The Plaid for X: What’s Next for FinTech Infrastructure?

There’s been a significant amount of ink spilled over Visa’s $5.3bn acquisition of Plaid. Some have speculated that this will kick off a wave of FinTech consolidation from incumbents (e.g., Intuit / Mint), while others have suggested we’ll see an increase in funding of the “Plaid for X,” and many have said this was a strategic deal at the right time, for an incredibly well capitalized incumbent, without the need for much read across. We think the truth is somewhere in between but are focused on where opportunities lie as we continue to see FinTech morph into a platform in it of itself as Bain’s Matt Harris has coined.

While we’re never a fan of the X for Y pattern matching that you frequently see we think the “Plaid for X” parallel is more difficult than most. Plaid attacked a unique space in online banking. There were hundreds of millions of people in the US with online banking access where they knew their username / password. There are also 9,000+ banks / credit unions in the US alone, and tens of thousands of financial institutions globally. Plaid did not have to work with the banks directly to enable their client’s (FinTech firms) client’s (end-users) to connect to their respective bank accounts. This connection was important to enable financial service activity; namely the movement of money. There is little other functionality that needs to occur daily where you don’t need permission on behalf of the incumbent to be able to access said services, that everyone knows their credentials to login. If there is…let us know.

If you’re tired of Plaid / Visa, you can skip below to What’s Next for FinTech Infrastructure, but we wanted to say a few words on price / strategic rationale.

Valuation: While Visa and Plaid tried to provide little details as it pertains to price paid, based on guidance from V, their TAM slide, and anecdotal comments on the investor call we triangulated three different approaches to FY19, FY20, and FY21 estimated revenues arriving at $110mn in FY19 / $165mn in FY20 / $248mn at FY21 which equates to ~48.2x FY19, 32.1x FY20, and 21.4x FY21 sales. The first was simply based on the TAM Slide on 7 looking at their market share vs. what they pegged TAM to be to get to FY19 #s. The second was base on V revenue guidance for FY21. The third was based on comments from V management that accounts / revenue grew “proportionally” off of a 2017 base where it was reported Plaid did $40mn. Whether it’s 20.0x-40.0x either way it was a healthy price paid. So why did Visa do it?

Visa’s Ability to Pay / Strategic Rationale: Visa has been one of the most impressive public companies over the past 15 years as it has seen EBITDA margins expand from 27% in 2005 to 70% in 2020E with net income margins expanding from 13.5% to 54.0% over that time period due to the significant operating leverage in the business. Visa has the world’s largest share of payments outside of China and is often described as a tax on global commerce. In the past fiscal year Visa processed over $12 trillion in total transactions which is nearly 2.0x Mastercard. Visa has a real economic moat as a result of size and scale of its payment network, and the advent of new technology products all of which are meant to drive incremental volume to VisaNet, which largely has a fixed network expense.

To put the $5.3bn price tag into comparison that represented ~1.3% of undisturbed enterprise value and ~3.5 months of EBITDA.

Visa 15-Year Financial Performance per Bloomberg
Visa’s ~$392.5bn Undisturbed EV

While the deal deck was light on details V noted that Plaid accomplished three main things for V including:

Enhances Visa’s role as a partner to FinTech developers globally- V was clearly trailing MA in the race for FinTech relationships, despite being ~2.0x the size. They viewed Plaid as a best-in-class team & product to close that gap and the acquisition provides them access to 2,600+ FinTech & Financial Institution Developers. This web of connectivity is concurrently integrated into 11,000 financial institutions, with 200+ million customer accounts including 1 in 4 people with a US bank account.

Expansion of Total Addressable Market- As Visa looks to expand their footprint, they’ve highlighted several opportunities including P2P (which Visa pegs at a $1.0 trillion opportunity) & B2B transactions (which Visa pegs at a $9 trillion opportunity). Visa highlights the importance of the FinTech industry noting that ~75% of internet enabled consumers have used at least 1 FinTech app; they peg this number to be ~3.375 billion people (which is greater than the internet enabled consumer population a mere ~5 years ago). One of the most significant opportunities is the expansion of Plaid to international markets which represents >50% of Visa’s total payment volume.

