Is Fintech the next innovation?
Some investors complain about the lack of new innovative companies today. As Peter Thiel puts it, “We wanted flying cars, instead we got 140 characters.” So what is the next wave? Cloud SAAS companies are practically mainstream, and block-chain seems overhyped. We’ve lived in China and seen the impact on an economy of Alipay and Wechat Pay. In China only old people carry wallets now, since a phone is all you need. But what fintech companies and where?
Australia has a small payment fintech cluster
In this article we look at some fintech companies, beyond investor’s normal horizon of the United States. In Australia there is a small cluster of listed fintech companies that have started to explode. Some have made gains of 400% in a year and more than 1,000% on the back of strong revenue and turnover growth. Moreover because Australian companies lack access to large scale V.C. investments, technology companies often need to capital raise through a public listing. So investors can get access to earlier stage companies than in the US, where much of the growth is captured by private investors. Uber or AirBnb are just a few examples.
So, what early stage fintech companies are there in Australia? And how do they compare?
Note: All figures are in Australian dollars unless stated otherwise. At current rates, $100 Australian is about $70 in US dollars.
Afterpay Touch Group (ASX: APT)
The largest and high profile of the three is Afterpay Touch. Afterpay has grown outstandingly fast over the last couple of years. Afterpay provides retailers a solution for customers to buy something now whilst paying for the item in 4 equal installments every 2 weeks, without any fees or interest, except late fees. Afterpay charges up to 4% to vendors, so the cost of the service is invisible to retail customers. In a short period of time the company has been astoundingly successful in bringing on signing up new vendors and increasing sales volume.
Formed through a merger of Afterpay and listed Touchcorp in early July 2017 at around $2.70, the stock has rocketed to $17.60 inside 2 years.
As you can see Afterpay’s stock price has had some heavy and quick runs, peaking at $19.69 in August 2018 before a plunge to $11.30 and then a recent strong rebound. This sort of early stage company is not the sort of place for your retirement savings and is purely for “play money”. We have a natural aversion to buying companies after a strong run without any reference to valuation, despite the clearly substantial potential.
Reasons to buy Afterpay
- Revenue growth of 390% for the financial year to June 30, 2018 over previous year. This is $142 M AUD over $29.9 M AUD.
- Growth in US vendors is impressive. Since entering the US recently in Q1 2018, Afterpay already has more than 1,150 retail merchants in the US as of January 2019 and 450,000 customers. This is up from 28 vendors in May 2018. Not bad for 9 months.
- The number of merchants and active users on the platform increased in 2018 by about 175 per cent and 238 per cent, respectively. By the end of 2018 the company had 3.1 million customers who had used the service in the last 12 months, growing by an average of 7,500 customers per day.
- Net Credit defaults are only 0.4% of transactions and falling as the company grows, which demonstrates that credit losses are not a significant risk. 95% of transactions are repaid on schedule without any further costs.
- Offering expansion is possible. An installed app base of more than 1.7 million customers and growing fast there is an opportunity to add or distribute further services.
- App Growth: Afterpay was the most download app on Black Friday.
- Possible takeover target. In our opinion, an innovative product with a quickly growing installed base and vendor relationships would be attractive to market leaders like Visa and Mastercard. This could either be sold as protecting market position and/or providing a new route to growth. Both could easily swallow the $5-7 B USD takeover offer required to be successful.
Risks to consider before an Afterpay investment:
- Valuation: The company reported a loss of $9 million AUD on revenue of $142 million. By contrast the market capitalization $4.3 B AUD. This is an eye-watering price-revenue multiple. At least the next 3-5 years of fast growth is priced into the company, possibly more. Anything short of impressive growth could be devastating for the stock price.
- Future regulation unclear. Regulators have yet to address how they want to treat Afterpay’s services since there is an element of lending. Should they be treated as a lender, given they charge no interest? Should they be treated like credit cards, even though there is no interest and no ability to build up a credit card like balance? Afterpay has a “one at a time” rule, which means customers much repay their first purchase. Still you can bet that competitors, particularly the credit card companies are lobbying regulators to increase oversight and protect consumers reduce competition.
- Competition increasing. As we will see there are several companies chasing Afterpay, and others like Paypal or the credit card companies could explore adding these services.
- Not yet profitable. Although it is early days, the company should now be of sufficient scale shortly to become profitable, and a failure to do so would reflect poorly on management.
US Market Entry – Still Early Days
Source: Afterpay AGM Presentation
- Overall, we believe Afterpay is an interesting company with a huge upside and a tremendously large addressable market. If the company can retain leadership for its offering then a market capitalization of $10-15 billion AUD is quite achievable.
