It may not be the glitziest area of financial services, but payments is increasingly becoming an attractive investment opportunity for private equity
Processing electronic payments used to be seen as the poor relation of financial services. Boring back-office systems staffed by steady, though dull, people who lacked the dynamism of startup buccaneers.
Yet a deal last month, backed by the turbo-charged efforts of private equity, created one of Europe’s largest payments firms. When Italy’s Nexi bought Danish rival Nets for €7.8 billion, it was the latest in a rash of private equity-initiated deals that has reshaped the once slothful payments processing sector.
Both businesses in that megadeal started out as part of traditional banks, spun off and led by private equity firms Advent, Bain Capital and Hellman & Friedman. Nexi’s acquisition of Nets followed hot on the heels of its €15-billion purchase of state-owned Italian rival Sia. It now vies with Worldline-Ingenico for the coveted title of Europe’s payments, or paytech, champion.
Why payments are such a pull
Simply put, payments processors facilitate merchants’ ability to accept both online and in-store payments while charging a small fee in the form of a sliver of the transaction price. But given the pressing need to offset the high capital cost of payments processing technology, a rush to scale up has attracted the gimlet eyes of private equity dealmakers.
According to data provider Refinitiv, close to $32 billion in transaction value has been sealed this year, compared with $8.5 billion in 2019. And that’s despite a 22 per cent fall in consumer spending between January and June this year, courtesy of the coronavirus pandemic, according to McKinsey & Company.
PitchBook’s Q3 2020 Emerging Technology Report: Fintech cites widespread regulations and financial reforms enacted since the 2007-8 financial crash, creation of oversight committees, ongoing stress testing and capital requirements as having left the financial system more prepared to handle the violent economic disruption wrought by COVID-19.
This perspective is bolstered by Cyrus Pocha, financial services regulatory partner and co-head at “magic circle” law firm Freshfields Bruckhaus Deringer’s Global Fintech Group. He says the current mergers and acquisitions (M&A) activity in the European payments sector can be traced back to the last financial crisis when the price of state aid for many universal banks was the compulsory sale of their payments capabilities.
What had once been seen as relatively uninteresting financial plumbing was pushed into the spotlight. Pocha says: “At the same time, in addition to the growth of online transactions, the last decade has seen a gradual move away from cash transactions towards card and contactless payments and now, increasingly, digital payments using crypto assets or another form of distributed-ledger technology.”
Payments’ easy-to-scale model highly appealing
So the demand for payment services is increasing and new ways of making payments has brought other smaller players with high potential growth opportunities into the market.
James Brocklebank, managing partner at buyout group Advent, points out that payments truly is a scale business. “The marginal cost of transacting a million extra transactions once you have scale is almost zero. So it makes sense for payment providers to get economies of scale,” he says.
“Also, because if you have developed good technology and good products in one market, it’s possible to use them in other markets and reap the benefit of the investment across a wider geography.” Private equity is perfectly able to give these businesses the focus they need, invest in them and attract top talent.
When Advent and Bain owned Worldpay, they spent approximately $500 million buying other payments companies to create an entity subsequently listed as a FTSE 100 company in London. That company was then bought by Vantiv, another Advent payments company and itself a bank carve-out, subsequently acquired by FIS for almost $35 billion. “So M&A is absolutely at the heart of the growth in the major payments players and has been a phenomenally successful strategy,” says Brocklebank.
Regulation has improved the landscape
In parallel, adds Freshfields Bruckhaus Deringer’s Pocha, the regulatory environment in which payments firms operate in the European Union has also improved. The first harmonised EU rules were introduced with the payments services directive (PSD) in December 2009 and updated by PSD2 which was generally implemented by member states in 2018.
These regulatory changes provided pure payment services firms with a European passport, similar to those enjoyed by banks, while imposing a lighter regulatory burden, among other things, in relation to capital. Overall, this meant that as the payments space became more interesting to sophisticated private equity, it was also becoming more accessible.
Traditional banks typically owned payment providers in the past, such as Royal Bank of Scotland-run Worldpay, Nets led by 186 Nordic banks, Nexi by the Italian Popolare banks and Concardis by German regional banks. These are not best owners of payments companies, according to Brocklebank, as it’s not their core business, which is lending and deposits.
“So they struggle to invest enough in them, attract the right talent, use M&A to acquire scale and capabilities, or give them the independence they need to be nimble operators in a rapidly evolving marketplace,” he says.
The perks of an international market
Given its history as a piece of market infrastructure run by banks or consortia of banks, the payments market has traditionally been characterised by strong regional or national players, says Pocha. “It therefore made sense to seek to grow the customer base through M&A in different EU member states and regions,” he says. “This also played to the private equity industry’s strengths: investors were perfectly placed to implement such cross-border ‘buy and build’ strategies.”
Coupled with the fact that private equity lives with the imperative of having to send its capital out to work, and many of the active funds were raised prior to the pandemic, this has meant it has been able to continue pursuing its M&A strategies at a time when other potential trade acquirers are pausing for breath or finding it harder to compete on price.
Additionally, the pandemic has impacted the payments M&A landscape by illustrating the danger of being too niche, as in the example of payments firms which relied heavily on servicing the travel industry and were disproportionately negatively impacted.
Surprisingly, penetration of digital payments remains relatively low in Germany, the powerhouse of Europe’s economy. Germans have traditionally not been comfortable with high levels of borrowing and instead preferred local debit schemes and cash. As a result, the penetration of cards, typically a precursor to digital payments, has lagged behind the rest of Europe.
Finding the right players for investment
Where competition is most evident is around the edges, says Brocklebank. For example, niche ecommerce offerings from nimble fintech players. “But even those struggle to get traction with big, global merchants who need blue-chip, resilient, scaled solutions,” he says. “These nimble fintech players are more of a threat in the small and medium-sized enterprise (SME) customer base.”
One such nimble fintech player is London-based payments processor Safenetpay, which services the UK and, imminently, European and Asian SME sector with innovative payments and business current account solutions.
Co-founder and chief executive Sanjar Mavlyanov says, although advances by private equity groups may be flattering, Safenetpay is not receptive to such overtures. “We pride ourselves on being independent and having a tightly knit global team that can act fast to meet and exceed clients’ ever-evolving payments needs,” he says.
So despite the evident surge in takeover activity in payments processing, there are still minnows willing to take their chances in fintech seas awash with hungry predators.