Fintech – Big Declines Across All Sectors

Fintech risk/rewards dramatically increased following the ‘Covid’ stay at home era aided by excessive valuations, ‘free’ central bank money, government stimulus, exuberant VC’s/Private Equity and run away share markets.

All of this is looking very shaky as ‘free’ money is withdrawn and interest rates must rise to curb runaway inflation.

Early in 2021 stock markets starting warning that risk would not be rewarded, and Fintech’s needing to make profits, not fancy charts of ‘future growth’ and massive cash burn. The declines gathered pace in 2022 in Tech stocks were smashed.

Current Risks are Extremely Elevated

The huge run up in shares and private valuation risk a new group of Fintech failures – many are fighting for survival right now.

Examples of risky areas:

BNPL – US Affirm has lost US$47 billion in market cap, Australia’s BNPL stocks have lost 95% of value US$32 billion in 15 months.

Klarna lost US$39 billion with its new valuation. The sectors could end losing US$100 billion.

Neo Banks – public float of NuBank in June 2022 shares closed at US$4.62 with market cap of US$21 billion – that’s not supposed to happen, its VC pre-IPO valuation of US$45 billion. This makes the much smaller Revolut private valuation of US$33 billion look ridiculous.

Successful Korean Neo Bank Kakao Bank has seen its shares decline 72% from IPO peak for this profitable bank (profit a rarity among Neo Banks).

Block/Square/Afterpay/Clearpay has felt the impact of its disastrous US$29 billion purchase of unprofitable Afterpay. Blocks market cap is US$43 billion down from its peak of US$127 billion.?

PayPal is not a Fintech, but its stock has also been punished – peaking at US$310.16 in 2021, today US$92 billion

VC Investments at All-time Highs in 2021

Total Fintech Investments 2008-18 were US$63.9 Billion which includes Venture Capital (VCs) and other investors including private equity and crowd funding, representing 6.7% of total start-up funding.

Since 2018 Fintech investments jumped to average $50 billion a year until 2021 which totalled a whopping US$131 billion. This declined significantly as first quarter 2022 show with early indications Q2 has declining further.

All VC Start-Ups Now Under Pressure

The VC challenge now is turning around all the start-ups, changing their mindsets and ‘runways’ to fit the new circumstances – some gig!

Given the thesis on VC investment returns is a margin over interest rates - hasn't this just become much harder??

Sentiment across the Fintech sector is one knifes edge with stock prices down on average 68% in 2021 and some sectors smashed. Just as concerning as declining inflows into VCs which will hasten decisions and scale back is already the new realty.

Read these two WSJ articles on early-stage start-ups and high cash burn in eCommerce.

Tech Downturn Slows Early-Stage Startup Funding

Power shifting back to investors after glut of cheap money heightened competition for deals

WSJ By?Berber Jin July 20, 2022

The slowdown in venture-capital funding has spread to early-stage startups, with that part of the market suffering one of the biggest investment drops in more than a decade.

In the second quarter, venture capitalists invested around $16 billion in U.S. early-stage deals—known as Series A and B rounds—a 22% decrease from the year-earlier period, according to PitchBook Data Inc.

That marked the biggest quarterly year-over-year decline in early-stage funding since at least 2010, with the exception of a drop in the second quarter of 2020, when investors pulled back briefly amid the onset of the global pandemic.

The retreat shows investors’ increasing caution toward riskier investments such as nascent companies, a marked change in sentiment from recent years, when competition among venture firms drove them?to invest ever earlier in a startup’s life cycle. It follows a similar pullback in funding for later-stage startups, which are closer to going public and thus more affected by stock-market changes.

The change is shifting more power in Silicon Valley back to investors. For years, a deluge of cheap money kept valuations soaring, and venture firms said they spent less time on research and vetting the companies to court founders and not miss out on deals. The pandemic accelerated many of these trends, as demand for software services increased to accommodate businesses moving online and interest rates stood at historic lows

As markets react to inflation and high interest rates, technology stocks are having their worst start to a year on record. WSJ’s Hardika Singh explains why the sector—from tech giants to small startups—is getting hit so hard. Illustration: Jacob Reynolds

Earlier this year, venture capitalists remained optimistic about the early-stage funding environment even as the public shares of technology companies ranging from?DoorDash?Inc. to?Snowflake?Inc. cratered. U.S. early-stage funding increased 50% in the first quarter compared with the year-earlier period, PitchBook data show.

That calculus has changed amid a worsening macroeconomic environment and a virtual freeze in investment for more mature, growth-stage startups. Venture firms that focus on early-stage investments typically rely on cash-rich money managers to mark up the value of their holdings in subsequent funding rounds. But many of these large investment firms earlier this year?slowed their deal-making?or?exited the startup market entirely?amid the stock market rout, according to venture capitalists, raising the investment bar for younger companies.

Even funding for seed-stage deals, often the first source of outside financing for companies still developing their products, has taken a hit. U.S. deal volume dropped 11% to $3.9 billion in the second quarter compared with the year-earlier period, the first such quarterly drop on a year-over-year basis in almost two years, according to data from PitchBook.

“The seed and Series A funding environment is the toughest I’ve ever seen in my career managing a fund,” said Jeff Morris Jr., who manages a crypto-focused early-stage fund called Chapter One. “It will be painful in the short-term.”

The pullback in early-stage investment follows a tough few months for more mature startups. Pandemic darlings including instant delivery firm Gopuff and virtual events company Hopin Ltd.—which?raised three rounds of financing?in less than a year—have had several rounds of layoffs in 2022. Startups across the board are also scrutinizing their balance sheets to conserve cash in anticipation of a worsening fundraising environment, heeding the?stern public warnings?given by VC firms like Sequoia Capital and Lightspeed Venture Partners.

