Waterdrop Goes Back to the Well, Cutting Losses by Lowering Costs

The online insurer slashed spending by 26.4% in the third quarter and will keep up its cost-trimming exercise

Key takeaways:

• Waterdrop Inc. reported a net loss of 477 million yuan in the third quarter, narrowing 27.3% quarter-on-quarter
• Company’s stock has fallen around 90% since its IPO, but its valuation still isn’t low

By Fai Pui

Cherish “water resources” for a sustainable future. That maxim applies not only to ordinary folks in their everyday lives, but also to online insurer Waterdrop Inc. (WDH.US) in its daily operations, since, “water” is also used by many Chinese to mean “money”.

The internet insurance brokerage established by Shen Peng, a co-founder of Meituan Inc. (3690.HK), reported a net loss of 477 million yuan ($76.6 million) in the third quarter, narrowing 27.3% from the previous quarter. The company attributed the improvement mainly to cost controls and implementation of a strategy to shift its focus from “quantity to quality.”

Stock down 88%

Given its listing price of $12 per share, anyone who has held the stock since its IPO in May, we’re sorry to say, has lost nearly 88% of their investment in just six-months. The company’s improving situation in its third quarter financial report didn’t fully convince the market. The stock price fell by another 5% in the following trading day, and another 2.1% the day after to close at a historic low of $1.40 last Thursday.

The worries center on declines in the company’s core revenues. The company’s net revenue totaled 780 million yuan in the third quarter, down 9.7% year-on-year, due to a fall in its insurance-related income. While its net loss narrowed on a quarter-to-quarter basis, it grew by 2.4 times year-on-year, and the company’s adjusted net loss rose nearly five times to 450 million yuan.

In its last financial statement for this year’s second quarter, the company attributed its losses to a sharp rise in operating costs and expenses which totaled a hefty 1.75 billion yuan due to its huge spending on user acquisition and brand promotion through third-party channels.

Three months later, the company’s insurance customer base had grown by 5.9% from 102 million to 108 million in the third quarter, among whom paying customers increased by 9.2% from 24.9 million 27.2 million. First-year premiums per customer in the third quarter increased slightly by around 2% to reach 1,292 yuan.

Digging deep into its coffers to acquire new customers did not quite pay off, and Shen said he was aware the company could not go on “burning money” forever. Thus Waterdrop needs to drive down costs in order to turn a profit. Accordingly, the company managed to bring down costs and expenses in the third quarter by 26.4% on a quarter-by-quarter basis to 1.29 billion yuan, and expected to further cut back on operating costs in the fourth quarter with the ultimate goal of returning to the black.

Shen established the company in 2016 as a crowdfunding platform providing mutual aid services to patients seeking financing for expensive medical treatments. He wanted to acquire a large user base with the platform first, which he could then cash in on by building up an insurance brokering business.

But Chinese regulators had other ideas and believed that companies like his needed official licensing to provide commercial insurance services. Shen was quick to note the risks and shut down the Waterdrop Mutual Aid platform in March this year, costing him a promotion channel for his new insurance business. He then started to search for new promotional outlets after the IPO, pinning his hopes on expensive third-party channels.

Waterdrop listed in first half of this year when Chinese tech stocks were all the rage, attaining a market valuation close to 30 billion yuan with backing by big names like Tencent (0700.HK), Meituan (3690.HK) and Boyu Capital among its stockholders.

But Waterdrop couldn’t stay above the fray as Beijing rolled out a series of measures to crack down on tech companies, sending the company’s stock price into a tailspin. To try to counter the selling, the company proposed a stock buyback and Shen promised not to sell any shares for 18 months. But those moves weren’t enough to stem the fall. The fact that the company’s collected first-year-premiums (FYP) in its insurance business during the latest quarter increased by 37.5% year-on-year to 14.5 billion yuan didn’t help, either.

Breaking even in two years

“We have successfully reduced our reliance on third-party channels by streamlining our own operating model and we will continue to improve our service quality and profitability in the future,” said Waterdrop CFO Shi Kangping. His remarks imply the company is planning to start anew and find a way to put an end to the losses.

Investment banks are fairly bullish on the company’s prospects. Goldman Sachs forecast the company would be able to break even with its mature business operations by 2023 by effectively slashing costs, and maintained a “buy” rating for the company with the target price of $9.50.

Morgan Stanly gave it the company an “overweight” rating, believing that a shift of the management’s focus from “quantity to quality” aimed at improving customer experience, coupled with cost-optimizing measures, would allow for continual improvement of its revenues.

But such optimism contrasted sharply with the pessimism from an analyst with strong insight into the industry. He said he believes the company’s business model revolves around spending lavishly to attract customers, then making money off its customer base and repeating the tactic again and again. The company got such a high valuation at the time of its listing, he said, because the market liked its potential for expanding its customer base.

“The company’s Medical Crowdfunding and Mutual Aid services helped it gain customers which it could monetize,” he said, speaking on condition of anonymity. “Investors are not really attracted to the company’s insurance brokering business. It’s a better bet to buy insurance company stocks if they want to invest in the insurance business. As its speed in acquiring new customers slows, the company is due for a re-evaluation by the market!”

Compared with other profitable peers, Waterdrop is losing money, so it cannot be compared by price-to-earnings (P/E) ratio. But its price to sales (P/S) ratio is about 3.39 times, which represents a significant premium to its peers. E-commerce insurer Huize Holding Ltd. (HUIZ.US), with a forecast P/E ratio of 101.4 times, has a P/S ratio of only about 0.25 times.

ZhongAn Online P&C Insurance Co. Ltd. (6060.HK), whose underwriting business became profitable for the first time this year, has a forecast P/E ratio of 29.39 times and P/S ratio of 1.5 times. Fanhua Insurance (FANH.US), which focuses on the offline market, and whose share price has been relatively stable this year between US$12 and US$15, has a P/S ratio of about 1.2 times.

All things considered and given the still somewhat gloomy profit prospects for Waterdrop in the short term, its stock is not cheap. Fast growth is always a must for high valuation. Once a company starts to lose speed, money naturally leaves. Such is life in the investment market.

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