May 4, 2022
Jamie Friedman is a senior analyst covering IT Services/Outsourcing and Financial Technologies at Susquehanna International Group, LLP (SIG).
He started on Wall Street as an associate at Prudential Securities, emerged as a senior analyst at Goldman Sachs, and launched research at Fulcrum Global Partners in 2001 as one of the firm’s first employees.
Mr. Friedman began his career in the industry working in the systems department at Bertelsmann Industries, and is a graduate of Columbia University.
In his 3,047 word interview, exclusively in the Wall Street Transcript, Mr. Friedman explores the current high growth areas of the financial technology sector and has valuable insight regarding the rise of blockchain technology:
“Payments are really fascinating. I’ll give you a couple of subsectors of growth.
One of the most interesting ones to me is those that specialize in cross-border e-commerce.
Cross-border e-commerce from a payments perspective is really complicated. Part of the complexity is that in a lot of the world, people don’t pay with credit cards. They pay with some alternative payment mechanisms. If you’re a big company and want to expand into an emerging market, you need to make sure that you enable that customer to pay the way they want to pay.
If you go present them — like if you’re Amazon (NYSE: AMZN) and you present a new consumer, new to Amazon in Brazil, with payment options at checkout, and you only offer them Visa (NYSE:V) and MasterCard (NYSE:MA), they’re going to abandon their cart.
My guy has to enable it so that you can pay with the options that are actually in your wallet.
These alternative payment mechanisms are a huge challenge. And really, the specialists in this market are growing 40%, 50%, 60%.
Examples are the companies like dLocal (NASDAQ:DLO) and Adyen (OTCMKTS:ADYYF).
Another subsector is platforms in e-commerce. An example is eBay (NASDAQ:EBAY).
But there are a lot of other platforms, like Shopify (NYSE:SHOP).”
The disruption of the sector looms large in Mr. Friedman’s estimate:
“…Then you have the emergence of online banks.
The best player in this is Square (NYSE:SQ), in our view.
Square has built Cash App. Cash App has 40 million users. They’re making $60 per user per year.
If you look at the functionality they offer, their competitors are ones like Capital One (NYSE:COF) and Discover (NYSE:DFS) and American Express (NYSE:AXP). But Capital One makes $300 per user a year.
So can Square get from $60 now to $100 and $150?
We think they will.
They are a very good option. Their Cash App business is really an attractive story.”
Another analyst specializing in this high growth sector is Lisa Ellis, a partner and Senior Managing Director at MoffettNathanson LLC. where she leads the Payments, Processors, and IT Services business.
She wrote several investment research reports and frequently appears as a commentator on Bitcoin, blockchain, and other cryptocurrencies.
In 2020, she was named to Barron’s list of “100 Most Influential Women in U.S. Finance.”
Prior to joining MoffettNathanson, Ms. Ellis was a Managing Director and Senior Research Analyst at Sanford C. Bernstein & Co.
While at Bernstein, Ms. Ellis was the #1 Institutional Investor -ranked Payments, Processors and IT Services analyst.
In her 2.650 word interview, exclusively in the Wall Street Transcript, Ms. Ellis sets out a framework for her equity analysis of the repercussions of blockchain technology.
“I would probably separate companies or businesses accepting digital forms of payment from them actually accepting digital currencies or cryptocurrencies.
In western markets, the majority of businesses nowadays take digital forms of payment.
That’s simply a credit card, debit card, prepaid card. You can also do other forms of electronic payments like using a digital wallet type of model like in PayPal (NASDAQ:PYPL) or something like that or in Venmo.
Those are digital forms of payment.
They’ve been around for 50, 60 years and are in the more mature stages of adoption in western markets.
Although in many developing markets, in Africa or in parts of Asia or Latin America or even some parts of Southeastern Europe, there’s still a lot of cash used in societies and digital forms of payment slowly take over and displace cash as the primary method of payment. And the vast, vast majority, meaning well over 90% of digital payments in the consumer context, consumers are paying merchants with a card, a digital card.
So that’s like a credit card, debit card. That’s the primary method of digital payment.
