Stripe, Paystack, Flutterwave and Why Payments is such a Big Industry

Unpacking the Payments Space

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Introduction

Recently the payments scene has been on an absolute tear. Valuations within the space are skyrocketing and payment companies are becoming darlings of the investor community. Globally, Stripe raised US$ 600m dollars in a Series H funding round at a valuation of US$ 95 billion becoming the largest privately held company ever produced by Silicon Valley. In January, Checkout raised US$ 450m in a Series C round that valued the company at US$ 15 billion making it one of Europe’s most valuable startups.

Closer to home, Flutterwave recently announced a US$ 170m Series C round that officially heralded unicorn status for the company. This brought the total amount of money raised by Flutterwave to US$ 225 million which is quite impressive for an African start-up. This followed on the heels of last year’s acquisition of Paystack by Stripe that valued Paystack at US$ 200 million. Stripe led Paystack’s Series A round back in 2018. Large deals within the region also included the acquisition of Direct Payments Online by Dubai Based Network group  for US$ 288 million. 

Adyen is a Netherlands based payments company that is listed in Amsterdam and offers an almost similar payment product like Stripe processes over US$ 357 billion in Total Payments Volume with net revenues of US$ 806 million. The total market cap is roughly US$ 66 billion as of 26th of March meaning that the market values it at 82x net revenues. This is a very attractive valuation for the company meaning that investors are pricing in tremendous growth in the future. It is estimated that Stripe had almost similar payment volumes in 2020 according to CB insights but has been growing at a much faster pace with a wider product suite. 

Why is payments so hot and what is driving these valuations? What is the mission of these companies and why does it matter? This week I try to unpack this industry and understand why the investor community is rewarding Payment companies such as Stripe, Flutterwave and Paystack with block-buster valuations.

What do these Companies Do;

Evolution of Payments

The evolution of Payments traces the evolution of communications technology. In the 19th century USA, to communicate a letter meant to send a letter through the existing infrastructure such as roads, rail and ports. When someone wanted to send money across the country, he/she would use this same communications infrastructure and would put cash in a letter, seal it with wax and send it across. Companies such as Wells Fargo, Western Union and American Express actually started out as delivery/postal service companies enabling Americans to send letters, cash and other items across the country. Wells Fargo in particular developed a reputation for sending Gold across the country from San Francisco. 

As time progressed, government institutions developed both communications and payments infrastructure in the form of; the US Postal Service which helped people move money across in the form of money orders as well as the Federal Reserve system which enabled the centralised clearing of cheques. As this infrastructure developed, companies such as American Express and Wells Fargo had to pivot towards other businesses. Wells Fargo pivoted towards full scale banking whilst American Express pivoted towards firstly money orders, then travellers cheques and eventually charge cards. Interestingly the two companies could be traced back to Henry Wells and William Fargo. 

In the 1950s, Diners Club followed by American Express introduced charge cards which were marketed to business executives. Charge cards were a closed loop network that worked by onboarding partner merchants who would accept them and customers who would be issued with cards. Merchants would send their itemised bills at the end of the month and Diners Club and American Express would issue these bills to the respective companies/individuals for settlements. In the 1970s, Bank of America introduced a card system that would later come to be known as Visa. In the 1970s, American banks could not expand beyond state lines therefore Bank of America licensed this new card system to other banks. According to Dee Hock who many consider to be the grandfather of Fintech and who was then the founding CEO of the Visa Credit Card Association. He saw the work of Visa as being in the business of “electronic value exchange” where transactions were “transmissions or acts of communication”. Bank cards would work by communicating debit or credit instructions throughout a system of networked computers.

In Kenya, a similar evolution can be seen with M-Pesa where communications infrastructure transforms into payments infrastructure. The idea behind M-Pesa arose from the realisation that people were sending airtime to their relatives as cash. Their relatives would find someone who would accept the airtime and issue cash. M-Pesa also displaced a physical parcel based money transfer mechanism for those who didn’t have access to bank accounts. This is very similar to the histories of American Express and Wells Fargo.

Primer on Card Networks

So first a primer on how the card networks work.

