Mark Odendahl
Welcome back to the Industries in Motion Podcast, brought to you by RBC Capital Markets. My name is Mark Odendahl and I'm Head of US Capital Markets Research here at RBC. Thank you very much for joining me today. This podcast is where we explore what's new and what's next in today's fast- moving markets in industries, to help you stay ahead of the curve. Please listen to the end of this podcast for important disclosures.
Today, we have Dan Perlin on the podcast. Dan is our fintech analyst here at rbc. He covers sectors like the processing space, IT services, as well as parts of the software industry. We recently held our seventh annual Financial Technology Conference, also known as our Fintech Conference, in New York City. At this conference, we hosted roughly 40 public and private companies in this ever- evolving fintech sector. Dan hosted fireside chats with executives, as well as panel discussions across the industries. Today, Dan and I are going to talk about his major takeaways from the conference, and also some themes that emerged from the presenting executives at the Fintech Conference. Welcome back to Industries in Motion, Dan
Dan Perlin
Thanks, Mark. It's great to be with you. And I have to say, having that conference live after a couple of years being virtual was just really a fantastic experience, and it was just so great to see everybody back under one roof. So it's great to be with you today.
Mark Odendahl
That's great, Dan. And yes, I thought it was a unique part of this conference this year to hear both Mastercard's president of operations and technology and Visa's head of crypto, they both weighed in on developments in the cryptocurrency space. What do you make of what they had to say, what these legacy companies had to say about cryptocurrencies?
Dan Perlin: So it was pretty interesting. We had Cuy Sheffield, who's the VP of crypto at Visa for the lunch keynote. And one of the things that was very, very clear from that discussion, and this is despite all this volatility that has been taking place, which is unprecedented right now, the key takeaway was that crypto's prominence is here and it's going to remain at a very important part of the ecosystem. And for the companies like Visa and Mastercard who are out there and obviously massive leaders in this space, what they were basically telling us is this. This ecosystem's still very, very early in its development, but their role in it, and I think what they're comfortable with is thinking about this is being an extension of this network of networks strategy. Whereby distribution of however people want to interact with money or movement of money, whether that's crypto or otherwise, they're going to want to help facilitate.
And so what they are effectively trying to do, by definition, is enabling the fiat on- ramps for individuals to get into what I would consider to be a more everyday spend category that would then be processed across their network, while at the same time enabling just very, very large cross- border opportunities to take place. So the goal, I think, for both companies, by their definition and what they're comfortable with is create on- ramps for consumers to get in there. Once you're in there, enable that to be facilitated across not only its existing network, but its network partners. And then beyond that, I don't think that they're looking at it from the standpoint of tradable securities and things like that. I think they're thinking about it in an everyday spend category. The other thing that's important is they both have advisory and consulting services businesses that are catering to this area.
And that's interesting because what we heard from them was that their bank partners are coming to them and they're asking them how do they manage all the demands that they're starting to see from their consumers, but how do you even put this into potentially a treasury management capacity? Is this one of the areas that you want to hold within these organizations? And so I thought it was interesting that not only are they facilitating the actual transaction itself and these on- ramps, but they're also acting as really a lead consultant to their 14, 000 plus financial institutions that are in their network. So it's prominent, it's real. The longer term question that we get, Mark, in terms of disruption around the space is, how do you protect certain types of industries if crypto becomes really the more prominent avenue?
And the question always becomes speed, security, those types of things. And I think as we sit here today, crypto's got a long way to go before it is ever going to displace, I think, some of the networks in particular. But at the end of the day, these are huge network operators, they're going to participate in it, and the fact that they're embracing it in the same way that I think we all thought they would, at some point in time, seems to be a little more accelerated in the current environment.
Mark Odendahl
Dan, I was there, I listened to your Q& A with these guys. So I'm curious, do you think both of these companies, both Mastercard and Visa, treat crypto more like an opportunity or they treat it as a threat?
