In the mid-90s, professional wrestling in the United States was at its best. It was the World Wrestling Entertainment (WWE) ruling the charts against the then upcoming World Championship Wrestling (WCW) promoted by United States billionaire Ted Turner. WCW had all thing going right – the billionaire’s backing, unlimited budgets, primetime slots and the who’s who of the game. WCW’s Monday Nitro Wars beat WWE’s Raw on airtime rating for 83 straight weeks. But basking on its success, WCW failed to pay attention to critical aspects such as new story lines and creative improvements. In 2001, just three years from its prime, it had to shut shop and be acquired by WWE.

The story of fintechs is very similar. They had a slow start. It was demonetisation that put them on the map and the pandemic led to their meteoric rise. In WCW’s style, fintechs are now where the big boys play. But ironically, not all have been able to cope up with the game.

The first challenge came in the form of zero-MDR applicable from January 1, 2020. This challenged their business models and forced them to look beyond. Pandemic came as a blessing and most fintechs took to distributing loan products offered by banks. They chose to become digital DSAs (direct selling agents). The arrangement was convenient for banks as well owing to lockdowns and physical constraints.

But then, lending is easy, ethical lending is difficult and collections can be a completely different ball game. With little handle over these aspects, fintechs messed it up.

Increasing instances of brutal collection mechanisms, opaque lending practices and mis-selling of products forced the RBI to increase its surveillance on fintechs. The recent move of barring prepaid instruments with credit lines or framing digital lending norms due out soon are outcomes of RBI’s decision to create a level playing field for regulated and unregulated entities.

How many can withstand the test?

This depends on the strength of the financials that fintechs have built. With nearly USD $ 20.3 billion invested in this space between 2014 and 2021, highest ever investments coming through in 2021 (USD $ 8 billion), money has flowed into fintechs easier and faster than water.

A new unicorn was being featured almost every week and they comfortably piggybacked on the success of larger players such as Paytm and PhonePe. The seamless flow of equity helped companies effortlessly reach out to their target customers and dole out attractive cashbacks to bring them into their fold. Exceeding revenue growth projections made at every fundraise roadshow was never a problem. But too much of something is also bad.

Despite being in existence for over half a decade, the industry relies on revenue metrices for their valuations, ignoring some of the basics tenets of businesses such breakeven, operating margins or net profit.

With nearly 50 per cent of fintechs in the growth and late stages of businesses and majority of the investors having rundown their investment tenure, how valuations take shape would be interesting to observe. Recent data indicates that equity inflows at USD $1.9 billion from January to May 2022 is less than a fourth of what was garnered last year. Initial estimates suggest that fund raised by fintechs in 2022 could fall short of 2021’s levels by a good margin.

When the listing of PB Fintech and One97 Communications didn’t take off as expected in the bourses, it was a moment of reckoning for the industry. It sent out a shrilling message that businesses cannot be valued merely on market opportunities. Their ability to return profits and consistently maintain a level of profitability are paramount. But the larger point is that while the early-stage investors of Paytm and PolicyBazaar have still managed to get an exit, how many are at that stage now to offer a similar exit to the investors?

For now, the exit door seems distant, given the disparity in valuations of private equity money and the stock market and explains why incremental investments are slowing.

Down and out?

Not really, says Vivek Belgavi, partner and leader – fintech, PwC India. Fintechs have assumed an important role from the perspective of ease of financial reach and better customer engagement. It is touted to be a $25 billion market by 2025. But when a business reaches a certain scale, players who can grow within the ambit of regulatory framework emerge successful and explains why Belgavi isn’t worried about some of the recent RBI diktats.

“We are going through a cycle and cycles and corrections are important. Businesses with proven models will continue to grow while those built on froth and loose models will fade out”. But that said, he affirms that the current blip in funding inflows has to do with the air of uncertainty on the regulatory front, rather than fintechs losing their relevance. Digital lending norms due out soon could ease this issue and lay out new rules of the game. Once again, fintechs may have to go through a round of business iteration just like in early 2020.

Fin or Tech?

At one time, HDFC Bank was trading at over 4x its one-year forward book because the bank combined its core business and technology chops. Investors were compelled to value the bank ahead of its peers. Today, the bank is going through its internal business cycles and its valuations at 2.8x one-year forward book mirror its balance sheet capabilities rather than other factors. Fintechs are now at that juncture. They enjoyed being valued like tech companies rendering financial services. But if they should focus on strengthening their balance sheets and adopt the playbook reemphasised by the RBI, they must choose sides.. Fin or tech, where should they be?

If the choice is to be a serious player in the financial services market with strong tech chops, they cannot raise capital indefinitely based on revenue multiples. The quality of their balance sheets will hold key and to that extent, valuations will correct. The gap between pre-IPO asking rate and post listing valuations of Paytm and PolicyBazaar are examples.

Alternatively, fintechs may choose to remain a tech company in the financial services space. But, this too, would lead to valuation compression as the option to scale up as a lending entity is almost ruled out. The company may be seen as a service provider rather than a product specialist and services trade at a discount to products.

Either way, the froth will settle soon.

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