In my recent blog post, I outlined why I believe large-scale public payment processors will maintain compelling long-term growth rates even as fintech disruptors take market share. I think that share will largely come at the expense of banks instead. Banks are still the largest players in the payments market, and their 50% – 60% market share is the easiest target for these fintech companies. In addition, in my view, many banks have weak product offerings and a lack of strategic focus in this space that results in a large amount of payments volume sitting in the weakest hands in the industry. This transition may also benefit scale processors if banks look to partner with them to maintain share. We are seeing this begin to play out in Europe, but I expect the trend to continue, if not accelerate, across most geographies.
Despite this long-term growth potential, some investors have wondered why these scale processors’ performance has recently lagged that of cyclical recovery stocks. The main reason is that these stocks have never acted as a cyclical element of portfolio construction in the past and therefore aren’t viewed that way by the market.
These scale processors are now being compared to peers that have had drastically different experiences in the pandemic due to distinct business models. The stocks that have underperformed have generally been impacted by the slowdown in areas like restaurants, education, brick-and-mortar shopping, and travel. In contrast, several of their competitors that have outperformed have seen significant growth from their peer-to-peer, contactless, and e-commerce payments businesses fueled by pandemic-driven behavioral changes.
One of the reasons I am so excited about the scale processors that have underperformed recently is that the market has not fully internalized the fact that, in my view, these stocks are likely to behave quite cyclically over the next one to two years given the unique nature of this cycle. Their near-term growth potential is broadly underappreciated as a result. As the economy returns to normal, I think the areas that underperformed in the pandemic could see significant growth.
The case for scale processors’ cyclical growth
The payments industry’s volume growth is driven by three key factors, in my view: real personal consumption growth, inflation, and the cash-to-card migration. I believe company-specific volume growth is a function of these three variables plus each company’s unique verticals, geographies, and distribution channels. I think evaluating these three main factors in the context of a post-pandemic economy shows why scale processors are likely to behave cyclically for the next few years.
- Real personal consumption growth: Various historical records post pandemics combined with today’s pent-up demand signal consumer spending is highly likely to increase as society returns to normal levels of dining, travel, and in-person shopping.
- Inflation: It is possible that we could enter a new higher inflation regime in the next few years. In my view, payments should be a good inflation hedge as many parts of the value chain are transaction-volume based, which means revenue should naturally rise as inflation increases.
- Cash-to-card migration: The shift to e-commerce, buy online/pick up in store ordering, and mobile commerce, as well as the aversion to cash, have all pushed us several years into the future in terms of card adoption. I expect broad industry growth from the cash-to-card shift to be higher than previously expected through 2024/25, in effect borrowing this growth from later in the decade. I believe scale processors have not yet seen the full benefit of this growth potential but are likely to as life returns to normal.
All of these factors point to strong industry growth potential over the next several years. As the global economy opens throughout 2021 and 2022 I think volume will snap back more sharply than people assume. In addition, based on the factors above, the duration of strong industry growth could be longer than many think.
Scale processors have never behaved cyclically in their histories as public companies because, before now, there has never been significant volatility in any of the components of industry volume growth outlined above. Real personal consumption growth has been relatively muted since the global financial crisis, inflation has been low, and the move from cash to card has been a steady grind higher. This has led to stable, low-variance growth over time.
The next two years, if not longer, are likely to be substantially different than the past. In that world, these stocks could act more cyclically on reopening than people expect, before going back to their more traditional steady compounder roles in portfolios. I’m excited about this potential cyclical growth stage for these companies and for the secular growth tailwinds I believe support them for the long term.