Mobile Payments: Moving beyond de-rating

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Understanding Mobile Payments

The Mobile Payments strategy aims to capitalize on the global transition to cashless economies by targeting companies driving innovation in payment infrastructure, digital payment rails, and processing solutions. While the COVID-19 pandemic accelerated the adoption of digital payments, the strategy now focuses on high-growth disruptors still reshaping the payment value chain.

With a forward P/E slightly higher (~30x) than large-cap indices like the Nasdaq but delivering double the EPS growth (3-year CAGR ~30%), the strategy embodies "growth at a reasonable price."

The payments industry has undergone distinct phases and focus by investors:

1. Overcrowded during Covid-19 – Prioritizing revenue growth at all costs.
2. Post-Covid-19 shift to profitability – A transition towards achieving sustainable financial metrics.
3. Stabilization in 2024 – Innovators are now delivering on promised EPS growth, allowing revenue to translate into bottom-line performance.

Beyond regional consumption trends

The payments industry has been navigating a challenging macroeconomic landscape in 2024, marked by mixed consumer sentiment and regional divergences. Resilient consumption patterns in the United States and optimism from Chinese fiscal stimuli contrast sharply with South America’s economic struggles (especially in Brazil, where inflation overshot forecasts) and Europe's stagnation.

Consequently, the United States remains the most favored region for the strategy. However, we shall monitor the net impact of various fiscal policies and political decisions on consumption spending, such as possible tariffs on imported goods, lower personal federal income tax, and cheaper energy costs.

The Mobile Payments strategy emphasizes high-growth, smaller companies with a weighted median market cap of approximately $10.3bn. We remain underweight on legacy players such as FIS, Fiserv, and Global Payments, which lag behind the industry’s annual growth rate of ~8-10%. Furthermore, we have increased exposure to specialized segments, including buy-now-pay-later (BNPL) solutions and software players automating accounts receivables/payables processes.

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Omnichannel buy now, pay later

WorldPay expects that the use of cash will fall to <10% by 2027, representing a floor. To grow faster than GDP, digital payments must gain market share from other digital payment methods. Payment cards (holding a 35-40% market share) are the most at risk, although contactless solutions have extended their lifespan.

Buy now, pay later directly targets the market share of credit cards and should continue to be the fastest-growing digital payment solution. Market leaders like Affirm Holdings Inc or Block (in addition to the upcoming IPO of Klarna) have expanded their product offerings to various channels (online and offline), targeting a wide range of industries. BNPL is particularly appealing to younger generations. Contrary to early fears, credit quality remains stable. For instance, over the last three years the delinquency rates for Affirm has remained steady at around 2.5%, while credit card delinquency rates have surged from 1.5% to 3.25%.

Finally, funding is expected to increase as lenders seek investment alternatives amid declining interest rates and historically tightened credit spreads.

Embrace stablecoins

The Fed's instant payment system, FedNow, cost $100mn to develop in 2023 and $245mn to maintain in 2024. However, the payment system has only been joined by 1'000 financial institutions (vs. a total of 9'000 firms) in the United States. This example proves that upgrading legacy systems is too expensive.

New technology must be used to modernize the payment infrastructure. Payment service providers understand this and multiply their investment in the blockchain ecosystem.

PayPal’s stablecoin was launched in 2023. It currently has a modest circulating supply of $500mn (compared to legacy stablecoins like USDT or USDC, which have issued an aggregate supply of $180bn), but it integrates well within the PayPal ecosystem. Stripe acquired the stablecoin firm Bridge for $1.1bn, allowing them to issue stablecoins. Bypassing card networks, payment firms do not need to pay network fees. Moreover, they reduce costs: a transaction on Polygon (a layer-2 of Ethereum) currently costs less than 1 cent (vs. 4.5 cents per transaction on FedNow).

Stablecoin offers an instant and cheap transfer solution, particularly for cross-border payments. With the most pro-crypto Congress in U.S. history, new regulations will help define standards for the stablecoin industry. Is stablecoin the killer use case the blockchain industry needs to be adopted by billions of people?

Antitrust challenges for credit card networks

Historically, we avoided the credit card networks, anticipating innovation would eventually outpace them over time. We did not anticipate though, that digital and mobile wallets would keep relying on card networks, as no other payment means effectively replaced them (at least in developed countries). Thus card network stocks kept performing well, while we fully endured the payment industry derating.

But looking ahead, we believe that downside risks for card networks are compounding. BNPL and stablecoins offer compelling alternatives while regulatory scrutiny intensifies. Visa and Mastercard face antitrust investigations across the United States, Europe, the United Kingdom, and Japan. These lawsuits may persist for years, creating ongoing negative news flow and weighing on these firms' sentiment and valuations.

Catalysts

• Cutting through red tape. President-elect Trump wants to deregulate the financial industry. Less oversight from the Consumer Finance Protection Bureau should eventually benefit BNPL companies, which had to adopt the same rules (e.g., in terms of regulatory reporting) as credit card firms.

• Stablecoin standards. Regulatory clarity on stablecoin issuance and backing, such as whether they must be fully backed by U.S. dollars, could drive widespread adoption.

• China stimuli. While we did not discuss China in this article, it remains a country to monitor. The government stimuli aim to boost the country’s consumption habits. With attractive valuation levels (compared to global peers), Chinese payment processors could beat expectations in the near term.

Risks

• Lower margins. Intensifying competition is driving commoditization, particularly in the enterprise segment, where firms like Adyen face pressure from clients with growing bargaining power.

• U.S. tariffs. Consumer sentiment impacts valuations of payment stocks. If consumers fear for their spending power in case of high tariffs, the payment industry could suffer.

• Money laundering. Reduced regulation doesn’t mean no regulation. Compliance with anti-money laundering laws remains critical. For example, investigations into Block’s Cash App impacted sentiment, underscoring risks associated with new payment platforms.