The global shift from cash to electronic payments, notably cards, is far from complete. Industry estimates suggest that more than 70 percent of transactions are still settled in cash, Guy de Blonay writes in his essay for finews.first.

This article is published on finews.first, a forum for authors specialized in economic and financial topics.

European payment stocks had a good year in 2019, with most players in the sector seeing a decent rise in their share price. So, there is no reason to think this year should be any different.

Even if there was to be an increase in economic volatility in 2020, as many observers argue, I expect the fundamental backdrop to remain favorable as the two structural drivers that underly the growth of the industry are still firmly in place. These are:

The global shift from cash to electronic payments (notably cards) is far from complete. Industry estimates suggest that more than 70 percent of transactions are still settled in cash in the eurozone (vs close to 40 percent in the U.K. and close to 30 percent in the U.S.).

«Industry estimates suggest banks still control close to 50 percent of the overall payment flows in the continent»

On the other hand, online payments should continue to grow steadily with figures from Statista pointing to a global e-commerce market of 2.5 trillion euros growing by 10 percent p.a. in the medium term.

Currently, the in-store payment space in Europe remains local, fragmented and dominated by banks. Payment providers like WorldPay, Wirecard, Adyen, and Ingenico have carved out dominant positions in European e-commerce with a combined market share of close to 60 percent but industry estimates suggest banks still control close to 50 percent of the overall payment flows in the continent.

This stands in sharp contrast with North America where the market has consolidated around a handful of technology companies such as FIS, Fiserv and Global Payments. Overall, I estimate that the top five payment providers have more than 75 percent market share in the U.S., compared to less than 40 percent in Europe.

«This has created an opening for new vendors»

However, I see three reasons why the current status quo in European payments is unlikely to last.

1. Innovation is Spreading From Online to In-store

The first is the spread from online to in-store. In the last two decades, innovation in the payment space has been driven by e-commerce. New players like Paypal, Adyen, and WorldPay thrived as they were better equipped than banks to help merchants cope with the new challenges related to customer conversion or fraud prevention.

I believe innovation is now spreading to the physical store. Traditional payment processing has become commoditized and merchants are instead looking for solutions to run their business more efficiently and improve the customer experience. They also want a unified view of their customer interactions across all channels as the lines between physical and online retail are blurring.

In a way similar to what happened in e-commerce 20 years ago, this has created an opening for new vendors. Square (in the U.S.), iZettle (in Europe) or Pagseguro (in Brazil) have gained traction with small businesses by combining payment acceptance with innovative software solutions for analytics, customer retention or inventory management. E-commerce players like Adyen have also started to onboard large in-store retailers like H&M on their platforms.

2. Regulation is Another Catalyst For Change

After several delays, the Second European Payment Service Directive 2 (PSD2) should come into force in the next 12 to 18 months. The directive creates new requirements in terms of security. More fundamentally, it brings an end to the monopoly of financial institutions on customer data.

In other words, banks will have to make it possible for third parties to access the financial information of account holders and to initiate payment transfers on their behalf.

This is likely to create additional pressure for banks on two fronts as they need to refresh their legacy IT platforms while fending off the threat from new competitors (fintech or big tech).

3. More Consolidation is Likely

Last year saw a step up in M&A activity in U.S. payments. FIS bought WorldPay for $43 billion, Fiserv took over First Data for $22 billion, and Global Payments acquired TSYS for $21 billion. In a low rate environment, some of these moves might be opportunistic.

However, they also reflect the need for scale in a fixed cost industry where core payment processing is becoming commoditized. In this context, we believe consolidation is now at the top of the agenda in Europe.

«So, who are the likely winners?»

Banks may struggle to catch up on innovation. While financial services is one of the industries with the highest IT spend as a proportion of revenues (close to 10 percent according to Gartner), most of this spend is dedicated to the maintenance of legacy systems and the compliance with legal requirements leaving only little room for investments in technology.

One option for banks could be to sell their payment assets altogether (like RBS did in 2010). Another option could be to outsource more broadly and partner with third parties to bring more innovation to their customers.

Obviously, it may take some time for banks there. Should these opportunities fail to materialize in the short-term, I believe we could start to see consolidation moving among the few independent European payment providers. So, who are the likely winners?

«At the other end of the spectrum, I also see value with some traditional in-store payment providers»

In a changing European payment landscape, the potential winners fall into two main categories. Innovative e-commerce vendors like Adyen are best positioned to go after the new opportunities unlocked by innovation. These include in-store payments (which still represent close to 80 percent of overall card transactions) and the provisioning of new offerings around fraud prevention, analytics or marketing services.

At the other end of the spectrum, I also see value with some traditional in-store payment providers like Worldline and Nexi that are well-positioned to become the partners of banks as the latter start to rethink their positioning in the market.

Guy de Blonay joined Jupiter Asset Management in 1995 and is currently a fund manager in the global team. He is the manager of the Jupiter Financial Opportunities Fund and the Jupiter International Financials Fund (Unit Trusts) as well as the Jupiter Financial Innovation fund (SICAV). In 2001, Guy joined New Star (which was subsequently taken over by Henderson) where he managed global financial equities. He returned to Jupiter in January 2010, initially in an advisory capacity, before again assuming fund management responsibilities in June 2010.

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