Back in 2017, we wrote about the incredibly rapid pace of growth in Chinese e-commerce and financial technology. To say the least, there’s been some water under the bridge since then — particularly the intensification of the economic and geopolitical conflict between China and the U.S. But one of our main observations was that by dint of necessity, China’s path was showing where the U.S. would also soon be going, in terms of e-commerce and fintech acceleration.
The 2020 pandemic has greatly hastened that process, and we believe the baton has now passed to U.S. companies in terms of global innovation and opportunity. This is especially the case in view of the apparent hardening of domestic Chinese political pressure against some tech innovators.
For investors, it’s key to note the opportunity China’s “social commerce” giants were seizing, and what the big U.S. fintech players have long known: this battle is about a lot more than just the plumbing of electronic payment systems.
The real focus on the battle is on integrating the entire funnel of consumer engagement, or in the jargon of the industry, “owning the relationship.” Such “ownership” allows the fintech platforms to offer value to both merchants and consumers.
The two most prominent U.S. companies in this area are Paypal [PYPL] and Square [SQ] who through their Venmo and Cash apps have become ubiquitous in the daily lives of Millennial and Gen Z consumers. Of course, there are other well-heeled and data-rich contenders in the emerging “wallet wars” — notably Apple [AAPL] and Alphabet [GOOG], but PYPL in particular, thanks to a series of strategic acquisitions, including Venmo and Honey, may be pulling away as the leader — though 2021 promises to be a highly competitive year. (Of course, the fintech offerings from AAPL and GOOG are small components of those companies, and their efforts in this area are much less likely to be needle-moving for earnings than the current aggressive strategies of PYPL and SQ.)
In essence, the “pure-play” fintechs are setting themselves up to move beyond being online payment systems, into being full-fledged digital banks, with additional native e-commerce integration.
PYPL and SQ have both added cryptocurrency functionality to their apps; PYPL’s will allow seamless e-commerce transactions using cryptos without any burden placed on merchants (another value add for PYPL acceptance from a merchant’s perspective). PYPL is rolling out other enhancements to the platform to introduce major elements of digital banking: billpay, direct deposit, check cashing, and consumer budgeting tools. All of these serve to increase the funding held at Paypal, which drives down Paypal’s costs per transaction — a savings which translates into significant earnings leverage (each 1% shift towards the use of balances drives a 3% improvement in earnings per share, according to Deutsche Bank analysts).
Several other PYPL initiatives are significant in our view. One is the new “Pay in 4” buy-now-pay-later program, which permits a buyer to spread a purchase out across four payments. This capacity increases the likelihood that a consumer will buy, and increases the average value of a purchase, which makes merchants happy and eager to use the PYPL platform, thus acting as a customer acquisition flywheel. Of course, this is a form of credit, so its success depends on PYPL’s capacity to mine their data to make correct credit decisions. We believe this is an area where they will probably outperform their legacy peers, given their native integration of AI and their provenance as a digital-from-inception company. There are other fintech startups specializing in the “buy now pay later” or “rent to own” area, which may prove a lucrative avenue for development; investors should be alert.
Another potentially beneficial initiative is the rollout of QR codes for merchants, integrated with the PYPL app. This will finally allow mobile consumer transactions to follow in their Chinese peers’ footsteps, with web and brick-and-mortar purchases as easy as snapping a picture with their phone.
Discount and coupon apps and programs also offer fintech companies a variety of benefits with large potential network effects in the future. For example, the Honey app and browser extension acquired by PYPL allows consumers to search for bargains, directs them towards deals, and lets them maintain want and watch lists to be notified when items drop in price. All of this information is very valuable to PYPL and to merchants that accept it — offering SKU-level granularity of data on consumer intent.
It is not difficult to image a near future in which geofencing allows PYPL to discover that a consumer is in a particular store, and allow that store to push an offer on an item that is in stock, which that customer has placed on a watch list — and cue up the relevant QR code to make the checkout process contactless and seamless.
All these features and capabilities expand fintech platforms’ value propositions dramatically and synergistically. It will take time before the flywheel effects begins to manifest — but as part of the pandemic accelerated digitization shift, investors should not neglect pure-play fintechs.
Investment implications: 2020 has been the year of digital acceleration. Fintechs are an essential component of that theme. We particularly like fintechs that are deepening into more comprehensive digital banking, payments, and e-commerce platforms via strategic acquisitions and new product offerings.
Please note that principals of Guild Investment Management, Inc. (“Guild”) and/or Guild’s clients may at any time own any of the stocks mentioned in this article, and may sell them at any time. In addition, for investment advisory clients of Guild, please check with Guild prior to taking positions in any of the companies mentioned in this article, since Guild may not believe that particular stock is right for the client, either because Guild has already taken a position in that stock for the client or for other reasons.
