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Matthew Sipos
Matthew Sipos
Articles (7) 

Value Idea Contest: Jupai Holdings Ltd.

The struggling wealth management company is worth more dead than alive

June 20, 2019 | About:

Company

Established in 2010, Jupai Holdings Ltd. (NYSE:JP) is a considerably juvenile company. The main business consists of advisory services to high-net-worth individuals and third-party distribution of wealth management services.

As of March 31, the company covered 47 cities with 65 client centers in China. According to Jupai's market research, China’s high-net worth population is concentrated mainly among three economic and geographic regions: Bohai Rim, the Yangtze River Delta and the Pearl River Delta. As a result, the company is well positioned to benefit from its comprehensive network of operations.

Due to growing concerns surrounding a mispriced acquisition as well as tumbling profits and revenues, the stock sank to a new all-time low of $2.23 as of the time of writing.

Revenue, net income and market cap for the seven-year interval

Business

The firm provides asset management consultancy and markets in-house and third-party products, such as real estate, private equity and fixed income. Investors need to have at least $500,000 of investable cash to meet the requirements of becoming a client.

For the last five years, revenue grew at a scenic 42.5% rate, while book value advanced by 66.9% yearly. This spectacular growth was cut short by a slowing Chinese economy, descending revenue and operational losses. In addition, a nasty goodwill impairment charge induced a net loss for the fiscal year 2018.

Further, Jupai lost a notable percentage of its client base. Changing consumer habits attributed to market panic made things even worse. Nowadays, potential investors tend to favor safe haven investments rather than stock funds and are more likely to buy more secure products. Those products are also less profitable for the asset manager, however.

Moats

The radically thinning margins, forfeiture of existing clients and short track record of earnings power means that there is no durable competitive advantage here. It may have a competitive advantage, but it lacks durability. Compared to its competitor Noah Holdings Ltd. (NOAH), it managed to steadily grow earnings with a superb return on equity at 15-20% and healthy margins, without borrowings.

Unambiguously, Noah is a far better trade at this time, if we neglect market valuations. Noah is already not on sale at its price. In contrast with Jupai, Noah managed to retain margins and grow profits at a high rate over the last 10 years. Unlike Jupai, it has had no bad years due to mismanaged acquisitions.

UBS Asset Management Americas Inc. owns 25.39% of the outstanding shares of Jupai. Larger asset managers may see Jupai as a discounted buy-off opportunity to enter the Chinese asset management business -- currently, this is somewhat of a fantasy. So Jupai has all the capability to become a great business, with a durable competitive advantage in the future, and this share price may attract institutional investors, too.

Financials

ROE and ROA

Revenue grew at 42.5% while book value rose by 66.9% yearly in the beginning. In the past, the company was able to operate with good margins (net margins over 20% and gross margins north of 60%). It also managed to maintain exceptional return on equity (the median was 26.12% over the past seven years). Also during that period, the return on assets was around 16% -- an exceptional return for a financial company.

Gross margin, operating margin and net margin

The downward channeling on the chart indicates shrinking profitability or poor operations. Sales for fiscal year 2018 were 22% lower than in 2017, at $192.13 million, generating an operating loss of $23.27 million for the year. According to the 2018 earnings call, the operating loss is attributed to the $39 million goodwill write-down from the purchase of Scepter in 2015. Practically, if the goodwill impairment is ignored, Jupai Holdings would have recorded an operating profit of around $16.5 million.

Revenue, cost of goods sold and net income

Lastly, Jupai has a rock-solid balance sheet. It holds $189.3 million in cash and cash equivalents with negligible debt. The cash-debt ratio is 14.13. In practice, Jupai can afford to pay out high dividends for many years. Hopefully, it is going to do so. In the last two years, it paid out 5 cents and 6 cents. This is an astonishing 22-26% dividend yield at current valuation levels (around $2.30 per share).

Management

Jianda Ni, on the board of the company since 2015, become CEO in May 2017. He has extensive experience in the field of real estate. The salary of management seems to be appropriate.

However, Jupai Holdings grants stock options, thereby diluting the interests of shareholders, and has a long-term plan to continue doing so. The company believes that it is going to attract and retain key employees in the future. That it is rather alarming.

The executive officers and directors own approximately 58% of outstanding ordinary shares of Jupai. Therefore, they are on the deck of the same ship as the common shareholders are. At the same time, lifeboats are only for insiders (deep dive into the variable interest entity structure to understand risks accurately).

Valuation

Historically, in a booming economy, the company can produce fat profits. With a price-book ratio at 0.38 and price-sales ratio at 0.44, the stock looks dirt cheap. In the past, it was able to earn $30 million to $40 million in profit with $160 million to $190 million in revenue. I surmise that, with effective, cost-cutting efforts, Jupai can successfully make $30 million to $40 million in net income yearly.

The market capitalization is around $75 million. Historically, the stock traded at a price-earnings ratio of 9, so the company has exponential growth potential from here. To make things even better, it has $189.3 million in cash and cash equivalents on its balance sheet. Jupai Holdings could easily pay off its current liabilities, and all of its debt, ending up with more than $100 million in cash. That is why Jupai qualifies as a net-net, with future growth potential.

Risks

Economic turmoil and loss of reputation might have a catastrophic effect on Jupai Holdings if it cannot keep up the pace.

"Once they lose confidence, it’s all over,” as Warren Buffett (Trades, Portfolio) said in an interview with The Wall Street Journal regarding the 2008 financial crisis and the bailout of AIG and Lehman. Potential clients of a financial institution must have confidence in the company to be able to do business over the long run.

The variable interest entity structure is another noteworthy risk factor. It is a loophole to allow foreign capital to fund otherwise restricted sectors. Practically, clients invest indirectly using an offshore entity for contractual arrangements and thereby claim its profits. VIE owners do not own the assets of the underlying business, nor do they have voting rights. Jupai has a continually growing percentage of its revenues and assets held in the VIE. In the worst case scenario, the management has the option to virtually make off with a notable percentage (probably around 60%) of the underlying assets of the VIE.

Outlook

Jupai Holdings may be best for risk-tolerant deep-value investors who are bullish on Chinese economics. Presently, I look at Jupai as a beaten-down cigar-butt, and if a turnaround happens, a growth stock with attractive return potential.

With no skin in the game, for me, it is far too risky an investment because of the wacky corporate structure and slowing growth prospects or recession concerns.

If I suggested that you to buy it at this price, I would be a hypocrite. Still, I think the story of Jupai Holdings is worth analyzing and for a high-risk tolerant investor, it may be a high-risk, high-reward situation. It is also in the insiders' interest to restructure operations and earn an enormous yield on today's cost.

Finally, Jupai seems to be positioned well to profit from the future expansion of China and become a prosperous investment in times to come.

Disclosure: No position.

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