Which FinTechs will survive the crisis?

Several research reports in recent weeks have weighed in on how FinTech firms are likely to weather the Coronavirus crisis, so FStech decided to do something of a meta-analysis to get to the bottom of this crucial issue.

The COVID-19 pandemic hit at a time of apparent rude health for the sector, with new startups coming through and scale-up players reaching unicorn status, but as none of them were around for the last recession, it remains to be seen which companies have the cash and customer base to survive the virus intact.

Exits and acquisitions

One potential weakness to the UK’s thriving FinTech sector is that in some areas there is perhaps a saturation of similar propositions, so some have speculated whether this market shock will drive the first big round of mergers and acquisitions (M&A).

Research from 11:FS director of research Benjamin Ensor and research lead Sarah Kocianski suggested that faced with falling revenues and a shortage of capital, weaker firms - particularly challenger banks - will be forced into mergers.

“Acquisitions will occur across financial services, including FinTech firms, with a mixture of purchasers including venture capital and private equity firms, as well as well-capitalised big tech firms,” the report stated.

Meanwhile digital partnerships will accelerate. “As they strive to cut operational costs to match their falling revenues, firms will look for partners that can provide non-core services more efficiently than they can deliver those services themselves.”

The longer the crisis lasts - and defaults pile up - the more likely it becomes that at least some banks and insurers will risk becoming insolvent, the authors predicted.

Michael James, technology consulting director at Altus, said the real crunch point for firms in a recession - assuming they have the cash to survive it - is the recovery period afterwards. “This is where lenders start to turn the screw, having supported them through what they consider the hard times – if businesses do not recover and increase activity fast enough in the post-COVID period, they will run out of money and would be unlikely to attract more.”

A Rosenblatt Securities survey of FinTech investors in October asked how they would react to a market downturn and how it would impact valuations, with 55 per cent stating they would be opportunistic and fund or acquire FinTechs if valuations dropped. The respondents also said they expected the 58 FinTech unicorns globally (as of October) to be most impacted, with average valuations contracting by about 15 per cent.

“When venture capital firms made FinTech investments in past years, they depended on a vibrant IPO market as one of the avenues for liquidity, but with IPOs markets tightly shut at least for the next few months, exits via strategic M&A might be the only option available for liquidity,” stated Rosenblatt.

Jay Wilson, an investment manager at AlbionVC, concurred that funding for FinTechs will now be constrained. “FinTech fundraising, M&A and public trading comparables are all down – the data is now confirming this,” he stated, adding: “Inorganic growth can perhaps offer some respite for the brave, or those with M&A and post-merger integration capabilities, but for the average startup that will be daunting.”

A handful of digital banks, including N26 and Starling, were eyeing an Initial Public Offering (IPO) in three to five years’ time, but any sooner IPO plans are realistically no longer an option, as valuations are getting hit hard.

Tom Try, partner at law firm Osborne Clark, stated that there will be an element of dumb luck, as companies which concluded funding rounds shortly before the outbreak will have had at least 12 months of runway.

“Conversely, companies which were looking to raise funds this year are going to find the potential investor base significantly reduced – they will almost certainly have to look to existing investors first, as new investors are going to find doing due diligence on new businesses in this environment very challenging.”

Recent weeks have seen some of those lucky enough to have completed funding rounds publicising their war chests – including $100 million for N26, $280 million for Robinhood, $600 million for Stripe and $100 million for Onfido on the large end, along with £2.35 million for Banked, £3.2 million for Snoop and £2.5 million for Chip at the smaller end.

Revolut – itself a recipient of $500 million funding in February – recently revealed intentions to take advantage of the crisis. Founder and chief executive Nickolay Storonsky told the Financial Times that he’d like to expand the app into other areas. “A lot of travel aggregators are in trouble at the moment – we could probably purchase one and sell flight tickets at cost and be 10 to 15 per cent cheaper than everyone else,” he said.

The digital bank recently hired Don Hoang, Uber’s former director of business, to head up its deal making. “This is not just blue-sky thinking – we’ve just done a fundraising, we’re cash-rich,” Storonsky added.

Anton Ruddenklau, a partner and head of digital and innovation for financial services at KPMG, said that venture capital and private equity firms will fund their portfolios at the expense of startup and early stage businesses.

“FinTechs are likely to see slower growth inclines as investors look for further headroom and longer periods between funding rounds,” he explained. “Corporate venture funding will increase as legacy firms seek to accelerate their digitisation and either buy or invest in FinTech partnerships.”

