It is a completely new ecosystem of modern services creating new consumer experience

Despite the slowdown in the growth of fintech (in terms of new investments), the industry has been leading in the venture world over the past two years. In addition, the slowdown is quite natural as the market is full of new ideas, technologies and players, and further evolution is the result of the development and consolidation of existing companies. Take, at the very least, the capitalization of fintech unicorns — their total value almost doubled in 2016 compared to 2015.

The market used to grow mainly at the expense of new players and new investment rounds, but currently, only major companies are rapidly growing. Therefore, the question arises with medium-sized fintech startups. Max Levchin (PayPal, Affirm) predicted even more than a year ago that it is becoming increasingly difficult for fintech startups to raise Series B funding. This problem is especially acute for the Asia-Pacific region (with the exception of China). I am discussing about it a lot in my new book The First Fintech Bank’s Arrival.

A sharp interest in fintech

A couple of years ago, in Asia, there was a sharp increase in interest in fintech. On the one hand, a large number of small startups were launched and received funding from already successful VCs (but they are all focused on early-stage investments). On the other hand, Asia has a large number of potential acquirers of these startups or their strategic investors. However, between the early and late stages, there is now a huge gap, which is fraught with fatal consequences for these startups in the next one or two years, and also with extensive growth, if the gap can be filled in.

Also read: Check out the 7 promising fintech startups from the FinTech Center of Korea

Why do these problems exist? On the one hand, due to the lack of fintech infrastructure in Asia (open APIs, BaaS platforms, special regulatory policies), the launch of each individual project is disproportionately expensive compared to the likes in the US and Europe. This consumes most of the investments raised in the first rounds, which could be spent on customer acquisition, and as a result companies can’t boast such impressive indicators on customer bases and turnover by the time they are attracting round B.

On the other hand, late-stage investors expect not only the success on the parent market but also the ability to scale to other countries (“go big or go home!”) or complementary industries — both are hampered by the lack of infrastructure.

On the third side, as mentioned above, there are many early and late-stage VCs in Asia and a small number of those participating in rounds B and C.

Limited organic growth

As a result, the organic growth of startups is rather limited and can be achieved by the very few. If you decide to wait for it, it will take too long and increase your risks. But this growth can be facilitated by artificial consolidation through mergers and acquisitions. In the two years that we’ve been in Asia, I have rarely seen fintech startups that are distinguished by a unique product or technology.

Basically, their advantages are in local insights, product localization, and efficient distribution. Let’s imagine a few startups from Singapore, Korea, Malaysia and Thailand that develop the same product (which happens pretty often). They have successfully raised the first $3-10M, their capitalization is $10-50M, and some have possibly become the absolute leaders in their countries. Venture firms which supported them earlier can’t afford the new $10-15M rounds, while larger players hedge their risks by investing in larger services operating in three or more markets.

Potential acquirers or strategists, if they already exist, are ready to acquire each of the companies only at a discount – while you are a local player, then the number of potential acquirers is much lower than the number of players, and they set the price.

These four players combined will make up a company with a capitalization of over $100M (an important psychological mark) capable of attracting the attention of large investors and $20-40M rounds, with the regional presence (it’s apples and oranges: whether to expand to one or four markets), and a top-of-mind brand. Such a company receives a premium for leadership not only at the expense of the aggregate share but also due to the reduction in the number of participants. Also, it cuts R&D expenses by four times (or increases R&D by four times for the same money) and finds it easier to attract talents (the larger and more popular the company is, the easier to attract candidates). This company is also interesting in terms of its operational indicators: the number of customers, turnover, and profit.

So far, we have seen a huge number of small and almost identical startups in each country in the sphere of mPOS- and online acquiring, remittances, lending, trading, e-wallets, etc. They have once successfully answered the question “How do you launch in your home country and show the first results?” and are now facing a completely different question: “How do you differ from the similar startups in neighboring countries?”

Not as simple as it looks

It is a mistake to believe that if everything sounds so simple and logical, then why does not anyone else do it. It’s not that simple indeed. The existing investors of these companies are usually not able to come to terms with the rules of the merger. In most cases, it is arranged by a new investor-facilitator that provides an additional bridge-round for the merger. He is also actively involved in a huge number of operational issues, like who will be CEO of the merged company, and what will other CEOs do (because it’s very important not to lose teams and their motivation when merging!); which areas to shut down and which to strengthen. Such period implies increased risks for which this investor eventually receives an additional fee.

