Fintechs bubble away

Are we in a bubble? Or maybe I should be more specific given that could refer to residential real estate, cryptocurrencies or non-fungible token (NFT) art. Are we in a fintech bubble? Whether that be digital versions of established banks, buy now pay later (BNPL) schemes, application programming interfaces (API), enabling innovation or artificial intelligence-driven investment products.

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Clearly, one condition of an investment bubble is present in most of these categories: stock valuations are at astronomical levels when compared with actual earnings. But this, in itself, is not sufficient. Some of today’s most valuable and cash-rich organisations, such as Amazon, went for long periods with a valuation well ahead of revenue and dividends.

"The 2020 class of start-ups are totally unlike 2000, most of whom went down with their options all totally worthless. This generation will not repeat that.” – Gavin Halverson, McLean Roche

Moreover, we are in a macro-economic climate where bubbles are almost inevitable because money is so cheap. Near zero interest rates means it’s easier for start-ups to keep going even with minimal revenues while providers of capital, desperate for yield, are more willing to increase their risk tolerance and chance some money on even the most far-fetched ideas

But there are other characteristics emerging in the fintech sector which suggest an environment more like the dotcom bubble at the turn of the century - or indeed even more inflated.

Margin debt growth has now surpassed spikes seen in the dotcom era and in the run-up to the financial crisis of 2008, according to data from Tanarra Capital.

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Meanwhile, in another classic signal of peak frothiness in markets, loss making initial public offerings have grown and now exceed the tech-wreck period.

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Furthermore, as long time fintech observer and investor Grant Halverson of McLean Roche points out, unlike two decades ago, when founders and early funders went down with the ship, today more and more of these principles are taking advantage of “free shares” to cash out.

“The 2020 class of start-ups are totally unlike 2000, most of whom went down with their options all totally worthless,” he says. “This generation will not repeat that – they are busy pulling money out as soon as they can.”

Early loss not a failure

According to Tanarra’s analysis, while aggregate losses in the BNPL sector have exceeded $US550 million since the start of 2018, various insiders in the major companies have crystalised more than $US600 million in stock sales.

Again, losses early on are not necessarily a sign of failure. Yet despite the high valuations and growth in revenues and raw customer numbers (from low bases), actual market shares, not just for BNPL but other fintech disruptors, remain very small.

Winner doesn’t take all

However, a major difference in this fintech “bubble” is the alacrity with which established players and start-ups have recognised common interests. Just a few years ago it was fintechs versus the banks in a winner-takes-all struggle. Now it is vastly more likely for a start-up to seek an established partner or even potential parent quite early on.

So-called “big tech” is also a market giant in the fintech space. According to start-up intelligence sheet CB Insights, Facebook, Apple, Google, and Amazon are “conquering key financial services verticals through new product launches, investments, M&A deals, and more”. 

“The adoption of fintech apps has skyrocketed throughout the COVID-19 pandemic, spurring further growth and investor interest in this category,” CB Insights noted in a new report “The Big Tech In Fintech: How Facebook, Apple, Google, & Amazon Are Battling For The $28.2T Market”.

“Fintech had one of the most successful quarters in history in Q1 2021, with record deals, funding, exits, and mega-rounds,” the report found.

Piling in big time was big tech: “Eager to turn the ongoing fintech boom into an advantage, big tech companies (Facebook, Apple, Google, Amazon) have been taking a number of strategic steps to grow their market share in financial services. From digital banking and lending to budgeting and payments, tech giants are revamping their financial services offerings through partnerships with legacy institutions and in-house solutions that fit into their wider product ecosystems.”

On the data, while big tech funding to fintech companies dropped slightly amid the pandemic, deal activity picked up. Big tech investment in fintech companies reached $US2.2 billion in 2020, a 4 per cent drop. But deal count increased by almost half to 32 deals.

Big techs, presumably, are not worried by the prospect they are buying in bubble territory. They have bigger plans in mind.

“Financial services are becoming increasingly intertwined with non-banking apps (for example social media, communication), giving tech giants more incentive and leverage to keep their financial offerings in-house,” CB Insights argues. “Tech giants already have the capacity to not only offer improved banking services, but also scale quickly within their large user bases. In big tech’s race to become the go-to app for banking, shopping, and connecting, legacy banks face the continued threat of being further pushed out of the financial system.”

“Legacy banks” is perhaps a bit unkind nevertheless it reinforces the importance of traditional financial institutions too being able to manage fintech investments and the emerging world of ecosystems where structured relationships with myriad start-ups and fintechs will be crucial.

To take just two examples, the payments platform Stripe, a disruptor fintech, is pushing into ID verification. “Stripe Identity” uses computer vision and machine learning to read and match up government IDs with live selfies, with Stripe managing the customer data in an encrypted format. It can be integrated into a checkout or offered as a separate service. This is attractive for banks and Singaporean bank UOB is the first to pilot using the country’s national identity framework, Sign with Singpass, to confirm transactions or product applications using a customer’s digital signature.

Meanwhile global payments schemes Visa and MasterCard have both entered into new partnerships to drive biometric payments. Here at ANZ there is a growing number of fintech partnerships in bank’s ecosystem and chief executive Shayne Elliott has articulated a strategy with many more to come.

A new, digital landscape

As to the bubble question then, it is more and more clear the big investors – big tech and traditional financial services players – are not looking at start-ups as discrete investments but key links in building a new, digital, financial services landscape.

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The value in the investment is not its projected earnings over a particular time frame as a discrete entity but what it brings to a bank’s “ecosystem” and helps a traditional institution meet radically new customer expectations. That role, be it for banks, big techs or others, is a major contributor to future valuations.

A new report for marquee financial services conference Money 20/20 argues “Fintech 0.0” was the dotcom era, “Fintech 1.0” came after the financial crisis when internet-based financial services were democratised but we are now entering “Fintech 2.0”.

“Fintech 2.0 will enable digitally native financial services to be fundamentally reimagined from the core out,” Money 20/20 found in a wide ranging survey. This means:

  1. Technology will be used to build digitally native financial rails, optimised for new use cases rather than simply distributing existing services.
  2. New products will need to communicate simplified value propositions and disclosures via phone screens or smart speakers. Fine print will become passé.
  3. Channels will adapt to consumer behaviours rather than vice versa.
  4. Consumer permission and intent of data will become more important than the data itself.

Now much of this may not be entirely original and many have argued along similar lines but the critical point is much of this transformation does indeed revolve around the innovation fintechs bring. The value proposition is not simply an isolated return on investment, it is how much they can expand and transform existing institutions.

Andrew Cornell is Managing Editor of bluenotes

The views and opinions expressed in this communication are those of the author and may not necessarily state or reflect those of ANZ.

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