Distinct from that is the concept of actually paying for goods with a digital currency.
This would be buying something with Bitcoin as a form of tender.
That’s just like we’ve seen in Ecuador adopting that model.
That’s extremely nascent and is to be determined on how widespread that will become over time.
The primary situations in which there’s a use case or a value proposition for using digital currencies or cryptocurrencies as a method of payment is in countries where the local fiat currency is unstable and so suffers from high inflation or an autocratic government.
Those types of digital currencies are truly an alternative to local fiat currencies.
In western markets where you’re using the dollar or the euro or the yen or some very stable free market currency, there’s not a strong use case really.
People might do it because they think it’s interesting or fun or a different novelty. But there’s not a particular use case for using or value proposition for using a digital currency, whereas in some developing markets, particularly those that suffer from very high inflation, there can be a pretty strong value proposition.”
Ms. Ellis then describes how digital payments have recently begun to evolve under the influence of the blockchain.
“…A shift that you see particularly in e-commerce payments — or it can be in a physical store where you might be paying with your phone — is the intermediation of using some sort of wallet as a method of interfacing.
That’s the best way I can describe it — the interface between you and the merchant, typically a wallet. So, this would be a wallet like Apple Pay (NASDAQ:AAPL), PayPal, Google Pay (NASDAQ:GOOG). The list goes on and on.
Typically, the underlying funding method within those wallets is again, the vast, vast majority of the time — like over 90% of the time, and in the case of an Apple Pay 100% of the time — is still a card-based model.
The underlying true payment method so to speak is still a card, like you load your card in your Apple Pay wallet or you load your cards in your PayPal wallet.
But the digital wallets offer a compelling form of intermediation with merchants because you can do that sort of one-click checkout where it makes it very easy to check out.
You don’t have to manually enter your card information every time and also those wallets can offer other interesting offers to consumers like some special promotions or merchant rewards, and they can keep track of your spending for you and provide information around it.
There are some other interesting aspects of it, but those aren’t new forms of payment per se, but they are new methods of conveying your payment, like interfacing over to the merchants, that has gained a lot of traction.
For example, in the United States across the primary categories of retail, e-commerce or consumer e-commerce — that’s retail, travel, entertainment, media, those types of categories of e-commerce — the PayPal checkout button or using the PayPal wallet as a method of payment is literally a third of the volume in those categories in the U.S. So that type of wallet has become very popular.”
This evolution has begun to develop into the promising use cases around Blockchain technology.
“One of the use cases for blockchain technology where it works particularly well or where it has a particular value proposition is in supply chains.
So, for example, the food supply chain globally is a great example of where companies heavily involved in food supply — so this is like companies like Walmart (NYSE:WMT), which run tons of grocery stores and all of their wholesalers and food suppliers can use blockchain technology.
The benefit of that technology is that it provides a way to very uniquely track items.
It has these unique identifiers that are impossible to copy or replicate. You can’t cheat and duplicate them.
There are very unique identifiers and then also the technology has a very unique aspect that all parties that are given permission on a blockchain system can have good visibility into everything that’s going on up and down the blockchain.
That means you can use that technology — just the characteristics of it make it very amenable to complex supply chain tracking applications.
So you can just imagine that you can track a box of mangoes from Latin America all the way through what ships.
They went on to ship to the U.S. and then what distribution centers they went through, all the way to what grocery stores they landed in. And that way you can not only create supply chain efficiencies to manage bottlenecks throughout the supply chain, but if there’s an outbreak of a foodborne illness, you can very easily track and trace where the food came from.
You can also better guard against illegal farming and things like that in some areas of the world like in the Amazon — also avoid and better track issues like that.
It doesn’t get as much attention I guess, but it’s actually one of the applications of the technology that’s gained the most significant adoption.
It has nothing to do with finance or payments. It’s an application of blockchain technology specifically that’s taking advantage of their unique characteristics associated with asset identification.”
The association of payments, blockchain secured provenance creates a road map for creation of the Smart contract technology.
“Smart contracts are another application of blockchain technology that has gained a lot of early traction in a bunch of different use cases.
