As trends go, financial technology is a beauty. The prospect of nimble “fintech” ventures disrupting financial-service incumbents has whet investor appetites.
An Australian fintech sector is rapidly emerging. Fintech has been a boom sector in the United States and United Kingdom as technology-based companies, with their capital-light business models, nibble at the market share of large firms.
It happened in print media, publishing, music and education. Now the same trend, where new firms offer financial products and services using online platforms, is disrupting parts of banking, wealth management, insurance, payments, accounting and foreign exchange.
There is, of course, much hype about fintech. But the financial-services sector looks a prime target for disruption given the high fixed-cost base of large incumbents, heavy regulation and the inability of some to move quickly in response to fast-moving, tech-based rivals.
As in other industries, fintech firms are disintermediating the middle man in transactions: the firms that “clip the ticket” for little work. Think stockbrokers who used to earn high transaction fees for buying or selling shares until online broking emerged. Or financial planners, some of whom will be made redundant by “robo-advice”.
The Initial Public Offerings market, usually a good indicator of hot sectors, reinforces fintech interest. Five of the 10 largest technology IPOs in 2016 were for fintech companies and many more are expected to join them in 2016. They included Pushpay, Bravura Solutions and the well-performed Afterpay Holdings, an electronic-payments provider.
Fund-manager interest in fintech IPOs surprised. Big funds typically avoid unprofitable, early-stage tech companies because they are too speculative. Institutional money flowing into loss-making fintech firms shows the interest in this sector.
Afterpay has interesting prospects. After raising $25 million at $1 a share in May 2016, it rallied to $3.14, before easing to $2.65. The company was the market’s fourth-best-performed IPO last year (by share price over the issue price) with a 165 per cent return.
Chart 1: Afterpay Holdings
Source: The Bull
Afterpay is an innovative concept. Consumers use the technology when they are ready to buy goods and split the payment over four equal fortnightly instalments. Afterpay quickly settles with the merchant and assumes all credit and fraud risk for the payment.
In doing so, Afterpay makes it easier for consumers to buy goods on credit, without filling in long forms or detailed applications. The company’s pitch is to drive new customers to retailers and increase their engagement and spend through clever technology.
Afterpay’s “buy now, pay later” concept appeals. More than 250,000 customers and over 1,500 retailers use the service, and numbers are growing rapidly. Some of Australia’s best-known retail brands have incorporated Afterpay into their systems, giving the company a valuable retail foothold.
Afterpay expects sales of $300 million this year through its system, based on purchases so far (it receives a fraction of that). The growth impresses because the technology is only a few years old.
Afterpay receives its revenue primarily from transaction fees that retail merchants pay for sales through the company’s technology. Merchant fees are mostly based on a percentage of the order value and a fixed transaction fee.
Afterpay does not charge end-customers interest or fees for providing credit. The company funds the period between paying retail merchants and receiving the full payment from end customers – on average, 29 days. The cost of funding these small transactions for short periods is less than the transaction fees Afterpay receives from retailers.
The business model is highly scalable. Attracting more customers and encouraging repeat business means more retailers wanting to offer Afterpay at their sales counters. That, in turn, attracts more customers and raises Afterpay brand awareness. The medium-term goal is leveraging the technology across more retail segments and platforms.
Afterpay lost $1.25 million in the first half of FY2016 and significant profits are unlikely anytime soon as the company, sensibly, reinvests cash to scale the opportunity. The $212 million stock suits investors who are comfortable with micro-caps and higher risk.
Afterpay is due for a bigger share-price pullback or consolidation after big gains since listing. But the stock is one to watch as the early interest subsides.
It’s another example of how fintech is hurting incumbents; in this case, bank credit-card operations that fund consumers. And using technology to solve problems for other customers, such as retailers that want to make it easier for consumers to buy their goods.