Fintech – Trouble in 2022?

US stock market up 27% -?yet Fintech stocks have declined in 2021

As we look forward to 2022 what will impact Fintechs?

Six unrelated events send a powerful message to Fintechs, VCs, other investors and the media – or at least those willing to look beyond the hype and spin.

Australia?– BNPL public stocks down 83% from 2021 peaks.

Brazil?– NuBank’s US share price sinks below its VC valuation pre IPO ?

India?– PayTMs November IPO was a total failure and stock continues to decline.

Sweden?– Klarna says it’s in ‘no rush’ to go public.

USA?– Stripe the eCommerce integrator and payment platform will “remain a private company”.

USA - Over 85% of Fintech SPACs closed below IPO price in 2021.

Sentiment across the Fintech sector is one knifes edge with stock prices down on average 48% in 2021 and some sectors smashed.

Tech IPOs were in trouble in 2021 –

NuBank a Symptom?

NuBank is a star Neobank with heavy weight investors – so the IPO New York in December was critical for Fintech investors and VC sentiment.

The pre IPO offer was already discounted by 20% as investors faced major concerns – the stock peaked Dec 10th $11.85 well below its pre-market valuation.

The fawning media even the FT claim the IPO a success – but is that really the case??

Nubank shares closed 31st December US$9 with market cap of US$43 billion that’s not supposed to happen at U$2 billion below VC valuation of US$45 billion.

NuBank has 48 million consumers across Brazil, Columbia and Mexico. The 48 million consumers spend US$29 billion is average spend $604 per year - this is peanuts and with no deposits, it seems a very fragile model.

Brazil based Nubank is backed by a star studded investor group – although the mix is interesting – Buffett, Softbank, Tiger International, Sequoia, DST Global and Tencent.

Wouldn’t you like to be a fly in wall when Warren Buffet meets Softbank??

Of 250 ‘major’ neobanks only 13 are profitable and that’s a good clue how many will survive this fourth wave of online start-ups banks, dating back to Egg in 1996, launched in 1998 and sold to Citibank in 2007.

Only a handful survives from phase three 2006-2012 – a real warning to current start-up incumbents happily burning cash while revenue is pitiful and losses increase.

Australian BNPL shares keep falling 83% in 2021

Australia has 11 ASX listed BNPL stocks -?rest of the world has four combined!!

Zip shares closed 2021 at $4.33 down 70% from its 2021 peak of $14.53. Zip share have lost 15% in December – but everything is fine and dandy in BNPLland!

If you invested $1000 invested in Zip at its February 2021 peak that was 68 shares, less brokerage - today those 68 shares are worth $294 - a loss from the peak of $705.56.

On this basis Square has lost US$18.2 billion on its purchase of that bucket of bolts called Afterpay – if you use the total decline figure Square has wasted US$22 billion - not bad for 10 months after 'paying' US$29 billion - its Square shareholders carrying the can as it was an all script offer and massive dilution.

Australia Leads the World in BNPL stocks……down 83% in 2021

Australian BNPL stocks peaked in February 2021 - since then it’s been a downward spiral - the decline speed up in the last eight weeks.

BNPL Stock Declines 31st December from peaks in 2021 unless highlighted

Zip?- down 70%

Sezzle*?- down 75%

Humm?- down 80% (peak Oct 2013)

Douugh?– down 82%

Payright?- down 82%

Zebit*?– down 85%

OpenPay?- down 85% (peak Aug 2020)

Splitit*?– down 87% (peak Aug 2020)

Fatfish*?– down 87%

Laybuy?- down 88%

IOUpay*?– down 97% (peak Dec 2002)

*BNPL stocks only listed on ASX – don’t operate in Australia

Humm the unsecured lender masquerading as BNPL app hung out the for sale sign and its stock ‘jumped’ to 90 cents but still declined in 2021.

Fintech Payment Start-Ups

Payment start-ups along with Neobanks represent the largest investment category within the private Fintech space accounting for 45% of investment dollars since 2019.

Large mega funding rounds now also dominate – in 2021 accounting for 69% or US$62.5 billion of US$94.7 billion raised in 3Qts 2021.