Acceleration of long-term revenue growth trajectory- This is perhaps the most important part of the strategy and something Visa management talks to often. Visa historically has been viewed as a card processor but in recent years has referred to itself as a “network of networks.” On the conference call CEO Al Kelly mentioned the desire to “move to move from being strictly focused on payments to being focused on the movement of funds for any purpose.” Plaid can play a big part in that for V as this allows them to be a significant player in any money movement not involving cards, all of which will accrete to Visa Direct. Mastercard announced a similar deal last summer in their largest acquisition to date when they made a $3.2bn acquisition of the account-to-account business of payment-technology company Nets, which followed their 2016 purchase of Vocalink. Both companies are concerned that as a society we are moving away from plastic spending (e.g., debit / credit cards) as payments begin to originate directly out of bank accounts, utilizing QR codes, or NFC technology, and potentially bypass the card-networks they’ve built. This is why they are laser focused on the “movement of money” holistically. Visa notes the acquisition enhances coverage of P2P and B2C use cases, while providing acceleration of cross-border, “network of networks” money movement strategy. They also note the ability to tack on value-added services including security, identity, and dispute resolution to FinTech firms; which are largely missing today.

What’s Next: Just because we don’t believe in the Plaid for X, we do think FinTech infrastructure is ripe for further investment and M&A activity amongst both challengers and incumbents. First let’s take a look at incumbent infrastructure and why challengers should aspire to emulate parts of the stack.

Infrastructure isn’t sexy. It’s tough to have a constantly evolving KPI dashboards with new user growth, ever-changing LTV / CAC ratios, and small wins every day. In regulated industries such as financial services it’s even harder. These businesses require significant up-front investment, typically some semblance of a regulated license or integrating into a regulated incumbent and are capital intensive in the early days. However, if you look at incumbents some of these businesses are the most defensible with significant regulatory moats, high barriers to entry, and designations as systematically important financial institutions which makes their removal all but impossible. Some examples:

· BNY- If you think about incumbents it’s hard to beat the longevity of BNY. Bank of New York Mellon traces its origins back to 1784 when Alexander Hamilton founded The Bank of New York. They divide their business into two segments Investment Services & Investment Management. Investment Services offers custody, corporate trust, clearing, collateral management, credit, FX, derivatives, depository, and cash management services and has $35.8trillion in AUC/A. Investment Management is a vanilla asset management product with $1.9 trillion in AuM.

· Broadridge- Broadridge describes themselves as a global FinTech leader providing “investor communications and technology-driven solutions to banks, broker-dealers, asset and wealth managers and corporate issuers.” Broadridge processes on average over $7.0 trillion in equity and fixed income trades per day in the US / Canada. They processed ~80% outstanding shares in the US for proxy services, they provide trade processing to 19 of the 24 primary dealers of Fixed income, and the processed over 6 billion investor & customer communications. While they claim to operate in a highly competitive industry, they have a license to print money on the clearing side of their business.

· State Street- State Street dates their lineage back to the founding of Union Bank in 1792, while its current charter was authorized by Massachusetts Legislature in 1891. How’s that for an incumbent? They too have two predominant lines of business 1) Investment Servicing & 2) Investment Management. In Investment servicing they provide core custody services + value add offerings such as clearing, settlement, and payment services. As of 9/30/19 State Street had $32.9 trillion of AUC/A. Their Investment Management line of business provides core / enhanced indexing, quant and fundamental strategies. As of 9/30/19 State Street had $2.95 trillion of AuM. They are also considered a systemically important financial institution. If you look at their investor deck their main priorities “improving our cost base” because despite fee compression those $30.0+ trillion aren’t going anywhere anytime soon.

If you think about the technological disruption that has up-ended industries how do two firms that have been around for a combined 464 years still custody $66.0 trillion of assets and generate nearly $30.0bn of top line revenue for largely the same job they’ve done forever? Bottom line it’s nice to be infrastructure even if it’s not sexy.

Are there challengers today that via the nature of what they build can be the incumbents of the future? Are there FinTech companies that can replicate the moats of V / MA and create that type of operating leverage which tends to be well in excess of what the “quasi monopolies” can command?