Ruddenklau also said its likely that e-commerce or scaled payments firms will use this as an opportunity to broaden their scope of services – noting recent investments by Visa, Mastercard, PayPal and announcements of Square and Intuit providing small business lending in the US for its COVID funding programme.

“Valuations will decrease, but it is unclear by how much and across which subsectors,” he continued, adding that talent will become attractive to legacy financial institutions and other adjacent sectors like HealthTech and PropTech.

Simon Cureton, chief executive of Funding Options - which helps to match SMEs with the best business funding for them - argued that FinTechs will be stronger through this pandemic if they stick together.

“COVID-19 exposed how fragmented the space is, nevertheless, FinTechs remain uniquely positioned to act quickly to help implement the government support small businesses at pace,” he commented, noting that Funding Options has more than £1.5 billion worth of loans from 15,000 businesses since March.

Of course, the first casualty came at the very beginning of May, with RBS financial reports revealing this its standalone digital banking app Bó is to close as part of a cost-saving drive – after just six months of operation.

Sakar Krishan, industry head of banking and capital markets at Capgemini, explained that the idea of a fully digital bank is a good one, so long as it is truly digital from first principles.

“This means having an integrated front, middle and back office which optimises operations and technology costs and delights customers,” he stated. “However, when profits halve like they did with RBS and reserves are set apart at close to a billion, with more to follow, there is very little wiggle room left for funding Bó.”

The winners

So which firms are best equipped and which subsectors give the best chance of making it through?

Finch Capital contended that prosperous times remain ahead for certain types of ‘disruptive winners’, pointing to demand for artificial intelligence (AI) and Internet of Things (IoT) companies that help financial firms with digital transformation, once Coronavirus ‘crisis mode’ lessens in the third quarter.

The venture capital investor’s report predicted that this shift will trigger a “big pocket” online battle between incumbents and challengers, as financial Institutions turn to tech companies rather than in-house capabilities to accelerate digital transformation.

It argued that potential FinTech sector winners include consumer and small business lending platforms - as a “best-adapting mechanism to swiftly and efficiently deliver capital to key segments of the economy” - along with mortgage and life insurance digitalisation firms - “leaping forward with technology to disrupt the role of intermediaries”.

As for AI, Finch put its money on success for call centre chatbots, account-opening procedures, loan automation technology and the automation of Know Your Customer onboarding processes.

A report from Forrester suggested that while the new crop of mobile-only banks may struggle, a handful will use the crisis as an opportunity to innovate, developing features and services to help customers better manage their finances and reassure them of financial safety.

It noted Monzo and Starling Bank reaching out to customers to explain that they are fully licensed banks and members of the Financial Services Compensation Scheme. It added that as fraudsters have exploited the outbreak, Starling for instance published a blog post explaining how customers could spot a Coronavirus scam.

Chris Hill, commercial technology partner at law firm Kemp Little, agreed that it is a difficult time for many early-stage FinTechs, particularly those that are in the phase where they are trying to get out into the market to make connections, test products and find finance.

“Some of the most interesting developments have been in FinTechs reacting to the lockdown situation by altering their business model to cater for it – for instance an automated loyalty cashback provider using its infrastructure to provide a crowdfunding-style service to help small businesses.”

Ruddenklau suggested that overall the crisis will be a net positive for the FinTech sector, as it promotes scaling and accelerated digitisation of financial services – but not without pain along the way.

“Digitisation will accelerate across legacy enterprises - clients have told us they have digitised in three weeks what would normally take 18 months - and FinTechs can support with this across lending, client management, onboarding, claims and queries,” he commented, adding that winning FinTech subsectors will probably be digital payments, market infrastructure, cyber security, data, AI and identity.

Hill also suggested that some FinTechs are already set to deal well with the current situation, particularly those connected to contactless payments, remote ID verification, cashflow forecasting, invoice insurance and small business lending.

The losers

Not all FinTechs will be so lucky however, so what does the prevailing analysis predict in terms of those companies and areas of the market set to fail?

Finch Capital listed challenger banks - suffering from “high valuations and lower expected activity post-crisis” - wealth management - hit by “client de-risking and lower assets under management impacting bottom line” - and payments or foreign exchange firms - with “decreased transaction activity affecting commission businesses” - as those potentially in trouble.

The Rosenblatt report explained that the FinTech sector has been underperforming as a whole since the start of March, pointing out that many management teams will be inexperienced in responding to difficult business conditions like weak customer demand, working capital squeezes and a tougher environment to retain employees.