Fintech Mega Rounds Dominate

Leading these mega rounds includes: Chime, FTX, Klarna, Revolut, Robinhood, Stripe and Varo which totalled US$8.16 billion in funding.

Has Fintech investing peaked?

The strength of the Fintech sector comes from investor’s ability to exit either by IPO’s or trade sales. Should either slow down or values reduce then all investment activity faces begin re-calibrated. Supporting Fintech investment has seen the most rapid run up in payment shares in the last 40 years.

Payment Stocks on a Tear Since 2015

Payment companies especially acquirers and processors have had fantastic growth in share prices, totally outstripping banks.

The US S&P 500 finished 2021 up 27%, completing its best three-year stretch since 1999. The Dow was up 19% on the year, while the Nasdaq gained 21%.

A key question for 2022 - what will happen to tech stocks?

At their peak in May 2021 three of the top 15 US stocks were payment companies – Visa, Mastercard and PayPal. Today only Visa is in the top 10 by market cap – Mastercard is 17th PayPal is 38th and Square is 112th at US$74.5 billion.

Payment Stocks in Correction Territory in 2021

This rosy picture all changed mid way through 2021

Visa and PayPal's shares peaked in July - Visa at $252.67 - now $216.71 and PayPal at $310.16 now $188.58, while Square peaked in February at $289.23 now $161.51.

Mastercard is down 10% to $359.32

Visa stock is down 14%

Adyen is down 18.5% to?€2310.50

Shopify is down 22% to $1377.39

PayPal is down 39%

Affirm is down 43% to $100.56

Square is down 44% to $161.51

Others are even more dramatic UP Fintech peaked at $38.50 in February – now $4.91 an 87% decline.

The major Exchange Traded Fund (ETF) IPAY shows the US payment stock drops – its ‘share’ price is down 20% from its peak.

The major 48 payment stocks in US and EU are down 36%.

Why have Fintech Stocks been Hammered?

Fintech stocks were given very high growth status and this has meant no need for profits or positive cashflow – they could burn cash with impunity in 2020 and part of 2021.

The global fintech market was valued at $5.5 trillion in 2020, and was expected to grow at a 23.5% CAGR until 2025 – these numbers are now in serious doubt.

The COVID-19 pandemic accelerated growth and the trend was clearly visible; roughly 6% of U.S. citizens (over 14 million people) now use digital banking only for their money management and online entertainment and purchasing surged in 2020.

This activity has unwound in 2021 as consumer activity moving from the home office to high street cafes, restaurant and shops – see this evolve in Google searches yellow is 'at home' with blue 'main street'.

Inflation and Interest Rate Rises of Real Concern

Also concerns over inflation and rising interest rates and other key factors affecting investor outflows in Fintech. Investors moved into more well-capitalized businesses that can weather inflation and macroeconomic impacts.

Rising interest rates won’t help businesses in high-growth models that need access to capital and in some cases it will affect returns on their core products, whereas some bigger players with large cash piles won’t face this issue.

Rising interest rates directly impact all Fintechs that lend or who process payments as interest rate rises directly impact products e.g. BNPL is totally unsustainable offering ‘free’ interest free periods, as they pay merchants immediately but need to fund consumers and costs like marketing, bad debts and processing.

Will This Transfer to VC and Angel Investor Funding?

The events of the past month calls for caution and re-examination of VC and Angel investing – the deal pipes just got much longer and with potential interest rate rises all deals need to be repriced.

If VCs and Angel investors face much longer deal times and rising interest rates as well as potential liquidly issues as central banks unwind bond purchases caution will return to new investing.

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Investors need to get a lot smarter about fintech

We are in an era of immense technological change, but cheap money and the need for growth has blinded many investors to the risks.

BLOOMBERG OPINION ?Ben Ashby Dec 31

?The good news is that advances in financial technology, or fintech, are going to improve customers lives. The bad news is a lot of investors are going to lose money while it happens.

With a record $US98 billion ($135 billion) invested in the first half of 2021 alone, taking the total to in excess of $US1 trillion over the past decade, the amounts involved are stunning.

Despite some amazing companies, many fintechs are poor investments, beset by serious flaws in their business models and operational performance. We are in an era of immense technological change, but cheap money and the need for growth has blinded many investors to the risks.

