23 Oct 2015
But any broad discussion today inevitably reaches a point where someone asks “is fintech (and indeed the venture capital space more broadly) entering bubble territory?”.
" The longer-term question is whether some of these fintechs could be the Apple or Google of financial services."
Andrew Cornell, Managing Editor
Bubbles, notoriously, are proven only when they pop. Compared with the dot com bubble period of 1999-2000, both the number of deals and amounts invested remain off highs. The peak quarter as the Dot Coms inflated saw just shy of 3000 deals valued at nearly $US30 billion.
By comparison the second quarter of 2015 saw a peak of around 1700 deals valued at just under $US17 billion and the market eased towards the end of the year. But both the number and value of deals has run steadily upwards since 2008 with the value seriously accelerating in 2013.
Moreover, there are signs the start-up community itself perceives some degree of satiation among investors. (It's worth remembering the VC market is extremely US-centric, with China emerging. Total VC for 2015 in Australia, by comparison, was just $A240 million.)
In the widely watched First Round survey of start-ups, more than 500 business founders were quizzed on the ease of raising capital over the next 12 months. First Round found 95 per cent of Series Seed, 97 per cent of Series A and 99 per cent of late-stage founders believed it will getter harder or remain the same in the coming year.
“Given that 80 per cent of these founders also said they raised exactly what they wanted or more in their last round of funding, it sounds like folks are expecting a rapid shift in the funding environment,” First Round said.
On Techcrunch.com, Josh Constine ran through a list of start-ups, unicorns and giants shedding staff including Mixpanel, Gumroad, Zomato, Twitter, Yahoo, Groupon and Evernote.
2016 is not 2001 however. In the view of one Silicon Valley veteran “2000 was insane because of the frenzy in the public markets which were willing to take Series C and D (and sometimes earlier stage) companies public”.
“This time the public markets are more demanding and insisting that only real business models go public and are demanding huge discounts for those that don't fit the profile,” he says.
“Hence the $US2 billion discount for Square (a payments fintech) from its last private round. The VCs and private companies are delaying the public market reckoning by raising money in the private markets. But that window is closing. The smart private companies will find a home soon.”
December data provisionally suggest deal flow has peaked right across the VC spectrum from Angel through to late stage. According to Pivotl's deal book, companies raised $US3.4 billion across 215 deals in December, down 42 per cent from November when $US9.1 billion was invested.
Meanwhile in November there was a record breaking $US9.1 billion invested including 12 $US 100 million-plus rounds while December saw only one, Lyft's $US 1 billion round.
In this universe Fintech is estimated at around 8-12 per cent of the market, around $US10 billion, although the number is debated. VC investors typically look to earn around 12.5 per cent a year and when a fintech like Square or even an established financial services giant like First Data disappoint on listing the herd can take fright.
Some of the peer-to-peer darlings like OnDeck and Lending Club have also seen share price slumps. The danger for VC investors is a fire sale mentality becomes established, lowering valuations more dramatically.
Now there are of course market forces at play and the longer-term question for investors is whether some of these fintechs and disruptive plays could be the Apple or Google of the financial services universe.
According to Morgan Stanley, marketplace lending platforms such as OnDeck and Lending Club are forecast to see loan issuance grow at a 51 per cent compound annual growth rate (CAGR) between 2015 and 2020.
But despite that, there lending books remain miniscule in the overall market with shares of low single digits and less. Moreover, credit quality concerns are more pronounced with new players across the board.
Morgan Stanley reported P2P lender origination has doubled every year since 2010 to $US12 billion ion 2014 - but that is just 1.1 per cent of total US consumer unsecured loan originations.
Take P20 veteran Prosper. Its website advertises total lending of $US5 billion in the unsecured market. Less than 1 per cent. Prosper launched in 2006 and by 2012 the company had closed $US150 million in loans. In 2014, it closed $US1.6 billion. In the first quarter of 2015, Prosper closed its largest quarter so far with $US912 million in loan originations on the platform, an increase of almost 12x over two years.
Impressive growth yet its market share is still a rounding error. And worryingly Prosper has been implicated in reports around the financing of terrorists which, even if unfounded, are worrying for both investors and borrowers.
Regulators are paying attention too. In a recent blog, miiCard vice president Magnus Bray wrote “in all major markets we are seeing a continued focus on lending by regulators who are shaping and creating the field of play – not all agree with their approach but clear for all is the need to lend responsibly and that requires greater accuracy and understanding of a borrowers affordability”.
These numbers tell across the broader sector. Even by 2020 Morgan Stanley forecasts the upper reach to be 10 per cent of respective markets, between $US150 billion and $US490 billion. By way of comparison, the market share taken by mortgage originators in Australia in the 90s, which did force wholesale margin compression and market disruption, was more than 20 per cent.
So it is unlikely market share erosion in itself will be enough to force traditional players to respond to the fintechs. Nor is the forecast market share enough to create the next Apple.
Yet there are approaching 10,000 fintech start-ups in sectors across mobile payments, data analytics, virtual banking, online lending, bitcoin applications and crowd funding. Some of these – notably the blockchain distributed ledger underpinning Bitcoin – may well be transformative in the industry. Traditional banks and central banks (including ANZ) are joining consortia and fora to explore the possibilities.
As a recent feature in Fortune magazine noted “the reality is, investment booms don't last forever”.
“In the late 1990s, several hundreds of internet and e-commerce start-ups emerged and only a dozen or so gained enough scale and traction to make it as standalone giants. Others saw their success in the form of an acquisition by a larger company. But the vast majority are now extinct. Fintech startups will face that same Darwinian future in the coming years.”
If the latest VC market trends are sustained, and the funding market has indeed peaked while competition grows in a slow growth world, the forces of evolution are becoming stronger.
The views and opinions expressed in this communication are those of the author and may not necessarily state or reflect those of ANZ.
23 Oct 2015
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