There’s good reason that financial technology firms – those that provide the tools that allow consumers to save, manage their wealth, access credit, and pay for things – might pique an investor’s interest. The most important one: they have outperformed the S&P 500 for seven of the past nine years. Within the fintech universe, Credit Suisse says that payment firms are the most investable segment, due to the relatively large number of publicly traded companies of all sizes, and also offer investors a long-term growth opportunity.
The growth of electronic payments – i.e., non-cash payments – is a particularly promising growth story for the industry, though not by any means a new one, given the proliferation of credit and debit cards in the developed world. But an emerging leg of growth for electronic payments – and the payment firms that make them possible – lies outside of consumer card transactions. Credit and debit card-based consumer transactions account for just $4 trillion, or 5 percent, of the $78 trillion non-cash payment volume in the U.S. The other 95 percent consists of business-to-business, business-to-consumer, and wholesale payments.
Global banks, already a major customer for payment firms, are poised to send them even more business. Credit Suisse expects banks to spend $4 billion updating their core processing systems, which handle transactions and store customer data, over the next four years. And while it may seem like online and mobile banking are ubiquitous, there is still a lot of room for growth. While 87 percent of people said in a recent survey that they had visited a bank branch in the last 12 months, only 35 percent had used mobile banking. Though big banks tend to develop online and mobile payment processing systems in-house, Credit Suisse expects small and mid-size banks to outsource the work of improving their online and mobile offerings to companies such as Fiserv, Fidelity National Information Services, D+H, and ACI Worldwide. Credit Suisse also expects banks to invest heavily in simplifying their existing payment infrastructure. The bank’s analysts explain that “global banks have dozens of unique payment systems to facilitate transactions across regions, countries, geographies and currencies.” Third-party providers can set up payment hubs that allow banks to consolidate those systems.
Outside the financial services industry, businesses with large, unwieldy supplier networks are in the market for outside vendors to streamline their payables and receivables departments, a task that could fall to companies like Fleetcor, a workforce payment solutions provider. Health care is another big market for payment systems. The Affordable Care Act included electronic payment mandates, and more consumers are participating in high-deductible plans. These plans often allow customers to set aside pre-tax money in health savings accounts to fund co-pays and pre-deductible services. Among the payment firms taking advantage of these trends is Wex, which sells payment services to doctors’ offices and hospitals, as well as software that helps employees manage health savings accounts through their employer’s health plan administrator.
Firms that sell payment terminals – also known as point-of-sale systems –– can expect continued demand growth from retailers thanks to changes in credit and debit card security. Merchants need terminals that can accept new cards with EMV chips – computer chips that make cards more difficult to counterfeit. While many major retailers have already upgraded their terminals, gas stations and small and medium-sized businesses have been slower to follow suit, presenting opportunities for companies like VeriFone, a leader in payment terminals, and First Data, a payment processor that recently entered the terminal space with Clover, a tablet-based point-of-service system.
All the activity in the B2B world notwithstanding, the digitization of consumer transactions is still a major driver of revenue and growth for payment firms – not least because cash is still king to a greater degree than many might expect. In 2013, consumers used cash in 59 percent of consumer transactions in developed markets (compared to 61 percent two years earlier) and 93 percent of consumer transactions in emerging markets (down from 95 percent).
As the number of cash transactions continues to shrink, and credit and debit card adoption grows, payment firms that process card payments will earn more money in fees. Those fees include card-not-present charges, which compensate for the higher fraud risk associated with transactions in which consumers don’t physically swipe their cards –– namely, online and mobile purchases, both of which are growing. For the first nine months of 2015, monthly online retail sales’ growth hovered between 12 and 14 percent, while overall retail sales growth stayed at or below 4 percent. While mobile retail payments make up just 1 percent of all retail sales, Credit Suisse estimates that they are growing 20 to 30 percent a year.
PayPal, one of the most popular online payment options for small and medium-sized businesses, is in prime position to take advantage of online and mobile payment growth. In addition, PayPal and other processors like Global Payments and Vantiv charge fees of 50 to 100 basis points for cross-border transactions, which are also growing fast. Global cross-border e-commerce is projected to reach $1 trillion by 2020, up from $230 billion in 2014.
The prospects for revenue growth are more mixed in another consumer-driven payments sector: P2P providers –– services that allow users to transfer payments to family and friends. P2P providers generally don’t charge users fees so they don’t have a proven revenue model, though Venmo, PayPal’s service, may be among the first to develop one. Venmo transactions have more than quadrupled in two years, jumping from under $400 million in the first quarter of 2014 to $1.6 billion the second quarter of 2015, and the company has developed a wide user base. What little money Venmo earns is through fees it charges for credit card transfers, as bank account and debit card transfers are free. PayPal is trying to convince its merchants to allow customers to pay through Venmo, which could bring in more revenue.
In the U.S. alone, Credit Suisse estimates the overall market for fintech payment firms’ products and services to be more than $150 billion. And within that market, analysts see “many different nooks and crannies of growth.” For financial technology-minded investors, the question may be not whether to invest in payments, but rather exactly which nooks and crannies to choose.
Written by Alice Gomstyn for Credit Suisse