Description

Overview

Noah Holdings is the largest independent wealth management firm in China and was co-founded in 2005 by Jingbo Wang and Zhe Yin, who collectively own ~28% of the company. Noah was seeded in 2007 by Sequoia China, who today owns ~5% of the business. Neil Shen, the founding partner of Sequoia China, is considered to be one of the best investors in China aside from Lei Zhang at Hillhouse and has been on the board since 2016. Neil and the team at Sequoia have been intimately involved in building the culture of the firm alongside CEO Jingbo Wang. Noah Holdings went public in 2010 at a $925 million valuation ($800 million EV). Over the past ten years, Noah has grown the number of registered clients ~58x, has distributed more than $115 billion in financial products, and has grown net income ~14x. Today, the company trades at a $2.6 billion valuation ($1.6 billion EV). 

China Wealth Management Landscape

Three decades of widespread reform has given rise to the first modern cohort of Chinese high net worth individuals (HNW). And while the last decade has witnessed a tenfold increase in domestic HNW, by almost any metric, the personal wealth accumulation in China is in its infancy. For example, consider that less than 0.5% of Chinese households are HNW, which compares to nearly 6% for the US. With this spectacular growth, China’s capital markets have necessarily evolved to meet the needs of domestic savers. This has taken place as an increase in size (more investable assets), an increase in scope (introduction on new alternative assets classes), and an increase in sophistication (more HNW turning to institutions to manage their wealth). Along these lines, Noah believes the China’s current domestic capital market is very close to that of the United States in the late 1970s when GDP per capita exceed $10,000. At this stage, financial assets account for only 30% of the household investable assets in China, and the value managed by institutional investors is just 18.5%. 

China Wealth Management – Becoming Something More Familiar

As recent as three years ago, the wealth management offerings in China were something altogether very different than what we are accustomed to in the US. The market was dominated by something known as wealth management products (WMPs). These products offered fixed rates of return well above regulated interest rates for deposits and were used by banks and trust companies to fund investments in sectors where bank credit was restricted. These products generally had a short-term set maturity date and were invested in a range of underlying loans and securities. One critical element to these products, is that they often came with either explicit, or implicit guarantees of principal. In other words, if the bank lost the HNW client’s money, they were expected to pay it back. However, in reality a very small percentage of WMPs actually had contractual guarantees, they were assumed (i.e., implicit), which allowed the banking industry to not report these on balance sheet. This created an increasingly troubling dynamic as non-bank institutions offered WMPs of their own, again with an implicit rather than explicit guarantee. Inevitably, there were some products that failed, and investors never saw a dime of their money back, even while they believed to be investing in a risk-free asset. In the last two years, regulatory authorities in China have come down hard on eliminating the moral hazard associated with WMPs and implicit guarantees. This has meant a transition to what we are accustomed to in the western world, NAV based products. Bond mutual funds replacing WMPs, in addition to an increasing acceptance of equity funds. Noah has been very clear since inception that none of its distributed products come with guarantees. However, they nonetheless have to navigate the mindset of the Chinese HNW at large which has been influenced by these practices. Today, Noah has transitioned entirely to NAV based products, and has eliminated its single counterparty alternative credit products, which were a similar value proposition to WMPs (more on this later). 

Noah Wealth Management

Unlike in the US, Noah distributes financial products to its clients and is paid both an upfront commission (paid by the client), as well as a recurring management fee paid over the fund duration and in some cases a share of carry which are both paid by the GP, not the client. They also provide clients with value added services like insurance, trust services, tax planning, inheritance services, family office formation, etc. (more on this later). Unlike traditional wealth managers, Noah’s brand has largely been synonymous with alternative investments, and private equity in particular. Due to their long standing relationship with Sequoia, Noah was very early to the alternatives space and is able to provide their clients with access to many of the best Private Equity, Hedge Funds, and Real Estate funds in China and abroad. Noah generally will receive 50bps to 1% in an upfront commission, with a slightly lower lever of recurring fee thereafter. 

