Is there too much investment in payments?

For more than a decade, the shift to e-commerce and mobile has brought huge amounts of investment into payments. As further fresh investment rounds are announced, PCM asks whether a bubble is forming, and asks what happens next.

According to KPMG’s FinTech Pulse survey, the payments sector led global fintech investment in 2020, even though overall investment levels were down from pre-pandemic highs. Last year, investors closed 404 deals that funnelled $19.7 billion into the sector — a sharp drop from the $105 billion absorbed by payments in 2019 across 422 deals. 

 

Nonetheless, the 2020 figure still represents an average of $50 million per deal in 2020, and last year only saw 18 fewer deals than 2019 in total. This suggests that investors still want a piece of payments, even if they’re being more cautious than before the pandemic.

KPMG’s study also says fewer M&A deals in payments contributed to a significantly lower global volume of investments in 2020 – a fact which, by itself, demonstrates just how much money has been flooding into payments in recent years.

Add to this the fact that KPMG’s study ignores the recent spate of mega-mergers in payments – FIS’s takeover of WorldPay, or Fiserv’s $22 billion merger with First Data Corporation, among others – and this flood of money starts to feel like a deluge. 

With more than $260 billion invested in payments companies over the last four years, questions are being asked about a “bubble” – are we seeing too much money coming in, and are investors about to lose their shirts?

The short answer to that question is: “it depends” – on how you define the payments market, and whether or not you believe investors have switched their focus to new areas of payments over the last five years.

Payments: from cash to pixel

According to Fortune magazine, the global payments market is currently worth $3.29 trillion, and is projected to reach $17.64 trillion by 2027, representing growth of 23.7 percent per year over the period.

These huge figures are driven by two factors: first, the switch to a digital economy and second, the relentless shift from cash to electronic payments, especially in the emerging economies of Africa, Asia and Latin America. 

In these geographies, the switch from cash to e-payments is accompanied by a huge rise in the banked population, which opens up the possibility for stratospheric growth through cross-selling of payments products such as credit and debit cards to the newly banked.

Andres Ricuarte, SVP and Global Head of Payments at cloud IT services firm Mphasis, argues that “payments can act as a customer acquisition vehicle for a huge range of services delivered to 7.5 billion people on the planet. By managing customer relationships the right way, it’s possible to rebundle all kinds of services for delivery alongside payments.”

Looked at this way, the payments business has the biggest total addressable market on the planet, and $260 billion of investment seems paltry when viewed on a per-customer basis. Among others, Alex Reddish, Chief Commercial Officer at European payments technology firm Tribe, believes the recent flood of capital into payments is justified.

“If you look at the recent run of takeovers in the processing segment as one example, they were driven by the need to deliver new products and innovative solutions. Although the consumer side of payments has seen more investment in recent years, the B2B segment has been relatively untouched, and we’re going to see capital chasing further opportunities in this segment.”

“Investors are switching focus from consumer solutions to the ‘plumbing’ behind payments.”

Data from the Klarna/MagnaCarta 2019 FinTech Disruptors Report confirms that the switch in investor interest from consumer solutions to business-to-business payments has been underway for a while now; between 2018 and 2019, the number of investments in new FinTechs focused on consumer payments dropped by around 30 percent, while new areas such as Artificial Intelligence and blockchain came from nowhere to account for between one-fifth and a half of all new payments FinTechs. 

Shape shifting

Recent years have seen the rapid emergence of successful new consumer applications like “Buy Now, Pay Later” (the subject of several investment rounds between 2010 and 2015) and Account to Account payments, also the subject of much investor attention in the last few years.

We’re only now seeing the fruits of investments made as long as ten years ago: it’s as though a new cycle is beginning, focused on what lies behind the point of sale, and beyond the interest of most consumers – business to business payments, and the automation of accounting and regulatory functions such as compliance.

As investment volumes grow, so investor expectations are rising. Whereas a $1 billion floatation might have attracted investors in the past, now investors are lifting their sights. “We’re seeing inflation in the market valuation of assets”, confirms Chris McCann, Partner at FinTech VC Race Capital. “And as a result, investor expectations of the end outcomes are rising considerably.”

“Investor expectations of end outcomes are rising considerably” – Chris McCann, Race Capital.

In terms of where we might expect to see investment dollars headed, look out for growing attention to some of the more complex banking needs of small businesses such as liquidity, funding and money movement.

Mphasis’ Andres Ricaurte describes B2B payments as “having ten times the growth potential of consumer payments … we’re just waiting for the iPhone of B2B payments to arrive – a software solution delivered as a service (SaaS) via the cloud that delivers on the priorities of business customers.”

Given the success of challenger banks like Revolut and Chime, we’re also likely to see more money go into “Banking as a Service” platforms and embedded payment solutions in 2021. Perhaps the biggest gorilla, or elephant, in the current investment cycle, though, is – you guessed it – digital currencies and blockchain.

Blockchain: building the Kingdom

Before diving into investor appetite for these technologies, it’s worth reviewing the negative mainstream media commentary.

The principle objections to digital currencies are that they are not linked to any recognisable asset, or based on any underlying economic indicator; that they are little used for real payments outside illegal activities; that they are the province of criminals and weirdos; and that they are environmentally unsustainable.

This last complaint also applies to blockchain, usually with the added objection that no-one has, to date, delivered a blockchain solution at scale. 

Recognising these objections gives us scope to enumerate the possible benefits of both technologies. Let’s take digital currencies first: more than any other payment method, they offer the promise of secure, traceable payments – as well as the ability to embed payment information into a transaction or exchange of goods or services, rather than separating payment from what’s being bought or sold, as happens currently.

