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Prepare For A Future Where FinTech Firms Dominate: Buy & Be FinTech

In the future where Fintech firms dominate, established companies are reacting with three main strategies:

Cut costs for legacy business lines – like what we said in a previous post Banking Headcount Cut
Consolidate with other legacy companies to gain more market share and thus more say/power, further cutting expenses and trying to get more economy of scale – like what we said in the last post From TD Ameritrade To E-Trade: A Wave Of Consolidation
Acquire Fintech startups or replicate what they are doing – like the title of this post Buy & Be FinTech

Visa x Plaid

In Jan 2020, Visa said it will acquire Plaid $5.3 billion. The deal includes a $4.9B cash consideration and $400M of Visa stock as retention equity and deferred equity consideration.

Plaid is a Fintech firm that enables a lot of other Fintech apps & digital transaction based businesses, providing underlying APIs. It counts Venmo, Robinhood, Coinbase, Acorns, etc. as customers.

Previously in Dec 2018, Plaid raised $250 million Series C at a valuation of $2.65 billion, led by Mary Meeker with capital from Kleiner Perkins’ growth fund. The growth.

In its mid-2016 financing tho, Plaid was only valued at $200 million.

The growth of valuation is supported by the growing business, the network effect and the sticky/recurring nature.

Through the Plaid acquisition, Visa secured a very strong spot in the future of Fintech and can expand/build upon the Plaid’s platform.

In Visa’s presentation, there is a list of Fintechs with rapidly growing users, on the top of which is Credit Karma with 100 million users.

Intuit x Credit Karma

On Feb 24, Intuit (Nasdaq: INTU) announced that it has agreed to acquire Credit Karma for $7.1 billion in cash and stock. (50/50).

Credit Karma lets people check their credit scores, shop for credit cards and loans, file taxes and more. It had close to nearly $1 billion revenue in 2019, growing at 20%.

In 2018, Credit Karma was valued at $4 billion when Silver Lake purchase $500 million in the secondary market.

The company started out originally in 2007 providing free credit scores, later extending that to full credit reports. Credit Karma’s launch of a financial planning tool in 2013 drew a direct comparison to Intuit’s Mint. And since then, Credit Karma has launched other products that directly rival Intuit, for example a free tool to help people file their taxes. These not only represented direct competition, but a disruptive threat, since Credit Karma’s products skewed younger and were built on a “free” premise (offering the products at no charge and instead making money off showing users and selling relevant, related products). The fact that Credit Karma partners with so many other financial services providers also means it’s sitting on a huge data trove that it leverages to build and personalize products, representing a data science angle for Intuit here, too. [TechCrunch]

Meanwhile, besides the notable acquisitions of Fintechs, companies are building similar services by themselves.

In Jan 2020, Goldman Sachs launched a long-awaited app of its online bank Marcus for customers . The bank launched Marcus in 2016.

And BofA’s AI-powered assistant Erica has pulled in more than 10 million users. Zelle peer-to-peer (P2P) payments increased 76 percent year-over-year in the fourth quarter of 2019.

While JP Morgan has closed its experimental mobile banking app Finn last year, its own branded mobile app is ranked one of the best. The idea was for Finn to reach locations—St. Louis among them—where it didn’t have branches.

By mimicking the experiences/apps offered by startups, established players are essentially becoming Fintechs themselves, thus evolving internally and embracing the future more positively.

From TD Ameritrade To E-Trade: A Wave Of Consolidation

Following the underlying trend of growing Fintech companies grabbing more customers & market shares (also discussed in a previous post about job cuts in banks), traditional financial service providers such as brokerage firms are thinking about their future.

And one answer is to consolidate the industry with mega M&As.

Charles Schwab x TD Ameritrade

In November 2019, Charles Schwab agreed to buy smaller rival TD Ameritrade in a stock-swap transaction valued at about $26 billion. Schwab will issue 1.0837 shares for each TD Ameritrade share.

The deal will create a company with more than $5 trillion in assets under management. TD Ameritrade will contribute approximately 12 million client accounts, $1.3 trillion in client assets.

The press release also says, “on expenses, current estimates are for approximately $1.8 to $2 billion run-rate expense synergies, which represents approximately 18-20% of the combined cost base” – a $2 billion cut in headcount and operating budget.

