The Global Digital Wallet Opportunity
Why Investor Interest in this sector is so high
Digital wallet providers are steadily growing and attracting significant investor valuations globally. Kuda Bank recently raised a Series A worth US$ 25m just four months after raising a US$ 10m Series A one of the highest in Africa. In Asia, Grab is set for a US$ 35 billion listing potentially through a SPAC. Chipper Cash from Uganda raised US$ 30m late last year in a series B raise. I have covered payments before in this newsletter - detailing why Stripe and the likes can become trillion dollar companies. The focus this week is on digital consumer wallets and the opportunity that investors see. Additionally, what factors have to be at play for wallets to take off and the example of M-Pesa in Kenya.
Ark investments earlier in the year released their 2021 “Big Ideas” report which covered the big ideas in technology that are likely to make significant commercial breakthroughs in the coming years. The digital wallet opportunity was featured. According to Ark Investments which has gained global popularity within the investor community in the recent months, Wallets present a US$ 4.6 trillion dollar opportunity in the USA by 2025.
The main drivers of this sky high valuation are the following core themes;
Wallets have significantly lower customer acquisition costs than existing banks - Ark estimates that a traditional US bank has CAC’s of about US$ 1,000 vis-a-vis digital wallets such as Cash App and Venmo with CAC’s of US$ 20;
Smartphones are enabling a new mode of financial services distribution away from the bricks and mortar channels that are owned by banks;
The API-fication of business enables financial services to be distributed in new ways from a previously tightly packed proposition to a more customised digital proposition.
The world has already witnessed digital wallets taking centre stage in different financial systems. In China, digital wallets such as Alipay and Wechat Pay have grown tremendously over the years. Mobile payments are now more than double GDP with a duopoly of Alibaba and Wechat. The Asian model has centred around the super-app model which has not travelled easily to other regions. Other examples in Asia are Grab and Gojek which also have significant payment volumes. Paytm and PhonePe in India are also worth a mention.
In the USA Cash App and Venmo have led the charge. Cash App was started out of a hackathon run by Square in 2013. The initial focus was on peer to peer payments and was widely adopted in the Southern states of the USA largely by the black and latino community. The focus was to offer a low cost payments wallet that would enable one to send and receive payments. With time, the product suite has been built out to enable fractional share investments, cards and crypto trading.
Venmo on the other hand was started back in 2009 by Iqram Magdon Ismail and Andrew Kortina. Their mission was to solve a problem they both had where on a trip, Ismail forgot his wallet and Andrew had to cover his expenses for a weekend. Three years later in 2012, Venmo launched its first mobile app. The key insights that Iqram and Andrew had was that payments have a core social element. Venmo was therefore built with social at its core with features such as being able to invite friends, see what transactions your friends have made and be able to split transactions. The core target was younger Gen Z and Millenials and this has evolved to a point where Venmo users tend to be younger and more affluent. To scale the business, Venmo sold in 2012 to Braintree which was later acquired by Paypal.
Over the years, the results have been quite impressive. Venmo and Cash App have both grown to over 30 million active customers. Venmo is bigger in terms of active customers but Cash App has been catching up.
In addition to growing their overall customer bases, the lower CACs have fed into higher net revenue per customer. The graph below shows that Cash App’s gross profit per cohort has been growing each year due to the increase in products per customer. Cash App estimates its CAC’s to be at around US$ 5 per customer.
Source: Square Q4 2020 Investor Presentation
The chart below shows that ROI per customer approaches 15x the longer the customer is retained within the Cash App ecosystem.
In 2020, Cash App made revenues of US$ 5.97 billion and gross profits of US$ 1.23 billion which increased by 440% and 168% respectively. The growth was largely driven by a significant increase in Bitcoin trading and thus a number of analysts have downplayed this result. Nonetheless the nature of business is that sometimes you get a lucky break, but you have to be ready to maximise on your break. These apps are designed to quickly adapt to market opportunities through the smart deployment of their APIs and integrations.
From the global examples of Cash App and Venmo in the USA as well as the Chinese mega-apps. The main take outs are;
Start with a clear under-serviced target market - For Venmo it was students and for Cash App it was underserved communities and demographics - largely the same demographics that Square targeted with their merchant solutions. In China, e-commerce growth drove an opportunity for payment systems that are built for the online opportunity. The absence of incumbents such as Visa and Facebook thus enabled both the digital payments and super-app opportunities respectively;
Start with a clear proposition such as P2P payments or B2C payments and develop capabilities around adjacent verticals.
