Summary

CONVOY FINANCIAL SERVICES HOLDINGS LIMITED (CFS) is principally engaged in the insurance and MPF schemes in Hong Kong as the agent of customers, and advises on matters related to insurance.

CFS establishes business relationships with the Product Issuers by entering into the broker agreements. Customers are policyholders whom the Consultant provides service to. The Group delivers their services to customers through consultants.

After the credit crunch in 2008, SFC is now planning to require much higher disclosure of different investment products including ILAS. Actually, the flexibility and liquidity of ILAS is much lower than that of Unit Trust because of the presence of lock-up period/ sales penalty before the end of lock period. From the perspective of the company, we company is facing the fierce competition from banks and insurance companies.

Compared with its local listed peers, Prudential plc (2378.HK) and MANLIFE (945.HK), they are now trading at 14.03x and 9.12x times 2010 EPS respectively. While the international peers, AIG is trading at 8.67x 2010 PE. Despite of the lowest market cap among peers, we set 2010 PE of CFS (1019.HK) to be 9x as it's higher profit margin. We set the expected 2010E EPS to be HK$ 0.097. Our 12-month target price is HK$ 0.87, which is far below the lower end of offering price range. Rating: Not Subscribe.

Company Description

CONVOY FINANCIAL SERVICES HOLDINGS LIMITED (CFS) is principally engaged in the insurance and MPF schemes in Hong Kong as the agent of customers (such as policyholders), and advises on matters related to insurance. CFS is a corporate member of PIBA and corporate intermediary of MPFA.

Business Model

The business model of CFS is illustrated as below:

CFS establishes business relationships with the Product Issuers by entering into the broker agreements. Customers are policyholders whom the Consultant provides service to. The Group delivers their services to customers through consultants. The consultants:

- Conduct financial needs analysis for customers who need long term insurance products and schemes (including Investment-Linked Assurance Scheme [ILAS]);

- Advise or make recommendations to the customers concerning the selection by them of the underlying funds of ILAS.

The Customers will pay contributions to the Product Issuers directly. The Product Issuers, which design the insurance products, would remunerate the Group on a commission and recurring fee basis for services provided by the Group to the customers.

Majority of Business is derived from referrals, recurring business from existing clients and direct marketing respectively, the proportions in 2009 is as shown below:

The Group mainly provides advisory services on ILAS, which is a types of long term insurance business, from which over 99% of revenue for three years ended 31 December 2007-2009 was generated; while the less than 1% of revenue comes from other insurance products and MPF schemes as shown:

Relationship with Consultants

The Consultants are generally not employed by CFS, but CFS has entered into contracts for services on the basis that they are providing exclusive insurance and MPF schemes brokerage service in HK to CFS.

Although the Group may be subjected to civil liabilities and/ or disciplinary actions of regulatory authorities (such as PIBA) if there is any misconduct by the Consultants in selling ILAS, the Group is protected by the indemnify arrangement once the Group is subjected to and against all actions, claims, proceedings, costs, damages and expenses which may be levied, brought, incurred or made against the Group by any customer and potential customer resulting from the misconducts Consultants.

The Consultants promote, arrange and negotiate contracts of insurance and MPF schemes with the customers independently in accordance with all applicable codes, rules, laws and regulations of the relevant regulatory bodies and Government authorities in Hong Kong and are remunerated on commission basis by CFS for the insurance products and MPF schemes which they have successfully arranged.

Relationship with Product Issuers

The Product Issuers are independent of the Group. The Business relationships with various ILAS Issuers are formed on the basis of the terms of business and/ or conditions issued by the ILAS Issuers to the Group. The Group is entitled to receive brokerage commission income from the Product Issuers for business referrals and introductions as a result of arrangement of insurance products and/ or MPF schemes to customers.

The top five ILAS Issuers of the Group in terms of commission income accounts for 98.5%, 96.99% and 97.1% respectively of the Groups revenue in 2007-2009. Those issuers include Zurich International Lift Limited, Friends Provident International Limited, Stand Life (Asia) Limited and Generali International Limited.

Industrial Overview

The insurance industry is one of the key financial services in Hong Kong. In 2009, the total general and long term insurance premiums was HK$185.7 billion, representing approximately 11.4% of the GDP of Hong Kong, according to the OCI and the Census and Statistics Department of Hong Kong.

The insurance industry consists of two sectors, which are long term insurance office premium and general insurance gross premium. The former accounted for about 84.6% of the total premium income, while the latter accounted for the remaining proportion.

The graph below demonstrated that the trend of long term insurance office premium, general insurance gross premiums and general and long term insurance premiums as a percentage of GDP from 1998-2009.

The long-term insurance office premiums grow faster than that of general insurance gross premiums starting from 1998. According to the Hong Kong Insurance Business Statistics 2009 published by the OCI, the growth rate and CAGR of ILAS, which is a major types of long term insurance, is much higher than that of non-investment-linked business and reached 31.8% from 2006 to 2009 respectively.

The following are some of the factors that contribute to the continuous development of ILAS in Hong Kong. ILAS is considered as a top-up of MPF, which gives extra protection to the retirees. These factors are:

- The launch of MPF coupled with massive promotion and education activities from the government to foster the awareness of financial planning.

- Possible failure of MPF to meet the retirement needs

- ILAS is more flexible than MPF, in terms of fund choices, time horizons and amount of investments.

Revenue Model

The Group is entitled to receive one-off brokerage commission income and recurring fee income from various Product Issuers for brokering the sale of their products. The breakdown is as shown below:

The revenue was largely attributable to one-off brokerage commission income derived from the sale of

- ILAS

- General and conventional insurance products,

- MPF schemes.

The profit margin depends on the commission rate offered by the Product Issuer and the group is subjected to the credit and bankruptcy risk of the Product Issuers.

Investment Thesis

After the credit crunch in 2008, SFC is now planning to require much higher disclosure of different investment products including ILAS. Actually, the flexibility and liquidity of ILAS is much lower than that of Unit Trust because of the presence of lock-up period/ sales penalty before the end of lock period. Besides, the there is a price spread between the price of ILAS and the underlying assets because of the servicing spread charged by insurance company. Therefore, the expected higher required disclosure of ILAS product in the future would have a negatively impact to the group and the growth rate of ILAS demand would increase at a decreasing rate because of higher efforts put in the investor education by SFC.

From the perspective of the company, we company is facing the fierce competition from banks and insurance companies. This can be reflected by the decreasing revenue in the track record period. Yet we also suspect the rooms to boost earnings by lowering commission expense and staff cost.

Conclusion: We would classify the Group as the high-risk investment as the long-term prospect is subjected to the great uncertainties.

Risk

- Fierce competitions in a highly competitive industry

- ILAS may subjected to stricter disclosure requirements of SFC

Valuation

The local listed peers, Prudential plc (2378.HK) and MANULIFE (945.HK), they are now trading at 14.03x and 9.12x times 2010 EPS respectively; while the international peers, AIG is trading at 8.67x 2010 PE. Despite of the lowest market cap among peers, we set 2010 PE and EPS of CFS (1019.HK) to be 9x and HK$0.097 as it's higher profit margin. Our 12-month target price is HK$ 0.87, which is far below the lower end of offering price range (HK$1.00—HK$1.20). Rating: Not Subscribe. We recommended investors who interested in this industry to accumulate MANULIFE (945.HK) instead.

Peers Comparison

Financial Information

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