(Source: Chopper)
There’s no cash here. Here, there’s no cash. Cash! NO.
Millennials are moving away from cash payments and embracing mobile and contactless payments.

We first published a piece on the highly disruptive forces emerging in the payments industry in mid-2016. That is a long time in the world of technology and rapid disruption and much has already changed across the industry landscape.
Today, millennials are continuing to enter the workforce, move up the corporate ladder and earn an ever-higher percentage of the economy’s total wages. In fact, by 2030 Macquarie Bank estimates $2 out of every $3 earned in the economy will be done so by those born between 1980 and 2000. This is a cohort that is ditching cash and embracing contactless and mobile payments as well as (god forbid) cryptocurrencies. This will inevitably benefit some players in the industry whilst making others redundant (think independent ATM providers).
There is massive potential here for businesses to create new virtual payment networks, whether it be in processing, mobile or credit based, to meet this newly booming demand. Statista forecasts the annualized growth rate of the global mobile payments industry between 2017 and 2020 to be almost 18%.

Figure 1. Global Mobile Revenue
Source: Statista

Figure 2. Number and Value of Cash Payments, Australia
Source: RBA/Roy Morgan
There are a number of emerging players in the market vying for various slices of the overall payments pie. Below is a list of the top twenty payments players globally, ranked by total websites linking to these companies’ sites or APIs.
Each of the below players targets a specific niche in the payments market, whether it be payments processing (PayPal, Braintree, Klarna, MasterPass, Amazon Payments), mobile payments (AliPay, Apple Pay), checkout APIs (Klarna, Stripe), transfers (Skrill, Neteller) and POS financing (Bread, Klarna, AfterPay).

Figure 3. Global top 20 payments providers, by external site references
Source: SimilarTech 2018
With well under half of the developed world currently having access to an internet connection, compared to 81% in the developed world, increasing internet penetration across the globe rate is a strong industry tailwind. Similarly, smartphone penetration rates are increasing, with the global rate expected to rise from 21.6% in 2014 to 37% by 2020. Whilst a major benefit to the players listed above, traditional finance companies such with exposure to credit cards (banks, card issuers), traditional sales finance (Flexi, Thorn) and brick & mortar finance retailers (Cash Converters) will (in our view) likely suffer, as the capital-light, technology proficient providers compete for market share.

Figure 4. Internet Users per 100 inhabitants, 1996-2018
Source: International Telecommunications Union, 2018

Figure 5. Global Smartphone penetration rate 2014-2020 (inc. estimates)
Source: Statista
One thing that many of these companies have in common is a strong network effect that grows stronger as more merchants and customers come on board. Whilst much of the software and offerings would be easily replicable by a competitor, players of scale can utilize richer databases to incrementally refine their processes, creating high and increasing barriers to success. . Below are four which stand out as being very well placed to capitalize on the changing landscapes in the industry:
One of the original payment’s processors on the internet, PayPal was founded eons ago (in technology time) in 1998. It originally developed security software for handheld devices but a year later developed its online money transfer service. One of the original differentiators that allowed PayPal to stand out from the crowd was its very high levels of consumer protections, allowing consumers to chargeback in a quick manner if their online purchase didn’t arrive or was materially different from the product description. This tendency to side with the consumer in dispute resolutions meant it built up a massive base of loyal users and became their payment method of choice when buying online, especially before a lot of the large, trusted e-commerce sites of today were as prevalent.
PayPal benefits e-commerce sites by bridging the trust deficit when a consumer wants to make purchases on unfamiliar websites. The guarantee that PayPal offers to consumers means that by simply offering it as a payment option on one’s site, volumes are highly likely to materially increase. In recent years, the company has made a number of acquisitions to increase its financial offerings, including Venmo (transfers), Braintree (processing/APIs) and Xoom (remittances). Whilst exposed to some highly positive tailwinds, a risk for PayPal would be the consolidation or dominance of e-commerce players (for example, recently dropped on eBay and not on Amazon).

