Outlook for FinTech investment and valuations in Brazil and the Americas

March 2018 | EXPERT BRIEFING | FINANCE & INVESTMENT

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Over the last few years, FinTech has been the ‘it’ sector in global startup ecosystems and venture capital. The investing play is based on the promise of future disruption, momentum and the potential of continued valuation exit highs. Globally, in 2016, there were approximately 836 investments worth $12.7bn in financing to venture-backed FinTech startups. This was slightly behind the record of 2015 with 848 investments worth approximately $14.6bn, according to CB Insights. So where is the market going? Moreover, what is the outlook in Brazil and the broader Americas region?

Global snapshot – onward and upward

After three relatively stagnant quarters, the global FinTech market rebounded strongly in the second quarter of 2017, with investment more than doubling quarter over quarter to $8.4bn. While the number of FinTech deals was below the 2015 peak, volumes remained robust. M&A activity was the main driver of sector liquidity.

However, looking at venture capital (VC)-backed deals, total deal volume hit a new high in 2017. By Q2, VC deal volume was also on track to approach the 2016 total of over 1000 deals, despite an ongoing slide in angel and seed-stage deal volume, which stretched to a fifth-straight quarter. According to KPMG, “the relative stability across other investment stages suggests that while there may be some caution in the VC market globally, investors remain interested in tangible FinTech opportunities”.

Looking at the public FinTech equity markets, stocks have seen strong performance. Furthermore, key financial metrics also continue to see upside pressure. By October 2017, trailing firm and equity valuation multiples (EV/EBITDA +6 percent and P/E +27 percent) continue to move upward as do top line growth projections, profitability and scaled growth-value indicators, such as PEG, for example.

Valuations continue to decline at the late-stage. Once again, the global median late-stage, post-money valuation fell during Q2 2017, likely as a result of the scarcity of such late-stage deals in the FinTech market globally, in addition to a normalising of investor sentiment with respect to VC investment. Meanwhile, FinTech exits increased during Q2 2017, with the number of exits matching the second-best quarter experienced to date. While the total exit value remained relatively weak, the increase in activity may be a positive sign for 2018.

Americas – positive outlook for regional FinTech

According to KPMG, after a very active 2015, total number of deals dropped significantly 2016, from 685 to 555. Meanwhile, value fell more than 50 percent year-over-year, although 2016’s $13.5bn investment remains the decade’s second highest volume. While VC and private equity funding to FinTech companies both dropped in 2016, the real differentiator was the decrease in M&A activity, with just $8.5bn in M&A deal value compared to $21.3bn the previous year.

If the M&A cycle continues to wind down and the IPO market remains frigid, venture firms’ ability to achieve liquidity may come under even greater scrutiny. Accordingly, the fact that FinTech exits remained steady, albeit for lesser total value, even as the broader exit market slowed, is promising.

The second quarter of 2017 saw an acute uptick in the Americas region, driven in part by strong US based VC activity and the multi-billion acquisition of Toronto-based lending and payments software company, DH Corp. VC investment in the region remained relatively stable quarter over quarter, with over $1.6bn invested according to KPMG. Despite the US being the largest investment market, other countries across the region are also seeing growing traction, especially Canada and Brazil.

FinTech in Brazil

Brazil is the largest FinTech market in Latin America, with over 200 startups divided into 16 key segments, compared to Mexico (158 startups), Colombia (77 startups), Argentina (60 startups) and Chile (56 startups), according to Finnovation. The largest sectors are payments (31 percent) and credit (12 percent). Leading FinTechs including Nubank, Creditas, Banco Original and EBANX are driving innovation in the financial sector.

In Latin America and Brazil, a lack of banking services, high demand for credit and historically high interest rates have created a boom for entrepreneurs and investors seeking to develop FinTech market leaders. Thus, the impact from FinTech disruption is expected to be greater in Brazil than in many other countries because of its highly concentrated banking sector. According to Techcrunch, “while 85 percent of Brazilians now live in cities, 40 percent remain excluded from traditional banking systems. Brazilian consumers are seeking better alternatives to credit card rates in Brazil that are in the triple digits. The industry is one of the world’s most lucrative, with return on equity still at nearly 19 percent for Itaú and 15 percent for Bradesco in the first quarter of 2017, even after almost three years of recession, according to data company Economatica, higher than US and European averages. Consumers in Brazil, Latin America’s biggest country, pay an average of 190 percent a year for unsecured overdraft, credit card and consumer loans with banks.” Even the reduction in central bank rates from 14.25 percent to 8.25 percent by September 2017, will impact spreads for banks and enhance opportunities for more efficiency. Smartphones are also broadly used in Brazil, with more than 60 percent of the population using mobile devices, which in turn helps drive the spread and delivery of FinTech products and services in the country, as does growing internet access. There is also a lot of legacy infrastructure in the financial sector, including many services that still run on COBOL, a computer programming language that has run on mainframes since 1959. COBOL is primarily used in finance and administration systems for financial services companies and governments.

Moreover a recent report by Goldman Sachs projects that Brazil’s FinTech market should generate a potential revenue pool of about $24bn over the next 10 years. Payments, lending and personal finance are three promising segments, as is insurance. Goldman Sachs cited “an oligopolistic market structure” in Brazil where the top five banks, excluding development banks, hold 84 percent of total loans. In retail branch banking, the top five banks have 90 percent of branches. The Central Bank is playing a role to enhance competition in the sector and changing its regulations to simplify the licence-approval process for foreign banks wishing to operate in Brazil. Indeed, according to International Banker magazine, “it is also looking to implement new regulations to formalise the rapid expansion of FinTech; in particular, the new rules would cover their partnerships with banks to offer loans – those providing securitised credit from institutional investors, and ‘peer-to-peer’ lenders connecting borrowers directly with individual investors”. However, the report concluded that although, “FinTech companies in Brazil are driving the innovation in the nation’s digital banking landscape, ultimately it will be the sector’s established leaders that will dictate the scope of changes in the industry. While in 10 years we expect incumbent banks to lose market share, the effect should not be perilous. We do not expect significant pressure on growth or profitability for large retail banks, despite market share loss and price pressure.”

Fintech investment

VC investment in the space has been on an upward trend over the last few years. In 2016, FinTech investment hit over $150m, more than tripling year-over-year. Vertical focus areas are also increasing, such as in InsurTech and RegTech.

Brazil was the destination for 63 percent of Latin America’s total investment in 2016. According to Isaias Sznifer, managing director at Greenhill & Company in Brazil, “we expect a lot more in the space to happen in the near future”.

Adam Paul Patterson is a director at Legacy Partners.

Adam Paul Patterson

Legacy Partners