Signals: "fintech is back" has become the consensus

Hello, Fintech Friends!

Many things happened since the previous Signals issue on publicly traded fintech companies. Donald Trump won the U.S. Presidential election and the Federal Reserve cut the federal fund rates by another 25 basis points. U.S. banks and fintech companies also reported their third-quarter results (for some reason many decided to report early).

There were two notable stock market moves when Trump was declared the winner: Coinbase and Discover. Coinbase's stock price surged by 31% in a single day, while Discover, which is currently in the process of merging with Capital One, saw a 21% increase. The moves signaled investor optimism for crypto and the expectations for large M&A deals to succeed under Trump’s presidency.

These moves also covered quite bleak third-quarter earnings results, with many companies missing analysts' estimates. The misses were mostly minor and likely reflect that Wall Street has finally set high expectations for fintech companies. The TWIF Index is up 58.8% YTD, and "fintech is back" has become the consensus. Where do we go from here?

Jevgenijsp.s. Have feedback? Ping me on X/Twitter.Happy to hear what we can improve in this column!

As of this writing, Sezzle (NASDAQ: SEZL) is up 1,776% YTD. I had to exclude Sezzle from the chart, as it made all others look like ridiculous underperformers, which obviously isn't true. To get into the Top 10 best-performing fintech stocks, a stock's price needed to (almost) double.

Earnings seasons in the financial services industry typically start with reports from U.S. money-center banks, followed by Visa and Mastercard. The largest banks and card schemes are interesting businesses on their own, but many analysts see their results as proxies for what's happening in the economy. And, payment volume growth, reported by Visa and Mastercard, sets a benchmark for many fintech companies reporting later in the earnings cycle.

Thus, in Q3 2024, Visa and Mastercard reported 7.7% YoY and 11.2% YoY payment volume growth respectively. On a regional level, Mastercard outperformed Visa in the U.S. (7.0% YoY vs. 5.1% YoY) and in Europe (16.2% YoY vs. 11.9% YoY). As you can also see from the charts below, Mastercard outperforming Visa on both sides of the Atlantic is becoming a trend. However, one of the key takeaways from their earnings is that card spending by consumers and businesses in the U.S. suggests that the economy is fine.

What's happening in Europe is way more interesting. In Q3 2024, the EU economy grew 0.3% YoY (compared to 2.8% for the U.S.). However, both Visa and Mastercard still delivered double-digit growth in European payment volume. According to comments from the earnings calls, many European countries are still going through a secular shift from cash to digital payments, which benefits both Mastercard and Visa. Moreover, both are winning business from local card schemes (e.g. girocard in Germany or Cartes Bancaires in France).

So which fintech companies, besides Visa and Mastercard, are capturing these secular shifts in Europe? In the third quarter, the largest European merchant acquirers, Worldline and Nexi, reported 0.2% YoY and 6.6% YoY revenue growth respectively (merchant services businesses). So not them. Could that be Adyen, which reported 20% YoY revenue growth for the third quarter? Or perhaps, Stripe, which in 2023 reported 30% YoY revenue growth in its European arm?

Read more: Visa Fiscal Fourth Quarter 2024 Financial Results and Mastercard Third Quarter 2024 Financial Results

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Visa stock performance: +18% YTD, +26% 1Y

Mastercard stock performance: +18% YTD, +24% 1Y

Block opened its Q3 2024 shareholder letter with a bold statement: "We’re about to transform 24 million Cash App Cards into a better alternative to credit cards when we launch Afterpay on Cash App Card." The company did not provide many details about what it means in practice, or when to expect this "transformation", but provided a few details about Afterpay and Cash Borrow loans. A common theme is that these are small-amount, short-duration, high-return loans (see the table below).

Cash App has been a growth driver for Block, offsetting growth deceleration in Square's business. However, Cash App, at least with its current value proposition, is clearly reaching the limits of its target market. The number of monthly active users on Cash App leveled off at approximately 57 million, while the number of active Cash App Card users stabilized at 24 million (see the chart below). In Q3 2024, inflows per active user were $1,233, up 9% YoY (and flat QoQ). Total inflows were $70 billion, up 13% YoY (and down 1.4% QoQ).

The key drivers of Cash App's gross profit are Cash App Card, Instant Deposits (withdrawal fee), and lending products (Afterpay and Cash Borrow). As the growth in Cash App Card active users and inflows slowed, gross profit growth naturally followed suit. In Q3 2024 gross profit grew 21% YoY, down from 27% YoY in Q3 2023. Thus, Cash App doubling down on lending products seems like a natural reaction to this deceleration. Perhaps, a credit card (or Cash App's equivalent of a credit card) could even expand the company's TAM.

Read more: Block Q3 2024 Shareholder Letter

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Block stock performance: +9% YTD, +49% 1Y

A year ago, Alex Chriss, PayPal's new CEO, set a goal to shift the company toward "profitable growth." One of his immediate focus areas was Braintree (reported as "unbranded" processing). It was widely believed that Braintree's rapid growth, comparable to competitors like Stripe and Adyen, was driven by PayPal pricing its services below cost to boost revenue. In Q3 2024, Braintree's payment volume grew 11% YoY, a sharp deceleration from 32% YoY a year ago (see the chart below).