Source: Ark Investments
Build a tech stack that’s adaptive and focus on engineering capabilities;
Importantly, embed clear identity markers in your app. For Wechat for instance, your identity is your social media identity marker. For Cash App, they introduced very useful $tags. I’d be $samorak for instance on Cash App. This is a very critical point, bank account numbers and sort codes are not intuitive. For Mobile Money it’s your phone number which for many people, you know the phone numbers of the people you interact with often such as your spouse, parents and closest friends.
Identity markers should be designed in a way that social can thus be embedded on top of that. Venmo is built with social in mind. For older generations this may be a turn-off but for younger Gen-Z’s sharing is embedded into their lifestyles.
It doesn’t hurt if an endogenous event boosts your business such as Covid-19. In Kenya, the Post Election violence of 2007/08 drove a lot of M-Pesa adoption.
The key opportunity thus is driven around adding specific value propositions on top of your core proposition. Already CashApp, Venmo, Alipay have shown that it's possible and profitable. Tinkoff and Nubank have already executed this in their respective markets of Russia and Brazil. Although they don’t share the same definition, to a customer they look the same.
In a sentence, the business model is to drive increased customer usage defined by monthly active users and increase revenue per customer through offering more products to your active users. All this whilst maintaining standard customer acquisition costs.
Kuda in Nigeria seems to be well on its way to achieving at least in theory this trajectory. Customer numbers have doubled from 350,000 to 600,000 in the space of four months from November 2020 to March 2021. In the similar period, total transactions processed have jumped from US$ 500m to US$ 2 billion. This roughly translates to a TPV per customer of US$ 3,300 up from US$ 1,428. I suspect that the TPV figures are cumulative rather than per month figures. If this is the case, then it would be the case that TPV increased by US$ 1.5 billion in the space of 4 months or roughly US$ 400m per month. If unit revenue per transaction is standard then it shows that Kuda is growing revenues by both the increase in active users as well as increased revenue per user.
Recently, Kuda has announced the piloting of an Overdraft product that will be priced at 0.03% per day for a limit of 50,000 Naira - roughly US$ 130. This will of course add significantly to revenue per customer.
Tinkoff in Russia recently released their strategy document to investors (a very useful read). The basic premise is the same. The focus is on growing their customer base and revenue per customer by offering adjacent products. Interestingly from the chart below, Tinkoff average balances per customer are almost triple those of comparable UK neobanks whilst having significantly lower average wages in Russia.
The chart below show the product roadmap in terms of growth opportunities as well as potential revenue per future product. Essentially, Tinkoff can achieve 28x their current net revenues of US$ 1.4 billion.
Source: Tinkoff Strategy Presentation
Additionally, another significant opportunity is to achieve the Nirvana of wallets by being a closed loop network like Mpesa. The idea here is that you can grab a higher share of the economics as opposed to sharing your revenue with the existing card networks. In terms of pricing power, the cost of cross-network transfer often costs around 2.75% to 3% where the wallet provider retains roughly 0.5%. A closed loop network can enable you to reduce your charges and attract more customers whilst retaining a higher share of the fee. Square is already doing this with Cash App payments to Square merchants.
In the long-term, the wallets could form a new modern settlements mechanism running on potentially Stripe’s Global Payments and Treasury Network or Crypto that can settle across wallets. So you could send money from your Cash App to someone on Wechat. An American tourist can pay via QR code from his Venmo to an Alipay merchant or even better you can pay someone directly from Paytm to M-Pesa.
In Summary, the potential is based on;
Increasing revenue per customer due to the easy integration of additional products;
Viral effects driven by engagement and network effects;
Increased share of wallet through more in-network payments activity i.e. closed loop and;
Cheaper inter-wallet payment capabilities locally and globally through a newer settlements mechanism.
The Kenyan Example
Global investors have looked at Kenya and seen the wallet opportunity. M-Pesa is the perfect example of all the above concepts executed perfectly. Everybody knows the M-Pesa story, but nonetheless here is a useful resource.
Overtime M-Pesa has grown from 1.2 million active customers in 2007 to over 24 million active customers in 2020 or roughly all of Kenya’s adult population. Given that over 70% of Kenya’s population is under 35, then each marginal adult is a future M-pesa customer. In 10 years, 40m active customers is a very realistic proposition.
Starting with P2P, Mpesa has successfully entered the following verticals;
Savings and Credit;
The result has been an increase in total users and revenue per user.