TD Ameritrade had a LTM revenue of $5.665B as of 2019Q3, thus receiving a roughly 4.6x revenue multiple. Or taking the revenue declines into account, it represents a 5.0x NTM revenue ($5.2 billion) multiple. Also, it’s around $2,167 per client account.

Morgan Stanley x E*Trade

On Feb 20, 2020, Morgan Stanley said it agreed to buy discount brokerage pioneer E*Trade for $13 billion. Also an all stock deal, E*Trade stockholders will receive 1.0432 Morgan Stanley shares for each E*Trade share, which represents per share consideration of $58.74.

Combined platforms will have $3.1tn client assets, 8.2 million retail client relationships and accounts, and 4.6 million stock plan participants. E*TRADE has over 5.2 million client accounts with over $360 billion of retail client assets.

Similarly, the acquisition price represents a 4.5x LTM revenue multiple. Also, it’s $2,500 per retail client account.

What We Can Learn From GrubHub’s Earnings

As a pure-play food delivery public company, GrubHub has a lot to provide for investors interested in this field.

When it went IPO in April 2014, GrubHub had an average of 135,000 orders daily in 2013.

In 2019Q4, that number has grown to 502,600 (almost 4x). But the year-over-year growth rate has dropped to single digit.

One slowly growing number is the gross dollar value per order, which was $30.74 in 2017Q1 and $33.56 in 2019Q4.

The per order value could implies that group buying (>1; friends gathering, small corporates/teams, etc.) is probably a major purchasing behavior on GrubHub. It’s also a natural choice when people can “split” the overhead (all sorts of fees).

The average order value increases by ~10% in two years and could continue to grow if more business users order food deliveries.

Of the GMV, GrubHub only takes commission, delivery and others as fees (revenues). That “take-rate” has increased from 17.4% in 2017Q1 to 22% in 2019Q4.

The increase could be due to the increased marketing spending by restaurants. See a brochure for Grubhub pricing. But eventually, the take-rate will be reflected in foods’ prices and split with consumers.

That increase is good for the company but consumers may feel that food delivery has become more expansive while what they are buying is not better.

Cross major marketplace platforms, due to the delivery part of business, those food delivery companies might take a bigger % of the GMV as revenues.

The most concerning part of the costs is called “Operations and Support”, which grew from 38% in 2017Q1 to 56% in 2019Q4.

A large part of that increase is due to the shift from independent contractors to GrubHub employees – on which regulators and other gig economy companies spent a lot of efforts.

Food delivery is still a very competitive space and market share needs to be won city by city. Compared with ride-hailing, which two big players remain in the US, we might see a few more players competing without major consolidation in the near term.

a16z: 100 Marketplaces

Andreessen Horowitz introduced the Marketplace 100, a ranking of the largest and fastest-growing consumer-facing marketplace startups and private companies.

The top 4 companies (Airbnb, Doordash, Instacart, and Postmates) account for 76 percent of the list’s total observed GMV

Fast-growing marketplace startups grow quickly in the early years—often >3-5x year-over-year

Banking Headcount Cut

HSBC recently surprised the outsiders with a 35,000 job cut plan in three years.

The largest bank by asset in Europe, London-based HSBC does most of its business in Asia.

Financial Times reported last year in October that HSBC has embarked on a cost-cutting drive that threatens up to 10,000 jobs, as its new interim chief executive Noel Quinn seeks to make his mark on the bank.

It will now cut the headcount from 235,000 to about 200,000 in 2022.

It is also not a surprise as fintech companies are becoming more compelling and providing more superior services efficiently.

The long-term trend is inevitable. For example, in retail banking, every major bank is shutting down branches. The previous “comparative advantage” of having more footprint in the last century has become a liability. The bigger they were, the more pain they were feeling.

In a Jan 2017 report, The Guardian said HSBC “will be left with 625 branches by the end of the year [2017], which means it will have more than halved its high street presence since June 2011 when it had 1,301 branches.”

And in today’s report, HSBC US said the bank will close about 80 branches this year in the U.S. alone, a reduction of about 30%.

