Banking

Fintech: why are they better valued than banks?

Financial technology (FinTech) is a sector made up of diverse companies, ranging from promising start-ups to more mature companies. What these fintechs have in common is that they use technology to make financial services more efficient. These businesses are changing at a rapid pace, driven by the sharing economy, supportive regulation and information technology. The innovations they are bringing to finance are so promising that valuation gaps are widening with traditional financial entities. The valuation of Revolut amounts to 33 billion dollars, equivalent to that of the English bank Barclays! So why are Fintechs so highly valued?

What is company valuation?

Enterprise value (EV) is a measure of a company’s total worth, often used as a more comprehensive alternative to market capitalization because it incorporates the company’s net debt into its calculation. This value makes it possible to calculate the fair price of a share on a market and is obtained via valuation methods.

The most famous methods are the comparables approach and the DCF (Discounted Cash Flow) method. The comparables approach identifies the price paid by investors for investments in similar companies. Reference stock market multiples are then calculated: EV/CA or even EV/EBITDA, and they are compared with those of the company to be valued.

The financial approach using the DCF method amounts to considering that the company is the discounted sum of the cash flows it emits each year, the time of its existence: this is the “cash is king” paradigm.

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Banking and financial activities follow specific valuation models that often focus on parameters such as adjusted equity or dividends. However, these parameters are not significant with FinTechs, especially if they are at the beginning of their existence.

In the rest of this article, we look at the valuation differences between traditional banks and FinTechs.

Fintech vs bank valuation comparison

The British company Revolut announced in July 2021 that it had raised $800 million in a new funding round led by SoftBank and Tiger Global. Revolut, which offers banking and trading services via an app, is now valued at $33 billion, six times more than the $5.5 billion that the company was worth last year.

In June 2020, Checkout.com became one of the first fintechs to triple its valuation, following a fundraising from 1$50 million in series B. Its valuation then reached $15 billion.

Similarly, financial API provider Plaid, which recently refused a buyout offer of Visa of $5.3 billion, raised new capital at a much higher valuation. The valuation of fintech has gone from $5.3 billion at $13.6 billion in April 2021, i.e. a growth in valuation of more than 2 and a half.

On July 29, 2021, the fintech Robinhood, which offers an online trading platform, entered the New York Stock Exchange, at the bottom of the initially forecast range ($38-$42). The company is still valued at $32 billion, two and a half times more than last year during its previous round. The group is valued 20 times its turnover!

Bank and fintech valuation gap: a concrete example with Bank Of America and PayPal

Below we present an illuminating comparison between the PayPal and Bank of America businesses to shed light on the valuation discrepancies.

PayPal Bank Of America Ratio Market Cap $354m $323m Enterprise Value (EV) $345m $323m P/R 92.6x 11.8x EV/CA 13.4x 3.69x EV/ EBITDA 44.9x N/AThe valuation levels are much higher for PayPal than for Bank Of America: multiples of 4 to 8 times larger! So how can such discrepancies be explained?

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How can such differences between banking and fintech be explained?

What valuation model do Fintechs follow?

FinTechs have a hybrid business model since they operate in the financial (banking) sector by deploying technological solutions. Regarding their valuation, one can therefore ask whether FinTechs follow the typical valuation models of banking/financial intermediaries or those of technology companies.

Below are three graphs that shed some light. We compare the performance growth curves of the NASDAQ 100 index, the FactSet Global FinTech index and the MSCI Europe Banks ETF issued by Amundi.

Graph of the evolution of the Nasdaq index from 2017 to 2021

Graph of the evolution of the FactSet Global FinTech index from 2017 to 2021

Graph showing the evolution of Amundi’s MSCI Europe Banks ETF from 2017 to 2021

We observe that the performance of Fintech is not correlated with that of traditional banks. On the other hand, the graph highlights the correlation between the performance of technology companies and that of Fintech, which the market therefore values ​​similarly.

Banking and fintech: different business models

The economic model of FinTechs is intangible-driven, combining e-finance, internet technologies, social networks, artificial intelligence, blockchains and big data analysis. It is more innovative than that of traditional banks. FinTechs also seem very far from banks in every respect: they do not collect deposits and do not lend money. They abstract themselves from hyper-regulation by not offering money intermediation but technological services. They don’t have the compliance constraints of financial institutions that require a lot of capital and labor investment.

By putting the technological offer at the heart of their positioning, they ultimately have nothing to do with banking institutions and everything to do with technology companies operating in markets other than finance.

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Market sentiment: euphoria on one side, disenchantment on the other

There are two market sentiment phenomena that are polarizing the valuations of banks and FinTechs. On the one hand, the existence of a persistent bubble in technology assets: these companies have outperformed in the period of COVID 19 and are widely sought after by investors. The rise in prices is catalyzed by the accommodating policies of low interest rates and “quantitative easing” by central banks.

This same macroeconomic environment, on the other hand, disadvantages banks, which must take on more and more risk in order to generate profits. Their margin is crumbling and their balance sheet is getting heavier. In addition, negative opinions are growing around these institutions, which caused one of the worst financial crises in 2008. The bank no longer inspires the values ​​of admiration and success that it conveyed in the 20th century and the consumer has no embarrassment to turn his back on it.

Image source: Freepik

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