- The company has only just entered the United States and United Kingdom and has experienced strong growth in vendors so far, so at current rates (300% per annum) if it continues at this pace, then Afterpay remains on track to hit its goals in only a few short years.
- However, any failures or significant slowdown in growth would hit the stock hard, and risk averse investors would be wise to look elsewhere.
- Competition is increasing fast and several companies with similar offering like Split-it and Zip Money plus potentially others, mean the company isn’t alone, although it retains a good sized first mover of at least 2-3 years of growth.
- The stock is volatile with a high beta and large daily price swings that still frequently exceed 5%.
- Given recent price strength that has pushed the company close to record highs, and the high price to revenue multiple, we would only consider building a holding only beneath $12 per share during the next risk aversion period of the market, and then only with risk capital.
Zip Co. (ASX: Z1P)*
*it’s a number 1, not an i
Zip Co. is quite similar to Afterpay and in some ways its closest competitor with an established market position. However in addition to payment splitting, it also offers interest based loans and is different in other ways.
- Zip Co. is smaller with a market capitalization of $380 M AUD (about $266 M USD), but still has 12,600 retail partners including most of Australia’s largest retailers, however it hasn’t yet entered the U.S. or the U.K.
- Zip Co. has Zip Pay, which provides a payment splitting application with no interest, but with more flexibility in length of time or repayment amount than Afterpay’s solution.
- Zip Co. also has Zip Money also provides loans for purchases above $1,000 AUD, with a 3 month interest free period, but with an establishment fee of up to $99.
- Zip Co. developed a new application in August 2018 in Australia and already has 600,000 users. That’s quick growth for a country of 25 million people. This acts more like an e-wallet, and allows purchases via a barcode on your phone (not dissimilar to Wechat pay and Alipay).
Reasons to buy Zip Co
- Cashflow positive. Zip Co hasn’t made a profit yet, but it has reported a cash-flow positive quarter of $4.6 M in Q4 of 2018 on revenue of $19 million AUD. That’s a very good rate of cash-flow and hints at strong margins for the business.
- Strong revenue growth of 100-200% per annum looks set to continue. For Q4 of 2018, there was revenue growth of 111% growth of the same quarter the previous year, so exceeding $100-120 M AUD in revenue this financial year (the year to June 30) is very achievable, compared to $40 M AUD the previous year. Growth in the range of 100-250% per annum looks sustainable for the next few years.
- If the company achieves the conservative goal of $110 M AUD in revenue in the year to June 30, 2019, then the price to revenue would be 3.45. That’s a long way below Afterpay and Splitit’s price to revenue multiples of 30+.
- An entry to the US hasn’t happened yet, but would raise the growth rate. Zip Co. is currently only operating in Australia and New Zealand and has made no public mention of US plans, but could lift growth rates and the stock price rapidly if Afterpay’s experience is replicated. Analysts point out that credit cards have several players, and that there is enough space for 2-5 providers in the payment splitting space.
- Zip Co.’s app is an e-wallet that has the combination of a killer app of payment staging driving download demand, combined with the ability to expand the offering into other services. Having seen the range of services available on Wechat Pay and Alipay in China I can easily see new areas of growth in the future.
- Zip Co.’s e-wallet and user growth, if it continues, would be an interesting takeover target for a bank with existing products looking for an electronic distribution channel but lacking the internal capability to deliver a compelling payment and banking application.
Risks to consider before a Zip Co. investment.
- Success in the US or other overseas markets is far from guaranteed. The United States is a very competitive market and one that can be quite expensive to enter successfully. A return to cash burning during this period would be quite likely.
- Valuation levels are still that of an early stage growth company. Although Zip Co. has reached a cash-flow positive level, it has not sustainably produced profits and what the on-going net profit margin will be remains uncertain.
- The chance of regulation is higher than other competitors on this list. Due to the company’s offering of providing loans with an interest rate, there is a strong chance that the company will need to engage with, and seek approval from regulators. This could slow growth and implementation, and would also raise costs and risks of a US or UK market entry. This factor alone could explain why the company has not yet chosen to enter overseas based markets.
- Loan default rates are higher than Afterpay. The level of NTL (net transaction loss) is about 1.8% compared to 0.4% for Afterpay, although trending down for both.
Source: Zip Co AGM Presentation
- Of the three payment staging applications, we prefer Zip Co. due to its combination of several factors. We believe it has a more acceptable valuation (although still far from a ‘value buy’), with strong growth, a strong market position in Australia and New Zealand, many options for growth from its e-wallet as well as scope for overseas expansion into larger markets like the United States or the United Kingdom. We also like the fact that it has already achieved a cash flow positive quarter twice in a row.