Gopher Asset Management

In 2010, Noah started a wholly owned asset management arm called Gopher Asset Management. Gopher largely operates as a fund of funds model, and has products across private equity, hedge funds, credit, public securities, and multi strategy. Today Gopher has $23 billion in AUM which has grown ~5x since 2013 (even after voluntarily redeeming its alt credit products in 2020). Notably, this AUM figure is at historical cost, not market to market. Approximately 70% of the AUM for Gopher is Private Equity, which means Gopher enjoys the same long term locked up capital dynamics as other listed alts (e.g. KKR), albeit with lower fees. Another 8% of AUM is in Real Estate with similar long term locks, while the remainder is invested across Hedge Funds can credit products which can have up to 3 year locks. Gopher receives anywhere from 20-60 basis point management fee, and a 3-5% incentive fee upon the full realization of a fund vehicle. Importantly, all funds are held at cost and Noah does not accrue any of its unearned incentive on the financials. In addition, while Gopher has historically been a FoF, it has been a strategic goal to evolve into more direct and co-investment strategies. Today, almost 40% of the $23 billion AUM is in direct or co-investments which can carry fees as high as 2 & 20. Consider that 65% of Gopher AUM is eligible for performance fees. Doing some quick napkin math… 37.5B RMB of PE FoF that are held at cost and subject to a 4% incentive fee, 37.5B RMB of PE co-investments that are subject at a 10-20% incentive fee, and 10B RMB of Real Estate investments subject to a 10-20% incentive fee. Assuming a 2x gross MOC and a 10% incentive for the direct and co-investments, this current AUM alone would produce $875m of performance fees upon realization. Again, none of this is being accrued for today. Finally, and most importantly, Noah’s fund returns have been exceptional. Many of the public security FoF are beating their benchmarks by 5%+ per annum, the Real Estate investments which are almost entirely direct have returned 16% gross IRR, and the PE funds have been mid-teens IRR. I would expect these solid returns to continue to attract inflows. 

A Word on Domestic China PE Markets

Readers will notice that while Gopher’s PE AUM has been growing, it has been growing slower in the past few years that one would expect, given robust growth witnessed in the broader PE landscape. This is primarily due to the fact that 85% of Gopher’s 113bn RMB PE AUM is on RMB denominated funds, which have seen a much slower growth rate than USD denominated funds. The markets for RMB denominated funds are driven almost entirely by domestic investors. Large US Endowments, Pensions, etc. would all invest in the USD denominated funds offered by groups like Hillhouse, Sequoia China, etc. Unlike US PE funds, it is very common for RMB denominated PE funds to provide no interim marks over the life of the entire vehicle (hence why Gopher holds its AUM at cost). You simply realize your returns upon distribution. As a result, it is really hard to get transparency on the current returns in the RMB market until exit. However, I think using broader PE marks in China, which include USD denominated funds, provides a good proxy. See the Preqin data below:

Camsing Incident

Like all things, there is more to the story. The reason why Noah’s shares remain depressed is because in 2019, an alt credit product that Noah distributed to its clients turned out to be a fraud, and on a very large scale. The product was a supply chain financing credit product for receivables between Camsing and JD.com. Noah has since sued JD.com, while JD.com claims it was uninvolved and it’s Noah’s own fault for not having better risk controls (effectively Camsing forged receivables documents, and JD.com is claiming that Noah never verified their authenticity with them, while Noah is saying they did). The controller of Camsing International has been arrested, along with a former procurement executive at JD.com who is expected to have played a key role in the fraud. Time will tell who was at fault. In my very biased opinion, at this point I think the evidence is mounting against JD. Every quarter since mid-2019 Noah has reported what percentage of the impacted clients have placed new orders with Noah and the cumulative value of those orders, which had increased to 54% of clients and 5.1B RMB of new orders as of Q2 2020 (this compares to 3.5B RMB of total principal lost in Camsing products). In Q3 2020, Noah announced a settlement agreement with their affected clients (which was not required) which pays clients in Noah shares (at a maximum dilution amount of 1.6% per annum) over the next 10 years. While they have no obligations to make clients whole, they felt it made economic sense to protect the brand. A small number of clients had filed lawsuits against Noah (~30M RMB worth, so tiny). But they didn't want that group to snowball and ultimately create a lot of bad press and ill will from clients. It made particular sense, given that many future clients come as references from existing clients. In order to accept the settlement, clients have to agree to 3 criteria: (1) give up the right to file a lawsuit against Noah, (2) commit to making purchases from Noah every year for the next 10 years, and (3) keep a minimum balance with Noah greater than the amount of lost funds. Importantly, Ms. Wang was adamant that this was not a plan to make the capital markets pay for their mistake. This is simply what is economically best for the business. With the Q4 results released in March, Noah announced that ~70% of clients accepted the settlement agreement, with more likely to commit in the coming months. This is a great achievement and will help to put this whole episode in the past. 

