Baige Files For Hong Kong IPO But Eroding Margins Raise Concerns

The company has filed to list in Hong Kong after substantially growing revenue in the last two years, but at very thin margins

Key takeaways:

• Baige has filed for a Hong Kong IPO, offering risk management services for insurers
• The company's revenue has grown substantially since 2022, but its margins are razor-thin due to its complex business model

Risk management is critical for insurers that need to assess the likelihood of certain events happening as correctly as possible to provide adequate protection for their customers while also making ample profits for themselves. Baige Online Digital Technology Co. Ltd. is seeking to capitalize on demand for such services as it seeks a Hong Kong IPO. But while that proposition certainly makes sense, the company's dismal profitability raises a bigger question of whether investors will rush to buy into its story.

Baige, which means "White Dove," filed for a Hong Kong IPO last Friday, with relatively major domestic investment banks CMBC Capital and BOC International as underwriters. In its prospectus, Baige describes itself as a "leading digital risk management solutions provider in the scenario-based insurance market" in China.

At first glance, the company appears to be doing pretty well. Its revenue jumped more than 60% to about 660 million yuan ($90 million) in 2023 from the previous year. And in the first nine years of last year, the figure grew by nearly another 40% year-on-year to 631 million yuan. Risk management services are Baige's primary income source, accounting for more than 90% of its revenue in the first nine months of last year.

Risk management sounds pretty straightforward. You provide such services for insurers and earn fees in exchange. But Baige is not exactly the most straight-flying white dove, using a costly business model that carries a bit more baggage beyond simple risk management services.

As you might expect, the company earns commissions by providing its risk management services that help insurers develop more customized products that often carry higher margins than standardized ones. But Baige's role doesn't end there. It also helps distribute its insurance partners' products to customers, paying fees to sales channels and brokers out of its own pocket.

That means Baige is more like a do-it-all middleman for insurers, offering not only risk management services for insurers, but also some brokerage and marketing services as well. In effect, the company seems to be telling its customers: "Use our services to develop new products, and we will help you to sell them."

But the costs for such marketing and brokerage services ultimately erode its own profitability. That shows up in the gross profit margin for Baige's risk management business, which isn't even 10%, a surprisingly low figure for a service provider, particularly one that runs online platforms. Worse still, Baige's gross profit margin further shrank from 2022 to the first nine months of 2024, indicating it sacrificed profitability to win more business. In its prospectus, Baige says it expects the fees its pays for distribution to increase as it grows, meaning its margins could deteriorate even further. 

At the same time, operating expenses, including costs for marketing and R&D, easily outweigh Baige's gross profit. The company also incurs significant finance costs, mostly because of interest on redeemable preferred shares it issued in 2022. With all these items eating into Baige's bottom line, its net loss for the first three quarters of 2024 amounted to about 15.6 million yuan, up about 6% from the same period in 2023. 

Profitability headwinds

All this shows that Baige may be facing a lot of headwinds in its flight to profitability. With its current low-margin business model, the only feasible way for it to turn a profit should be to rapidly grow its revenue to achieve more economies of scale, while also keeping its operating expenses under control. But for any business, fast expansion inevitably requires spending.

A rapid business expansion would require Baige to quickly boost its customer base. But the company seems to have difficulty doing that. Baige says it worked with more than 70 insurance companies in 2022. But more than half of its revenue – about 55% – came from its top five customers. Its reliance on that small group for the majority of its business has only worsened, ballooning to nearly 80% of its revenue in the first nine months of 2024.

Baige in theory can win more business from this small customer group, but there's only so much room for those insurers to outsource risk management to third-party service providers like Baige. Conversely, if any of these key customers leaves Baige, which is possible as they aren't affiliated, its revenue would take a big hit.

One reason why Baige may face difficulty diversifying its customer base seems to be stiff competition. Citing third-party data in its prospectus, the company says it ranks first among companies providing scenario-based risk management services for insurers in terms of revenue in 2023. But its market share of just 4.4% indicates Baige competes with many similar service providers in a heavily fragmented market. That may explain why it feels compelled to also offer distribution and marketing services to its customers that ultimately drag down its margins.

Making matters worse, insurance sales in China aren't exactly booming right now as consumers cut back spending on non-essential items during the country's economic slowdown. That may be hurting Baige's ability to acquire new customers, making it more reliant on its biggest ones.

Reflecting the difficulties that similar companies catering to the financial services industry are generally facing, OneConnect (OCFT.US; 6638.HK), which provides services mostly to banks, this week disclosed a plan to go private launched by its parent, Ping An Group, after reporting years of losses that saw its stock languish.

And not surprisingly, Chinese insurance-related companies aren't commanding lofty valuations. Online insurance broker Waterdrop (WDH.US) currently trades at a relatively low price-to-sales (P/S) ratio of about 1.2. Such a multiple would give Baige a market capitalization of more than $100 million based on its 2023 revenue. But for Baige, even that kind of valuation could be a long shot as it may face plenty of skepticism about its prospects from investors who need to manage their own risks.