If we look at the different layers of FinTech infrastructure the verticals that we’re predominantly focused on include:

· AML / KYC

· Banking Core Technology

· Custody / Clearing

· Data Aggregation

· Distribution

· Exchanges

· Middleware

· Payments

AML / KYC

Move fast & break things doesn’t work in financial services. It’s one of the most regulated industries globally and for good reason; you can’t mess with people’s money. Some startups in the space have learned this the hard way, while other’s have had small slaps on the wrist. Either way as we look at the re-bundling trend that’s occurring across financial services the identity layer is critically important as it pertains to AML / KYC. The Bank Secrecy Act of 1970 is the US law that requires financial institutions in the US to detect & prevent money laundering. The US Patriot Act which was finalized in October of 2002 made KYC mandatory for all US Banks. As the rest of the FinTech industry rapidly evolved the regulatory compliance & fraud prevention space lagged. This became more problematic as FinTech users grew; if we look at Plaid alone the number went from 10.0mn accounts in 2015 to 200.0mn+ accounts in 2019. As individuals open up numerous checking / savings accounts, lending accounts, credit cards, etc… there’s a significant opportunity at the KYC / AML identification layer.

There’s a real need to bring together the disparate data sources from the various financial institutions to improve user on-boarding experience, and company compliance. Firms like Alloy have some of the most compelling offerings on the market with a customizable API to create a seamless user on-boarding experience. They allow clients to more cost effectively perform their regulatory responsibilities while helping to reduce fraud and automate previously manual intensive processes. Alloy is checking 30+ different sources / data points ensuring proper account creation, whereas firms such as ComplyAdvantage focus on maintaining compliance with transaction monitoring.

Who are the potential buyers here? We think firms like Thomson Reuters through their World-Check program with Refinitv would be natural buyers.

Banking Core Technology

If we look at the banking core’s there are three main competitors in the US including FIS, Fiserv, and Jack Henry. The WSJ had a good article last April discussing small bank frustration with these incumbents who attempt to bring big-bank technology to firms that can’t internalize these services. “I’ve met with over 3,000 bank CEOs, and this came up time and again: the challenges and constraints they face with their core provider,” said Rob Nichols, chief executive of the American Bankers Association.

One of the interesting players in the space is Finxact which received $30.0mn from the likes of the American Bankers Association, SunTrust Banks, First Data and others. As FinTech firms compete with incumbents there is a push to open banking allowing third parties to use their data; which Finxact will enable. Historically switching costs have been prohibitive as it required significant capital outlays coupled with hardware maintenance. Since Finxact is a cloud-based SaaS model charging on a per-user basis this significantly lowers the switching cost.

As we see from incumbent core providers there’s over ~$10.0bn+ / year spent on this type of technology which is only growing given ample opportunity for a challenger to become public scale. The core providers historically have been very acquisitive looking to find a new technology, buy the business, eliminate R&D, and sell it to existing clients. We could envision a similar scenario here where they look to acquire their FinTech challengers, or these businesses grow to 10 figure+ annual revenue numbers, while maintaining the 30%-40%+ EBITDA margins.

Custody / Clearing

As we think about the re-bundling trend that’s occurring with seemingly everyone rolling out fractionalized equity investing to complement their core product offering it’s really a two horse race between Apex & DriveWealth. Apex is the “FinTech incumbent” with backing from PEAK6 and SoFi. They helped Robinhood first launch the trend of fractionalized equities and have since partnered with firms like Stash and SoFi on their respective offerings. In September of last year, they acquired Electronic Transaction Clearing which expanded Apex’s footprint in the institutional community. DriveWealth is the challenger that leads with a cloud-based architecture, and suite of modern API’s to enable execution, clearing, settlement, tax & regulatory reporting for clients which include Square Cash (15.0mn accounts), Revolut (8.0mn accounts), MoneyLion (5.0mn accounts), and Monzo (3.6mn accounts).

When you envision the suite of services that any user would want to have in a financial application whether it’s a discretionary brokerage account, a managed account, retirement, HSA, robo-advisory, round up investing, stock-back loyalty etc… this becomes a critical part of the stack that we don’t believe many firms would want to internalize due to the incremental regulatory burden.

