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M&A will keep driving fintech narrative, analysts say ahead of Q2 earnings

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M&A will keep driving fintech narrative, analysts say ahead of Q2 earnings

Consolidation is still the focus as the fintech industry heads into second-quarter earnings, analysts say.

Following three megamergers in the first half of the year, analysts expect M&A activity to drive the narrative as the market gauges the strategic rationale for those combinations and the potential for other deals. But uncertainty on the macro front threatens to counteract the positive momentum in the industry, analysts said.

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The fear of a slowing economy has been a top theme for several quarters, though growth in the economy seems "reasonably strong," Keefe Bruyette & Woods analyst Sanjay Sakhrani said. Positive trends in consumer spending are also still being tempered by ongoing trade disputes, Sakhrani said in an interview.

Payments companies in particular are expected to be able to cut through the noise. Analysts believe that sector will continue to benefit from growing e-commerce and card payment volumes, trends that would continue developing even during a recession.

Across all fintech industries, about two-thirds of companies are expected to report better results than in the second quarter of 2018.

Just 12 fintech companies are expected to report second-quarter earnings results below their normalized first-quarter results.

Payment processors might see a threat from the mid-September implementation of the revised Payment Services Directive in Europe, which could cut into e-commerce sales volume, Wolfe Research analyst Darrin Peller said in an interview. Every time consumers want to buy something online in Europe, they will soon have to use two-factor authentication, such as receiving a text message or email that they must confirm to proceed with the purchase. The change adds friction in the payment process, Peller said, adding that he expects to hear from management teams on their earnings calls about possible impacts.

Since July 2018, fintech stocks have outpaced the banking and technology sectors and the S&P 500. Fintech valuations are at all-time highs after eclipsing the previous highs reached in fall 2018.

Sakhrani questioned why so many large deals are happening now. The selling companies might believe current valuations have hit a peak, suggesting that their near-term growth outlook might not be as strong as it has been in recent months. If that is the case, these deals would be more of a defensive strategy, Sakhrani said, adding that he sees truth to that theory.

"It was probably a good bet to sell," the analyst said.

Only one of these deals — Global Payments Inc.'s pending $22.15 billion acquisition of Total System Services Inc. — was announced during the second quarter.

More deals are "definitely" part of the discussion around the industry, the analyst said. Although megamergers are less likely given the now-limited field of potential tie-ups, there could be more further in the future. The core bank processors in the U.S. — Fiserv Inc. and Fidelity National Information Services Inc. — could come back to do other deals, Sakhrani said. Jack Henry & Associates Inc., which has thus far remained a stand-alone bank processor, could engage in a deal to get more payments exposure. And as legacy payment processors consolidate, emerging independent payments players such as Adyen NV and Square Inc. might jump into the fray in the long term, Sakhrani said.

Fidelity National, commonly referred to by its stock ticker FIS, is expected to close its pending $35.36 billion merger with Worldpay Inc. on July 31. The companies are then expected to report second-quarter earnings results together.

The bigger story for Fiserv's pending $21.79 billion tie-up with First Data Corp. is the state of First Data's joint venture with Bank of America Corp., Wolfe's Peller said.

In May, the bank added a disclosure to its quarterly filing stating that a "significant portion" of its merchant processing activity today is performed by the joint venture. Bank of America could develop its own business to move money between customers and merchants and exit its decade-old joint venture with First Data. The venture automatically renews unless either partner gives a written notice of termination at least one year before the end of the term, and the current term ends in June 2020.

The lack of an announcement is likely a sign that discussions are progressing amicably, KBW's Sakhrani said in a July 9 note.

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