It should be noted that if you look at the overall pattern of investor behavior in Asia (excluding China), the VCs very rarely lead investment rounds preferring to co-invest with other players. In the context of a conservative mentality, it is difficult to imagine that they are capable of taking an increased risk of mergers and acquisitions.

While the Chinese have already demonstrated that they are able to aggressively invest both at home and abroad (one-third of deals in Silicon Valley are performed with the participation of money from China), and now they are even launching special funds for mergers and acquisitions worth $1B and $1.5B. China benefits from this not only in terms of investments, but also in the operational sphere, as most of its fintech unicorns are extremely successful at home, but are absolutely unable to scale to other markets and acquisition of their likes will help them to accelerate their expansion.

Taking into account that the largest number of new fintech unicorns comes from China and the country itself is the leading industry investor, if you miss the moment for mergers and acquisitions, you can possibly forget about fintech without a constant prefix “Chinese”.

Mergers and synergy

It is a mistake to believe that only investors benefit from mergers. Let’s imagine several startups: three of them are mPOS-acquirers from different Asian countries, one more company in the field of big data and online scoring from another country, p2b/SME-lending platform from one of these countries, and an e-wallet from a different country.

Also read: Preparing for a merger or acquisition? Here is what you can not afford to ignore

Let’s assume that the first three companies are able to attract customers quickly and cheaply but they have a very low-margin product, which makes it expensive for them to enter a new market and they prefer to grow deeper into the current market. The big data company can quickly analyze and predict markets for any customers, but it has a constant shortage of data sources (which are very many in the case of mPOS-startups, but they do not monetize them at all) and they do not lend themselves. The lending platform has high-margin products but the customer cost per acquisition is constantly growing, and they do not understand how to reduce risks (without data on client’s behavior history) and a few have the resources to strengthen the risk management team (they are more focused on lending).

While e-wallets are able to quickly attract large customer bases, but also quickly lose them because they vanish in a narrow segment between offline payments and emerging new full-fledged online banks.

The merger of these companies will result in their synergy. For example:

mPOS-players can be used as channels for cheap and fast attraction of SME clients, as well as for accumulation of qualitative data on their behavior.
The big data company will stop wasting time for experimenting with new sources of data and will focus on specific markets and existing customers, while the lending platform will eventually be able to issue loans to already attracted customers (cheaper than before) and even with reduced risks.
The e-wallet will be able to enter a new niche of SME wallets (on the basis of personal profiles of customers of mPOS-startups) and offer to install the wallet to the clients of their clients (retail customers), who have used mPOS terminals (currently mPOS-companies are not analyzing this client audience at all!), and also after exchanging APIs for terminals, they will be able to provide opportunities for card-not-present payments.

Toward a viable fintech bank

Finally, the market is waiting the first fintech bank (my book is about this new phenomenon) – please, do not confuse this fundamental concept with online-, neo- or challenger banks!

In principle, online banks provide an interface for opening and managing accounts and deposits, as well as issuing banking cards. However, the financial services spectrum is huge: transfers, micro-/P2P-/P2B-lending, crowdfunding and crowdinvesting, online-trading, personal financial management, etc.

In the short term, no player can deliver 10 and more major products in a set for retail and SME clients. Every startup has its piece of the puzzle and piece of the “market pie”. Most exit strategies in the market look like “to be acquired by a major bank, telecom or Internet giant”, which by the way have a profitable core business (with other elements).

Just imagine how many products (customers, turnover, etc.) will have a fintech bank built by combining 6-8-10 successful fintech services! It would be very convenient for customers, simplifying the problem of choice and improving the services combined together. Moreover, it would solve many problems of these fintech startups: their market share and “premium for leadership”, a variety of monetization methods, improved cross-sales, increased margins and profitability, integration of services based on new technological platforms (rather than old bank IT infrastructures!).

It’s like the introduction of Tesla: a completely new ecosystem of modern services creating new consumer experience! But it’s not just an electric motor inside an old well-known car brand or other services like charging stations, with(out) dealer service and 24-hour customer support based on big data provided by an old market player.

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