We think firms like BNY or StateStreet could ultimately look to get into this business given the efficiencies these companies enable for the handling of retail accounts. We also don’t think the “shelf space” should be under-rated and the ability to funnel differentiated product through similar distribution channels via their front-end clients which could make this type of business compelling for a range of potential suitors.

Data Aggregation

What is Plaid? Plaid started to become a household name in the FinTech community but there was misunderstanding of their role within the ecosystem. Many thought it was a payments layer when in fact it was a data aggregation layer. While we discussed the importance & strategic rationale above, any analysis of FinTech infrastructure is incomplete sans the data aggregation layer; that said we think Plaid is only going to be further well entrenched post the Visa acquisition and see difficulty in anyone usurping their position as the clear leader. Broadly firms like Alloy straddle the line as it pertains to data aggregation, that said we’d be surprised to see yet another dominant challenger emerge over the next several years.

Distribution

Why did Facebook engage Morgan Stanley & Goldman Sachs on it’s IPO? Why did Uber follow suit and hire them as well? Without going into a debate about IPOs vs. Direct Listings and what value add (if any) investment banks bring to the process, the number 1 reason most companies engage them is for their distribution capabilities. These firms have spent (in many cases) hundreds of years building relationships with clients, client families, and institutional investors to have “distribution” for product they originate. Despite all the advances in technology it’s tough for those in need of capital to directly connect to those that have capital to deploy without these intermediaries. Why have some chosen to value Robinhood at $7.6bn? It’s not predicated on any discernable financial metric, but instead due to the ~10.0mn accounts they have which puts them just behind Fidelity, Schwab, and TD while being ~2.0x ETrade and Interactive Brokers combined. Why is that important? There is a view that they can be a distribution channel for the long tail of retail investors on a given IPO that has historically been held by some of the lower-middle-market investment banks, as well as the ability to put other banking products (savings accounts, credit cards, loans, etc…) in front of a sizeable amount of users who are experiencing a growth in discretionary and investable income.

When we talk about distribution the focus is largely predicated upon one of the most “untapped” channels that exists which is the RIA channel. There is ~$13.0 trillion of investable capital in the US sitting with the ~13,000+ RIA’s. Right now, they are significantly under allocated to alternative assets. While institutional investors have a ~25–40% allocation, those individuals at RIA’s attached to wirehouse banks (70% of assets) are often at ~8–10% and those in the independent channel (30% of the assets) are often ~1–2%. Companies such as Artivest, CAIS, and iCapital have done a good job at democratizing access to fund products to these channels. We think the next logical evolution is distributing single assets through this existing channel. You’ll want to have connectivity into several large pools of capital including 1) RIA’s 2) Family Offices and 3) FinTech incumbents.

These businesses become compelling for large asset management complexes (e.g., BlackRock, Fidelity, Franklin Templeton, Vanguard, etc…) and can also reach public market scale themselves.

A company that has connectivity to the 17 firms listed below can access ~180mn accounts and north of $15.0 trillion in assets. While this is significantly easier said than done, we believe there’s an opportunity for both “Exchanges” & “Middleware Platforms” to do just that.

Exchanges

The exchange industry has been one of the most acquisitive verticals within financial services given the economies of scale and operating leverage inherent in that business. Firms like ICE, NDAQ, CME, and CBOE were all formed after waves of consolidation and now support 60%+ EBITDA margins and 35%+ net income margins.

We think there’s significant white space opportunity in the alternative asset space. Prior to the Great Depression there was no concept of public / private markets, instead they were divided into regulated / non-regulated and liquid / illiquid markets. It feels as if we’re going back to that period of time as lines are once again blurring but those “non-registered” instruments are now looking for a liquidity destination.

We spoke about some of the tailwinds associated with alternative assets in our 2020 predictions article. Private markets continue to outpace public markets as it pertains to total capital raised and there’s the potential for trillions of dollars of incremental allocation from the RIA community. This allocation is only feasible if there’s a marketplace whereby investors can access liquidity.

In our view there are three ideal marketplace structures depending upon the supply construct of the marketplace:

· Supply of One- Auction is the best format

· No Meaningful Supply Constraint- Seller Lifting Model (e.g., AMZN)

· Supply Constrained- Stock Marketplace model is the most efficient.

