Tailwinds for the banking software industry

23 October 2019

Bottom line:

Research & Development. By using third-party packages, banks are transferring part of the innovation to the software developers.

The latter need to invest substantial amount in R&D to maintain a competitive advantage and to offer what the banks and the end-users need. Low barriers to entry in the software industry.

Open standards and architectures are a threat. Cybersecurity. Financial institutions deal with sensitive data. Data theft could cause reputational damage to the software developers.

Banks Digital Transformation In Numbers

Banks must either pursue a digital transformation or disappear. Margins are under pressure. They have to reduce costs while adapting to new and costly regulations.
According to UBS, the total IT budget (software, hardware, personnel, etc.) of U.S. banks is estimated at $67bn for 2019.
JPMorgan (JPM US), Bank of America (BAC US), and Wells Fargo (WFC US) lead the way, with IT budgets reaching $11.4bn, $10.0bn, and $9.0bn respectively.
According to Temenos (TEMN SW), banks are expected to spend globally $57bn on software in 2019, and this market is expected to grow at a CAGR of 5% over the next three years.
80% of these expenses are still allocated to the in-house maintenance of legacy systems.
The U.S. is the largest market in the world, accounting for approx. 40% of the total banking software expenses.
By switching to third-party software instead of in-house solutions, banks and financial institutions can reduce costs, increase spending on innovation, and reduce time to market for new products.
Third-party developers are gaining market shares compared to inhouse banking software. This market is expected to grow at a CAGR of 8% over the next three years.
Even tier-1 players must rely on third-party products to implement the latest technology trends like cloud computing, big data, machine learning, chatbots and Robo-advisors, distributed ledgers, APIs, mobile and internet banking, etc.

Click the image to enlarge

Click the image to enlarge

Temenos, The World's #1 Banking Software

Among the pure players, Temenos (TEMN SW) offers one of the most comprehensive product portfolios.
The company has invested $1.9bn in R&D between 1990 and 2018, or about 20% of revenue each year, twice the level of its peers.
A flexible solution with over 700 APIs developed to match the clients’ needs.
The company expects total revenues to grow at a CAGR of 10-15%, well above the third-party banking software market’s 8% CAGR. Profitability is also on a rising trend.
With a market share of 16% on core banking systems and 5% on other financial programs, the company has still room to grow.
Temenos is winning more new customers than its competitors. Recent wins include PayPal (PYPL US), KuniFin (non listed) in Finland, or TSB Bank (non listed) in New Zealand.
The acquisition of Kony (non listed) announced end August 2019, will significantly increase revenues and market presence in the U.S.
Kony is the #1 digital banking Software-as-a-Service (SaaS) provider in the U.S., and will enhance Temenos' digital front-office platform, Temenos Infinity.
Quarterly bumps cannot be ruled out. In its Q3 2019 results, Temenos confirmed its guidance, despite lower software licensing revenues (+7% Y/Y vs +15% expected).
The shift to software-as-a-service (SaaS) (+93% Y/Y) may hurt the top line initially, but will provide better visibility down the road.
Investors should focus on the long-term potential of the company, keeping in mind the steady migration of financial institutions to packaged software.

Click the image to enlarge

Click the image to enlarge

A Fragmented Competitive Landscape

Despite its leading position in the banking software industry, Temenos must face competition from different kind of players.

Click the image to enlarge

Catalysts:

Disruptive technology. Payments and trade finance transactions are moving to distributed ledger technology. Millennials bank on their smartphones. Artificial intelligence fights money laundering. For banks, it is an adapt or die situation.
New regulations. Basel III, Mifid II, FIDLEG, AEOI, etc. are introducing new requirements and standards that banks cannot comply with by using their legacy software.
Legacy software. Banks are still using software developed decades ago. Their replacement will boost the software industry.
Newcomers. N26, Revolut, or Robinhood are shaking up the banking sector but are also increasing the total addressable market, notably the unbanked. Legacy banks must invest in technology if they want to remain competitive.

Risks:

Research & Development. By using third-party packages, banks are transferring part of the innovation to the software developers. The latter need to invest substantial amount in R&D to maintain a competitive advantage and to offer what the banks and the end-users need.
Low barriers to entry in the software industry. Open standards and architectures are a threat.
Cybersecurity. Financial institutions deal with sensitive data. Data theft could cause reputational damage to the software developers.

Sources:

UBS Evidence Lab Insider: IT survey suggests size matters, March 2019 / Temenos 2018 Annual report, AtonRâ Partners

AtonRâ Partners, Temenos 2018 Annual Report

Back to all articles Next article

Explore:

Disclaimer

This report has been produced by the organizational unit responsible for investment research (Research unit) of atonra Partners and sent to you by the company sales representatives.

As an internationally active company, atonra Partners SA may be subject to a number of provisions in drawing up and distributing its investment research documents. These regulations include the Directives on the Independence of Financial Research issued by the Swiss Bankers Association. Although atonra Partners SA believes that the information provided in this document is based on reliable sources, it cannot assume responsibility for the quality, correctness, timeliness or completeness of the information contained in this report.

The information contained in these publications is exclusively intended for a client base consisting of professionals or qualified investors. It is sent to you by way of information and cannot be divulged to a third party without the prior consent of atonra Partners. While all reasonable effort has been made to ensure that the information contained is not untrue or misleading at the time of publication, no representation is made as to its accuracy or completeness and it should not be relied upon as such.

Past performance is not indicative or a guarantee of future results. Investment losses may occur, and investors could lose some or all of their investment. Any indices cited herein are provided only as examples of general market performance and no index is directly comparable to the past or future performance of the Certificate.

It should not be assumed that the Certificate will invest in any specific securities that comprise any index, nor should it be understood to mean that there is a correlation between the Certificate’s returns and any index returns.

Any material provided to you is intended only for discussion purposes and is not intended as an offer or solicitation with respect to the purchase or sale of any security and should not be relied upon by you in evaluating the merits of investing inany securities.

Contact