Insurance Distribution

Over the past several years, Noah’s other value added services, which includes insurance, trust services, tax planning, family office formation, etc., have grown at incredible rates. In particular, insurance distribution has become a large driver of one time commission in the wealth management segment. However, in 2020, much of Noah’s overseas (Hong Kong) insurance distribution ground to a halt. This is because KYC regulations in Hong Kong require physical examinations at local medical centers, and physical client signatures to obtain healthcare coverage. In 2020, overseas insurance contributed 154m RMB in revenue, which compared to 460m RMB in revenue in 2019. Noah is confident that insurance sales will rebound strongly as COVID dissipates which will be a strong driver in 2021 and beyond. 

Strong Digital Platforms – WeNoah, Fundsmile , and iNoah

Noah has put a great deal of effort into building world class digital platforms (Sequoia influence no doubt), largely aimed at targeting the upper middle class before they become a high-touch Noah client. WeNoah is Noah Holdings digital portal for clients, while FundSmile and iNoah are digital mutual fund distribution platforms that have witnessed triple digit growth rates to date. For FundSmile, Noah charges a 10bps up front commission plus 50bps fee share annually from the fund managers. While offshore (iNoah), Noah charges a 1% upfront commission and a 50bps annual fee share from the fund managers. These revenues fall under the wealth management segment, and are growing rapidly off a small base. 

Balance Sheet & Capital Allocation

Noah has ~$1B in net cash and investments on its balance sheet (including $150m of investments held at cost), which is both attractive and concerning. They have been wildly conservative/inefficient with the capital structure, and while I am optimistic that things are progressing in the right direction, I’m not expecting wholesale changes. Noah had expected to complete an acquisition with its on balance sheet cash around 2017/2018 which never materialized due to valuation concerns, then this was followed by Camsing and COVID which created 18-24 months of high uncertainty, causing the management team to simply opt to sit on the cash. Notably, in Q3 2020 Noah announced a $100m share repurchase program, and perhaps even more critically, they actually completed that program entirely between November and February. I would expect the company to announce a dividend or potentially more share buybacks in the years ahead. 

Valuation

Noah has guided to $185 million (1.25B RMB) in net income for 2021, which I believe is highly conservative. Thus, on an EV of ~$1.6B, the company is trading at 8.7x this year’s earnings. Assuming you ascribe zero value to the balance sheet, the multiple increases to ~14x. Over the last decade, Noah has compounded net income at ~24% per annum, and I expect the growth runway ahead to provide for many years of high growth. Assuming Noah meets its guidance this year then grows net income at 15% per annum in 2022 and 2023, at an 18x multiple, Noah would provide a 2.3x return in 3 years assuming you simply let the free cash pile up on the balance sheet and you ascribe a 1.0x value to the BS. There is upside to this figure from multiple angles including: achieving higher growth rates, earning a premium multiple, and doing sensible things with the BS. The downside is protected by the net cash, and high margin predictable revenue streams. 

Catalyst

- Sentiment improvement following time elapse since Camsing incident

- continued fcf growth

- rational allocation of balance sheet capital