OneConnect in forced divorce from parent Ping An

By Doug Young

The story of former fintech highflyer OneConnect Financial Technology Co. Ltd. (OCFT.US; 6638.HK) is rapidly shaping up as a tale of an incredible shrinking company. It also offers a valuable corporate lesson on the dangers of relying too heavily on business from related companies.

OneConnect made headlines late last week when it would shutter its cloud services division, its largest breadwinner, accounting for 44% of its revenue in the first quarter. The company first hinted at such a development in May when it warned that some of its cloud customers intended to stop using the services.

The story is quite the family affair, since nearly all of OneConnect’s cloud customers were related companies. OneConnect was previously a wholly owned unit of financial services giant Ping An Group, which spun off the company and separately listed it in New York in 2019. The idea was to let OneConnect become an independent provider of software services to China’s massive financial services industry by weaning it from its reliance on various units of Ping An.

But OneConnect never made much progress in achieving that goal. In this year’s first quarter, the company still got about two-thirds of its revenue from various units of Ping An, and from Lufax (LU.US; 6623.HK), a Ping An-controlled online lender.

This kind of reliance is quite common in China, and occurs when a company spins off one of its units with an ultimate goal of encouraging it to become independent by finding its own customers. During the transition period, meantime, the parent continues to supply the spun-off company with a steady stream of revenue from its various related businesses.

The problem with such a model is that spun-off companies like OneConnect often become addicted to money from their parent and other related companies, in relationships that are often more about helping each other out than any real commercial need. Then, when the parent grows impatient or needs to tighten its belt during difficult times, it suddenly scales back or cuts off the business it supplied to its spun-off unit.

That’s exactly what’s happening now with OneConnect.

At the time of its original of some defections from the cloud services business, OneConnect said there were “uncertainties whether any other connected customers would continue to use (the cloud) services.” Now, those uncertainties have been resolved, and the company has decided to completely shutter the cloud services platform, Gamma Fincloud.

According to the latest announcement, OneConnect’s board decided on July 11 “the company shall gradually discontinue the operation of its cloud services from July 2024 onwards and will discuss with its customers regarding transitional arrangements (if any).” It tried to reassure investors by adding “The company’s strategic business relationship with Ping An Group remains unchanged.”

The cloud services business generated 318 million yuan ($44 million) in the first quarter of 2024, or about 44% of the company’s total of 723 million yuan for the period. Nearly all of the cloud services’ business – more than 99% – came from Ping An and other connected companies like Lufax. So, in one fell swoop, OneConnect is losing nearly half of its business.

Investors weren’t thrilled about the loss of such a big chunk of OneConnect’s business, but their reaction was surprisingly muted. The company’s U.S.-listed shares are down about 20% since the original May 7 announcement. But that decline is actually quite a bit milder than the 44% revenue loss that OneConnect will feel with the closure of the cloud platform.

The company’s stock now trades at a meager price-to-sales (P/S) ratio of just 0.17, though that figure will go up somewhat due to the sharp reduction in the company’s sales. But even if the figure doubles, it will still be behind the 0.49 P/S ratio for Lufax, and the 1.71 for Weimob (2013.HK), which provides similar software services for e-commerce companies.

While a shrinking company is never cause for excitement, investors may still be encouraged because this latest development will finally accomplish what OneConnect has been unable to do by itself – wean the company from reliance on its parent and related companies.

Ping An companies and Lufax provided OneConnect with 480 million yuan in revenue during the second quarter, or roughly two thirds of its total 723 million yuan. Ping An supplied most of that, 422 million yuan, which was down 21% year-on-year. By comparison, the company’s 243 million yuan from other, non-related customers was down by a milder 14.8% year-on-year.

This shows that Ping An was already scaling back its spending on OneConnect more rapidly than the company’s other customers. Now, with Ping An’s decision to stop using OneConnect’s cloud services, the latter’s revenue mix will become much more balanced. Specifically, about 60% of OneConnect’s reduced revenue pie will come from unrelated third-parties, and only 40% will come from Ping An and Lufax.

From an investor’s perspective, this looks like a much stabler business model, since the majority of remaining revenue is presumably coming from clients that really need the services and aren’t just paying OneConnect out of a sense of familial responsibility. Thus, OneConnect, in the process of shrinking, is losing “less desirable” business that lacked a solid economic foundation, removing a major risk that was hanging over the company.

At the same time, OneConnect is also trying to expand abroad to lower its reliance on China. The company likes to talk about its global expansion, and says on its website it is currently active in 20 countries and regions, including South Africa and most of Southeast Asia. In its latest report it said its overseas revenue grew 14.8% in the first quarter. But its failure to include a specific figure suggests the amount is still insignificant.

At the end of the day, OneConnect is doing something it should have done long ago, namely weaning itself from dependence on Ping An and other related companies. In this case it really didn’t have much choice. But the lowered reliance on Ping An will ultimately make it a healthier company with a more solid foundation to build from.

Now, it just needs to find a path back to growth.