Investors need to first focus on the basic product. The key question is what problem the fintech firm is trying to solve? Does it add value to customers and is the product better than its competitors?

Surprisingly, I have seen a lot of fintechs where these basic questions seem not to have been asked. A good example is the myriad of blockchain companies, with many trying to find a problem that can fit their perceived solution. Their products might be technically sophisticated, but are they enough for customers to switch?

?The wider problem is that many firms lack a viable strategy. Rapid product rollouts, a slick user interface or innovative technology are often cited as key competitive advantages, but these are not strategies in themselves. Neither is lower cost. In many cases the competition could also reduce its pricing, thereby crushing returns. How long could firms like the money-transfer firm Wise Plc or Revolut Ltd survive if a major incumbent such as HSBC Holdings Plc started a price war by offering the same foreign-exchange rates?

A poor fundamental strategy is common and can often be detected by firms entering “Red Ocean” markets. A Red Ocean is an existing market with lots of competition. Usually, the returns are determined by market forces and disrupting these can be extremely difficult.

Unless you are doing business in a very different way, you are going to be hostage to these same forces and see disappointing returns. Hence, the lacklustre performance of European challenger banks like Metro Bank, Monzo Bank or Peter Thiel-backed N26 GmbH should come as no surprise. They were doing nothing fundamentally different than the incumbents. As Thiel said, most firms fail because they fail to escape the competition.

‘Blue Ocean’ opportunities

By contrast, “Blue Ocean” strategies are overlooked. A Blue Ocean is one where there is a lack of competition and an opportunity to create new demand. A Blue Ocean strategy could start in a niche of an existing market but expand or even create a completely new market. This is often where true disruptors are born. The best example is Amazon, which started in selling books and expanding into new markets such as cloud computing.

Unfortunately, many fintech management teams lack the skills or an understanding of the complexities of the markets they are trying to enter. The markets they are trying to disrupt are often highly regulated with complicated dynamics. The electronic money, or e-money, payment firms have had a particularly tough time.

A deep knowledge of financial markets is often absent. Money is possibly one of the oldest “technologies” in existence, yet many cryptocurrency proponents appear to be unaware that bitcoin is essentially an old idea – private sector money – in a new form.

Crypto early stage

Private sector money has a checkered history and has often run afoul of governments seeking to protect their monopoly on money. Various well known behavioural fallacies also abound, such as the vast energy usage creates inherent value. It doesn’t, this is almost classic sunk cost.

Does this mean the entire crypto universe can be casually written off as a worthless fad? I don’t think so. It seems likely that something will emerge from the massive innovation in the digital asset space, but I doubt that the early-stage cryptocurrencies will prove to be the ultimate winners unless these significant issues are addressed. To get an innovation right the first time would be very unusual.

A lot of the problems with fintech emanate from the wider venture capital industry. Flooded with liquidity the industry has grown enormously in recent years and there has been huge pressure to deploy capital.

Red Ocean markets are already in existence and their size and value can be relatively easily quantified. Groupthink is widespread, and fashionable investment themes attract lots of capital but increase competition. By contrast, Blue Oceans might start in inauspicious places so it is much harder to conceive their true potential or where skilled management teams can take companies. They also require greater patience.

Starting with flawed business models has meant many of the fintech start-ups seem to be too focused on getting a higher valuation in the next round of funding while the need to become profitable seems secondary. Given a lack of profitability, valuations are often inflated. Many of these businesses will struggle in the next downturn.

Technological revolutions often come in waves, and we may well only be half way through a multi-decade one. They can trigger deep change around how business and even societies are structured in ways that are hard to predict.

The expansion of the auto revolution enabled suburbanisation and the way we shopped. Based on valuation, Walmart appears to have been a bigger winner from the automobile than the car companies themselves.

It may take years for the winners to emerge, and the biggest winners may be from other industries entirely. Rather than chasing fashionable themes at extreme prices, investors should perhaps consider more Blue Ocean opportunities or just be patient. Some of the best times to invest in tech in the last cycle was after the crash and history may well repeat itself.

Ben Ashby is a partner at Good Governance Capital. He was previously a managing director at JPMorgan Chase?&?Co’s Chief Investment Office?&?Treasury.

Bloomberg Opinion

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