The way a smart contract works is that you embed into a transaction a form of what’s referred to as conditionality, meaning it says, “OK, transfer money from Person A to Person B under the condition once these following conditions are met.”
A classic amazing use case of that technology in a developing market like, say, in Africa is for something like crop insurance.
This is insurance that you pay and then you get paid out if your crops fail for some reason. You can set up a smart contract that says, “OK, pay farmer John a certain amount of money if the following conditions are met, temperatures reach a certain level or water fall reaches a certain level, etc.”
So it’s like an automated contract — insurance contract — and what that does is it allows you to do much smaller increments of insurance, for individual farmers for example, which are hard to reach through a traditional labor-based insurance company like actuaries and everything.
You can do it in a very automated online fashion.
It also eliminates corruption, the risk of corruption, from the system because it’s just literally baked into software that automatically pays out under certain conditions. That’s a good example of a smart contract.”
Ms. Ellis wants to emphasize that we are in the early days of blockchain technology growth.
“Bitcoin was invented in 2008.
We’re only 14 or 15 years into a very transformational disruptive technology. It’s still in its early stages.
If you think about that in the internet context, the internet, the origins of the internet, were back in the 1960s and it really wasn’t until the 1990s that you saw the explosion and adoption of the internet.
We’re still in very early stages and many of the companies that investors are the most interested in in the space are actually the companies that are providing the building blocks or the infrastructure for these technologies.
They’re still so nascent that you’re still figuring out foundational things, like how do we securely store digital assets or digital currencies, how do we store them in a secure way such that they are accessible, but also protected from theft and fraud.”
Ms. Ellis has ample advice for how to invest today.
“There’s a group of companies that do asset custody and storage, which are very popular.
These would be companies like Coinbase (NASDAQ:COIN), who is very active in that space.
Paxos is another one.
Bakkt (NYSE:BKKT) is another one that is very strong in that arena.
Similarly, there are companies that just provide a method of moving — on-ramping and off-ramping between traditional assets and currencies and into the digital assets and currencies.
They provide this intermediation layer. Again, that would be exchanges like a Gemini or an FTX, or Kraken is another one.
These are what you’d call the picks and shovels companies of blockchain and crypto or digital asset technologies.
That’s the stage of development that we’re in right now.”
This investment universe is growing.
“In addition, though, increasingly there are other methods of getting exposure to crypto, more to the technologies and the companies building these technologies.
So there are increasingly funds or ETFs, etc., that invest in a group of companies that are all quite active in the space and there’s also some individual companies that are now publicly listed that retail investors could get access to those companies.
Coinbase, of course, is the most prominent large-cap name, but there’s some other ones like Silvergate (NYSE:SI), it is a bank, and Signature Bank (NASDAQ:SBNY) is another bank.
These are two specialty banks that are pretty active in the space, and there’s probably over the next 12 months going to be another wave of new listings that are companies that are directly involved.”
Robert Maltbie, CFA, is President of Singular Research, which provides performance-based research to over 100 institutional clients, and with over $60 billion in assets under management. He also manages a private fund for high-net-worth institutions and corporate executives.
In his 2,319 word interview, exclusively in the Wall Street Transcript, Mr. Maltbie advances his case for small caps with upside potential in the development of financial technology with a view towards the expansion of blockchain technology.
“We focus on small and micro caps. We’re independent performance-based research, unbiased, no banking.
We have about 100-plus, 110 institutional clients. They have about $60 billion in assets.
They look to us for discovery, research, new ideas or old companies with new management, new products. We’re, I guess, frequently called on by major national media when they’re interested in small caps, which is less these days.
And we follow about 40 names and we’re doubling our coverage this year. We think there’s opportunity to grow our share in the market and also valuations are favoring that as well.”
“I think one application is disrupting traditional banking. I’ve seen estimates ranging from one to several trillion in revenue just on fees for withdrawals or bank accounts or wire fees — we’re not even talking about interest rates.
We’re talking about transactional fees that consumers incur from banks.
And if you’re a merchant, of course, using American Express (NYSE:AXP) or Visa (NYSE:V), you incur fees that way.
