Waterdrop Will Either Become China’s Dominant Insurer or Go Bust

Tencent backed online insurance tech company, Waterdrop Inc (NYSE:WDH), slumped after its initial public offering (IPO). The company raised $360 million having sold 30 million American Depositary Shares (ADS) at the top of its targeted $10 to $12 per share range. Given the difficulties being faced by Jack Ma’s Ant Group, the pricing of the company shows that investors were not particularly concerned about regulatory scrutiny and political pressures in China. Indeed, the company itself faced pressure to push back the IPO, according to reports. It must be said that the company denied these reports and said that they were in regular communication with Chinese authorities ahead of the IPO. The IPO comes with what is known as a greenshoe option, which allows for a further 4.5 million shares to be sold to raise an added $54 million. Waterdrop distributes insurance policies online as well as providing illness crowd-funding.

Investing in China is fraught with risk given the lack of transparency surrounding accounting issues as well as the interference in markets by Chinese authorities, for what seem like entirely political reasons. This demands that investors have to factor in Chinese political maneuverings and this is a very difficult thing to do. This perhaps explains why, after the IPO, the company’s American depositary shares opened at $10.25 before recovering to $11.50.

The company has essentially eschewed the search for profitability, choosing instead to grow its user base and user experience. To date, the company has yet to turn a profit. Seemingly, the dearth of profitable IPOs is a global phenomenon. The company wants to become China’s version of the UnitedHealthGroup. The company’s chief executive officer and founder, Shen Peng, has indicated that until 2025, the company’s focus will be on growing the business in China. After a decade, it plans on expanding outside of China. Growth and serving customers is, according to Shen, more important than the search for profits at this stage. 

Now, in the very first innings of a business’s life, it makes sense to chase growth as opposed to profitability. So, we cannot wholly criticize Waterdrop for its stance. However, we also have to realize that in investing in Waterdrop, we are making a very stark bet: that the company will be able to achieve the scale it needs to become profitable. The company has been clear in outlining that it is chasing dominance in China. The other side of that bet is that the company goes bust. The result of this on the road to either dominance or going bust is that the company’s ADS will likely be very volatile. Every earnings announcement will be fraught with peril. Investors’ convictions will rise and fall dramatically as they try to read the tea leaves and determine if the company is going to go big or go home. Each decision management takes will take on epic proportions. Are they using the right professional customer relationship management tool? Are they growing fast enough? Are revenues high enough? Is the company growing fast enough? If the company achieves its goals, it could earn investors an incredible profit. If it fails, investors could lose a lot of money. Volatility is baked in simply because of the company’s strategy. Dominance or Peril.  You only have to take a look at Tesla, Bitcoin, and Netflix, to understand that when a company makes this bet, volatility is part of the package. 

Founded in 2016, the company is still young enough and small enough to be growing dynamically. Revenue is up 100% year-over-year, the kind of return you’d see investing in a Moissanite jewellery business.That, in any country, is sensational growth. Yet, as we have seen with binary bets, any kind of cooling off, any kind of setback, sends markets crazy. 

An added layer of intrigue is that the government of President Xi Jinping has signaled a willingness to hurt Chinese companies who cross his government. Jack Ma’s Ant Group was forced to pull out of what would have been Asia’s greatest ever IPO. Other firms have found that the Chinese government has increased scrutiny. Balancing fundamental analysis with political analysis makes investing in China especially difficult. Doing so when your investment is a binary investment, doubles the risk. 

Since the Ant Groups’ IPO was shut down, regulatory scrutiny of the financial sector in China has risen. The Chinese government has said that it will be especially watchful of Chinese firms with listings outside China. Shen has tried to paint a rosy picture of cooperation with Chinese authorities and their happiness to see their businesses triumph abroad. Clearly, the Chinese government is not irrational and it wants Chinese businesses to do well. It also has extra-economic goals that can come into conflict with its economic goals and lead to the kinds of disruptions that have hurt the Ant Group. We simply do not know enough about the regulatory path going forward to as yet assess the risks of investing in China. 

If an investor is willing to overlook these risks, that investor is advised to invest only a small proportion of his holdings in the business, a proportion he is willing to lose.