- The most significant risk we can see is that of regulation that might take management attention away from growth and onto compliance.
- The second risk is that larger and well funded competitors like Paypal, Square or even Facebook might launch offerings that limit the scope for international expansion.
- We haven’t yet bought Zip Co. stock yet, but there is a strong chance we could be a buyer for ourselves and/or our clients in the near future at market levels.
Splitit – (ASX: SPT)
Fintech is like all business in that good ideas attract imitators, and Splitit, an Israeli firm listed on the ASX, possibly as a result of the headlines generated by Afterpay. It also has a couple of key differences.
- It’s far newer, younger, smaller (less than 400 vendors so far) and was only listed on the Australian Stock Exchange in late January 2019.
- It provides a staged payment service, but does this by scheduling payments to existing credit card providers like Visa or Mastercard. This means it is not competition to credit card providers. It’s a complementary service for payment scheduling and budgeting tool.
- It allows customers to decide on the number and schedule of repayments (within boundaries). So rather than be limited to 4 payments over an 8 week period (as Afterpay currently is), their flexibility to say stage payments over 10 repayments over a couple of months could be attractive to many clients, particularly for larger ticket items like furniture and appliances.
Splitit SPT – Stock Price – New and Volatile
Source: Google Finance
Reasons to buy Splitit
- It can make you money fast. Splitit price at IPO was 20 cents on 29th of January and it rocketed to 95 cents on February 7. If the company pulls back further it would leave plenty of room for another big run.
- It’s very early stage. If you like early stage companies for large upside potential gain, then Splitit might be for you. Their prospectus is so recent that it is still worth a read. Currently the company has a market capitalization of $238 M AUD, but that could change quickly given daily moves are still often double digit.
- Complementary innovation that doesn’t threaten major industry players. For this reason we believe it is less likely to come under negative regulatory attention.
- Next Afterpay? If you are disappointed that you missed out on the massive gains that Afterpay’s stock price has seen over the last few years, then perhaps Splitit’s your chance to make amends. Is it different enough to succeed despite Afterpay and Zip Co’s head start, but similar enough to use Afterpay as a guide to the growth that is possible?
Risks to consider before a Splitit investment:
- Valuation at current levels seems quite excessive and includes considerable growth. On January 25, 2019 Splitit reported annual income of $1.45 M AUD compared to a current market capitalization of around $230 M AUD. That’s a price to revenue of an eye-popping 150+.
- It’s brand new, so there is relatively little history to go on in judging the company or growth.
- It will probably burn money for a couple of years, so profits aren’t immediately on the horizon and another capital raise, or two, is a pretty good bet. Dilution is certain.
- Competition is intensifying, with Afterpay already there and others, like Zip Money growing their staged payment offering. Is there anything stopping Visa or Mastercard providing a similar online staged purchase service at a lower cost and rendering the company obsolete? They already have the vendor relationships. This would quickly kill any growth for Splitit. This is unlike Afterpay and Zip Co which provide an alternative to existing card providers, and are thus more attractive to millennials that don’t have a credit card.
- Too early for us. Buying Splitit at the present moment is a short term gamble with too high an investment risk for us to recommend to ourselves or others. Splitit would be a venture capital holding in the US and an early stage one at that, rather than a listed firm. So you should treat it like VC’s treat their holdings when they budget on a chance of failure that runs in the range of 60-80% for each portfolio holding.
- If you must invest, wait for a pull-back. Currently Splitit is in strongly over-bought conditions and a 150+ price to revenue indicates it is very over-valued on current metrics. We would wait for the initial IPO enthusiasm to cool before making our entry, preferably below 35 cents per share. Given the size of current market moves, that might only take a few days or weeks.
- Limit yourself to pure gambling money. This company is at least third in line in payment splitting and it’s competitive advantage doesn’t appear overwhelming. It will have to execute far better than its competitors to have a long-term chance. At least the global market is big.
Pushpay Holdings (ASX: PPH)
After several consumer spending services and applications it is somewhat refreshing to see Pushpay Holdings, which has a rather different focus for its payments business. Pushpay, originally from New Zealand where it still has a listing, has focused on providing churches with fund raising and payment solutions. Pushpay continues to grow fast and has very recently entered the United States, which is easily the dominant market for church based fund raising.
Pushpay’s recent stock price movements are decent, although not quite the rocket ride of the others on this list.
Reasons to buy Pushpay Holdings
- A strong focus on a vertical often leads to good growth and a strong market position. Combine that with a client base with a generally limited technical know-how and a conservative risk-averse culture, that can lead to what Warren Buffett might call a “moat”.
