►Futu Securities is transforming to a multi-outlet online securities company, providing brokerage services with margin trading, IPO underwriting and other to-business services. 
►With the wide-open online investment market, future developments for Futu look encouraging.

Shares of Futu Holdings Limited (FUTU:NASDAQ), a Hong Kong-based online brokerage and wealth management platform backed by Tencent (00700:HKEX) in China, hit a new high of USD 22.15 on June 17, up 50.07% since the company’s IPO in March 2019, and 73.59% since the release of the financial results for 1Q 2020 on May 14. These results have pushed the market capitalization over USD 2.36 billion.

Bank of China International (BOCI) reaffirmed the ‘buy’ rating of FUTU with the target price adjusted from USD 12.9 to USD 17.3. Meanwhile, CitiBank stated the benchmarked entity of the company in the online brokerage industry, with the target price, had moved up from USD 11.1 to USD 17.9.

A 100% online-based brokerage, Futu benefited from the market volatility during the coronavirus pandemic. As of February 20, the investment trust assets had hit HKD 100 billion, topping the list of Central Clearing and Settlement System (CCASS) online stockbrokers in Hong Kong. 

Financial performance highlights

With the increased dependencies from investors on online investments under the pandemic, Futu handed over a strong performance in the first quarter of 2020 and the fiscal year of 2019. 

The trading volume reached HKD 595 billion in total in the first quarter, with a 165.9% year-over-year increase, representing a high activity as clients tried to seize on the market volatility. 

The enthusiasm is also reflected by the number of paying clients, which refers to the number of clients with assets in their trading accounts on Futu’s platform. This had added 40,154 in the first quarter, 60.4% up from the same period last year. The year-over-year growth rate of the Hong Kong local paying clients of the company consistently topped 90% for each quarter, achieving 97% in Q1. This marked tremendous opportunities for Hong Kong, the core target market.

The daily average client assets in mutual funds increased 70%, to HKD 6.9 billion, consistent with the confidence Futu previously stated in regard to its wealth management business. 

Ending 2019, the total number of paying clients increased by 49.4% year-over-year to 198,382. The total number of users ran up 34.7% year-over-year to 7.5 million. 

The ongoing pandemic is impacting the financials in ways like higher trading revenue, higher net interest margins for the margin financing business and lower interest rates from bank deposits, resulting from lower benchmark interest rates.

Revenue increased by 107.5% from HKD 236.4 million in 1Q19 to HKD 490.6 million (around USD 63.3 million) in 1Q20. Among which, brokerage commission and handling charge income, which is the main revenue source of Futu, recorded HKD 299.2 million (around USD 38.6 million) with a year-over-year rise of 161.1%, mainly led by the rising trading volume. Total revenues reported HKD 1.06 billion (around USD 136.3 million) for FY2019, a jump-up of 30.9% from HKD 811.3 million in 2018. 

Net income was HKD 154.9 million (around USD 20.0 million) in the first quarter of 2020 with a year-over-year rise of 240.4% from HKD 175.2 million, and HKD 165.7 million (around USD 21.3 million) for FY2019 with a year-over-year rise of 19.6%. Fairly to say, Futu has been growing steadily in recent years, and as the pandemic boosted the entire industry it sped up the expansion of the company even further.

Expenses seem to be well controlled. The total costs ran up 92.3% in 1Q20 and 12.9% for FY2019, which are both lower than the corresponding revenue and profit growths. Futu continued to attach great importance to research and development, with R&D expenses rising year-over-year by 57.5% in the first quarter in 2020 and 73.6% for 2019. Other expenditures, including SG&A, are growing at steady rates. 

Futu is building a multi-fee-generating structure 

Futu Holdings mainly provides services through its subsidiary, Futu Securities, which is a licensed company recognized by the Hong Kong Securities and Futures Commission.

As a young company that has been operating since 2012, Futu Securities expanded in the early stages through its stockbrokering business, by offering online transaction support on products in Hong Kong and US stock markets to retail investors. Futubull, a proprietary digital platform developed independently by the company, gives real-time stock quotes, market data and news, and allows investors to trade securities in various markets. 

In order to build itself into a more professional and comprehensive securities company to compete traditional offline investment banks, Futu debuted its margin trading business, IPO underwriting business and other to-business services since 2017, which are diversifying the revenue sources, from brokerage commissions solely to a combination with interest income from margin and other income mainly from Employee Stock Ownership Plan (ESOP) added. 