They also promise (or threaten, depending on your point of view) to remove a number of intermediaries from the payments process and make payments faster and cheaper. The potential to disintermediate large players, especially banks, perhaps explains much of the negative media coverage we’ve seen around digital currencies. 

As with e-coins, so with blockchain. Race Capital’s Chris McCann notes that blockchain-based solutions potentially offer vastly improved flows of funds between merchants and consumers, with value moving between digital wallets and merchant accounts without the need for bank mediation.

That said, McCann believes there’s a long way to go before blockchain-based payments go mainstream: “such consumer infrastructure as there is tends to be heavily developer-oriented, almost like middleware, with a somewhat rough user experience.”

Both corporates and investors recognise the growing importance of blockchain to the future of commerce. Although overall investment in blockchain slumped in 2020 owing to the pandemic, no less than nine in ten major global companies surveyed by Deloitte last year said blockchain technologies were key to the future of their business, and more than half (55 percent) numbered blockchain among their top five strategic priorities for the next five years.

Both of these figures are tracking at the highest level they’ve ever been, suggesting that interest in blockchain solutions continues to grow – and investors are seeing the potential. 

In essence, what we’re seeing is a complete re-tooling of the financial infrastructure for the digital era – and this Herculean task requires no small levels of investment. Marcus Treacher, Director at specialist UK transaction clearing bank ClearBank, makes an analogy between where we find ourselves today, and the introduction of the internet 25 years ago.

For Treacher, we’re seeing nothing less than the beginnings of decentralised finance, or as he puts it, “the democratisation and decentralisation of information and value, which consumers and companies are going to be able to hold and share with greater control.”

Treacher believes investors should be looking less at specific solutions, but at which companies have what he calls a “vision of deep impact” – those companies that are going to become the Apples, Googles and Amazons of the blockchain/digital finance era. 

Phone wasn’t built in a day

Building on Treacher’s analogy, it’s possible that investors should be thinking slightly longer term – and that they should hold on for a somewhat bumpy ride. It took seven years after the introduction of dial-up browsers for the iPhone – the first widely-available smartphone – to arrive.

On that basis, we might expect that digital currencies and blockchain won’t reach anything like their full impact until at least the middle of this decade. And, as with the first online revolution, we can look forward to no small amount of blood on the carpet as digital finance develops. 

“Digital currencies and blockchain might not start to make a real impact until the middle of this decade.”

Consider those who invested in the failed forerunners to Netflix twenty years ago. Streaming content was always a great idea, but bandwidth issues – and regulatory hassles – meant that it took some time before streaming services could take off.

In the same way, there will be many speed-bumps and false turns before the promise of decentralised finance is realised.

No doubt, regulation will be a key battleground as (for instance) it becomes possible to transfer value faster than regulators can track and identify participants.

The longer-term promise of decentralised finance (or DeFi, to use its trendy moniker) to one side, it’s clear that there are huge improvements possible in the nearer term, especially when it comes to serving the needs of mid-market companies who feel banks don’t understand their businesses and offer them unsuitable “vanilla” payment services.

No less than half the European mid-market firms surveyed by Banking Circle last year said they wanted to switch banks for better payments and lending services; perhaps the huge capital inflows we’re seeing in areas like the automation of accounts receivable and invoicing, faster payments and currency transfers will finally give smaller companies, their customers and employees the great B2B payments services they deserve. 

Underneath talk of an investment bubble lies a larger, more profound change. Not only are traditional ways of paying for goods and services set for radical transformation, but the entire infrastructure of payments is being reshaped, with new business models emerging.

That reshaping involves two parallel trends: an evolution of the front- and back-end parts of the payment system, and a revolution involving huge structural changes to the payment mix and ecosystem. Given these changes, let there be no talk of an investment “bubble”: while risk will always be with us, the size of the changes we’re experiencing suggest that, if anything, the amount of capital coming into payments is adequate at best.

THE MAGNIFICENT SEVEN: TOP INVESTMENT AREAS TO WATCH IN 2021

1. Blockchain and crypto – as we make clear, reports of a bubble in blockchain and crypto are exaggerated. We’ve seen some medium-term retrenchment, but still expect blockchain to make a major contribution to the digital retooling of the financial system. Cryptocurrencies will also play a role.

2. Transaction security – for e-commerce, m-commerce and contactless transactions, no player has yet delivered a breakthrough in this area. As digital business continues to replace cash and physical transactions at around 14 percent a year, watch for this to be an area of ongoing investor focus

3. Embedded (or integrated) payments. Look out for increasing numbers of merchants to offer permissioned customers immediate payments (think Amazon’s “click and pay” service) as friction at checkout refuses to go away

4. B2B payments – as covered in this article, B2B is a bigger opportunity than consumer payments these days – higher transaction values, and more pain points to solve. Expect investors to dive in for rich rewards

5. P2P payments – Trustly, Zimpler, Venmo and Zell have all shown huge growth in recent years, demonstrating the depth of consumer demand for rapid settlement times and fast transfers between friends and family. With P2P still in its infancy, investors will keep wanting a slice of the action.

6. Super-wallets and multi-function cards – digital wallets are expanding their functionality. Watch for the traditional payment card to respond with new functions that go beyond debit, credit and loyalty to include insurance and instant transfers, among others.

7. Card Platforms – as traditional banks tool up to compete, expect investors to take an interest in Banking as a Service and cloud-based third party card platforms that serve traditional banks. Many consultants feel these are the only way high-street banks can maintain their competitive position.