Other retail banking services such as trading and wealth management are also shifting online + automation. Younger generations just don’t need much face-to-face financial services and digital infrastructure has become more potent than ever. The industry’s reduction in cost structure leads to lowering fees and squeezes every player who couldn’t adapt (fast).

Many Institution services are also digitalized/automated.

Not surprisingly, many parts of the investment banking world such as trading are cutting headcount as well.

Last August, Financial Times reported that

Almost 30,000 lay-offs have been announced since April at banks including HSBC, Barclays, Société Générale, Citigroup and Deutsche Bank. Most of the cuts have come in Europe, with Deutsche accounting for more than half the total, while trading desks have been hit hardest.

A graphic with no description — Source: FT

「What’s News In China」

On Feb 14, Oaktree Capital Management, a Los Angeles-based distressed debt manager, became the first foreign company to set up a wholly owned unit in China under a trade accord with the U.S. The Beijing-based subsidiary has a registered capital of $4.55 million. // Caixin

On Feb 17, OYO reported a $951 million revenue globally for the financial year ending March 31, 2019, growing 350% yoy. In 16 month, OYO China has grown into an annual revenue of $307 million (~1/3 of total revenue). While facing more pressure, OYO China now has expanded into 3 brands and signed up 19,000 hotels. // TechCrunch | FT

Coronavirus has pushed many industries in China to go digital. In the past few weeks, there are booms in enterprise remote working apps 远程办公 (DingTalk surpasses WeChat to rank first in the App Store in China on Feb 5), online house tours 云看房 (of the top 100 residential real estate developers, 92 have launched the online selling services), online grocery shopping 生鲜电商 (Miss Fresh GMV grew by 321% yoy during the Chinese New Year), etc.

Tesla (NASDAQ: TSLA) is in advanced stages of talks to use batteries from Contemporary Amperex 宁德时代 (SHE: 300750) that contain no cobalt – one of the most expensive metals in electric vehicle (EV) batteries – in cars made at its Gigafactory 3 in China. Tesla started to deliver cars from that factory in December 2019. // reuters

Industries For Reducing Greenhouse Gas

Greenhouse gases trap heat and make the planet warmer.

Several of the major greenhouse gases occur naturally but increases in their atmospheric concentrations over the last 250 years are due largely to human activities. Other greenhouse gases are entirely the result of human activities. [IPCC’s Fourth Assessment Report]

Carbon dioxide (CO₂) is the primary greenhouse gas emitted through human activities.

Global GHG emissions by gas: 65% is from carbon dioxide fossil fuel use and industrial processes. 11% is from carbon dioxide deforestation, decay of biomass, etc. 16% is from methane. 6% is from nitrous oxide and 2% is from fluorinated gases. — Based on global emissions from 2010 | Source: IPCC, EPA

In 2017, CO₂ accounted for about 81.6 percent of all U.S. greenhouse gas emissions from human activities.

Emissions of CO2 from fossil fuel use and from the effects of land use change on plant and soil carbon are the primary sources of increased atmospheric CO2.

For total U.S. CO2 emissions, which mainly come from the combustion of fossil fuels (coal, natural gas, and oil), by economic activity types, transportation accounts for about 34.2 percent, electricity accounts for about 32.9 percent, industrial processes accounted for about 15.4 percent.

Pie chart of U.S. carbon dioxide emissions by source. 33% is from electricity, 34% is from transportation, 15% is from industry, 10% is from residential and commercial, and 7% is from other sources (non-fossil fuel combustion). — Source: EPA

1. Passenger Vehicles Going Electric

An analysis by the International Council for Clean Transportation (ICCT), shows an estimate of lifecycle emissions for a typical European conventional (internal combustion engine) car, the hybrid conventional car with the best available fuel economy (a 2019 Toyota Prius Eco), and a Nissan Leaf electric vehicle (best-selling EV overall in Europe for 2018) for various countries, as well as the EU average.

An electric car using average European electricity is almost 30% cleaner over its life cycle compared to even the most efficient internal combustion engine vehicle on the market today

In most countries, the majority of emissions over the lifetime of both electric and conventional vehicles come from vehicle operation – tailpipe and fuel cycle – rather than vehicle manufacture. The exception is in countries – Norway or France, for example – where nearly all electricity comes from near-zero carbon sources, such as hydroelectric or nuclear power. Lifecycle emissions for electric vehicles are much smaller in countries such as France (which gets most of its electricity from nuclear) or Norway (from renewables). [carbonbrief]

There is an important variable here – how the batteries of EVs are produced, as the largest part of the emissions, around 50%, is currently from battery (including cell) manufacturing.

