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Our dedicated Fintech Team is led by Bruce Glazer, with nearly 25 years of experience covering the fintech industry. Wellington has a distinct approach to research, with analysts spending their entire careers covering their industries, creating deep domain expertise and long-term company relationships across cycles. This depth is critical to our Fintech Team’s focus on pure-play companies where fintech drives at least 80% of revenues. In this Q&A, Bruce dives into the impact of COVID-19, the latest opportunities in fintech, and the sector’s long-term tailwinds.
How has COVID-19 affected the fintech opportunity set?
If there is one silver lining, the crisis has made companies and consumers much more aware of the benefits of technology. In our view, COVID-19 has accelerated many of fintech’s existing trends. E-commerce was already gaining share, but the inability to go to physical retailers is moving more people to brand new forms of online commerce. Online groceries and pharmaceuticals are among the things that, in my opinion, signal a permanent shift in behavior that benefits the digital payments ecosystem.
Secondly, people don’t want to use physical cash anymore. There’s been an expanded rollout of contactless payments around the world and consumers are becoming more comfortable using technologies like mobile wallets, peer-to-peer payments, and other online transactions that they used to do in the physical world. Lastly, a huge portion of the population is now working remotely, and companies are trying to digitally transform themselves overnight. The crisis has really highlighted the ease of managing and updating cloud-based infrastructure compared to legacy on-premise technology. Financial institutions with more modern technology have been able to respond better to an increasingly digital customer and more remote workforce. So, there’s been an acceleration of companies moving their back offices to the cloud, which we think allows for greater innovation, a faster time to market, more secure data, and lower costs.
In my view, these changes shift up the sector’s growth curves and leave many well-positioned fintech companies even better positioned because of the crisis.
What are the long-term structural themes driving the fintech opportunity?
We think the fintech opportunity is fueled by three big themes. The first bucket would be payments, specifically the digitization of cash through e-commerce, software-enabled payments, and new payment flows being digitized.
The second major theme is the digitization of financial services. Companies are automating or digitizing financial services to improve the user experience and deliver more functionality. These include new ways to do taxes, branchless banking, online wealth management platforms, and buying real estate, among many others. These are all things that used to be manually intensive, that have become more automated and digitized.
Finally, the fastest-growing bucket of the three is the upgrading of technology infrastructure. Most financial services infrastructure was built in the ‘70s and ‘80s and is in significant need of an update, creating a long runway for growth. Though companies have been hesitant to upgrade, this is changing with innovative and disruptive start-ups as well as the evolving industry landscape. Firms are now starting to embrace the cloud, valuing both its security and its ability to enable the use of artificial intelligence and machine learning to deliver new insights and value to customers.
Payments are a large part of your opportunity set. Is there scope for many different payment companies to succeed?
I do believe there is enough room for many to succeed. There is significant differentiation between companies by industry served and by geography. Importantly, it’s very difficult to scale payment companies globally. There have only been a handful to do so historically because there’s a lot of regional expertise and regulatory complexity in the industry, and customer acquisition costs can also be high.
It’s important to note that we are now addressing brand new payment flows in new geographies and market segments, so I think the sector’s historical double-digit rate of growth can sustain itself. In addition, payment companies are increasingly adding more value around transactions through both software and the payments ecosystem, meaning cost is no longer the only way to gain share. Our team’s goal is to find the best-positioned companies that will either gain share or add more value to grow faster than the overall market.
How do you think payments will be impacted by new digital and crypto currencies?
In my view, the existing payments infrastructure has very high barriers to entry. For example, consider how many card holders there are and merchants that accept those cards, and how difficult and expensive that would be to replicate. Creating an alternative payment system requires creating value for two sides of the network — both consumers and merchants. It’s really easy to create an incentive for one side or the other, but not both.
What we have found over the past five or so years is a lot of companies that have started down the path of competing with the incumbents ultimately decide to partner with them instead. The fact that new entrants are eventually just plugging into the existing infrastructure highlights to me how high the barriers to entry are and the significance of the incumbents’ global scale. I’m not overly concerned about disruption from digital and cryptocurrencies for the foreseeable future.
Some investors may wonder about the security of new fintech firms. How safe is a company or customer putting their assets on these platforms?
I’d like to put investors’ minds at ease and say fintech companies have indestructible technology backbones where they’re incapable of being breached, but that’s not being honest. I do think data security and data privacy are real risks to the overall industry and they are key elements we evaluate for each company in our opportunity set.
Merchants, financial institutions, and governments have all been breached. Fintech companies at some point have the potential to be breached. In our view, if the company is delivering enough value to consumers or businesses, it can withstand a security breach. For example, the world’s biggest security breach saw over 100 million social security numbers seized. Twelve months later, the company was still growing revenue. I think that shows that there was tremendous value in its business model. In fact, historically, many breaches for individual companies have turned out to be good buying opportunities. Notably, that company’s solution to making their data more secure was to move it to the cloud, which I think is a significant endorsement of the technology.
Given fintech’s strong recent performance, investors may be worried about valuations and where we are in fintech’s growth curve. How do you think about the timing of the fintech opportunity?
With regard to valuations, I think it’s important to note that technology stocks over the past decade, broadly speaking, have had earnings-driven performance. This hasn’t been a bubble in valuation, this has been earnings-driven market appreciation rather than multiple expansion. Some valuations may seem high but, in my view, these fintech companies are going to be much bigger in our lifetime. Importantly, we do focus on companies we view to be structural rather than cyclical growers and we avoid balance-sheet-intensive companies and lenders. We believe our opportunity set will have earnings that hold up better than the broad market in this volatile environment.
In addition, my approach to investing in technology stocks is to look for the best-positioned companies and extend my time horizon. I spend most of my time thinking about the sustainability of growth and the business model and I worry less about near-term multiples. In this evolving environment, I don’t know if next month or next quarter will be better. However, I do believe there are powerful structural tailwinds fueling fintech’s long-term growth story that, in my view, make now a good time for the sector.
Do you think the fintech theme can be accessed passively?
We think an active approach with a team with deep industry expertise is particularly important to finding the winners and losers in this theme. We’re often asked about the three large-cap incumbents that are a major part of passive fintech exposure. We think they’re wonderful businesses that are the foundation for the payments ecosystem. However, we also believe there are many lesser-known small- to mid-cap names that are really well-positioned to grow well above the market. These are companies that have got to a certain point of critical mass, where there are real opportunities for leverage and the barriers to entry are high.
How do you think about the long-term potential for the fintech industry?
We are at the tipping point of the industry embracing new technology. Two billion unbanked people around the world are now reachable through new technology. In the past ten years, there have been over 150 IPOs of exciting innovative companies.1 So, every year, our opportunity set gets even richer. And it’s not just about disruption. Many of those companies are partnering with well-positioned industry incumbents.
In fact, though the health care crisis has clearly accelerated existing fintech trends, I think we’re still very early in the growth curve. I’m very bullish on fintech for the long term and believe today’s volatility could be an opportunity to buy into this enduring growth story.
1Sources: FT Partners, Wellington Management estimates, as of 30 June 2020.
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