FinTechs or TechFins, whatever you call them, are still ventures, new businesses, and enterprises that should, at a certain point, generate a reasonable return for their investors. Returns should be given more consideration in an era of rising interest rates. The point here is to stress the importance of carefully considering returns rather than to speculate on the future performance and profitability of a given company.
When discussing FinTechs, Bahaa Abdul Hussein feels that a little attention is usually paid to profitability and r eturn on equity (ROE) is rarely mentioned in sell-side reports. While this may be explained in part due to the fact that many FinTechs are startups. It does not mean that financial returns should be outshined by other Key metrics (user base, TPV, ARPU, etc.).
Payments appear to be the one in a rather more seasoned stage of development of the numerous subsectors in which FinTechs may be operating.
Despite the fact that many companies have already been listed (PayPal, Square, Stone, Cielo, Getnet, Visa, and many more). Potential for growth continues to draw more attention than future and current profitability.
There should be no adjustments needed to calculate the ROE. Simply dividing disclosed net profit by reported shareholders’ equity should suffice. The net profit after stock option adjustments should be avoided.
Integrate income growth and ROE as management compensation metrics, and you may have a recipe for disaster.
Prepayment of merchant receivables can easily inflate earnings growth.
Payment businesses usually offer prior payments in exchange for a percentage fee because merchants receive money from credit card sales in 30 days.
This can be accomplished by simply putting more money into the operation.
Why would that be an issue? Earnings growth is boosted by prepayment revenues. Using one’s own cash, on the other hand, reduces equity optimization as the probability of repurchases and dividends decreases.
Those who are bullish on payments may argue that advance payment spreads are high, and thus company returns are high. When you look at ROEs closely, the picture becomes less rosy.
Prepayment spreads are not likely to remain high indefinitely. Large merchants have already left certain markets. In others (such as longtail), they may survive, but they are expected to face increasing competition from other forms of payment.
Payment companies have historically reduced the cost of other services (money transfer processing, POS terminal rental) in order to increase prepayment revenues. When third-party funds are used in the operation, the reality becomes truly terrifying.
Because many investors are unaware that receivables from issuances are reduced by debt amenities structured by payment service providers, the market rarely captures the true picture of the companies’ indebtedness. And this has a significant impact on returns on invested capital (ROIC) – the criterion that more accurately reflects payment companies’ profitability.
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