Fanhua uses savvy share-based acquisitions to rekindle growth

Fresh acquisitions paid for with the insurance broker’s stock yielded revenue growth that outpaced spending in the first quarter

Key Takeaways:

• Fanhua’s revenue grew 21% in the first quarter, while its operating costs rose by a milder 15%
• The company completed two stock-based acquisitions in the first quarter, providing immediate new revenue without the need for cash

By Warren Yang

Combining revenue growth and effective cost controls is a time-tested formula for boosting profits. But doing both is easier said than done since business expansion often requires big spending, especially for strategic acquisitions. Insurance broker Fanhua Inc. (FANH.US) has found a clever way to tackle that tricky problem by using shares to pay for a string of recent acquisitions that provided an immediate lift to its top line revenue.

Fanhua’s total net revenue grew about 21% year-on-year to 827.7 million yuan ($116 million) in the first quarter, according to its latest quarterly results released on Tuesday last week. At the same time, the company limited growth in its operating expenses to a milder 15%, helping its operating profit to nearly triple to 60 million yuan. 

Admittedly, the eye-popping first-quarter operating profit surge owes partly to a low comparison from a year ago. Still, the improvement in the company’s operating margin, to 7.3% in the first quarter from 3% a year earlier, is something investors can appreciate, especially so as Fanhua is showing that it’s operating more efficiently independent of the acquisitions. And more notably, Fanhua swung back to the black in the first quarter from a loss a year earlier, with investment gains and interest income, which aren’t part of its operating profit, neatly offsetting its income tax bill.

The latest revenue growth was fueled by fresh acquisitions Fanhua made during the period. Fanhua, China’s first listed insurance broker now celebrating its 25th anniversary, said it acquired three companies during the first three months of the year, adding about 164 million yuan to its life insurance revenue that accounts for the bulk of its sales.

February was a busy time for Fanhua. In the span of just days, the company signed two deals to buy 51% stakes in both Jilin Zhongji Shi’An Insurance Agency Co. Ltd. and Wuhan Taiping Online Insurance Agency Co. Ltd., paying for both stakes with its own shares. Both transactions were expected to close by the end of March.

While Fanhua didn’t have to fork over any cash or borrow funds for the purchases, its shareholders were diluted by issuance of new shares to pay for the deals. But share-based acquisitions can bring long-term strategic benefits by tying the interests of both parties through equity swaps.

The first-quarter results don’t include an “operating income contribution” from the newly acquired companies because their integration isn’t complete yet, CEO Hu Yinan said on the company’s earnings conference call on Tuesday this week.

The acquired companies are likely to get a boost as members of the Fanhua family by making use of its platform and other resources. Such purchases also typically help to boost margins by eliminating overlapping resources among the involved parties. In particular, Fanhua is counting on its digital capabilities and new open platform to maximize both revenue and cost synergies from its acquisitions. Fanhua plans to complete integrating the new units’ systems by the end the first half.

When all is said and done, “we expect to see material expense synergies and revenue synergies reflected in our future results,” Hu said.

Investors cheered Fanhua’s first-quarter report, sending its shares soaring more than 20% after its earnings disclosure. Much of the gains were sustained through the rest of last week, suggesting the market reaction wasn’t just brief euphoria about headline numbers.

More deal-making ahead

Fanhua may just be getting started with the deal-making as it tries to boost both its new life insurance sales and operating income by 50% this year. Acquisitions will remain a focus for the insurance broker to achieve that target, the company said in its earnings release.

“We intend to accelerate market consolidation through the open platform strategy and M&A,” CEO Hu said on the earnings call.

Acquisitions may provide one of the few options for Fanhua to reignite its strong growth of previous years. The company’s annual revenue started slipping even before the Covid-19 pandemic, weighing on its shares as they fell sharply from a peak five years ago. And in an economy still recovering from Covid-19 restrictions that dampened consumer spending, increasing revenue organically is anything but easy for insurance companies in the current climate. 

These challenges are vividly highlighted by the weak first-quarter performance of Waterdrop Inc. (WDH.US), an online insurance broker that is more focused on cost-cutting and organic expansion than Fanhua. Waterdrop’s net operating revenue decreased 6.6% year-on-year in the first quarter, while its operating costs increased 12% despite its efforts to control spending.

Waterdrop and Fanhua have different business models. The former specializes in online sales of short-term products, whereas Fanhua has a large network of brick-and-mortar distribution channels focused on long-term policies. Yet Waterdrop’s difficulties suggest that the broader insurance industry isn’t out of the woods just yet.

In parallel with the acquisition push, Fanhua has also been taking steps to improve its operational efficiency, which is reflected in its improving margins. For one, it slashed its life insurance agents by a fourth as of the end of March from a year earlier. Yet premiums facilitated by each agent nearly doubled year-on-year in the first quarter. The company said it achieved this by shifting its focus to higher-end customers and eliminating underperforming agents.

Of course, Fanhua’s acquisition campaign that is now its biggest growth driver has its own risks and limitations. Firstly, good targets don’t grow on trees. And even with completed deals, there’s always the risk of hidden problems emerging later on. Plus, such purchases using shares ultimately dilute existing shareholders, while paying with cash could quickly deplete its capital reserves.

And when the acquisition spree slows, Fanhua could have more difficulty delivering quick revenue growth unless insurance demand starts picking up again with an improving economy.

Despite last week’s big share gains, Fanhua’s valuation could still use some spark. The company’s stock currently trades at a modest forward (P/E) ratio of about 14, based on one analyst’s estimate complied by Yahoo Finance. The company’s price-to-sales (P/S) ratio is also relatively low, barely exceeding 1, compared to about 2.5 for Waterdrop.  

Things may look tough for Fanhua as it seeks to rekindle some of the excitement from its earlier years of headier growth. But its acquisition push, coupled with efforts to improve efficiency, if executed well, could pay off and breathe new life back into its shares. Only time will tell.

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