FinTech on sale: The upcoming shopping trip

In 2009, former Fed Chairman Paul Volcker said the ATM has been the only useful innovation in banking for the past 20 years. How much innovation have the banks made since then? Does the current market downturn create an opportunity for them to catch up? I would say that, yes. If they will of course. Brendan Greeley, wrote in FT this weekend that banks choose not to innovate and give consumers better products, because the returns are terrible. They would rather continue with expensive credit cards, difficult and expensive transfers, large overdraft fees and unnecessary fees in general for very bad digital experiences – because it increases the margins of low balance accounts.

Banks have done a very poor job of meeting the financial needs of their customers. Only 1% of Americans view banks as crucial to their financial success. FinTech companies have stepped in to meet these unmet needs, and are slowly taking more and more market share from incumbents – financial technology and payment companies have gained a quarter of the total value of the financial industry over the past decade.

The market downturn and falling technology stocks provide a strategic opportunity for banks to regain ground, protect their market shares and catch up with the fundamental changes in technology and digitalisation that (most) are lagging behind.

What is happening in the markets

FinTech shares have fallen over the past year. An index combined with aperture indicates that FinTech shares are down 60% on an annual basis compared to NASDAQ 100 which fell 20% in the same period. * In addition, there has been a decline in public valuations. In June 2020, NTM EV / Revenue multiples for FinTech were 34% higher (at 7.5x) than the average for NASDAQ 100 components (5.6x). After leveling in June 2021 to 5.5x, public FinTechs are now trading around 2.3x NTM EV / Revenue compared to an average of 4.5x for the NASDAQ 100. This is a significant adjustment from 7.5x to 2.3x EV / Revenue over 2 years – a clear depression in public valuations.

The valuations of FinTech in the private market are also declining. Growth rates are a massive driver behind private valuations since they are extrapolated far into the future and with an expected economic downturn comes an inevitable multiple compression. Klarna, Europe’s star FinTech, is expected to cut a third of the valuation, based on recent financing discussions.

FinTech’s private fundraising activity is still quite strong. Crunchbase data suggests that $ 24.1 billion has been raised so far this year in seed, early and late phase investments compared to $ 22.7 billion in the same period in 2021. FinTech seed stage has attracted $ 200 million more in the first 5 months of 2022 compared to the same period last year. The funding history for the rest of 2022 will probably be less rosy. The sharp decline in public FinTech stock valuations will take 3-6 months to reflect in the private markets. In addition, recent external pressures and macroeconomic fears are likely to lead to FinTech fundraising.

The research and investment banking store, Rosenblatt Securities, emphasizes here that the price development of the public market FinTechs has more to do with investors who are buzzing with growth and technology shares and less a reflection on the long-term value proposition of FinTechs. It is probably also a reflection that investors are only more realistic when it comes to growth prospects and valuations. The point is, it has more to do valuationsand less with the interior to do value by FinTechs. The current investor movement has more to do with broad macro concerns about ongoing interest rate hikes due to central bank austerity policies and the risk of a financially hard landing and possibly a prolonged recession.

The sitters’ time to shine

In a recent interview with Davos, UBS CEO Ralph Hamers commented “The market value of (FinTech) companies may be in question now, but the business models are here to stay. [Because these are] technological business models supported by demographics and accelerated by client behavior change “. These behavioral changes include increases in online spending, changes in engagement channels, attitudes toward buying financial services online, diminished confidence in financial institutions, and the need to be served digitally. His comments reflect those of Credit Suisse’s chairman Axel Lehmann, who said “valuations are down and there is a shake-up, but the fundamental trends in technology and digitalisation will continue to affect business models. “

Now is the perfect time for strategic acquisitions. Not only is it a good time for established financial institutions to adapt to the changing landscape, but also the next few months will probably mark some of the cheapest prices for FinTech for a while. As FinTech begins to lay off employees, some will inevitably not have enough cash to survive and can be obtained cheaply.

Why now?

McKinsey found that companies in the cyclical industry could more than double their shareholder returns (relative to actual returns) if they bought assets at the bottom of a cycle and sold at the top. Carlyle co-founder David Rubenstein also notes the opportunity at hand, saying it is an opportunity for investors to go in and “buy at the bottom.”

Companies that invest wisely when times are bad usually surpass peers. Capital expenditures for the 500 largest US companies over the past 45 years are strongly correlated with last year’s profitability. When profits are high and financing is readily available, it is easy for companies to invest in capital projects, and it is a difficult cycle to break. Companies that can time investment expenses and buy assets to invest countercyclically usually outperform their peers.

Buy versus Build

Forbes describes the urgency, and the trade-off, well in this article: “Banks must act now if they want to participate in accelerating consumer and technology trends or just to defend their market share. They can build by using many of the plug-and-play applications on the market, “but they require huge ambitions, focus and a clear vision. Or they can make an acquisition, which can provide a way for late entrants to catch up. »

Building the right solutions, provided they can be designed internally, is likely to be more costly than picking the right one in the current market. Furthermore, it is considerably less risky to buy a proven service that is already on the market, given both the challenges of product innovation in an existing financial institution, as well as the market risk that the product will not be well received by consumers.

Seated operators can now obtain the right FinTechs, at affordable prices, to:

• Get skills and technology faster or cheaper than they can be built
• To protect against digital disruption and secure the future of their business
• Get a new generation of customers along with the knowledge to serve these customers
• Gain a competitive edge over less ambitious or brave peers
• Get good products from companies that do not have the resources to go to market
• Speed ​​up the market with extra resources and / or access to new geographies
• Challenge the DNA of the existing organization and start changing the culture

Pick right

JP Morgan is all about payments and looks at winning in payments as their strategic imperative. The bank made almost 20 investments in the FinTech area in 2021. In the same year, more than 65% of JP Morgan Chase accounts were opened online. But to succeed in the banking business of the future will require more than “winning in payments” and a solid online offer. Banks should think about how they can serve all the financial needs of consumers (such as risk management, budgeting and investment) in a way that consumers want to be served, digitally, frictionlessly and through channels where they live their daily online lives. It’s about much more than just payments.

Sedentary financial institutions can learn from these technology companies that took advantage of the dotcom bust in the early 2000s and acquired companies to protect market share and accelerate the market.. Cisco acquired 71 companies between 1993 and 2001. Their revenue increased from $ 650 million in 1993 to $ 22 billion in 2001. In 2001, 40% of the revenue came from these acquisitions. Google acquired Android, possibly the most value-added technology acquisition of all time, as valuations remained low in 2005.

Consolidation is on the way in the industry, and the established operators who are brave enough to trade now have the opportunity to regain market share and make up for the lack of innovation in recent decades. Hopefully we will see more than “ATM innovation” as a result.

Notes:

* Price performance as of 20 June 2022. The FinTech index combined with aperture is an equally weighted index.