To see where the great digital shift that is transforming financial services is headed…
….follow the money.
In an interview with Paul Purcell, partner at Continental Advisors, four panelists — investors and analysts all — weighed in on the current investment climate … and whether that climate is getting overheated. The discussion was part of the ongoing B2B Payments 2021 PYMNTS TV series.
The panel included: Doug Bergeron, managing partner at Hudson Executive Capital; Ian Drysdale, executive in residence at Great Hill Partners; Amit Jhawar, venture partner at Accel and Rick Roberts, analyst and portfolio manager at Vulcan Capital.
The panelists noted that there is heavy interest, even amid the pandemic, in investing in financial services platforms across all manner of verticals. And though valuations may be stretched, fundamentals are indeed sound.
The Big Picture
The panelists agreed that there is no lack of liquidity in the market.
And as Hudson Executive Capital’s Bergeron said, valuations are high. But that’s against a backdrop where interest rates are low, and thanks to the Federal Reserve, will be near zero over the course of several years. Financial and corporate assets of all stripes — particularly in the payments realm — are attractive investment candidates, especially as investors look for yield.
“There’s the feeling that [these investments] will be worth a lot two or three years out, whereas keeping cash is going to be a loser investment.”
Caveat emptor, though, goes the saying.
Bergeron noted that such investments and markets are “hot until they’re not” and there could be an exogenous event that shocks public and private markets and reset valuations.
“It’s not for the fainthearted, but if you’re investing in strong businesses with moderate or zero leverage, which is typically the case in our world, and you believe in the secular and organic prospects, for those businesses, I don’t see a tremendous amount of downside,” he said. Even so, lower equity returns (against a risk-free rate that is effectively zero) may become the norm.
With perspective on both the public and private market, Vulcan Capital’s Roberts noted that there are “similarities and some dissimilarities” across those spheres.
“I’m a strong believer that you make your money when you buy the asset, not when you sell it. And so you have to buy it.”
Successful investing, he said, is “about finding something that’s durable and has a place where the speed with which things are changing is accelerating. Finding that product, from that team that is able to develop quickly and execute, is really the challenge.”
Great Hill’s Drysdale echoed that sentiment, stating, “What we’re looking for is great management teams with a sustainable growth rate that can be increased. Sometimes we’re looking for subscale assets that we can bring to scale.”
Where The Money Is Going. And Who’s Got It
As to who’s got the money, and where it’s going, private equity investments have grown from tens of billions of dollars several years ago to hundreds of billions, approaching trillions of dollars (if counting the market caps of firms that have gone public.)
Special purpose acquisition companies (SPACs) are certainly heating up. As has been reported in this space, in the year to date there have been more than 143 SPAC transactions, with gross proceeds of roughly $55.1 billion, with an average deal size of $385.5 billion. That dwarves the 2019 tally of 59 deals for gross proceeds of $13.6 billion, with an average deal size of $230.5 million.
In terms of mechanics, SPACs are blank-check development-stage shell companies that enable companies go public through a reverse merger that happens with a private firm.
The lure, according to Bergeron: Investors get to vote on the transaction. “It’s kind of no-risk — other than locking up capital for up to two years, if you don’t like what the sponsor is proposing, you can redeem and vote no, or vote yes. ”
And with a nod toward capital market innovation, Bergeron predicted “a lot of money will run to them until there’s too much money in them.”
Looking Toward Growth (And Fundamentals)
Beyond the investment vehicles themselves, the secular and organic trends do indeed point toward growth, with an underpinning of technology that is moving companies into the digital age.
Accel’s Jhawar noted that companies are able to scale technology more quickly than ever before, thanks to the cloud — which enables new financial services and products to be deployed without having to get servers in place or install data centers. On the consumer side of the equation, of course, higher mobile device penetration and internet connectivity mean that consumers can take advantage of those new offerings.
The mobile device has become the primary instrument of communication, agreed panelists, and increasingly users — especially younger consumers in the Millennial demographic — will use those devices to conduct daily financial life. That trend has pushed FinTechs and FIs to craft more direct financial interactions with consumers.
In the great digital shift, as Purcell mused, is every app becoming a bank (and vice versa)?
Jhawar noted the convergence of a range of features, where data can help cement durable relationships between consumers and enterprises. Debit cards work virtually. Loans get people started on online stock trading platforms. Financing options allow consumers to buy now but pay later.
Any drive toward innovation, towards leveraging data, must balance the use of that data with data privacy.
And according to Jhawar, younger generations are more comfortable with sharing their data. But, he added, “I think there will have to be a marketplace that allows consumers ultimately to control which information is shared and how it’s used. And you are starting to see seeing this on some of the platforms” where firms are stating how data is collected and used. Piecemeal approaches to data privacy (or in the U.S., on a state by state basis) will impede innovation, he warned.
As Drysdale told the panel, even though FinTechs such as Revolut and Chime have been growing quickly, and have been making inroads into financial services, there are still some challenges in place.
“It is extremely difficult to succeed as a bank,” he said. “It’s a real challenge to make money and satisfy the regulators. I think that it’s easier to be private and to find niches.”
The traditional FIs have their own challenges, too, according to Bergeron, who said that older firms have to maintain their legacy systems even as they strive to innovate.
“Perhaps somebody starting with a blank piece of paper can innovate faster,” he said. “The capital markets, the venture capital markets are certainly willing and ready to underwrite that.”
As a result, banks playing catch up have to face the age-old question when it comes to playing catch-up with tech-nimble upstarts — build it or buy it. Many times they have to “buy” innovation by acquiring smaller firms, said Roberts. But don’t count on banking going entirely digital, as relationships with bankers still matter, even if the migration to digital is moving quickly.
Looking ahead, as to the firms that may be termed investment “winners” amid the pandemic, Drysdale noted that “COVID has been a real accelerant towards online everything,” especially eCommerce. Vulcan Capital’s Roberts stated that there remains room for innovations that address present-day inefficiencies in AP/AR processes. Optimizing B2B payments remains a strong growth opportunity for banks and FinTechs.
As Bergeron said, “The digitization of B2B in the supply chain is obviously still rolling out.”