Noah Holdings Stung by High Costs Amid Pivot to China's Rich

Key points:

• Asset manager Noah Holdings’ second quarter revenue grew 20%, but margins got squeezed by faster-growing operating expenses
• High expenses came from recruitment of new wealth management staff as company shifts focus to affluent Chinese customers

By Warren Yang

For a refocused Noah Holdings Ltd. NOAH banking on Chinese millionaires as its main customers, growth is proving costly.

The company, one of the oldest private asset managers in China, reported 899.4 million yuan ($139.3 million) in second-quarter revenue, up 20.3% from a year earlier, according to its latest financial report released last week. That’s not bad for a company worth more than $2 billion.

Yet its quarterly net income increased just 2% to 305.5 million yuan year-on-year, while earnings per share actually fell about 6% as its share base expanded. On a non-GAAP basis that excludes items like share-based compensation, the net income gain improved a bit to 7.5%. But that’s still far short of the pace for top-line revenue growth.

The big discrepancy lay in the company’s operating expenses, which swelled 31.8% to 564 million yuan. As a result, Noah’s operating margin fell to 37.3% from 42.7% in the second quarter of 2020.

So what’s behind the swelling costs?

The culprit appears to be Noah’s wealth management business, which serves high-net-worth individuals – a label that typically refers to people with more than $1 million in liquid financial assets. Operating expenses for that part of the business grew 29.7% year-on-year to 448.9 million yuan, even as revenue for the unit grew at about half that rate.

By comparison, operating expenses at Noah’s Gopher asset management unit, which targets ordinary investors, grew only 3.2% even as the unit’s net revenue increased by a far healthier 41.1%.

In percentage terms, the wealth management business now accounts for about 70% of Noah’s revenue, while Gopher accounts for most of the rest.

As solid as Gopher’s performance was, that’s not where Noah’s attention is focused right now. Instead, its attention has shifted to the fortunes of its wealth management operations – part of a broader strategic move prompted by a fraudulent shadow banking product that created a nightmare for Noah and its asset management clients in 2019.

Following that disaster, Noah’s shift into wealthy clients has been progressing nicely, even if the transition is costing the company in terms of operating margins. Noah had 19.6% more clients for that part of the business as of June 30 versus a year earlier, while the number of clients defined as “active” jumped 38.9% year in the second quarter.

On its conference call to discuss the results, Noah CEO Wang Jingbo touted that the company’s wealthiest “diamond” and “black” card clients increased at the fastest pace in the first half since the strategic shift began two years ago.   

Hiring Spree

But the shift has come at a cost. Operating expenses at the wealth management business ballooned mostly due to a hiring spree, as Noah added almost 200 relationship managers in the first half of this year. Despite that, the wealth management unit’s contribution to company-wide revenue in the second quarter actually declined to 69.6% from 72.6% in the same period of 2020 – an outcome that doesn’t fit too nicely with the company’s new strategic focus.

Such investment may ultimately pay off, and Noah management indicated it intends to stick to that course on its call. CFO Pan Qing said the company will continue to spend on talent, along with technology, now that it’s primed to enter the “next phase of business growth” after getting rid of all non-standardized credit products like the one behind the 2019 scandal.

Management also noted the company is ahead of schedule to meet its 2021 guidance for non-GAAP net income.

S&P Global Ratings gave Noah a vote of confidence earlier this month, upgrading its outlook to stable from negative. The credit rating agency acknowledged the company’s success in stabilizing its revenue streams and assets under management, while expanding its clientele of ultra-high-net-worth individuals and reducing litigation risks related to the product behind the 2019 scandal.

But equity investors were having none of it. After Noah released its second-quarter results, the company’s shares slid four straight days through Aug. 20, losing a 14.3% of their value. They’ve rallied slightly since then, though are still around 10% below their pre-earnings announcement levels.

At their Aug. 20 closing price, Noah shares traded at a forward price-to-earnings (PE) ratio of about 11, based on analysts’ average earnings estimate for this year compiled by Yahoo Finance. That’s far below a forward PE ratio of 24 for global giant BlackRock, though is closer to State Street Corp.’s 12.

Noah’s latest report represented a return to earth after it delivered first-quarter results that were too good to be sustained. Net income for the first three months of the year surged 87% from a year earlier, thanks largely to “performance-based” income tied to stock prices. Such revenue is volatile and unrelated to an asset manager’s operational or strategic superiority.

Noah’s shift from mon-and-pop investors to the super rich comes more broadly after Beijing cracked down on high-yield, high-risk products targeting average savers that had fuelled a rapid expansion of the asset management industry in China. That boom was embodied by a rise of peer-to-peer (P2P) lending platforms, most of which have now closed or changed their business models.

Following that clean-up, which included a raft of new regulations, compliance has become is a key priority for Noah. On the earnings call, Wang said a complete removal of funky “non-standardized” credit products from the group’s offerings was a “milestone” at a time when regulatory compliance has become “a matter of life and death for financial institutions.”

But that also means compliance costs have increased. At the same time, now that it can only offer standardized products, Noah needs to find ways to differentiate itself from competitors with similar offerings. All that is happening as competition intensifies with the recent elimination of limits on foreign ownership of fund managers and securities companies.

So big spending to stay ahead of the competition makes sense. But without massive revenue growth, something Noah hasn’t achieved in recent years, profitability could suffer during that transition. Investors are growing impatient as the transformation moves forward. But without convincing results, you can’t blame them for not sticking around for Noah during the process.