Fintech Stock downturn provides opportunities
The Buy Now Pay Later sector has been hit hard in early 2022 but we see buying opportunities now for investors in Fintech stocks.
Last week PayPal Holdings Inc. fell over 25% following news of weaker-than-expected growth due to increasing costs, including wages and supply chain pressures. Its shares have now more than halved since last July.
The problem at PayPal is one that has afflicted the entire Fintech industry, which is that much of the growth achieved through increasing payment volume was not profitable (people signed up but didn’t use the service).
On top of this, there is more competition than had been anticipated. Firms are fighting for the same digital payments dollar from a total addressable market that is not nearly as big as previously envisaged by many.
The problem at PayPal is one that has afflicted the entire fintech sector, which is that much of the growth achieved through increasing volume was not profitable (people signed up but didn’t use the service). On top of this, there is more competition than had been anticipated. Firms are fighting for the same dollar from an addressable market that is not nearly as big as previously envisaged.
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What does this mean for BuyNowPayLater?
The famed but nascent BuyNowPayLater sector has been hit particularly hard. This has been one of the most successful industries in history at capturing digital payments of the great credit unwashed, which currently includes Generation Z, born between the mid-1990s and the early 2010s. By promising financial freedom for online payments, their use of BNPL climbed from 6% of the entire cohort in mid-2019 to 36% in the past year, challenging traditional banks and credit card companies. That is explosive volume, but the stock market is now concerned about profitability.
Afterpay is down 50% since the announcement of its scrip-based takeover by the giant US company Square (NYSE.SQ) now called Block inc, whose shares have fallen by the same quantum. That’s one of the better performances!
Zip Co (Z1P) is just over 20% of where it was 12 months ago, while Beforepay (B4P), fell 40% upon listing on the ASX in January 2022, the worst of any newly listed stock in recent weeks.
While marketed as a type of BNPL technology, the contactless payments lender is closer to payday lending, which is as old as the hills. B4P uses Artificial Intelligence to credit check its offers of loans for employees against their expected pay.
We are cautious on a number of fronts: first, how well its repayment-related algorithms hold up amid changing economic conditions; second, the risk inherent in online lending for young people and the problem of debt recovery.
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How should the stock market react?
Fear not, amid this carnage there exists opportunities to profit when adopting a Sell Now, Ask Questions Later approach.
We had been advising to take profits across the board in the sector last year due to excessive hype, but now that valuations have come back, it’s a much more interesting proposition. This is especially so because the fear of rising interest rates are overdone.
The US 10-year Treasury yield is still under 2%, as is the Australian equivalent.
The point is: Profit margins do matter! As interest rates creep higher, the painful realisation that fintech companies might not be the consumer spending gravy train envisaged this time last year, has hit stocks across the fintech sector.
The two big factors weighing on the BNPL have not changed, which are credit quality and regulation.
In December 2022 the US financial regulator announced investigations into the use of data behind the fintech startups. However, as each app uses its own proprietary algorithms to establish creditworthiness in real-time, it is unlikely they share data about credit exposure with other apps.
Since there are five or 10 different BNPL apps, individuals shop around for the best deals. Many have multiple accounts, with the consequent impact on their next few weeks or month's cash flow. More than half (53%) of US-based Gen Z with income lower than US$75k per year have missed at least one payment, and 40% have missed multiple payments.
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What should investors do?
What this means is investors still have to be very careful. The sector consists of those behemoths, listed and otherwise, including companies Square/Afterpay, PayPal, Affirm, Klarna, and even Z1P. These fintech companies will survive any economic malaise and hoover up smaller competitors.
We’ve covered the financial services industry, including company Z1P for some time and believe that its success in going global through acquisition will deliver significant growth, which was highlighted in its latest earnings report this most recent quarter. But even after its share price collapse, this company is still valued at $1.9bn.
On a risk-adjusted basis, the much smaller finance company Splitit (SPT) looks like a better bet. Valued at under $100m, this is an outsider with potential. The company’s technology levers off existing credit card holders and is aimed at the top end of unit transactions, i.e. over $1000. SPT also has partnerships with some big banking operators, which includes Goldman Sachs.
The point is that when there is uncertainty, there are opportunities to make money. Fintech stocks, once the belle of the ball, are now on the nose. The sector isn’t going away, but at times like this, when upward momentum is absent, you need to dig a bit deeper.
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