- Revenue growth was 35.5% year on year, which is decent without being gob-smacking like others on this list.
- The US market penetration is still low and much growth can still be achieved. Currently Pushpay will process about $5 billion USD of annualized processing volume in the US, which the company estimates is less than 5% of religious giving. The company has a medium term goal of reaching $10 billion, or a little less than 10% and a long term goal of processing 50% of medium and large church segments, which the company estimates would generate revenue of over $1 billion US dollar annum.
- A recurring income business with almost 100% retention (the company claims 100% retention, but that seems difficult to believe). The business model of processing transactions is completely recurring, yet the costs of bringing new churches onto the network are front loaded, as they relate to sales, installation and training. Thus it seems very likely that sales costs should remain stable while revenue and processing volume continues to grow in the 25-40% range for several years. This will mean there will be inflection point where cash flow quickly turns positive and rises steeply, possibly from now.
- Profit inflection point passed in Q4 2018. Pushpay announced on 7 February 2019 that the company turned cash flow positive and profitable during Q4 2018. This also means that equity issuance and dilution of shareholders is much less likely going forward.
- 60% gross margins. Company reports have stated that gross margins are now greater than 60%, which is a nice juicy number in the range of Facebook or Apple.
- A US secondary listing has been mentioned several times, and this would raise the company profile in its most important overseas market. It could also see an increase in investor interest with a good chance of a short term boost to the stock price.
- Pushpay, unlike others on this list, does not provide any form of loan or credit. Therefore it is not a capital intensive business, nor is it exposed to bad debt rates. It would also limit its exposure to regulatory risk.
Risks to consider in a Pushpay Holdings investment
- Market size is smaller than other payments companies. Without unexpected diversification, Pushpay will remain focused on the church and religious sector. Thus it has a smaller addressable market than companies like Afterpay, Zip Co, Visa, Mastercard. According to Pushpay’s estimates it seems as the addressable market is about $100 billion US dollars in religious giving per year.
- Company valuation currently isn’t low. With a market capitalization on February 8, 2019 of about $850 million AUD (about $603 M USD) on projected revenue over the company financial year to June 30, 2019 of about $100 M AUD (about $71 M USD). Thus price to forward revenue multiple is about 8.5, which is far from a low number, although lower than others in this report.
- The addition of churches to their service offering is slow and steady. A growth of 5.5% in the number of churches is positive, but hardly outstanding. Although processing volume is rising at an annualized rate of 28.6%. This shows that volume can increase as churches and their patrons gain an understanding of the service offering.
- We like Pushpay’s focus on a particular industry and the fact that it’s about to become a cash producing machine with potentially good margins.
- Management seems to be disciplined in growth as head count increase has been sedate. Last year it grew from 345 to 358, or 3.8% year on year, which is a sign of conservative cost control. Pushpay has also focused on the largest churches in its market entry, which being larger and more bureaucratic, plus earlier than others in the US, may explain the currently slow rate of new church acquisition. It’s possible the rate of new church signing may increase now the largest have joined and had good results.
- We could see the company achieving its medium term goal of a $10 billion annualized processing volume within 2-3 years. Conservatively we could see growth slowing eventually reaching $25-30 billion in payments per annum. Although $50 billion per year is possible, we consider this unlikely for the foreseeable future.
- So assuming payment processing of $25 billion and revenue of $500 M per year with a recurring profit of $150-200 M AUD per year. Thus we could see the company value grow to $3-5 billion AUD over the next 5 years based on a multiple of 15-20 times earnings. This is far from certain of course so short term and low risk investors should look elsewhere.
- Strong competition from other payment processing companies may yet emerge but the risks to a company customized to its client base aren’t high, at least in the short to medium term.
- We would be interested in buying at or close $3 per share, and have done in the past.
A Quick Comparison
Sometimes putting data in a table can highlight differences and opportunities that can be difficult to see in a text format.
Source: Caterer Goodman. Data from respective company reports.
- The very impressive growth in transactions and revenue for these companies is certainly very interesting for growth investors looking for the next wave of innovators.
- Do keep in mind that these companies are early stage and risky. We also haven’t done a deep dive and a proper inspection of reports, balance sheet, key shareholders and emerging competitors is a very good idea.
- For our money, we believe Zip Co. at current prices and Pushpay below $3 are worth a small amount of risk capital.
Disclosure: I am/we are long PPSHY. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
Additional disclosure: We currently have a small position in Pushpay Holdings and may initiate a holding in Zip Co, Z1P over the next 48 hours. We do not have holdings in Afterpay or Splitit and do not have any current plans to buy these stocks.