The flexibility in business models and the ability to dial-up and down costs will become critical for FinTechs and will determine which survive, stated the US brokerage firm. Firms that rely heavily on large marketing expenditures to generate growth will come under investor scrutiny, as they can no longer justify customer acquisition costs due to weak transaction volumes.

Rosenblatt’s analysis indicated that lending FinTechs would suffer the biggest drop - due to lower valuations and slower funding - followed by capital markets, with insurance and payments less impacted. “Business-to-consumer models like challenger banks are also likely to see valuations contract faster than business to business models like corporate banking and treasury.”

Forrester’s research similarly said that mobile-only banks will have to fight harder for deposits and new account signups, meaning many will have to reduce operations and see a deterioration of business performance. It pointed out that hardly any have achieved profitability to date – with Aldermore and OakNorth Bank in the UK standing out as rare exceptions.

Senior analyst Aurelie L’Hostis emphasised that challenger banks were already experiencing issues before COVID-19, with a crowded market, a lack of clear product differentiation and struggles to scale.

“The outbreak of the virus has changed the market radically in just a few weeks, further clouding challenger banks’ prospects,” she stated. “Challenger banks will need to fight to survive – a handful of digital banks will manage to weather the pandemic crisis until the third quarter of the year and then make it through a 12 to 18-month recovery period.”

Ruddenklau agreed that challenged subsectors will be digital banks, aggregator platforms, retail foreign exchange and small business lending – although lending platforms to banks will thrive.

Wilson also said the SME lending sector could be in for a tough time, as bad debt provisions have to be reviewed and we don’t yet know the scale of the defaults.

“If we enter an increasingly capital constrained environment, this will only compound the issues for lenders – from an investment standpoint those businesses that went down the ‘user acquisition first, monetisation later’ route could fall out of favour, as having a path to profitability comes into focus.”

Try stated that wealth management FinTechs may find this a challenging environment in the short term, as consumer saving habits change. “It will also be very interesting to see whether the disruption we are seeing accelerates demand for blockchain-based projects, as people become more comfortable with a higher degree of abstraction in tech, or whether there is a flight to the safety of more established technologies.”

Peter Kennedy, partner and UK head of technology at Capco, pointed out that one aspect the reports did not cover relates to company culture.

“Many FinTechs rely on highly collaborative, iterative ways of working which thrive on the creative buzz of co-located teams – for instance Agile is possible with people working remotely, but it takes real expertise and specific process work to get right.”

He continued that the other critical point is that with a prolonged market downturn for the next year at least, it tends to be the buy-side - investment and wealth managers - that struggle. “So FinTechs specifically servicing those institutions may find that investment spending is down, and they will need products and services which offer genuinely differentiated, enhanced customer service and products.”

Survival of the fittest

Any predictions made in such an unprecedented and uncertain time are of course bound to get a lot wrong, with even the data not giving a particularly clear picture. Take banking app downloads for instance.

A survey of 1,000 UK adults, commissioned by FinTech firm Nucoro, found that between 14 March and 14 April, around 12 per cent of the adult population in the UK - some six million people - downloaded their bank’s app for the first time. Some 21 per cent of those aged 35 to 44 did this, as did just over five per cent of people aged 55 or more.

But data compiled by Finbold indicated that on average, challenger banks’ app downloads fell by 23.38 per cent by the end of March, compared to the previous month.

Monzo’s app downloads declined by 36.12 per cent, registering 148,608 downloads – down from February’s 232,639. Starling Bank’s app download were down by 20.03 per cent, having registered 80,523 downloads in March – down from 100,704 a month earlier. And Revolut also saw a slump of 18.16 per cent, with 95,461 downloads in Marh compared to 116,648 registered in February.

Wilson from AlbionVC concluded by stating that irrespective of the length and depth of the crisis, the biggest challenge facing all startups is one of leadership.

“First and foremost it’s the leadership challenge of securing and managing the health and wellbeing of employees, but secondly it’s the leadership challenge of brutally managing cash flow,” he commented. “This is not an exercise in shaving two or three per cent of costs off the budget – they need to zero-base on the business plan; leave no stone unturned; get cash from wherever they can.

“However, cash shouldn’t be constrained to the extent that it erodes value – if there are demonstrable investment opportunities, then take advantage.”

Finally, Wilson said it’s the leadership challenge of being decisive, creating a set of scenarios that the senior management team can fully stand behind and getting on with things. “Some great businesses were born out of the last financial crisis, but they didn’t sit around and wait for things to settle down.”

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