PayPal has "accepted a lower near-term Braintree revenue profile in exchange for better margins", as per the company's Chief Financial Officer, Jamie Miller. The company's management also expects "lower Braintree volume and revenue growth in the fourth quarter and through 2025." However, it seems that Braintree is not the only area that is impacted. Thus, international volume growth has also decelerated to 8% YoY in Q3 2024, down from 19% YoY in Q3 2023 (on a currency-neutral basis). The pivot to profitable growth is killing two key growth drivers.

The new PayPal management has revived the fintech pioneer. The company launched Fastlane, an accelerated checkout solution, as well as partnered with Adyen, Fiserv, and Global Payment on its distribution. PayPal has also become an alternative processor for Shopify Payments, as well as partnered with Amazon on Buy with Prime, proving that it can compete with new-generation processors like Stripe. The market rewarded the stock (+39% YTD) for these initiatives, but would probably expect them to translate into growth at some point.

Read more: PayPal Third Quarter 2024 Performance

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PayPal stock performance: +39% YTD, +47% 1Y

Marqeta's stock plummeted more than 40% after the company lowered its Q4 2024 guidance. "Our fourth quarter guidance reflects... the heightened scrutiny of the banking environment. The incremental scrutiny and rigor translated into delays in launching new [card ] programs." - commented Simon Khalaf, the company's CEO. The company guided for 10-12% YoY revenue and 13-15% gross profit growth in the fourth quarter of the year.

For those, who are new to the company: Marqeta is a modern issuer-processor serving many fintech companies, including Block (Cash App and Square), Affirm, Klarna, and many smaller ones. Although Marqeta's top five largest clients account for nearly 80% of its processing volume, it is the smaller customers that drive growth and have a higher gross profit margin contribution. For instance, in Q3 2024, processing volume from the top five clients grew 23% YoY, which compares to an increase of 67% YoY for all other clients.

It is also the smaller fintech companies that were impacted the most by the regulatory scrutiny. Numerous consent orders issued to the sponsoring banks lead to stricter due diligence processes and longer approval times. Max Levchin, CEO and co-founder of Affirm (one of Marqeta's clients) framed it the best: "Regulatory scrutiny increasing is a thing you experience if you're small and unknown to the regulators. We've been big and getting much bigger quarter after quarter. We're very familiar with all of our regulators."

It is not the first roadblock for Marqeta. Thus, in 2022, its fintech clients faced a challenging funding environment. In 2023, the company went through a painful renegotiation of the agreement with Block and many other large clients. Now 2024 brought "regulatory scrutiny" to sponsoring banks. Early-stage fintech companies are not an easy segment to work with. However, the customers are not leaving Marqeta, and the processing volume continues to grow at a 30%+ rate. The company also has over $1 billion in cash and cash equivalents. So, perhaps, the market is writing off the company too early?

Read more: Marqeta Q3 2024 Earnings Supplement

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Marqeta stock performance: -43% YTD, -34% 1Y

There were a few promising reports. Shopify reported 26% YoY revenue growth for the quarter, and guided for "mid-to-high-twenties percentage rate" growth in the fourth quarter, which exceeded analysts' expectations. Toast reported 26% YoY revenue growth, and raised its guidance for the fourth quarter (also beating analysts' estimates). Bill reported 18% YoY revenue growth for the quarter, and raised its fiscal year guidance (guess what? also beating analysts' estimates). The market gladly rewarded such performance.

What's common about these companies is that they are not typical fintech companies. These are vertically integrated software companies that generate a large portion of their revenue from financial services (primarily payments and lending). For instance, Shopify generates over 70% of its revenue, and close to 50% of its gross profit from "merchant solutions", which includes fees from payment processing and lending. Perhaps, AI isn't killing software companies after all, and Shopify, Toast, and Bill continue to prove that controlling the software part of the chain gives them the right to win market share.

These are also some of the most expensive fintech stocks on the EV/EBITDA or P/E multiples (see the tables at the bottom of this email). This suggests that the market, most likely, values Shopify, Toast, and Bill as software companies, rather than as fintech companies. It doesn't matter that the majority of revenue (and a large share of gross profit) comes from financial services, the market seems to value the software part of these businesses. I would think there is some learning in this for the up-and-coming fintech companies.

Read more: Shopify Q3 2024 earnings release, Toast Q3 2024 earnings release, and Bill FY Q1 2025 earnings release

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Shopify stock performance: +39% YTD, +59% 1Y

Toast stock performance: +122% YTD, +179% 1Y

Bill stock performance: +3% YTD, +42% 1Y

Fintech stocks became more expensive despite underwhelming earnings results. Most likely, the market is pricing in the belief that Trump's presidency will benefit financial services companies.