Soaring stock brokers, and rising tobacco

“Stock brokers thrive on market volatility — it doesn’t matter if stocks go up or down, as long as there’s trading activity.”

By Doug Young & Rene Vanguestaine

For those of us who’ve closely tracked China’s evolving market, the recent spectacular performance of online brokers Futu and UP Fintech, also known as Tiger Brokers, alongside striking growth at China Tobacco International — the publicly traded arm of China’s tobacco monopoly — offer insight into the intriguing dynamics of Chinese regulatory challenges and market opportunities.

Both Futu and UP Fintech began their journeys by offering U.S. and Hong Kong-listed stocks to investors in Mainland China. However, regulatory headwinds emerged around two years ago when the Chinese government effectively halted their ability to acquire new customers in China, viewing these platforms as a conduit for capital flight. Their apps were even temporarily removed from Chinese app stores, compelling them to realign their business strategies in accordance with the Communist Party’s guidelines.

Surprisingly, these restrictions proved less crippling than anticipated. Instead, they served as a catalyst for aggressive international expansion, primarily targeting Chinese communities abroad — particularly in Hong Kong, Southeast Asia and North America —and catering to non-Mainland investors interested in the Hong Kong and U.S. markets. This strategic pivot seems to have paid off handsomely. Futu’s revenue surged an impressive 87% in the fourth quarter, and its profits more than doubled. UP Fintech wasn’t far behind, boasting a 77% revenue increase and record profits.

We believe these impressive figures partly reflect renewed optimism towards Chinese stocks, driven by government efforts to rejuvenate the economy, particularly within the technology sector. Yet, sustainability remains an open question. In our view, despite remarkable short-term performance, both brokers may face limitations in expanding beyond ethnic Chinese communities overseas. They encounter fierce competition from established Western platforms like Robinhood and newer aggressive competitors such as Webull, a U.S.-founded broker with Alibaba roots now rapidly expanding internationally.

Investors considering these stocks must be mindful of their inherently cyclical nature. These companies primarily thrive on market volatility, benefiting directly from trading commissions when markets fluctuate. This dependence means their revenue profiles are volatile — strong in active markets and weak during calmer periods. Although interest income from clients’ cash balances provides a more stable revenue stream, it remains minor compared to trading revenues. For investors looking at these online brokers, we recommend seeking firms that can diversify revenue streams beyond purely transactional activities.

Paradox of state-run tobacco profits

Turning to China Tobacco International, we see another fascinating case of strong financial results with inherent contradictions. As the export and import unit of China’s state-controlled tobacco monopoly, the company recently posted a 10% rise in revenue and a remarkable 43% jump in profit for 2024, with its stock soaring 140% over the past year.

Interestingly, this comes at a time when the number of Chinese smokers is reportedly declining. Yet cigarette demand — at least in terms of monetary value — continues to rise, possibly due to growing consumption of higher-quality, premium tobacco products driven by China’s rising living standards. It’s a paradox that underscores the broader ethical questions of a government-run entity promoting a health-damaging product domestically and abroad.

China Tobacco International highlights a broader conundrum for investors interested in state-owned enterprises (SOEs). While such companies benefit from near-monopolistic positions and immense domestic markets — in China’s case, a tobacco industry valued at more than $250 billion annually — they remain subject to unpredictable government decisions. Historically, we’ve seen SOEs like Moutai or PetroChina subjected to politically motivated interventions, prioritizing national policy objectives over shareholder returns.

We believe that investors must approach these state-run enterprises cautiously, recognizing that while their market positions may be attractive, they operate at the behest of governmental priorities, not purely market forces. Investors need a careful, discerning eye to identify where political risks outweigh the potential benefits.

Ultimately, whether looking at dynamic online brokers or powerful state-run monopolies, investors must weigh impressive short-term results against longer-term structural and political risks.

About China Inc

China Inc by Bamboo Works discusses the latest developments on Chinese companies listed in Hong Kong and the United States to drive informed decision-making for investors and others interested in this dynamic group of companies.

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