1. Issuing Bank - The bank that issues a credit/debit card to the customer;

2. Issuing Processor - The company that enables the issuing bank to connect to card networks such as Visa and Mastercard - Provides Gateway and support services;

3. The card networks - these are the global card networks/schemes such as Visa and Mastercard that create and run the infrastructures that enable transactions to be processed;

4. Acquiring Bank - This is the merchant’s bank i.e. where the merchant has an account;

5. Acquirer processor - This is the company that enables merchants to be onboarded into the card networks to accept payments. There are traditional Payment facilitators or modern versions such as Stripe and Paystack. The key role is to carry out KYC checks, handle disputes and process chargebacks for merchants;

6. Merchant - The person/company receiving payments.

This diagram from Bank of England clearly demonstrates how a card payment works;

Source: Bank of England

Some other critical concepts;

1. Interchange fee - a commission charged to the merchant by the networks through the processor;

2. Chargebacks - these are reversals of the transaction initiated by the payer in a transaction. According to the card schemes, chargebacks should always be processed in favour of the customer and be paid by the merchant via his acquiring bank. 

The Payment processor/acquiring processor business is then about managing the risk of chargebacks against the income from your processing fees. In most instances, this is done through strict onboarding and to a large extent the exclusion of smaller less profitable merchants. The card networks are thus open loop platforms where merchants pay to have access to the multitudes of card holders and issuers are incentivised via interchange to onboard customers. The Anatomy of a Swipe by Ahmed Siddiqui is a good read if you want to have an overall understanding of how card payments work.

Enabling Payments in the 21st Century

In the past, the acquiring business was focused largely on large off-line stores with a long on-boarding process centred on minimising the risk of chargebacks and fraud. In the 90s, with the advent of the internet, the Payment Facilitator model (PayFac) gained traction with the likes of Paypal. This model was based on a PayFac onboarding sub-merchants under his main merchant ID and was targeted towards enabling people to receive payments online.

The origin story of the likes of Stripe, Paystack, Flutterwave and other such companies is to make it super easy for merchants to receive online payments by offering an API-driven on-ramp to these payment networks. They abstract all the complexity of the card business and offer their clients - primarily developers a simple API that enables you to accept payments within minutes. The abstraction includes KYC, AML checks, fraud and risk management as well as the technical work behind creating check out pages for your website or app. This is all embedded within a simple API.

Further, these companies offer more than just the usual traditional card networks and enable you to collect payments using the multitude of global payment options. The diagram below best describes this.

The diagram above is a good stab at showing what happens under the hood. The merchant deals with simple payment APIs from Stripe, Paystack, Flutterwave depending on where he operates. These APIs abstract the complexities of the multitudes of payment options. Here is a useful guide by Stripe on different payment methods.

Stripe’s main goal is “to increase the GDP of the internet”, Paystack and Flutterwave have similar aims to enable economic growth via providing the economic infrastructure to participate in the internet economy. The CEO of Flutterwave Olugbenga Agboola says that for “Africans to develop, we need to have three things, logistics, payments and commerce”. Their mission is thus to develop the African payments layer.

These companies are API first, in this video below, the CTO of Stripe David Singleton gives a great talk on how Stripe develops its APIs. 

The screen grab below shows their laser focus on simplifying the process for developers. For a developer, you don’t have to understand industry jargon such as “Primary Account Number - PAN” which is simply your card number. Card number in this case is more intuitive.

Therefore, these API first payment companies offer a simple intuitive onramp onto the financial system and abstract all the complexities required to receive and make payments into a simple API. The critical success factors are thus the simplicity of the API, transparent pricing and how robust the system is as it scales. Stripe for instance has an API reliability of 99.999% for the last 90 days. 

Once the simple payment process is solved, these companies have offered further value around the payments cycle. Flutterwave and Paystack for instance have launched their storefront features where they make it very simple for African merchants to set up storefronts and start selling goods online. Other products include fraud detection, invoicing and billing capabilities for SaaS companies, card issuance and payment links that can be shared on social media.

For Stripe, the core product is the Global Payments and Treasury Network which is largely the abstraction layer and on top of this, products such as Stripe Billing, Stripe Connect (payouts), Stripe Terminals (physical POS terminals) are built on top. Recently Stripe has launched Stripe Treasury which is their global Banking as a Service offering as well as Stripe Capital that enables merchants to access credit facilities. 

The economics of payments is quite straightforward, you charge a fee to your merchants to receive and make payments on your platform. This fee is shared across the infrastructure value chain i.e. from banks, networks, wallet providers and payment infrastructure services. You then have your net revenue from payments. From this you can have additional revenue streams such as interest on float, exchange commissions and commissions on other value added services. You can even add interest income on credit facilities or commissions on loans advanced via your platform. The idea is to grow the payments volume which has net margins of roughly 22bps and grow high margin business around this.

