Where is Value in Fintech?
When you wish upon a star
Makes no difference who you are
Anything your heart desires
Will come to you
"When You Wish Upon a Star" (1940)
May 2, 2022 | Last week, it finally began to dawn on a number of analysts that the gains seen in many part of the US economy during the period of extraordinary ease by the Federal Open Market Committee in Q1 2020 were transitory, to borrow the now famous phrase. With the mere suggestion of an end to quantitative easing or QE, stocks are swooning, down the most since 2008.
Bond bond prices too are falling as real interest rates revert with astonishing speed to the very mean. The scene makes us recall a favorite observer from antiquity, Charles Mackay, who wrote in 1841 (h/t Edward Chancellor) in the Extraordinary Popular Delusions and the Madness of Crowds:
“Is it a dull or uninstructive picture to see a whole people shaking suddenly off the trammels of reason, and running wild after a golden vision, refusing obstinately to believe that it is not real, till, like a deluded hind running after an ignis fatuus, they are plunged into a quagmire?”
No matter how humans may think that we govern our own actions, in fact we are animals hard-wired to chase the shiny object. Whether it is crypto or top-performing banks in 2021 like Silvergate (SI) or Western Alliance (WAL) or Tesla Motors (TSLA), the movement draws our attention irresistibly. We all are just small mouth bass in June hitting anything that touches the surface of the water.
Those “wish upon a star” names in the magical world of fintech, stocks that could only ever thrive and issue public securities under QE, are headed south fast, back to something approximately fundamental value + a growth premium. We’ll be writing about some of these magical names in the Premium Service of The Institutional Risk Analyst in coming weeks. Our surveillance list for Fintech stocks is shown below.
Source: Bloomberg, Google
This list of fallen angels may be tough for some investors to view, but the roll call of wannabe fintech names that did not make it out of the proverbial birth canal is a lot longer. Names like RobinHood (HOOD), WISE PLC (WISE) and Marqueta (MQ) have been hammered for the past year, but recently stabilized near 52-week lows. Yet there are some more substantial names such as PayPal (PYPL) and SoFi Technologies (SOFI) that have performed even worse, evidencing the more general market angst as the FOMC prepares to change directions and in a dramatic fashion.
The question about value in these stocks is to a large degree a function of the Fed, which is likely to raise interest rates sharply and at least stop reinvestment of portfolio redemptions. Much of the exuberance that took payments plays such as legacy provider Fiserve (FISV) and new arrival Block Inc (SQ) to highs in 2020 and 2021 is now gone, thus the entire sector has given up roughly half of its value. Notice that crypto enabler Coinbase Global (COIN) is now trading at just 8x earnings, surely a bargain until you see the slowdown in crypto volumes as well as prices. The shark must swim or die.
As we have noted with respect to the banking sector, the higher beta stocks in the fintech sector have returned to more or less 2020 levels for the stocks, with names like SQ again below $100 vs $281 last August. Indeed, if you lay these names onto a single graph, the sector looks remarkably homogeneous.
When we first purchased SQ five years ago, we took the rule of the shinny object as our operative thesis. Our investment strategy included the likelihood that the thundering herd of equity managers would eventually discover this relatively new payments (aka "fintech") platform. It was not so much about blockchain or new markets, merely the fact that the swarms of wealth managers out there really want, no, desperately need to own fintech stocks.
Many managers who follow the "deep value" school of Cathy Wood and the ARK Innovation ETF (ARKK) have, in fact, been riding the wave of momentum driven by COVID and the response from the Fed and Congress. Now that this wave of fiat cash has subsided, what do managers who held onto ARKK or these individual stocks all the way down do? Double down on fintech? We may need a larger trash container on the virtual trading floor. After all, the two is more important that the twenty when it comes to equity investment managers.
Use as an operative benchmark the fact that ARKK's value has been cut in half since the start of 2022. Now that the great liquidity water balloon inflated by the FOMC in April 2020 is starting to shrink, the aspirational stocks must necessarily suffer. Many of the names on our fintech surveillance list have specific reasons for declining, but the common element in the narrative is the retreat of the speculative hoard, the same crowd that pushed up crypto currencies, fintech stocks and fix-and-flip homes and, yes, even mortgage servicing assets.
We’ll be writing about the FOMC-induced train wreck in residential housing in the next edition of The Institutional Risk Analyst. But here is the question: Are the more substantial fintech names like PYPL and SQ a value at these levels? For us, we first recall that both companies have growing businesses that deliver true value to their customers. Yet in the post QE era, managers may need to significantly recalibrate the measure of value. Does SQ deserve to trade on 300x trailing earnings? Without QE, probably not. SQ reports Q1 2022 financial results on May 5th.
PYPL, on the other hand, at just 24x trailing earnings seems a more reasonable value when compared to other financials. Take the financial performance and add some unicorn dust in terms of innovation to the mix and perhaps a double-digit PE ratio for PYPL makes sense. But the key thing for investment and risk managers to appreciate about fintech stocks and pleasant derivatives such as crypto is that the valuations of the past 24 months had more to do with COVID and QE than with the specifics of a given investment. Notice in the chart below from PYPL's Q1 2022 earnings release that payment volumes have plateaued in the past few quarters.
Of course, if blaming the collapse of fintech stocks on the end of QE makes you a tad uncomfortable when speaking to clients, then you can always seek comfort in the war in Ukraine or the fact that the US economy is stalling. Just remember that the swoon in names like PYPL, SQ and the rest began in Q4 2021, four months before the fighting began between Russia and the Ukraine. Naturally the thundering herd of equity managers will now run for cover in risk free assets, thus many of the fintech names could get a great deal less pricey in the days ahead.