Source: Safaricom Investor Reports
Total revenue per user has grown from about KES 750 in 2010 or roughly US$ 7.00 to an average of KES 3,389 or US$ 33 on an annual basis. To note is that M-Pesa is yet to launch investments and wealth management products as well as direct insurance brokerage. There are a number of verticals yet to be serviced and this can realistically drive revenue per user to US$ 45-50 per annum. If in 5 years, M-Pesa can achieve 35 million active customers then total revenue will be US$ 1.75 billion per annum from the current level of US$ 830 million.
Kenyan banks on the other hand have had stagnant revenue per user metrics. I calculated this using total number of customer accounts and total revenue from Kenyan operations. The total revenue was calculated as gross interest income plus total fee and commission income and I did not adjust for net interest income.
Source: Central Bank Supervision Reports and Company Financials
KCB bank has had lower average revenue per user largely driven potentially by a growth in customer numbers due to KCB M-Pesa. Equity Bank has also had stagnant Kenyan revenue per customer. Standard chartered has significantly higher revenues per customer driven by their corporate and HNWI strategy. All banks have had their revenues affected from 2015 by the interest rate caps.
The point remains though that a digital wallet with mass adoption has potentially better long-term economics than a traditional bank account. The new generation of customers will not see the point of having a traditional bank account given that most of these digital wallets will be their primary point of managing their financial lives. Of course, like with Standard Chartered, higher value customers will need deeper financial services that digital wallets can’t provide such as private banking. This segment is nonetheless being attacked by firms such as M1 and Alpian.
Within Mobile Money, the following has been achieved;
Socially enabled viral adoption - in Kenya, I finally got an M-Pesa wallet late in 2012 just because everyone I knew had one (as a disclaimer I was studying abroad for most of this time). I just couldn’t afford not to have an M-Pesa wallet;
Increase in revenue per user by adding products on top of your core proposition;
Standard and decreasing CAC’s - In the case of M-pesa most existing M-Pesa customers just had to press a button on their phone and become an M-Pesa customer. The point was that they were already Telco customers and it was an exercise in conversion. This point can’t be understated. I have managed a product that is built to compete with mobile money solutions and mobile money customer acquisition is magnitudes of times easier and cheaper than bank account opening;
Closed loop payments - M-Pesa is the gold standard of a closed loop payments system with all the economics accruing to Safaricom. No interchange and revenue share to worry about;
Within Africa, MFS Africa has built the capabilities for inter-wallet funds transfer capabilities within Africa. MFS Africa has managed to connect over 350 million wallets across the continent. Their basic model is centred around working with partner banks in different countries and having a claims settlement mechanism based on daily reconciliations i.e. inflows vs outflows and settling the balance.
Of course, Safaricom is yet to perfectly execute their app strategy. Nonetheless, there is one in beta testing and it would be interesting to see the new M-Pesa app.
We have seen from China that there is a potential death zone for these apps. Governments have been accommodative of these apps because they largely solved a useful function of driving financial inclusion and trade. Nonetheless continued growth has made these payment apps to be giants that affect the basic assumptions of the financial system such as transmission of monetary policy and concepts such as velocity of money.
As these payment companies grow, I expect global regulators to react in the same way that the Chinese reacted. In two key ways, tougher regulations such as higher capital requirements as well as introducing digital currencies and wallets.
Beware the threat of Regulators - Mother of Dragons!
There is an existing financial system that is governed by Central Banks, the IMF, World Bank and globally systemically important banks. Adjacent institutions such as SWIFT and BIS are also key pillars. Finance has geo-political implications and an unwieldy financial system run from Silicon Valley may be unpalatable. The main challenges can be summarised as;
Within Africa especially but also globally - capital flows are a concern for governments. In Africa for instance, MFS has a significant issue with capital flows. Central Banks are very accommodative of remittance inflows but restrict remittance outflows thus affecting inter-wallet compatibility. It’s important for Central Banks to be able to balance their capital accounts and this has largely been done via banks. Crypto is very attractive in this sense;
Regulators are likely going to ask for higher capital requirements thus significantly denting the unit economics of payments companies. Additionally, current payment companies don’t have the requisite expertise in balance sheet and duration management that banks have. Jamie Dimon had a good analysis of this in his 2020 Shareholder Letter. We have already seen this recently in Nigeria with the Nigerian SEC banning investments in foreign shares thus adversely affecting companies such as Bamboo and Trove. In the same week the CBN banned BVN verification services for Fintechs.
The two main threats are thus regulatory which can take any shape and form as well as capital flow issues particularly within Africa.
Nonetheless the wallet - electronic store of value model is likely to be the default paradigm for mass consumer financial service provision in the future.
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