Stripe, Paystack and Flutterwave are notoriously secretive when it comes to their financial performance. Nonetheless, Adyen is a listed company and offers a relatively similar product to Stripe. 38% of its 2020 revenues were generated from its top 10 clients and it has a net margin of around 22.5 bps. Attracting whales such as Netflix and Shopify is therefore critical in this business model. 

So What’s the Big Play?

There are four main themes that are driving the valuations of these API driven payment processing companies. They can be summarised as;

1. Growing the internet GDP;

2. Software is indeed eating up the world;

3. Infrastructure Play;

4. Stocks vs Flows Framework

Growing the Internet GDP

According to the Internet Association, the internet contributed over US 2.1 trillion dollars to the American economy in 2018 or roughly 10.1%. This grew from US$ 966 billion in 2014 or slightly over 5% of the US GDP at the time. Moreover, e-commerce accounted for over 20% of total retail trade in the US. Globally, e-commerce sales are expected to grow to over US$ 6.5 billion and represent over 22% of total trade worldwide in 2022. Covid has definitely accelerated this number.

The underlying infrastructure around the internet such as Cloud, Big Data and higher internet speeds will drive growth in the internet economy. One of the main things around the growth of the internet is that we are very poor at predicting the second order effects of the improvements in technology. 20 years ago, nobody would have predicted that the largest taxi company in the world didn’t own a single taxi. Now Uber utilises these payment processing companies and the Taxi economy has shifted over into the internet. The same can be said about AirBnB, Substack, Shopify and many other platform players that have shifted whole industries into the internet. In my view some of the predictions around how big the internet GDP is going to be are very conservative. If these trends play out, then Payment processors such as Stripe and Flutterwave are expected to grow significantly.

Think for instance as an African buying a car from Japan or China. The existing model involves using a website such as BeForward to search and book then switching into the analog world via sending a Telegraphic Transfer to Beforward for them to ship it. Payments infrastructure will soon embed into this process and enable things like escrow and purchase finance via APIs. This bit of economic activity will shift fully onto the internet.

Software is Indeed Eating the World

Marc Andreesen in 2011 coined the term “Software is eating the world” in his 2011 essay. The whole idea was that;

Six decades into the computer revolution, four decades since the invention of the microprocessor, and two decades into the rise of the modern Internet, all of the technology required to transform industries through software finally works and can be widely delivered at global scale.

The idea here is that in the 80s and 90s, software was built to add value and productivity to business processes. In the modern world, business logic is embedded into the software and thus software is the business not just a productivity enhancement tool. The image below from a very good article by Jay Kreps, the founder of Confluent gives a very elegant summary.

Using a loan application as an example, software is the business and rather than going through bits of software at each level of the loan application process, the bank becomes software and the client can get a straight yes or no answer in seconds. APIs in this world are now critical as they enable businesses to communicate to each other. Remember payments and communication?!

What then happens is that companies that provide a service should thus convert that service into APIs. The older vintage of software companies were targeted primarily at enterprises and thus the sales process revolved around a sales team who would meet their potential clients, sign NDAs, agree on pricing and licence volumes and go through a 3-6 month implementation period. Nowadays, all this should be embedded into self-service APIs. It’s crazy that some payment companies still ask founders to meet over lunch, sign NDA’s and go through a months long onboarding process.

There’s a great interview by Azeem Azhar with Scott Farquhar, the CEO of Atlassian that has a great discussion on how businesses should think about software. 

In this new software driven world, what happens is that developers become more important in the decision making process of any organisation and thus selling a product to a company becomes more and more about how simple and powerful your APIs are. In this world, Stripe is king! The video below is a good discussion about this concept.

Infrastructure Play

In the earlier part of this article, we noted the rise of Wells Fargo and American Express tracing their roots in building out communications and transport infrastructure in the USA. These were build out using the main infrastructures of the time i.e. Road, Rail and Ports. Amex and Wells Fargo then rode on this infrastructure and the trust that resulted from it to build out very successful businesses in banking and financial services.

Stripe, Flutterwave and Paystack are also building economic infrastructure for the 21st century on top of the internet. The key insight when the Collison brothers set out building Stripe was that there was no payments layer within the internet. Actually, when the internet was being built out by Tim Barners Lee, the 402 message was intended to tell a visitor to a website that they needed to pay to access that website.

