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December 2021 / U.S. EQUITIES

Two Dominant Trends Changing Fintech Stocks

Key Insights

  •  We are seeing two dominant trends in the fintech space, and specifically payments, that continue to drive a lot of our secular investing themes.
  • The first is the continued transition to digital payments away from cash and checks, and the second is embedded finance.
  • Users who have come to expect high-quality digital experiences in their personal lives are demanding innovations in their business lives. 


We are seeing two dominant trends in the business services space, and specifically payments, that continue to drive a lot of our secular investing themes.

The first is the continued transition to digital payments, and specifically this means anytime that you're using a card, a QR Code, PayPal, any sort of digital transaction where in the previous time you have used cash or check. So this long-term trend toward the displacement of cash and check by digital payments is something that we continue to invest behind, and I think has a multi-decade length to it or opportunity to it.

If we think about what those numbers actually are and how it's under-appreciated, today about 78% of consumer expenditures in the U.S. are some sort of digital payment. And we think by 2025, we estimate that number can be as high as 90%.

When we look globally, we think this trend has even further to run and is even less appreciated. In Europe, those same percentages are around 40%, or we estimate that they're around 40%. And in Latin America, we estimate that they're around 30% today.

We also see digital payments accelerating in new areas, like person to person. Think Venmo or Cash App. But also in business-to-business environments as well with greater use of digital invoicing and also greater use of virtual cards.

The second trend that we are seeing more and more of is embedded finance. This term simply means that more and more software is coming with some sort of financial product embedded in that software.

The example that I like to think of is if you were a software developer today, and you were building software for a bike shop, that software might include a core inventory module. And historically that would be the single piece of software that you would sell to that bike shop. But today, as you actually look at the needs of that small bike shop, it might include accepting payments, making payroll. It's likely to include some sort of banking relationship if you're going to have a loan to purchase that inventory. All of those different features can now be embedded in that single inventory software. And as a result, you can sell each of those individual features at a higher and higher level of monetization. And this allows entirely new TAMs and business models to be created.

Users, think small businesses, consumers, even large enterprise users, are becoming accustomed to high-quality high-grade digital experiences in their personal lives. They expect these same kinds of experiences at work and in the software that they use every day at work.

We've seen dozens of young and interesting companies bringing new products to market that fit this need. It's also important to highlight how much the start-up world has changed in the period of time that I've been at T. Rowe. Cloud computing and SaaS [software as a service]  deployments have dramatically changed the cost of starting a new company.

At the same time, the funding environment for all sorts of venture companies has become much more aggressive. You’ve now got this mix where you have very low costs of starting a company and a lot of capital invested in new companies or chasing new companies. And this combination is bringing all sorts of new products to market.

Maybe the last thing I'd say on this topic is that because financial services is such a highly regulated area of the economy, it has tended to lag behind from an innovation standpoint other areas like consumer internet. We're seeing enough dollars invested and enough interest in the sector that progress is being made, and the same expectations that we have in consumer internet are now coming to digital financial services.

Some examples of this are real-time payroll, but also the use of QR Codes for payments in all sorts of different venues, restaurants, business to business, and invoicing, and a number of other areas.

Early in my career, when I started covering financial services and technology in general, I realized that we needed to follow what the large financial services companies specifically we're doing as they set the rules for much of the ecosystem.

So Visa and MasterCard dominate the vast majority of the overall payments universe. For context, Visa and MasterCard combined processed USD $18 trillion of volume in 2020.

Their rules, their incentives, and the priorities that they have strategically shaped the entire payments landscape. Because of their scale, small changes in their goals or their rules have massive downstream implications for the entire ecosystem.

Visa has a rulebook that's hundreds of pages in length and full of industry jargon. I studied that rulebook extensively, and I know that it heavily influences what technologies can emerge, and it also shifts the priorities of the payments industry.

The example I like to cite is Square. If you’ve paid for an item at a small shop or boutique, maybe shopped at a farmers market, or purchased something from a food truck, you've likely used Square. Before Square, a merchant had to go to a bank and be underwritten by that bank for a merchant account. That merchant account and that underwriting process were required by Visa to accept Visa and MasterCard payments.

Now, the business model that Square was creating was meaningfully different. They wanted to create an environment where very small merchants, merchants that would never be able to be underwritten by the bank, could accept Visa and MasterCard payments. To do this, they actually had to have Visa and MasterCard change what was allowed in their rulebook. These changes opened up a massive TAM of small, micro-merchant-sized businesses that could now accept Visa and MasterCard payments.

As small as that change was, it actually changed the total amount of revenue that you could earn selling software to a small merchant. You used to only be able to earn software revenue. Now you can earn software revenue and payment revenue from the same small merchant.

This change dramatically opened up the addressable market for Visa, for MasterCard, and for all of these small software sellers. We've invested behind many of these small software sellers, and we see it as a continued area of innovation and investment opportunity.

Another area that we're watching closely is cryptocurrencies. We've been interested in cryptocurrencies for a long time, but we're beginning to see the infrastructure come into play to support broader adoption.

We don't currently hold any cryptocurrency in our portfolios. And there's an extraordinary level of speculation and volatility in many crypto markets. But we see the potential for disruption in the payments industry and across business services. Our research in this space will continue to intensify.


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