Producing batteries in a plant powered by renewable energy – as will be the case for the Tesla factory – substantially reduces lifetime emissions. The IVL researchers estimate that battery manufacturing emissions are between 61 and 106 kg CO2-equivalent per kWh.

With the technology advancements and cleaner energy sources for plants, the marginal and average cost of producing batteries will continue to go down.

Casper’s IPO And Valuation

DTC is a buzzword that attracts capital in the private market.

However, public market usually doesn’t have much patience or appetite for future stories.

Casper, the magical mattress unicorn, which raised $100 million in March 2019, marketing itself as a “Sleep Economy” company, is receiving a market cap of $400 million (EV ~$300 million).

The main problem though, is not about the DTC model.

Brands such as Canada Goose and Lululemon are counting on DTC to grow.

The slowing revenue growth rate is also okay. Public market is not relentlessly looking for 100% or 50% growth.

Indeed, Canada Goose and Lululemon, which grew at sub-25% in the last 12 month, are valued at over 4x and 8x sales respectively.

Casper, which is expected to grow at 23% for 2019, has EV/Revenue below 1x.

The cost structure is where things are different.

From 2019 April to December (FY20Q1-Q3), Canada Goose‘s SG&A expenses are 31.2% of revenue.

From 2019 February to October (FY19Q1-Q3), Lululemon‘s SG&A expenses are 36.4% of revenue.

That ratio is 70.5% for Casper from Jan to Sep 2019.

Plus the differences in gross margin, the unprofitable DTC brand growing at sub-25% still needs additional efforts to prove its business is viable/sustainable.

「News of the Week」Tesla, $968.99/share

Financial Times – Tesla shares surge again despite Saudi Arabian exit

Tesla made the company the world’s second-largest carmaker by market value.
The stock rose as much as 24.2 per cent to $968.99 about 12 minutes out from the closing bell, closing at $887.06.
The stock has more than doubled since the start of the year.
The stock notched their most actively traded day on Feb 4, with ~61 million volume.
Tesla reported a $105 million profit for 19Q4 the week before
Short squeeze – On top of the record dollar loss of $5.8bn in January, short-sellers lost a further $3.2bn as the extraordinary share price rally accelerated on the first day’s trading of the new month.
Tesla’s recent delivery from its Shanghai factory to the China market added to the enthusiasm. It is the first fully foreign-owned car plant in the country.

Youtube’s First Official Financial Result

It has been more than 13 years since Youtube was acquired for $1.65 billion by Google back in October 2006.

Founded in February 2005, with $11.5 million total venture funding and 65 employees at that time, Youtube commanded 46% of visits to U.S. online-video sites in September. That compared with a 21% share for the video activities of News Corp.’s MySpace site and 11% for Google Video. Youtube had close to 20 million monthly visitors in August 2006.

A year and half before Youtube’s acquisition, MySpace’s parent company Intermix Media Inc. was acquired by News Corp. for $580 million.

Back then, Google reported total revenues of $6.14 billion in 2005 and $10.60 billion in 2006, and had a market value of $132 billion. Its net income was $3 billion in 2006 with $3.6 billion cash flow from operations and more than $11 billion cash balance.

On Monday Feb 3, 2020, Alphabet first provided the breakdown for some of its non-Google-search businesses, including Youtube.

Year Ended December 31,
	2017		2018		2019
Google Search & other	$	69,811	$	85,296	$	98,115
YouTube ads⁽¹⁾	8,150		11,155		15,149

(1) YouTube non-advertising revenues are included in Google other revenues.

Youtube ads generated $4,717 million revenue in 2019 Q4 – a ~$19 billion run rate.

Using a multiple of 5.0x, Youtube could be valued at ~$100 billion – a 60 times return for google acquisition or an IRR of 37% for 13 years.

I guess the success formula is: with the right synergies, acquire early & provide support to grow it.

Alphabet 2019 10-K

2019 Q4 Earnings Call Transcript