As we wrap up 2022, we look back to the roller coaster of market volatility, macroeconomic uncertainty and unforeseen geo-political events since the onset of the COVID. The Financial Technology (FinTech) sector was one of the strongest accelerants of the changes brought on by the pandemic. Aided by historic federal reserve stimulus, the sector rallied precipitously in 2021 to inflated multiples, followed by a sharp reversal down to reality in 2022.
It has been a turbulent year for the sector with many curveballs thrown, including a sudden spike in inflation to levels not seen in decades. While expense lines rose swiftly, some FinTechs were actually net beneficiaries of inflation (e.g., merchant acquirers and their networks as they have a higher base of payment volume from which to earn revenue). As rapidly as inflation crept up, central banks quickly reacted with hawkish interest rate policy, causing FX headwinds. Companies operating in cyclical end-markets saw challenges, as well as those who had no clear path to profitability. We started to see unprecedented levels of CEO/CFO turnovers, drastic employee layoffs and strategic financial playbooks re-imagined. The pendulum shifted from “growth-at-all-costs” to “cash is king.” With this renewed focus on profitability, the million-dollar question prevailed: Who can best sustain a recession?
As the year progressed, the focus on earnings calls became much less about the beat or miss of the quarter itself and instead on the current trends and full-year outlook. Investors flocked to safety within the space including the networks (e.g., Visa, MasterCard) and the legacy processors (e.g., FIS, Fiserv, Global Payments) given their defensible business models and relative resiliency in a recession.
While FinTech valuations are now at levels many could argue are attractive and have already priced in a recession (to some level of severity), institutional investors remain cautious. Many FinTech companies have never seen a bear market before — let alone a recession. Investors are patiently waiting to see how these companies fare, which will help inform their investment thesis. For example, investors are closely monitoring the quality of the technology itself through this macro cycle (e.g. with A.I. driven underwriting models), levels of consumer/business demand, credit quality and access to funding.
As many of the FinTech companies provide FY 2023 guidance on their Q4 earnings calls, some investors believe this will be an opportunity to help identify the market bottom if analyst estimates come down soon after. This, combined with macro clarity from the Federal Reserve on inflation and stabilizing rates, might further help create support levels. A swift near-term “V-shaped” recovery is less likely, especially with the days of highly accommodative Fed policy in the rear-view mirror.
Many view this market reset as healthy, necessary and long overdue. The long overdue part contributed to the extremity of the reset. It’s no debate that the core fundamental thesis of the automation and digitization of financial services remains firmly intact and has never been more exciting. We are still in the early days of digital transformation with some of the most exciting FinTech trends and themes including:
- Accounts payable automation transforming the back office
- New focus on SMBs in B2B that were historically overlooked
- Convergence of payments and vertical SaaS software (opportunity to cross-sell)
- Early days in open banking and embedded finance / Banking-as-a-Service (BaaS)
- Account to Account (A2A) and Real Time Payments
- Pursuit of the “Financial SuperApp” to be a one-stop shop tech platform for everything financial
- Significant growth ahead for emerging markets including Latin America and EMEA
There is no shortage of new companies chasing these opportunities. The reality is there will be winners and losers and that has yet to play out. The current macro environment, characterized by a shock to the interest rate system not seen in decades will be the ultimate stress test to many of these players. It will test their strategic playbook, technology, funding and access to capital. Many will emerge thriving with momentum, some will be acquired by strategics or private equity, some will streamline through divestitures, while others may face insolvency.
As we gain more clarity into 2023 on the macro condition, and hopefully as markets stabilize and buy-side demand returns, we expect IPOs in the sector (and generally) to at some point resume, particularly given the pent-up backlog. However, valuations will be more realistic and those who will make it to the public markets will need to be quality compounders or have a highly actionable near-term path to profitability.
This leveling back down to earth is healthy for the FinTech sector, though many would agree we could have done without the extreme ups and downs. The structural thesis for FinTech has never been stronger and this transitionary period into the new normal will ultimately benefit the sector in the long run.
Follow the entire ICR 2023 trends series on the ICR Insights blog.
