Investors Seek Profit Over Growth in Post-Pandemic Fintech Sector
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Investors Seek Profit Over Growth in Post-Pandemic Fintech Sector

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Peter Appleby By Peter Appleby | Journalist and Industry Analyst - Mon, 11/23/2020 - 08:03

The bearish turn that saw investment in Mexico’s booming fintech sector drop during 1H20 is coming to an end. Having sought shelter and paired back risk over the last eight months, investor appetite is growing once again. But for Mexico’s fledging startups competing to access equity, the rules of the game have changed.

The passing of the landmark Fintech Law in 2018 propelled the Mexican market to international renown as the country's mix of low banking penetration and high smart phone use provided a captivating starting point for fintechs to build from. According to a recent report by strategy consultancy KoreFusion, Mexico's  249 fintech companies have so far attracted US$1.3 billion in equity.

The market's rapid evolution pushed those early adopters to carve out a space for themselves and, in some cases, cast fundamentals aside in pursuit of the immediate growth that they hoped would attract additional investment and sustain them into the future, experts suggest.

“Before the crisis, fintech was very hot and there was a certain degree of spray-and-pray investment,” says Rafa de la Guia, Mexico City-based Principal at Quona, an emerging market venture capitalist firm that includes challenger bank Klar and SME banking platform Konfio in its portfolio. “Some of this went to great companies but there was also an element of hype and a fear of missing out from the investor side,” he told MBN.

Now, with a global recession underway, investors are reassessing their bets. Rather than growth at all costs, there has been a reversion to fundamentals. Fintechs must offer a sound business strategy and a clear path to profitability, says Nick Grassi, COO and Co-Founder of fintech provider, Finerio Connect. If companies do not adapt to this new environment, they risk being overlooked during new investment rounds.

“We have to assume that this will continue for the next year at least and those who do not adapt will die,” Grassi told MBN.

 

Uncertainty Remains

The worldwide pandemic caused the global stock markets to fall at their fastest levels ever recorded. On March 16, the Dow Jones fell  2,997.10 points and marked its steepest drop ever, breaking a record that had been set just four days previous. On the same day, the BMV suspended trading after its main index fell by over 7 percent. Days later, the peso would sink to its lowest ever recorded rate against the dollar, MX$25.34 per USD.

The wild rates of depreciation and economic chaos that the virus unfurled threw the technologies that fund managers and VCs depend on for their investment decisions into total disarray. Programs are still struggling to make sense of the situation, Hernán Fernández Lamadrid, Managing Partner at Angel Ventures, told MBN.

Algorithms on default rates, for example, are being challenged by the pandemic as more people are defaulting. It is harder for the program to predict,” he explained. “Lenders are therefore asking companies to lower origination or be more cautious with their portfolios.”

Simple economics means that riskier verticals, including lending, may struggle to receive the same degree of financing in a world that is still battling a defiant virus that is proving difficult to subdue. Mexico’s death toll recently surpassed 100,000 and governments around the world have reinstated lockdowns, including curfews in parts of Italy, France and Spain. Risking equity at this moment would be unwise, Rafa de la Guia believes.

“Questions remain around lending because the dust is still settling on the economic impact of COVID-19. We are not sure how defaults or collections will evolve. Debt capital lenders do not want to be aggressively lending at a time of great uncertainty.”

 

New Opportunities

Mobility restrictions in response to the virus’ spread also opened opportunities. Banks that were forced to close local branches saw an surge in online activity, with BBVA adding 400,000 digital clients between January and March 2020, MBN reports.

This search also spurred growth for fintechs able to step into the breach left by companies powerless to carry out business as usual. The pandemic has shown the importance of digitizing several sectors of Mexico’s economy and investment is following companies that will play a key role in the development of those sectors.

Cristian Huertas, Country Manager Mexico at Spanish neobank Bnext, told MBN that the need to shop online during lockdown had driven growth for the company in Mexico.

COVID-19 has helped Bnext to acquire more customers because many more people are willing to buy online at the moment. Before COVID-19, people had the ability to purchase online but were dubious. Now, because they do not have the option to go to shops, they are more willing to order through the internet,” he said.

Meanwhile, companies that offer financial services to gig economy workers, like Latin American fintech Lana, have also spaces of potential open in during the pandemic. Gig economy workers have been neglected by traditional banks because their fluctuating income means they often cannot meet banks’ requirements for services like credit, but these workers have experienced contrasting consequences depending on the vertical they work in, Juan Camilo Pineda, Co-Founder and Country Manager Mexico at Lana, told MBN.

Ride-hailing dropped severely amid the restrictions on movement. To help workers, we offered loans through a partner, with very low interest rates. On the other hand, food delivery apps saw a huge boost during quarantine and the number of gig economy workers increased as a result,” he said.

 

Belt Tightening

Fintech funding during 1Q20 fell back to levels not seen since 2017, according to a report from consulting firm CB Insights.

Some industry insiders including Fernando Lelo de Larrea, Partner at ALLVP, a Series A venture capital firm, believe that 2019 was an outlier in financing terms. The involvement of Japanese multinational Softbank, via its US$5 billion Innovation Fund in Latin America, pumped US$2.4 billion into the region in 2018 alone. This doubled the previous year’s total and grew again in 2019, according to El Economista.

2019 marked a record on all fronts and it is very difficult to surpass that. If we compare data from 2019 with 2020, it might scare us into believing that the industry is being greatly affected but the truth is that the base was affected from the beginning,” Lelo de Larrea told MBN.

According to the CB Insights report, “companies will have to tighten their belts, and focus more on profitability and positive cash flow than growth at all costs” in the post-pandemic environment. They must accept that without solid fundamentals, liquidity is unlikely to flow their way.

Some companies are already pivoting from growth to profitability, assessing where savings can be made to meet investor expectations in the new reality. Adrian Fernández de Mendoza, Managing Director at personal lending fintech Creditea, told MBN that nothing is considered sacred as long as customer satisfaction is met.

“We are looking at efficiencies everywhere including those related to fixed costs, increased approval rate, lowered acquisition costs and more. As long as it does not impact the customer experience or the service, everything should be questioned,” he said.

Industry insiders suggest that international equity and investors without specialized knowledge of Mexico or fintech may have been pulled in by the gold rush. The pandemic has proven to be a sound suppressor of the scatter-gun investments that were taking place in Mexico before the arrival of the virus. While not quite a case of the emperor’s new clothes, those fintechs that were surfing on the wave of hype could suffer in a future with limited liquidity available.

“There has been a flight-to-quality”, says Rafa de la Guia. “Fintechs in interesting sectors with great teams that were executing before the pandemic are still attracting interest from investors. But for fintechs in subsectors or verticals where questions were being asked prior to the crisis, or that had flaws in their business model exposed by the crisis, liquidity has dried up.”

Photo by:   QuoteInspector.com, Flickr

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