Technologies like blockchain allow fintech-oriented transaction processors or firms that focus on using this new technology to disrupt and disintermediate by using something that’s far more efficient, more decentralized and open ended, open architecture, that results in quite a bit of benefit to consumers in terms of saving on those transactions…
I think the totality of transactions done with even MasterCard (NYSE:MA) or Visa is so immense that there’s such a margin there to disintermediate within that you could squeeze out a trillion right there, just from that alone.
And looking at companies that can benefit from that, they’ve quite a bit of room for growth.”
“If you’re aiming to be high growth along the cutting edge, or if you have a huge franchise, like a Visa or a MasterCard that you need to defend, you’ve got to be on this. You’ve got to make investments now.
And you have to be very, very serious about this right now because it’s the pace of innovation, the pace of change. Look what’s happened already with the internet and internet two, three, etc., and offshoots of that — it is just an amazingly fast pace of innovation. And you don’t want to end up like a Sears (OTCMKTS:SHLDQ) or a Kmart in retail or other entities that just didn’t prepare and didn’t invest in R&D and in innovation.”
Moshe Katri currently serves as Managing Director of Equity Research at Wedbush Securities, where he has been for more than a year. Mr. Katri has been covering IT Services and Payments for more than 20 years, covering companies such as International Business Machines (IBM), Square (SQ), and PayPal (PYPL), to name a few.
Prior to joining Wedbush, Mr. Katri was a Managing Director with Sterne Agee CRT, where he expanded coverage of the fast-growing payments sector and continued his coverage of IT Services.
Mr. Katri spent the previous 16 years at Cowen & Company, as a senior analyst covering IT and Business Services.
He started his career on Wall Street in 1991, joining Oppenheimer & Co.’s equity research team focusing on Aerospace and Defense before moving to UBS, where he transitioned to covering IT and Business Services.
Prior to his career on Wall Street, he served as a military intelligence officer in the Israeli Defense Forces.
Mr. Katri received his B.S. in Finance and Information Systems and MBA in International Business from New York University.
In his 4,307 word interview, exclusively in the Wall Street Transcript, Mr. Katri develops the basis for his current recommendations in the financial technology sector and his views on the rapidly growing blockchain technology trends.
“…we cover the network Visa (NYSE:V) and MasterCard (NYSE:MA).
And these are, I would say, collectively they probably control about 80%, 85% of the total purchase volume.
We also cover the payroll processors, ADP (NASDAQ:ADP) and Paychex (NASDAQ:PAYX).
We cover the two-sided platforms that service consumers and merchants, so that would be Square (NYSE:SQ) and PayPal (NASDAQ:PYPL).
And then we also cover two-sided platforms that cater to financial institutions and to merchants. So that would be the likes of FIS (NYSE:FIS), Fiserv (NASDAQ:FISV) and Global Payments (NYSE:GPN)…
We cover Coinbase (NASDAQ:COIN) also as a monetization play, but not necessarily as a crypto play.
It’s predominantly the company’s ability to monetize roughly, I don’t know, 40 million users and build an ecosystem of products and services around it.”
Mr. Katri believes much of the upside for these current stocks lies in their ability for the monetization of networks.
“Each one of these players has a place in what we call the payments ecosystem, right?
The networks are sitting pretty much at the center of every transaction.
Instead of clearing transactions, they connect about four different parties in that payments ecosystem.
If you look at the companies that have platforms that service merchants, they’re the ones at first that serve as the gateways between the merchant and the network. That’s another way of looking at it.
But I would say a couple of things about what all these companies are trying to do today, all these companies — and this is not something I would have told you five years ago — all these companies are focusing on monetization.
So what does that mean?
Let’s look at MasterCard and Visa.
Their bread and butter historically has been more about generating or charging fees, right, for transactions that are done, whether via a shopping network or if you’re traveling. That’s what we call cross-border.
Now, the networks serve as financial institutions.
These are the card issuers and they’re also connected to merchants.