For now, fees and commissions are still the main revenue source of the company, consisting of over 50% of the total income since the very beginning, though with a gradually decreasing percentage. In the new business, margin financing and securities lending services and to-B elements are considered to be the future drivers of the company based on its higher profitability. 

Also, the higher growth of new business compared to the brokerage business marks Futu’s transformation to a multi-outlet online securities company. 

Wide-open market space 

Online Securities companies in China are those Internet and technology startups providing digitized brokerage services who mainly focus on outbound security markets, represented as Futu Securities and Tiger Broker – these seek to take on Chinese retail investors. 

With the increasing disposable income, more Chinese Investors are moving their attention to the overseas market. According to the State Administration of Foreign Exchange, the scale of securities investments in the outbound market of China increased from USD 280.8 billion at end of 2015 to USD 646.0 million ending 2019, with an annual compound growth rate of 18.1%. Among these,  Hong Kong and the US are two target markets for Chinese investors. Ending 2019, the investments in Hong Kong and the US security markets recorded USD 226.4 billion and USD 162.8 billion, which took up 35.05% and 25.21% in the total figure. Moreover, the rising percentage of investments in Hong Kong over the US represents an even larger market for Futu, which targets its core market in Hong Kong.

When narrowing down to the Hong Kong market, Oliver Wyman, a consultancy, stated that the online transaction securities market rose at a GAGR of 31.6% from 2012 to 2018, and will continue to expand at a rate of 11.7% in the next 5 years. The main individual participants in the Hong Kong security market are currently the local residents. The amount from individual investors in mainland China is expected to exceed Hong Kong residents in 2021, achieving USD 289.2 billion.

The individual investor figures from mainland China in the US security market are growing rapidly as well. The investment figure is expected to reach USD 920.6 billion in 2023, which will be 22 times Hong Kong residents’ investments, under projections from Oliver Wyman.

Competitiveness among players

Tiger Brokers (TIGR:NASDAQ), founded in the US and then exported to the Hong Kong market, is the largest competitor for Futu, which launched its business in Hong Kong first instead. 

The two companies provide similar services, but with a totally different business model. Tiger Brokers serves as an introduction securities company, providing investment services through Interactive Brokers, a large global brokerage firm. On the other hand, Futu provides services based on broker licenses. 

The traffic diversion model for Tiger Brokers has limited controlling power for the clients’ assets, with only the right to share commissions active. While the brokerage business for Futu is not only entrusted with the control of clients’ assets, but also has higher durability under different economic conditions. When the market goes bull, the company will generate revenue from margin financing business; when the market goes bear, the assets in investors’ accounts can bring interest income; and when the market becomes volatile, the fees collected from the broker business will dominate the income. 

As of the end of 2019, Futu recorded total client assets of USD 11.2 billion, way exceeding the figure of USD 5.1 billion of Tiger Brokers. The total account number is 720,000, higher than the 650,000 of the latter. What is more, Futu hit its first profit earlier than Tiger Brokers. 

However, Tiger Brokers is also actively seeking a transformation, with increasing expenditure on R&D and brand promotion. The ESOP and IPO business, as well as new wealth management business, are expected to generate significant profit for Tiger Brokers in the future. 

With the increasing number of clients flooding into the market and the high substitutability between products among players, competition can only be fiercer in the future.

Challenges

As a young technology and Internet company that has limited experience in the capital market, Futu’s future has been concerning for the market. 

The company hasn’t acquired related licenses in mainland China, which put an investment limit to individual investors in the form of a USD 50,000 a year ceiling, which affects the revenue. Though the figure might be acceptable for most retail investors, this unregulated situation adds to fears of insecurity. The Chinese government even stated that the services provided by the company would not be protected by Chinese laws. 

Also, the strategy based on using a low commission to attract traffic does not look like a long-term solution. The revenue of Futu is still dependent on the commissions and fees income, which has no competitiveness and differentiation. The downwards trends of brokerage commission fees in the industry even put more pressure on online securities companies. According to the Securities Association of China, the industry average commission fee decreased from 0.099% in 2010, to 0.03% in 2019, and few online brokers in the US even canceled the commission charge. Getting over the dependence on the commission fee generated structure as soon as possible will be pivotal for Futu to develop sustainably. 

With the diversifying and complex demands on investments, financial institutions are urged to develop more comprehensive products and services with higher standards on professionalism. Futu, in essence, is an Internet company, with limited finance professionals and experiences, with more members in the management team coming from Internet backgrounds instead of finance.  How to gain recognition from investors and even business clients will be a crucial breaking out point for the company.