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Key takeaways:

1、Linklogis grew the number of anchor enterprise customers using its supply chain financing services by 50% to 327 in the nine months to September

2、The strong gains came after Beijing began requiring state-owned companies to build systems to help finance the operations of their suppliers

Beijing has come up with a clever solution to aid small businesses that are critical links in complex supply chains as it faces pressure to jumpstart economic growth: Providing them with financing backed by receivables from their deep-pocketed state-owned buyers. Beneficiaries of that campaign include Linklogis Inc. (9959.HK), which reported its business received a strong boost in the first nine months of the year as a result of the new policy.

Since the end of last year, the entity that oversees big state-owned companies has required those companies to use technology platforms to assist in financing for their suppliers. In such a transaction, a company, or an “anchor,” uses unpaid bills it owes to its suppliers to help those suppliers obtain advance cash from banks to fund their operations.

Both the anchors and suppliers benefit because the former get more time to pay their bills, while the latter can get cash immediately. The bank earns a fee, and also can feel relatively safe knowing its cash advances will be repaid by the anchors that typically have sound financials.

As China’s economy stagnates, supply chain financing backed by receivables can be particularly handy for small suppliers that have difficulty borrowing from banks or other lenders for short-term funding of their operations. Such suppliers can even be forced out of business as their working capital dwindles while they wait to get paid, causing a ripple effect in supply chains.

Since banks lend based on the creditworthiness of a borrower, they can feel more secure using the low default risk of large state-owned enterprises as reassurance when advancing money to help smaller suppliers fund their operations. Tencent-backed Linklogis enters that picture by providing cloud-based software-as-a-service (SaaS) platforms that link up all parties involved to facilitate such supply chain financing.

Indeed, the company’s latest business update released late last week shows it is gaining handsomely from Beijing’s attempt to get state-owned enterprises more involved in supply chain financing. In the nine months to September, the number of Linklogis’ anchor enterprise customers grew 50% to 327, with the volume of supply chain assets for such companies on its platforms up by a similar rate. Linklogis’ new anchor customers this year include state-owned titans like China Mobile and China General Nuclear Power Corp.

The company’s shares have risen about 9% since it released the business update, suggesting investors believe Beijing’s supply chain financing campaign will keep bringing Linklogis new business for now — an expectation that seems reasonable enough.   

Even before the government program, supply chain financing in China was already expanding fast. China Insights Consultancy projected the outstanding balance of such financing will grow at a compound annual rate of about 12% to 40 trillion yuan ($5.6 billion) by 2024 from 2019.

Part of the growth owes to a general shortage of financing that small and medium-sized enterprises (SMEs) can obtain from traditional banks, which are becoming more risk-averse as China’s economy slows. Their need for funding has become even more acute as China’s “zero-Covid” policies continue to disrupt their operations with forced closures, often with little or no advance warning.

Good news, bad news

The bad news for small businesses in supply chains is that it doesn’t look like Beijing will change its Covid policy anytime soon. But the good news is Beijing is sympathetic to their plight. In April, midway through a two-month lockdown in Shanghai, Chinese authorities pledged financial aid and temporary exemptions to debt repayment for companies in supply chains so they could resume operations. And in June, China’s official Xinhua news agency said the government will “make the unimpeded and stable operation of its industrial and supply chains a top priority.”

But after months of business suspension and interruptions, many suppliers likely ran short on cash. As we’ve previously noted, banks are typically more reluctant to lend to small businesses due to their shaky situation, and that reluctance only grew after the Chinese government allowed struggling suppliers to defer their loan repayments.   

Stress among banks was evident in Linklogis’ latest disclosure. In addition to financing services for supply chain manufacturers, the company also provides products for financial institutions to digitize and automate functions for supply chain financing, including for asset securitization. That group of customers grew much more slowly in the first nine months of this year than big anchor enterprises, increasing just about 8% from the end of last year in terms of customer numbers.

Regardless of the slow growth from that group, business from non-bank state-owned enterprises may be enough for Linklogis to get by for now. Encouragingly for the company, economic activity in China is showing signs of some recovery, with the Purchasing Managers’ Index moving into expansionary territory in September.

Linklogis appears to be cutting its fees for customers, based on the fact that its revenue growth in the first half of this year was far slower than the increase in its customer base. But that’s not necessarily bad, as it may be part of a company strategy to expand its clientele by bundling products at discounts, which reduces the cost of sales and improves gross profit margins.

The real risk is the potential that the company’s anchor customers may not pay money they owe to their suppliers. Such credit risks are mostly borne by banks, which rely on payments by anchor companies to recoup their cash advances to those suppliers.

But Linklogis does hold supply chain assets on its balance sheet before financial institutions purchase them. If any anchors fail to pay bills that come due while on Linklogis’ balance sheet, it has to take the losses, though that’s relatively unlikely because receivables don’t typically stay on Linklogis’ books for long. But it its interim report for the first half of this year, the company did warn it is holding supply chain assets longer on average as banks or other investors become cautious.

Especially problematic for Linklogis is its reliance on real estate companies as its largest customer group, although their share of its total supply chain assets has been steadily decreasing, to a little less than a third in the second quarter.

Linklogis stock is down about 80% from the price of its IPO last year, and currently trades at a price-to-earnings (P/E) ratio of just 1. A lot of that owes to China’s ongoing crackdown on fintech companies and generally sour sentiment towards Chinese stocks. But even so, the company’s P/E ratio is far lower than those for leading fintech loan companies like FinVolution Group (FINV.US), which currently fetches more than 4.

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