These guys realized a couple of years ago, and probably MasterCard is the one that really started this trend, that if we service so many financial institutions, why don’t we also build a whole set of services business, or what we call value-added services, or ancillary services, where we can actually sell these to our end markets, which would be the financial institutions?
So we’re talking about consulting, we’re talking about other things that are related like cybersecurity or data analytics.
The thought here is that not only can we help them clear transactions or make sure transactions go through, but we can also sell them services.
Lo and behold, four or five years later, for MasterCard, value-added services accounts for 20%, 25% of revenues and it’s a very profitable piece of business.
And ironically, this is the fastest-growing business right now for both networks. So 20% to 25% of revenues from MasterCard, roughly 15%, maybe 15% to 20% of revenues with Visa, the fastest-growing business is here.
And Visa probably had been very defensive, especially given some of the recent volatility in general in travel and a bunch of other revenue sources for the networks.
So the networks have been focusing on monetization and then everybody else has been doing the same thing.
Look at the payroll processors, ADP and Paychex, they’ve also built a set of ancillary services.
Not only are they helping employers pay employees, send them checks or deposit checks into their accounts, but they’re also selling them other ancillary services that are related to back office, whether it’s recruiting, whether it’s insurance.
And it’s interesting that’s really been working nicely.
Look at Square and PayPal, which are two-sided platform companies.
They serve merchants on one hand and they also serve consumers on the other hand.
Square probably has the best monetization strategy that’s been working flawlessly in the system.
We’re assuming that they cater to about 5 million to 6 million merchants. Not only do they provide these SMBs or mid-sized merchants the ability to clear transactions, but on top of that they also provide them access with other software tools that are necessary for them to operate a business: inventory control, loyalty, other things that are really necessary, and they charge them for using these tools.
That’s what we call ancillary services.
On the consumer side, Square built a digital banking app called the Cash App, which enables you, the consumer, to have a sort of banking account on this platform.
You can get your salary sent there, you can use it for purchases.
And then on top of that, you can access other services that are related to that platform, too.
That’s Square’s monetization strategy.
PayPal also has been focusing on how to monetize their two-sided platforms.
Then you have other two-sided platform companies that we cover and these are companies that on one hand service financial institutions and then on the other hand they service merchants.
So we’re talking about FIS (NYSE:FIS), Fiserv (NASDAQ:FISV) and Global Payments (NYSE:GPN).
On the financial institution side, these guys provide financial institutions with an infrastructure that’s related to trading, commercial banking, peer-to-peer, or P2P. That part of business that’s doing relatively well.
The other side of the business is more focused on merchant processing.
They provide gateways connecting between merchants and the networks and obviously charging fees for that gateway for merchants using the gateway to clear transactions.
But again, every single one of our companies has been focusing on trying to monetize the end markets that they’re focusing on.”
Mr. Katri has become concerned about the “buy now, pay later” space that Square, now called Block (NYSE: SQ) has recently acquired:
“Now the area that we’re concerned about the most in the industry today is the emerging, what we call, “sign up and buy now, pay later,” or BNPL area.
Anything that has to do with buy now pay later from our perspective is a bit problematic because this is effectively an alternative lending business.
This reminds us a lot of the subprime lending business that we’ve seen, I don’t know, 10 years ago.
There are some companies that focus predominantly on that, companies like Klarna, Afterpay that was acquired by Square, Affirm (NASDAQ:AFRM).
What worries us the most here is the fact that the model has not been battle tested during a recession.
We are concerned about rising default rates.
We are concerned about the fact that this kind of form of payment is relatively fast-growing in a consumer base that isn’t necessarily qualified to get your typical credit card.
We’re concerned about rising default rates and people are accumulating debt they cannot afford.
This is probably the only form of alternative lending that is not regulated.
For example, Square acquired app2pay.
Luckily for them, because Square shares fell so much from their high, they’re not paying $30 billion for it but about $10 billion.
Effectively they’ve acquired a lender and I don’t know if this strategically made a lot of sense for them.”
Get the complete detail by reading the interviews of all these equity analysts and more insights into the IT Services sector, and the emerging blockchain technology sector, exclusively in the Wall Street Transcript.