Innovation – Finance – Technology


Has fintech lost its appeal?

If it looks like a duck, acts like a duck, and quacks like a duck, then it probably is a duck. Fintech was for a long time believed to disrupt financial services without being subject to the same requirements as banks. As the market matures and access to capital becomes scarcer, all signs point towards the market coming to terms with the fact that many fintechs are in fact closer to financial services companies than software.

As the market overall has taken a downturn, forward ARR valuation multiples have seen a steady decline through 2022, and fintech has taken by far the worst hit in terms of valuation multiples.  It is without a doubt that software companies in general will have to reevaluate and recalibrate their valuations. However, as software as a whole has declined, fintech valuation multiples have literally plummeted.

This graph from the excellent blog post A framework for navigating Down Markets by leading fintech-investors a16z shows how fintech has fallen from having premium multiples to the bottom-tier of valuation multiples.

Has fintech valuation been over-inflated and based on the profit pool of the financial services industry rather than sustainable business models that create value over time?

Their explanations may be many, but the consequences are nevertheless the same.

First of all, of all venture capital raised last year, the fintech segment amounted to about 20% of venture capital raised last year. The fintech sector may simply have had further to fall even more as investors came to terms with the fact that fintechs cannot achieve the growth entrepreneurs’ pitch decks promised.

Data from CB Insights shows that global fintech funding drops in terms of both the number of deals and total volume. However, it is worth noting that while funding has dropped nearly 70 percent since the top in 2021, funding levels are still on par with Q4 2020.

As a result, Nearly half a trillion dollars has been wiped off the valuation of fintech firms by the end of the second quarter of this year when their current value is compared to their peak valuation, according to CB Insights.

This is not only limited to early-stage pre-revenue fintechs, but the once universally admired unicorns are also feeling the pressure. Perhaps best exemplified through Klarna’s 85 percent valuation plunge from its highest valuation at 44 billion USD to 6,7 billion USD earlier this year. If it were any consolation for Klarnas shareholders, they are far from alone. Stripe’s valuation fell 64% as a leading investor marked down shares, while shares in Affirm are down more than 80% this year.

Market uncertainty and rising interest rates are here to stay (at least for a while), and fintechs are not excepted from being affected by this. Given the diversity of the fintech sector, the impact of shifting interest rates is likely to vary. Nevertheless, market turmoil is unlikely to favor fintechs.

This puts a squeeze on fintech lenders, as well as players in the BNPL that are both highly dependent on wholesale funding. At the same time as financing becomes more expensive, consumers are finding themselves in an economic squeeze amongst rising interest rates and inflation, resulting in soaring losses for unsecured lenders and BNPL players. This is not the only obstacle facing the BNPL space. Regulators have stated an urgent need to regulate BNPL products the same way traditional unsecured lending products are regulated.

Fintechs in the wealth management space is as likely to be affected as the young, new-to-the-market consumers they court feel confident in their market approach as the economy tightens, and the urge to buy meme stocks becomes less appealing.

Challenger banks are also struggling on their path toward profitability.  

According to research by analysts, Simon-Kucher, only 5 percent of challenger banks are able to turn a profit, while the majority of challenger banks earn less than $30 USD in annual revenues per customer. Out of the 25 biggest challenger banks, only two of them were able to reach profitability.

The research also discovered that in the US, less than “a handful” of the country’s leading 85 neo-banks have reached a breakeven point, and several are losing as much as $140 per customer annually.

Alongside the growth of the sector, competition has also increased, making it harder to stand out as a new entrant in the market. Not only have incumbents invested in their digital offerings, but as many as one in three challenger banks are digital subsidiaries launched by incumbents in the financial services industry. Thus are able to combine deep industry knowledge, lower cost of capital for lending, as well as piggybacking on established brands in the market.

As growth has been the primary metric for success, many challenger banks have rapidly expanded in new geographies and have been obsessed with opening as many accounts as possible without thinking about how to make them profitable, while at the same time operating with affiliate programs and customer onboarding benefits that might not be financially sustainable in the long run.

Even though market sentiment affects various players differently. While players like Revolut announce new feature expansions like instant messaging and extended crypto functionality to enable its user to pay with crypto with their Revolut cards like Chime are resorting to cost-cutting measures by laying off 12 percent of their staff.

Thus, joining the ranks of a growing roster of fintechs such as Stripe, Credit Karma, Pleo and several others that are announcing layoffs these days.

As we enter the inevitable recession that has been looming on the horizon through 2022, the fintech space will have its acid test on its staying power and a force to be reckoned with for incumbent financial institutions.

Although a shift in the market sentiment undoubtedly represent a wake up call for the industry, it is not all doom and gloom. There is still a plethora of problems to be solved in the financial services industry. Although incumbents have awakened from their slumber, small niche fintech players are avle to move faster, and tend to be more socialized in their approach.

Even though the fintech term is a wide umbrella covering various business models and concepts, a majority of leading fintech players inhibit core economics derived from financial services businesses. Businesses that are capital intensive, slowed down by compliance, and tend to have lower multiples.

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