For alternative assets it’s clear that the stock marketplace model would be the most efficient. We’ve seen several companies look to target this including firms like Carta, Cadre, EquityZen, Forge, Templum, SharesPost and Zanbato.

Given the acquisitive nature of the industry the incumbent exchanges are likely acquirers, while we could also see banks, or large asset management firms throw their hats into the mix.

Exchange Precedent Transactions Per BATS / CBOE Proxy
ICE now has 63% EBITDA margins / 39% NI margins
CME now has 68% EBITDA margins / 46% NI margins
NDAQ now has 54% EBITDA margins / 31% NI margins
CBOE now has 70% EBITDA margins / 38% NI margins

Middleware

The financial service industry has a fundamental problem as constructed today. Individuals think about money by purpose e.g., discretionary spending, student loans, recurring bills, retirement, travel, mortgage, home down payment, wedding, emergency payments, etc… Yet the industry is structured in regulated silos broken down by licenses e.g., banking, brokerage, retirement. These legacy players have trouble integrating given decades of technical debt, disparate systems, and regulatory constraints.

As we look at FinTech 1.0 the early companies sought to improve these vertical experiences such as Neobanks focused on banking, new-age brokerage firms, retirement accounts, etc… all with the attempt of easing the user on-boarding experience, eliminating friction, and modernizing the rails in which individuals interact with the financial system. As we see the next generation of FinTech companies the re-bundling trend continues to take hold as institutions are expanding horizontally to offer different product offerings to end-users. The problem with this is the complexity involved building across multiple financial silohs. Given the different regulatory licenses one needs to offer compliance, banking, brokerage, retirement, payments, and card issuance services this becomes a time consuming, and expensive build for front-end clients. A middleware solution becomes a much more efficient vendor management solution as you can have a single master contract with said provider as opposed to 6 disparate offerings to build your core product.

A properly constructed middleware solution needs to offer a unified experience for clients that solves the customer needs of thinking about money by purpose, and enabling the concept of “Autonomous Finance” or “Self-Driving Money.” This solution needs to allow compliance to scale for their regulated partners, at the same cadence front-end clients can leverage the API to build new offerings / services.

The middleware solution should be integrated into multiple banking partners, a data aggregator such as Plaid, a KYC/AML partner such as Alloy, a transaction monitoring solution such as Comply Advantage, a brokerage enabler such as DriveWealth, and a card issuance platform. These middleware platforms have 3 core client segments including 1) FinTech Firms 2) Incumbent Financial Institutions and 3) Non-Financial Brands (e.g. Tech) that are looking to get into financial services. While the offerings are largely similar the suite of services will vary significantly between clients.

At present the two largest players in the space are Cambr and SynapseFi, both of whom have run into issues in the past with their banking partners given the time / magnitude of sale. There are new challengers being built as well such as firms like Rize.

These firms have the ability to touch nearly every other segment we alluded to and as a result we think will see significant value accrual over time which leads to a number of potential exit opportunities. As it pertains to consolidation from incumbents we think banking core providers are interesting potential buyers.

Payments

As it pertains to payments, we also discussed payments in some detail during our 2020 forecast, describing the vertical as the “holy grail” of FinTech given the size of the market which is expected to approach ~$3.0 trillion/year in annual revenue. Within the FinTech space you can tie the Plaid / Visa deal back to this trend as everyone is focused on money movement more broadly and what happens as we transition away from physical cards to NFC with phones, QR codes, or if Amazon has its way biometric scanning. It’s tough to see a company better positioned than Stripe in this industry. We’re also focused on B2B / SMB payments, intracompany payments, and real time payments.

Those that gain market share here will be some of the largest standalone companies or will be attractive targets for V, MA, FIS, or even some of the large technology companies that may look to get into the space.

Bottom Line:

Bottom line we’re constructive on value accrual across the FinTech infrastructure layer and think the Visa acquisition of Plaid may accelerate the investment and speed of the R&D life cycles in the industry, allowing us to get to FinTech as a Platform sooner than we would have otherwise.

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