Dan Perlin
Well, I think it's a competitive necessity, and I think that that's how they would probably want to frame it. I think that they feel as though they could be opportunistic and that it is somewhat of an opportunity. But here, again, I think the competitive dynamic from where they sit is a question of trust. Do you trust these brands or not? If you don't, then crypto is potentially an opportunity. I think they realize that there's some questions around the state of crypto today, so maybe the crypto environment or the crypto ecosystem isn't quite ready for that yet, then it becomes a question of speed. When you think about the networks processing capabilities as an example, they can process 65,000 transactions a second, sustainable for an hour. And on any given day outside of the holidays, they're only doing 3, 000 or 4,000. So they're not even anywhere near their capacity. So that's not an issue, even if you've got lightning networks and things of that capability that can do a million transactions a second, it's just all that relevant yet because these companies are not at capacity.
So I don't think they view that as a threat. And then the latter one is cost. And if you think about the network's unit cost to process, they can do that under a penny if you just remove the marketing and those types of expenses. So the actual unit cost to process is not all that different than what you hear in crypto. And I think oftentimes crypto doesn't bear some of the incremental costs that one might associate with actually being able to run a network, not the least of which is energy consumption at least today.
Mark Odendahl
So as we look at what Visa had to say, their head of cryptocurrency presented, I thought it was interesting how he broke it down into three categories, Bitcoin, stablecoin and NFTs. Did you hear anything interesting or new there related to any potential opportunities for Mastercard in Visa?
Dan Perlin
Yeah, I mean, I thought Cuy was really quite impassioned around the NFT world. And the reason for that was he talked about it being, again, another extension of enablement for consumers to have marketplaces that primarily did not exist previously. And so that's something that can very much be utilized for creators. They have specifically a creator network that they're building upon, and there's a certain franchise value that can be created around that. So I thought the NFT commentary around the expansion of an ecosystem, and really, at the end of the day, creating an entire new network, I thought was very interesting. As they think about stable coins, I mean, I think are the way in which you want to have these fiat- to- crypto on- ramps, you can't have all the volatility associated with these huge moves. So I think that that was pretty much a standard, I think, answer for them, and I think's going to play more prominently in how they get consumers in and out of the network.
And then specifically, I guess around Bitcoin as an asset or those types of things, I think at the end of the day they view it just like everyone else. They think of it more as digital gold as opposed to something else. So I was most intrigued by his commentary around the NFTs, quite frankly.
Mark Odendahl
Thanks, that was a great rundown. And another major theme that we heard from a lot of the companies that were attending the conference was how they're really battling for that point of sale, or battling for the merchant. Competition is stiff, can you describe a few examples from the companies we heard from, and maybe talk a bit about how technology has disrupted that area, that area of point of sale?
Dan Perlin
Sure. We've been around the point of sale software space for longer than I care to admit. And what you found over the years is that, you had enterprise software that was integrated in these boxes and they were software inside of hardware, very expensive, typically sold by companies like Micros or some other company like Aloha out of NCR. And they dominated the point of sale market, but they really weren't very good for SMBs, very expensive, and again, they were integrated, it was software inside of a box. What you've seen over the past five to seven years is that as software has become much more amenable to the SMBs, i. e., it's no longer cost prohibitive and it's much easier to be distributed over the cloud, you're seeing enterprise software companies that are embedding payments inside of that. And so they've come up with much more elegant, much cheaper, much more efficient solutions for mostly SMBs.
Enterprise is still different, but for the SMB market it's been revolutionary. And so you've seen a whole host of companies. You had Square that started it early on, you've got Lightspeed, you got Toast that went public last year. You have some of the legacy players that are trying to get in there and revamp their products. So the list becomes lengthy, but what you're finding is that there was big parts of the market, call it 15% of all US payment (inaudible) was still processed through these third- party resellers, which don't provide a lot of technology and are not very much value enhancing. And so the share gains that you've seen within restaurants, as an example, are really coming, in many instances, because of those legacy players in the ISO market, these independent sales organizations. What's happened is that's manifested itself like this big secular growth story, and really what it's become is a massive market share shift story, which is still ongoing, but the space has become very crowded.
And so as a result, I think you're going to see some of the more, they'll be bifurcations. There'll be consolidations in the hands of the few as we say, and then there'll be everyone else. And I suspect that's how it's going to play out over the next five years, as opposed to this massive land grab that we've had over the prior five.
Mark Odendahl
Okay, so you talked about some new public companies that came public into the space in 2021. So as we move through '22 and even into '23, how has the competitive environment really changed? For instance, you mentioned we might be looking at a more crowded space, fighting for that merchant, fighting for that customer. So what will that look like? What are you seeing in the marketplace so far?
