Actis on why cash isn’t making a comeback

For Actis, fintech isn’t the most exciting investment opportunity in emerging markets – emerging markets are the most exciting opportunity in fintech, says partner Ali Mazanderani.

Ali Mazanderani

This article was sponsored by Actis and first appeared in the December 2018/January 2019 issue of Private Equity International.

The move away from cash is happening quicker than ever before, more dramatically, and on an unprecedented scale.

A recent McKinsey report found the global payments market had far outstripped its previous estimates, with revenues growing by 11 percent in 2017. Its report for the previous year had suggested the industry’s revenues would hit $2 trillion by 2020, yet it is on course to beat that total in 2018, with projections of $3 trillion in revenues by 2023.

The growth has been even more pronounced in emerging markets (2-3x faster than developed markets), such that ‘Emerging Asia’ is now a larger payments market than North America, and within the coming few years Latin America will be a bigger payments market than Western Europe.

Actis has invested more than $1 billion over the last decade in emerging market financial services businesses, with a focus on payments. It has been at the forefront of the transformation having invested in six separate platforms, totalling 20 payments transactions, with companies operating from Brazil to Malaysia, from Egypt to India from South Africa to the Philippines.

We spoke to Actis partner Ali Mazanderani about the payments opportunity as well as what the future holds for this rapidly growing industry.

It’s clear payments businesses have a lot of scope for growth in emerging markets. What are the key drivers behind this?

Ali Mazanderani: The underlying driver of growth is the migration from cash to electronic payments. In emerging markets, the vast majority of payments are still made in cash – ranging for around 80 percent in Latin America and South East Asia, to more than 90 percent in Africa and South Asia – so there’s a lot of growth to come – especially when compared with Western Europe and North America, where the equivalent figures in most countries is between 30 percent and 40 percent of transactions in cash.

In addition, because there is no, or little, legacy infrastructure in many of these markets, they have a ‘second mover advantage’. Companies in emerging markets are able to offer their customers purpose-built products, using the latest technology, that are better and cheaper than what was available previously or indeed might be available in developed markets. After all, why invent the typewriter if you have the computer? By contrast, in developed markets, many banks and payment companies have legacy infrastructure, and substantial sunk costs that don’t allow them to be as nimble, or to offer as fit for purpose or cost-effective solutions.

Compounding this, emerging markets also have youthful populations who tend to be easier adopters of electronic payments – 90 percent of people under 30 live in emerging markets and this age group accounts for 75 percent of online transactions.

So how are electronic payments transforming emerging markets economies?

Cash is highly inefficient. Pretty much all stakeholders benefit from it being reduced in the economy. For governments, an increase in electronic payments allows them to better address tax avoidance, money laundering and the grey economy. For retailers, electronic payments can reduce fraud, improve working capital management, and can help them understand their customers better supporting revenue growth. For consumers, paying electronically should be safer, more convenient and cheaper. The move to cashless payments is a particular game-changer for populations that have, to date, had no alternatives.

The move towards electronic payments has had a profound impact on financial inclusion across emerging markets, offering access to financial services that would not otherwise have been available, whether card based, online or mobile. The consequence is dramatic with it estimated that on average a 1 percent increase in financial inclusion results in more than a 3 percent increase in GDP per capita in an economy.

In addition, the recent experience of mobile money has shown us that income levels aren’t the bottleneck when it comes to electronic payments – it’s about access and enabling regulation. Bangladesh, for example, has seen explosive electronic payments growth despite being a low-income country and has amongst the largest number of mobile money users in the world. If you go to Shanghai today, you might be struck by the fact that buskers prefer to be paid through a mobile ‘QR’ payment than with cash.

What tend to be the barriers to uptake of electronic payments?

AM: We think of payments as infrastructure and in some ways its development resembles that of the buildout of the transportation infrastructure of the 19th century. Railroads were initially built by and for the oil, cotton, steel or cattle companies (depending on the market) to transport their goods to ports or hubs. However, the full potential of the railroads could not be realised when they were captive to one or other particular group with multiple and often competing interests.

In a similar way, payments systems have typically been incubated by banks, mobile network operators, ecommerce companies or even cab hailing apps (depending on the market). The objective of these companies in building their ‘rails’ is usually not to build the infrastructure, but to support the utilisation of its core business lines. The consequence is there are a variety of systems and standards, but each is only applicable to a subset of customers and use cases. ‘Interoperability’ is still remarkably limited in payments – companies are typically reluctant to use the infrastructure of a competitor. This leads to a proliferation of redundant or limited use infrastructure. Like with railroads, the full potential of the payments market can only be realised when the infrastructure is predominantly ‘independent’.

How does that translate into deal opportunities?

AM: The payment opportunity is most pronounced in investing in, and creating, ‘independent’ payments players that enable economies of scale through offering infrastructure that allows customers or merchants to use or accept as wide a range of payment types as they wish.

The first payments platforms we created was EMP (Emerging Market Payments), a buy and build to create a leading African and Middle Eastern payments company. The nucleus of that platform was two business we acquired, one in Egypt and another in Jordan. In both instances those businesses were owned by a consortium of banks, who had come together to try and kick start the nascent electronic payments industry of their countries but ultimately recognised that independent ownership was in the best interests of all stakeholders and so entrusted Actis to enable this.

More recently our investment in GHL, a leading ASEAN payments company is a great example of an independent payment company whose proposition is enabled by its independence. GHL offers its merchants the opportunity to accept payments offline or online, whether cards or mobile payments, across a wide variety of payment schemes and methods. If you are an American using a Visa card, it will facilitate it, if you are Chinese tourist using AliPay on your mobile phone, it will facilitate that.   

To what extent are these businesses scalable across different growth markets?

AM: No two payments markets are the same, but they rhyme. The points about independence and interoperability are valid in all the markets where we invest, although there are nuances. That means we can grow across our markets, taking the products that work in one to another. GHL has now expanded from Malaysia across ASEAN with a substantial presence in the Philippines and Thailand. EMP went from being a small Egyptian processor when we invested in 2010 to operating in 40 countries across Africa and the Middle East by 2016 when we exited.

We have also increasingly seen our portfolio companies being able to move across different regions within the emerging markets. Paycorp, a South African payments company we bought out from a listed conglomerate in 2013, now has scale operations in South-East Asia and Eastern Europe.

How do you see the industry evolving in the future?

AM: You’ll increasingly see ‘pure payment processing’ as a diminishing part of the revenue of payment companies. Our investee companies are offering an ever-expanding range of auxiliary products in addition to processing to provide better financial access to consumers and to help merchants grow their businesses. These can range from working capital to foreign exchange to loyalty to promotional products. For example, we are invested in an Indian payments company called Pinelabs, which, amongst many things, offers consumers the ability to purchase goods across its point of sale network in installments.

I think you will also see emerging market payment companies emerge as the global thought leaders and increasingly move into and win in developed markets. Interestingly investments the other way around have a more muted track record. Large, international payments groups and investors have certainly spotted the potential, but they typically use the same model in emerging markets as they had in developed markets, and that seldom works. On multiple occasions we have acquired loss-making subsidiaries of international payment companies in our markets which have quickly become profitable. For example, in April 2016 we invested in a three year old Brazilian payments company called StoneCo to acquire Elavon do Brasil, a joint venture between two US financial institutions that had been very successful in their home markets. A few months later, it became profitable. Less than three years later, StoneCo listed on the Nasdaq with a market capitalisation of $6.7 billion.

Ten years ago, it was hard to find opportunities in emerging market payments that were big enough to digest the equity cheque we were seeking to invest. The explosive growth of the industry means the opportunity set is now far more than the capital we have to invest.