt-free status as it tightly controls its spending. Its cash expenditure for investment more than halved in the fiscal year to June. While such frugality may look commendable and prudent, it also suggests the company lacks big strategic plans for the kind of growth that most investors want.

The latest tie-up may suggest that Fanhua could be preparing to step in and help Puyi jumpstart its growth, perhaps through an asset injection. Such a move could quickly pump up Puyi’s revenue to a much higher level, which might justify the company’s big valuation despite its unimpressive revenue trends.

Cost control

Puyi’s net loss narrowed in its latest fiscal year, thanks to efforts to reduce operating expenses. It cut marketing costs, switching its focus to “stimulating the growth of new investments” from opening new accounts, CFO Hu Anlin, who left the company late last month, said on Puyi’s conference call to review its latest earnings in September. Puyi also divested a subsidiary and closed a number of branches, while cutting some staff.

The extensive cost controls reflect the rough times for China’s highly competitive wealth management industry as growing investor gloom over China’s economy dampens demand for the kinds of wealth management products that Puyi sells. As Chinese stocks were some of the world’s worst performers this year, Puyi’s latest annual revenue dropped nearly 40% in the 12 months to June to the 114 million yuan we previously mentioned.

Puyi distributes third-party wealth management products, with affluent and middle-class retail investors as its main target customers. But it’s trying to boost its sales to larger, professional institutional investors that are generally more profitable due to their larger size and trading volumes.

The aggregate value of publicly raised funds that Puyi distributed to its financial institutional clients, including banks, insurers, brokerages and trust companies, jumped 266% year-on-year in the 12 months to June. But its overall distributions of such funds actually decreased during that period, suggesting the company lost quite a lot of smaller individual retail clients over that time.

Sales of publicly raised funds through Puyi Fund are Puyi’s primary revenue source. The company prioritizes funds backed by public securities with transparent prices, and conducts due diligence on providers of such products. Such caution is increasingly necessary for wealth management companies in China to avoid losses linked to funds backed by murkier assets. Earlier this month, another wealth management services provider, Hywin Holdings (HYW.US), ran into trouble in that regard after saying it was unable to provide promised payments for some of its wealth management products presumably linked to assets in China’s troubled real estate market.

Despite its apparent caution lately, Puyi has also been trying to diversify its business. It started a family office operation in 2020 to help rich investors set up trust accounts and provide other related services. But such expansion was a small, incremental move that won’t provide a big new revenue boost anytime soon.

The latest deal with Fanhua is a different matter, and could make Puyi’s stock worth a new look for investors. Fanhua has a far larger revenue base than Puyi and operates profitably, which will provide major new resources for Puyi. For example, the growing alliance could allow Puyi to diversify its product offerings to include insurance, which could become a major new growth engine. Only time will tell where this new marriage will lead, perhaps even to an eventual true merger of the two companies. But for now, at least, there really isn’t much to dislike about the deal for Puyi shareholders.

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