“In this climate, my mind-set has totally shifted. It’s close sales, close sales, close sales,” said Anurupa Ganguly, the chief executive of two-year-old education-technology startup Prisms of Reality Inc., which is looking to raise a Series A round in the fall. “When things tighten, it forces founders to be far more rigorous.”

Ms. Ganguly said she didn’t believe the market had soured enough to affect her $4.3 million seed round, which she completed in March, but that it will become more important for startups to hit key financial metrics if they want to raise at good terms from venture capitalists.

Venture capitalists raised a record $139 billion in U.S.-based funds last year, according to PitchBook, and have already raised $122 billion this year. They include a $1.9 billion early-stage fund raised by Founders Fund in March and a $2 billion early-stage fund raised by Lightspeed Venture Partners in July this year.

The large amount of committed capital means VC firms will still have to search for new startups to back, though the pace of investment could slow down for some funds, said Nina Achadjian of Index Ventures. She said Index’s partners had more time to make decisions on new investments compared with last year, when popular founders often held the upper hand in deal negotiations.

Some seed startups are already struggling to raise Series A rounds, an investment stage where investors typically expect businesses to show clear signs of traction among customers. Many of these companies are now raising extension rounds, capital usually offered from existing investors at the same price as the last round, according to Ms. Achadjian and other venture capitalists.

Crypto startups?have been hit particularly hard, in part because of the sharp selloff in established cryptocurrencies like bitcoin and Ethereum. Venture capitalists invested $8.4 billion in global early-stage blockchain startups in the second half of last year as fervor for the nascent sector took off. The numbers?have declined sharply since: just $2.4 billion was invested into such companies in the second quarter this year, down from $3.1 billion in the first quarter, according to Crunchbase Inc. data.

E-Commerce’s Red-Hot Cash-Burn Problem

?If winds blow in the wrong direction, some e-companies could face the risk that their cash burn turns into a bonfire

WSJ By?Jinjoo Lee July 20, 2022

?E-commerce companies’ share prices reached stratospheric levels in 2021, propelled by two forces:?homebound, cash-rich consumers?and cheap financing. With the two propellants now sputtering, the rate at which some of these companies burn cash—their backup fuel—is starting to be unnerving.

The online furniture seller?Wayfair,?W?4.10%▲?as well as the online used-car sellers?Carvana?CVNA?19.82%▲?and?Vroom,?VRM?9.52%▲?are among cash-burning internet retailers that will—within a few years—need to raise external financing or repay maturing debt to avoid a cash crunch, according to a report from Stifel that aims to track cash burn among small to midsize internet companies.

?Stifel estimates that Vroom will require external capital as soon as 2023 before reaching self-funding status, while Carvana will need to do so as early as 2024. Wayfair, which has roughly $1.5 billion of convertible senior notes due in 2025, will either need to improve its cash-flow position if it wants to pay that off or refinance it, according to the report. Of course, that timing could become more or less urgent depending on how deep the cash burn becomes.

Cash burn, or negative free cash flow, is particularly noticeable at Carvana, which burned through nearly $1 billion in both 2019 and 2020. Last year that cash burn tripled to reach nearly $3.2 billion. The company’s free cash flow isn’t expected to turn positive annually until 2026, according to analysts polled by Visible Alpha. Its smaller rival Vroom had nearly $600 million of cash burn last year and, after a brief reprieve this year, is expected to burn cash annually until 2029. Wayfair, which had positive free cash flow in 2020 and 2021, is expected to burn cash this year and next.

Though cash burn isn’t unusual when a company is growing quickly, the risk is that it turns into a bonfire when winds start blowing in the wrong direction. That might already be happening. Once-favorable online retail conditions are reversing as cash-squeezed consumers shift spending away from goods to services and others opt to return to in-person shopping. Wholesale used-car prices have stabilized in recent months,?according to Manheim. Meanwhile, industrywide sales growth for furniture has slowed.

Impressive revenue growth is unlikely to return for some time. Carvana, which saw its revenue more than double in 2021, is expected to have a compound annual growth rate of 25.4% through 2026, according to analysts polled by Visible Alpha. Wayfair, whose revenue grew nearly 55% in 2020, had a 3% decline in its top line last year, and analysts expect more shrinkage this year. While Vroom’s top line more than doubled in 2021, sales are expected to decline 22.4% this year, before picking up by a sluggish 2% in 2023.?

Rising interest rates?make it more expensive for cash-crunched companies to raise new debt or refinance existing borrowings. Carvana’s latest debt offering was something of a caution flag, according to?Scott Devitt, the equity analyst who led the Stifel report. In April, Carvana announced that it had raised $3.3 billion of notes due in 2030 at an interest rate of 10.25%, which was more than double the rate it paid for notes of a similar term in 2021. That financing alone adds more than $300 million of additional annual interest expense as the company is already bleeding cash. Not long after announcing that financing, the bulk of which was used to fund its?acquisition of a car-auction business, Carvana published an operating plan to cut expenses and capital expenditures.

Mr. Devitt says he is still bullish about e-commerce in the long run, adding that some of the most cash-crunched companies could still come out ahead if a few things move in their favor. Given that everything could move in exactly the wrong direction, though, investors might want to assess whether they are comfortable hanging on to cash burners through the worst scenario.

As markets react to inflation and high interest rates, technology stocks are having their worst start to a year on record. WSJ’s Hardika Singh explains why the sector — from tech giants to small startups — is getting hit so hard. Illustration: Jacob Reynolds