Figure 6. PayPal payment volumes, 2014-2017
Source: Statista/PayPal company reports
Similar to Klarna, Stripe is a fully integrated checkout API. The company was founded in 2010 by Irish brothers John and Patrick Collison. It provides a payments platform which can be used for SaaS, e-commerce checkouts and non-profits to enable mobile donations. It allows businesses to quickly setup an online e-commerce presence without the need to apply for a merchant account and jump through a bank’s red tape. Stripe was created as its founders identified a gap between self-hosted payments solutions that allowed credit card and electronic cheque payments and third-party processers that allowed a single payment option like Google Wallet and Paypal.
The US online processing market is expected to grow at a roughly 13% CAGR into 2020, powered by the continued adoption of online and mobile sales by old-world retailers. The company was recently ranked number 1 in Forbes Cloud 100. The company is currently private with over 100,000 business customers from around the globe.
Bread is a new breed of consumer point of sale financing. It was founded in 2014 with initial funding from venture capital firms Bessemer Partners and Greycroft Partners. In a similar way to how a company like Flexi-Group would partner with a retailer to offer their consumers financing, Bread offers a white-label checkout option for businesses to integrate into their website. When a consumer visits an e-commerce site which offers Bread, they are offered a range of easy to understand financing options for their purchase. It operates real-time credit checks through its own internal systems as well as through standard credit reporting agencies.
Bread is typically quite protective of sharing many details about total integrated merchants and loan book, although 3rd party analytics as well as the US$140m raised through two funding rounds suggest that the company is growing rapidly. The technology and automated systems that operate behind the Bread interface mean its operating expenses are quite low, with a much lower headcount and smaller back-office than traditional financing companies. As retail sales continue to shift online, companies like Bread and Zip-Money (local player) are well placed to compete and take share away from their industry incumbents.

Figure 7. Example of Bread’s integrated checkout
Source: Company reports
Afterpay Touch Group:
Swinging back to the local market and to a company we have profiled a few times before, Afterpay offers a one-size fits all layby/financing option for consumers at online and more recently, instore checkouts. Founded in 2014 in Sydney, the company was created as a solution to retailers struggling with stock and cash-flow issues stemming from layby offerings. It offers interest free micro-loans for its customers, to be paid back in four fortnightly instalments, with fees being generated from merchants and late fees. Since listing less than two years ago, it has grown its customer base from 50,000 to 1.5 million, merchants from 100 to almost 12,000 and annualized underlying sales from $40m to over $2b.
In a similar fashion to Bread, Afterpay utilizes real-time credit analysis of its customers to decide whether to approve their purchase. It uses data collected from the user at the time of purchase such as location, card type, make and model of phone (for mobile payments only) and time of day to decide whether to authorize a transaction within seconds.
Promisingly, the company is attempting to capitalize on its success by offering an in-store version of its product as well as expanding into the U.S, with the help of U.S. venture capital firm Matrix Partners.
Whilst the share-price of Afterpay has gone from $1.00 in 2016 to over $7 today, we believe it is well justified by the meteoric growth and flawless execution of its management since listing. The current share-price implies lofty expectations for future earnings, however we believe there remains substantial upside from success in the much larger US market.

Figure 8. Afterpay’s main business drivers since IPO
Source: Company reports
The strong willingness of millennials to adopt disruptive technologies points to continued growth of these new-world finance companies. It also points tocontinued erosion for legacy business models.
For many, the earnings assumptions and multiples prescribed to these new-age companies might seem excessive, however, the drivers behind their growth such as internet and smartphone adoption are set to continue for decades to come. We believe this is a sector that should continue to meaningfully outperform the broader market in the coming years. Whilst not all of the companies listed are public yet, many will inevitably IPO in the next 5 years and are well worth keeping an eye on.
Clime Asset Management owns shares in Afterpay Touch Group.