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Investing May 24, 2022

Fintech And The Great Unbundling Of Financial Services

Fintech is revolutionizing financial services forever.

By Accrete Team

Over the years we have witnessed the unbundling of financial services with incumbents being challenged by fintech leaders disrupting various categories such as deposits vs. challenger banks, lending vs. non-bank lenders and peer-to-peer lending platforms, passive investing vs. robo-advisory, and insurance carriers vs. mono-line DTC carriers, etc. 

Generally, what we have witnessed is that these businesses — some despite experiencing massive scale and growth over the years — are predicated on long cash flow J-curves to fuel customer acquisitions. As the industry has unbundled, we now see a convergence of platforms and service offerings, which has given rise to an emerging space of embedded finance, in other words, companies which enable regulated, often complex financial services products to be offered in one place at the point of purchase. ABN AMRO estimates this market to be worth $7.2 trillion by 2030.

Over the years, we have made a number of observations which we think are noteworthy when assessing opportunities in the space:

  1. While all fintechs may not be created equal, eventually they are broadly valued the same way. The intrinsic value of a financial services business is really determined by the book value of its equity. If a bank is able to generate a return on equity (ROE) over the cost of the bank’s equity (COE) (determined by capital market dynamics in its own country, country risk where it operates, as well as other factors such as inflation, etc.), then deservedly it should also receive a multiple on the book value of its equity over 1x. Clearly, growth and scalability also play a role in this equation, and, as such, most of Wall Street relies on an intrinsic price to book value of equity as ROE-g / COE-g to determine the P/B value you should pay. We believe that at steady state this will be the key determinant of value. 
  2. Like all emerging and fast growing sectors, we always prefer the picks and shuffles of the industry, and act as growth investors with a value lens. The embedded finance industry is made up of banking as a service, insurance as a service, lending as a service, and payments as a service and often relies on third-party platforms to provide meaningful regulatory infrastructure, a technology stack that is scalable, and ancillary services to support such activities as they scale. We find higher margins and increasingly healthy levels of profitability in such third-party businesses vs. the marketing heavy and dependent models in financial services. 
  3. Regulatory robustness is a competitive advantage. Charter holders or fully regulated platforms stand to win in the long term. While it certainly takes a longer period of time to secure a banking charter or to become a fully regulated platform and is more capital intensive in the early days, long term this pays off in terms of scalability. Usually it is very difficult once you have scale to then become regulated.

Learn more about opportunities in the fintech space here.

Last updated May 24, 2022
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