Where we have protocols such as HTTP as the application layer, TCP as the transport layer and IP (4/6) as the network layer, it is feasible that these companies are building the payments layer that sits on top of the internet. When you consider that more and more of our GDP will run on the internet; then a company like Stripe can easily become more valuable than companies such as Apple, Amazon and Alphabet. Collecting pennies on global trade is a multi billion dollar business.

One thing to note is how there is a trend towards commerce rather than just ads on the internet. The earlier vintage of internet companies such as Twitter, Facebook and Google were ads based. Now, the focus is shifting towards commerce. In this Podcast, Tobi Lutke, the CEO of Shopify says the following about the shift to commerce based models

Silicon Valley has always, and still does – and potentially will always – underestimate commerce, just straight up. There's a reason why most commerce companies can't come from Silicon Valley. And I think this is actually has a lot to do with by osmosis everyone kind of observes the current debate. And the early successful business models were advertising-based. And by the way, in China, they are commerce-based. And I think that is a very, very big difference between those two places. Business models are generally more about selling things than advertising. (emphasis mine) And for a European living in Canada and observing places from outside, that just kind of felt really obvious that it was underestimated. I just, even when I was meeting with venture capitalists, they always wanted me to answer how big the TAM was...Which I always got terribly confused, because this is retail, you realize retail is basically everything, it's a four trillion-dollar business, a four trillion-dollar market just for online parts in the next couple of years.

In China, payment facilitation for ecommerce has given Ant Financial a multi-billion dollar valuation. Speaking of TAM, current systems such as Chaps, Fedwire and Target in Europe process between 1.5 and 3 trillion dollars per day. As more and more of our GDP and commerce move into the internet, payment processing companies will start doing the kind of volumes that existing payment infrastructures process.

One of the key points here is that infrastructure is a key enabler and businesses that would have had insurmountable hurdles to jump will now be able to sell online and receive payments. There’s a massive invisible e-commerce space that will emerge in the coming years.

Stocks vs Flows

In finance, the distinction between stocks and flows is usually useful in analysing business models. Lex Sokolin in this article does a great job in detailing this concept as it pertains to the payment companies. Flows relate to transactional volumes e.g. foreign exchange volumes and stocks related to balance sheet items such as deposits and assets under management. The economic model of flows relies on creating a platform through which transactions flow through you and you get a small economic rent for facilitating the transactions. The economic model of stocks relies on you building trust with your clients over time and attracting more of their money and getting a rent on this through interest or fees. 

Paystack, Stripe and Flutterwave enable flows and clip off a small fee for every transaction that is enabled. The idea is that the valuations are being driven by the expected growth in the volume of transactions that are expected to flow through them. Adyen for instance is valued at 82x forward revenues. The market thus expects that future revenues are going to grow significantly on the back of ever growing payment volumes. The drivers for this growth have already been detailed. In a low interest rate environment, investors are rewarding the flow model more than the stock model.

Nonetheless, we have also detailed how players such as Amex and Wells Fargo calcified these flows and converted them into stocks by moving higher up the value chain to offer banking services through the trust they had developed from their flow business. Companies like Stripe are creating economic infrastructure for the internet and thus attracting growing payment volumes. These can down the line be converted into a multitude of income types since merchants and other businesses will trust them with more and more of their financial lives. Paypal has already shown this by creating a closed loop system where clients can maintain balances on which Paypal receives interest income from. The number of verticals that Stripe and Flutterwave can thus get into in the future is limitless and just depends on what they want to focus on.

Interestingly as infrastructure services, business models can be built on top of Stripe. Down the line merchant banking can be built on top of a service like Flutterwave for instance where a software driven bank can use Flutterwave payment flows to design bespoke trade finance facilities for African traders.

Summary;

Modern payment companies in this case Stripe, Paystack and Flutterwave amongst others like Checkout and Adyen are benefitting from a number of tail winds such as growth of ecommerce, overall internet GDP and the changing nature of software from a productivity tool to the core of the business. These tailwinds create a situation where the companies that execute the best in this case largely Stripe, will become a critical pillar of commerce and the economy extracting significant rents from the service they provide. 

The playbook should involve investing in these companies via IPO as a long term growth and income play as well as building fintech companies that sit on top of their infrastructure. The internet and software are swallowing the global economy whole and the companies that do well will be those that partake in this secular trend. However, it is worth noting that there are two approaches to creating the economic system of the internet; the Stripe approach and in the longer term, the blockchain or De-Fi approach.

As always thanks for reading and drop the comments below and let’s drive this conversation.

If you want a more detailed conversation on the above, kindly get in touch on samora.kariuki@gmail.com;