Dan Perlin
To say it's like A Tale of Two Cities is not even saying it properly because I think there were somewhere around 40, 42 new public companies in fintech over really the past, I guess 18 months or so, maybe 24 months. And the competitive narrative during that window of time was such that every one of these new companies that were coming to market were just going to crush anything else that had existed in and around the fintech space over the prior couple of years that maybe were there. So we sit here today and the conversations are quite different, and the reason that they're different is because not so much that there's not new entrants coming into the market, it's that the ones that came into the market are still, in many instances, beholden to customer acquisition models that were heavily funded by VC- backed firms or maybe newly raised capital. And so as a result, it makes it harder for them to be as aggressive as they once were, relative to maybe some of the more legacy players.
The other thing that's happening is a lot of those companies were not profitable or were close to it. And so in an environment where the cost of funds are going up dramatically, it's a tougher environment for them to operate in. And I think what that's doing from a competitive narrative standpoint is it's shifting it away from these no less than profitable, if not profitable at all companies that maybe once had a lot of growth, partly fueled by customer acquisition models that are not sustainable in the current context, relative to some of the more legacy players who have enormous cashflow dynamics, certainly grow slower, but this is their window of opportunity to take advantage of that mindset. And part of that will lend itself, I think, Mark, to a lot more M& A opportunities in this space.
Mark Odendahl: Okay, so let's talk about M& A, mergers and acquisitions. In general terms, without mentioning any specific companies getting together, what could M& A look like in the FinTech space over the next couple of years? How do you think about that?
Dan Perlin
So I would not be surprised if some, if not several companies that went public last year or the year before that are at a position where they need additional capital to fuel growth look to be acquired by some of these much larger public companies today. And again, not naming names, but I think the big legacy players are looking for those opportunities. The other thing that's happening, and we're seeing that in real time now, is public valuations have come in a ton, private valuations are starting to come in. One of the things we heard at Fintech from a lot of the private companies, because we had a little over or close to 40 companies, half of those were private, was that at the time their boards were not really prepared for a reevaluation down round. They just hadn't reached that point yet. But you've started to see that in lots of private companies that are happening.
Some very prominent, and again, I won't name them here, but there's a lot of prominent names where down rounds have occurred where companies were once valued well over $ 40 billion and now they're being valued at $6 billion, $7 billion. So these are huge reductions, and as those boards come to those realizations, many of which are held inside PE firms, those discussions can start to happen with some of these larger public companies. And I think they already are. We've heard that from some of the public executives, that those conversations, only in the past several weeks, quite frankly, have started to sound a little bit more realistic. And I think what that suggests to me is that in an environment where we've got this tough macro backdrop and maybe the organic growth environment is a little more challenged, these inorganic opportunities are going to separate, I think, some very successful companies from some, I think, more challenged ones. So I suspect in the next six to nine months, it's going to be a pretty heavy dose of lemonade in the space.
Mark Odendahl
That's great, Dan, thank you. Now, I don't want to do a podcast on the fintech space without at least talking about some of the more near- term trends. And I know you've just completed midyear earnings and a midyear look at the space, in which you adjusted some of your models and some of the things we're seeing in the marketplace right now, such as foreign exchange, et cetera. Obviously, FX is important to many of the companies we saw in attendance at the conference, Mastercard and Visa, for instance, have massive global businesses. So can you tell us a bit about what you're seeing, what you're looking for in this quarter and the coming quarters this year?
Dan Perlin
You're right, Mark, FX is clearly an issue. It's interesting because we first started talking about it right after FinTech, so you got to think about the timing of that, that was mid- June. I mean, a lot of the companies, even at that point in time, were starting to raise the red flag a little bit about how quickly the US dollar strength was going to start to play into their business. And so what we've done as we've canvased our universe is we have looked at really what I think companies have embedded in their guidance, relative to where these currencies sit today. And what we have found is that, for the most part, and I think across the entirety of the universe, I don't think anyone's really gotten this right, is that most companies are just way, way behind the eight ball as it pertains to where current euro- dollar rates are, the pound or the Canadian dollar, Australian dollar, I mean, you pick it, there's a lot of correlation between that right now.
