How digital transition is spurring payments consolidation

Consolidation has been a prominent theme within the global payments industry in recent years, driven by a collection of different commercial rationale and strategic imperatives.

The commoditisation of payment service providers’ core offering has placed greater pressure on fees and gradually eroded profit margins. Consequently, scale has become critical, as processing higher volumes of transactions on their fixed-cost platforms allows providers to offset these margin pressures. In a highly fragmented market, acquisitions have been a natural tactic for payments companies to grow their business and obtain new customers. Recent examples include Nets’ acquisition of Concardis and the strategic partnership between Worldline and SIX Payment Services.

The structure of the payments market has also been conducive to a succession of cross-border transactions. Historically, many of even the largest payments providers had been heavily reliant on their respective domestic markets. Acquisitions of competitors in foreign markets, such as the US public company formerly named Vantiv buying UK-headquartered Worldpay, provide a beachhead in a new market, access to new customers and, in turn, the opportunity to scale the business further.

Moreover, a fragmented market is an attractive proposition not only to acquisitive payment service providers, but also to private equity investors with long track records of successfully implementing buy-and-build strategies at the companies in which they invest.

So the need for scale, the benefits of geographical diversification and elevated interest from financial sponsors are all indisputably drivers of the recent surge in payments M&A. However, an empirical analysis suggests that, together, they still only provide the principal rationale in a substantial minority of cases, rather than the bulk of recent transactions.

An Arma Partners analysis of over 300 payments M&A deals, from 2015 to 2017 inclusive, shows that only 19% of transactions had financial buyers, with strategic acquirers accounting for the remaining 81%. Within this large majority of deals featuring trade buyers, we identified that scale is the acquirer’s primary motive in only 15% of cases, while geographic expansion accounted for just 8%.

Instead, the remaining three quarters of strategic acquisitions can be said to have been fuelled, first and foremost, by the search for innovation and broadening product offerings in the search for growth.

The proliferation in companies seeking to obtain new IP, technology, and products through acquisitions is a function of how the transition towards digital payments has accelerated rapidly in recent years, driven by fundamental changes in technology, consumer behaviour and regulation. While M&A is no silver bullet for navigating these profound transformations in the payments market, it has been a key weapon in the arsenal of those payments providers that have anticipated these changes most successfully.

Proprietary technology has become increasingly central to a payment service provider’s viability in the digital age. Service-oriented architecture has established itself as the software model of choice and data is shifting to the cloud. Looking forward, the next frontier for payments service providers will be data analytics with a particular focus on the SME market. The ability to draw conclusions from large data sets about customer behaviour, loyalty, or fraud will allow providers to offer value-added services to merchants. This presents large incumbents with a challenge in keeping pace with this rapid innovation and changing market landscape. Frequently, they have responded by pursuing a more aggressive M&A strategy and acquiring smaller, nimbler, tech-enabled start-ups, as seen in PayPal’s acquisition of iZettle in May 2018.

Meanwhile, consumer expectations of greater pricing transparency and seamless transitions between online, offline, mobile, and other forms of commerce have increased the value that merchants attach to payment service providers with an omnichannel offering. The continued shift to electronic payments (with card-based transactions expected to reach USD 8.2 trillion by 2021 in the US alone) and growth in alternative payment methods have fuelled the explosive growth of new providers such as Adyen in Europe, Stripe in the USA, and Alipay and WePay in China.

For providers previously focused on a narrower set of payment channels, such as point of sale card machines and/or online payments, it can often be quicker and easier to bolt on and integrate a mobile payments provider than to build a new product from scratch, for example.

A combination of these new technological possibilities and enhanced customer expectations also encourages providers to invest in new products tailored for specific sectors. The payments gateway used by an airline, for example, needs to offer global coverage and multi-currency services. A gambling company, by contrast, will likely prioritise high capacity around peak events and pay-out capabilities. A retailer will likely be different again, preferring a multi-channel front-end and the potential to optimise authorisation for frequent customers.

And, in terms of regulation, the introduction of the Payments Service Directive 2 (PSD2) across the European Union earlier this year has opened up deeper opportunities for tech companies to displace banks as the consumer-facing front-end of the payments market. Internet giants, traditional payment companies, and startups have therefore been incentivised to acquire (further) payments capabilities, with the ultimate aim of relegating banks to the role of financial plumbing, in the same way that tech companies successfully began supplanting the incumbents in the telecoms space 10 years ago with the launch of smartphones.

Consolidation between providers and tech startups is itself reshaping the landscape of the payments market. However, frequently, this M&A activity is a consequence of and strategic response to the fundamental changes in technology, regulation, and consumer behaviour brought about by the move towards a digital economy.

This editorial was first published in our Payments and Commerce Market Guide 2018-2019 - Insights into Global Payments and Commerce Market. The Guide presents the key trends and developments in global and regional payment methods by highlighting the innovation, challenges, and developments in the use of the most important payment methods across geographies and verticals.

About John Meehan

John Meehan is a Partner and founding member of Arma Partners and heads Arma’s activities in the FinTech sector. He previously worked at Goldman Sachs, Lehman Brothers, and BZW in London, New York and Paris, focusing on the technology sector.

About Arma Partners

Arma Partners is a leading independent M&A advisory firm focused exclusively on the Communications, Media and Technology sector. With offices in London, Munich, New York and Palo Alto, Arma works with start-ups, established market leaders, financial investors, and publicly-listed companies.