And so historically, this would not be that big a deal because the swings wouldn't be that big. But right now, they're highly correlated and the moves are massive. I think numbers have to be recalibrated as people think about what FX means for these businesses. And to your point, it's not just about this quarter. If you think about the current quarter, there's real downdrafts here, but if you just carry current rates forward, this is a four, five quarter impact that I think what will happen is we're going to hear from managements in the current context, numbers will get recalibrated associated with that, and then it'll be a question of whether or not things get better and/ or worse from where we sit. Historically, it's not something that the fintech guy is flagging in the quarter is the FX exposure, but I am raising a flag pretty aggressively this time around because the moves are that material, and it's just very hard for managements to have reacted as quickly as they were probably needing to.
So that's clear. The other one that I think is somewhat worth mentioning is that for companies that have variable rate debt, here again, when we looked at the expectations embedded in guidance, what you find is that the pace of the Fed move has just been a lot faster than what people would've put in guidance. So on average, I think Fed's sitting here today up 150 basis points, most teams would've had probably 75 basis points embedded. So they're behind the eight ball on that as well. So this is going to be a very interesting time in the market for I think a lot of recalibrations, both in terms of FX exposures as well as companies that have higher variable rate debt, and what that means in terms of interest expense forecasts. But then you also have companies that have float exposure in the space and that's a net positive. So this is going to be a tough near- term season, but I think FX is the bigger issue for sure.
Mark Odendahl
Now, this was the seventh FinTech Conference you've hosted here at RBC. How have you seen these events change over time? If you think back to our original one versus the one we just hosted this summer, where has the growth been in terms of new companies presenting at this conference, and what are some of the trends that we discussed early on that have continued to build over the years?
Dan Perlin
It's great to think back over seven years of this thing. I would say one, the investor base that is interested in fintech has very much skewed over that timeframe to software and internet investors, as opposed to just payment- centric investors. That's been a huge shift. The other shift is the sheer number of companies that are out in this space now, and are of size. These are not complete startups. I mean, a lot of these companies have become very, very sizable very quickly. So the sheer magnitude of the companies we're able to speak with and have at the conference has grown over the years. I think the other theme though, as we think about it, is the blurring lines between what's happening in software, and enablement at either points of sale or enterprise levels. And that's just creating a lot of new cross- currents within the payment space in particular. So that's changed dramatically. In the early days, we might have talked about mobile payments, we might have talked a little bit about software at the point of sale, but today, those are all commonplace themes.
Last year, we talked a lot about buy now, pay later as a big thematic. Although that still resonates I think in the current market, it's a much more crowded space today. The economic backdrop calls into questions some of these lower income consumers and sustainability of how healthy they're going to be over the next 12 to 18 months. And the reality is, a lot of the buy now, pay later users, they're going to fall into that camp. That was another big thematic. The other one I would've said, as this thing has evolved over the years, we used to talk a lot about nationalistic networks and WeChat Pay and Alipay and Paytm and all of those networks that are outside the United States that we thought would be portable to other GOs. That's the case still, but it feels as though it's become less of a threat relative to, let's say, three or four years ago, when we would've had the networks back at the conference having that discussion.
So I think it's evolved into a much more mature industry. I think back in the beginning, I would've called it the island of misfit toys, and that's not really not the case today. It's grown up in its own space, and I think the real cross- currents are mostly fell between software and internet that's fallen into fintech.
Mark Odendahl
Well, the conference has certainly turned into a great event for us here at RBC Capital Markets. So thanks for all the work that you and our partners around capital markets have done. You put on such a great event that really explores these topical themes in depth, and bringing in the crypto leaders from Mastercard and Visa this year was something unique. I'm glad we got a chance to talk it over with our audience listening in here. Thank you very much for coming on the show again, Dan.
Dan Perlin
Thank you so much, Mark. It's always a pleasure.
Mark Odendahl
What else lies ahead in today's ever- evolving markets and industries? We'll be keeping track right here on Industries in Motion. Until then, thank you for joining us on this episode recorded July 14th, 2022. Be sure to subscribe to Industries in Motion wherever you listen to your podcasts. If you'd like to continue this conversation or are interested in more information, please contact your RBC representative directly, or visit us on the website, which is www. rcbccm. com/industriesinmotion for further insights. Thank you very much for your time today.
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