By Ann Train
Influenced by a positive economic climate amid six consecutive years of U.S. stock market gains, initial public offering (IPO) activity in recent years has been on the rise. PricewaterhouseCoopers revealed IPO listings in the United States more than doubled in 2015 to 293, up from 128 in 2014.Global investment in fintech firms has also been robust. KPMG projected fintech investments would surpass $20 billion in 2015 versus $12 billion the previous year. Most analysts anticipate private and public investment will continue, though with less fanfare on the IPO front as company valuations undergo a reality check. The era of "unicorn" startups valued at $1 billion or more based upon fundraising could be over as evidenced in the highly visible public offering by Square Inc. on Nov. 19, 2015.
Experts marked the devaluation of Square from $6 billion pre-IPO to $2.9 billion at the time of its public offering as a defining moment for both unicorns and highly leveraged companies. Some perceived it as a bellwether for a more conservative investor market ahead guided by a return to sound financial principles, including profitability, something that has eluded Square since it launched in 2009.
As America enters another election year, which have historically favored stocks, economic pressures elsewhere could dampen the U.S. stock market and investments in general. Anticipating this possibility, a number of payment companies entered the public arena; some even staked claims in mergers and acquisitions.
"The fact of the matter is the IPO windows tend to come in cycles, and when there is a thirsty market for it, more companies consider it because they want to go out while the IPO window is open," said Marc R. Paul, Principal and Chair of the North America Corporate & Securities Practice Group at Baker & McKenzie LLP. He said some companies accelerate plans to go public before the window closes.
Generally speaking, private companies choose to go public either to raise capital for expansion or pay off debt, provide an exit for existing investors, obtain acquisition currency, reward employees through stock incentives, or increase brand visibility.
"When you have sponsor-based companies that are owned by VC or PE funds, looking to establish exits makes sense, because they are typically on a timed basis," Paul said. As an example, he said that in the case of a 10-year fund, the sponsor might add a one- or two-year extension, but in the end, the two exit strategies are sale or IPO. "Most businesses, as they develop and grow into some scale, generally the owners want to cash out or take advantage when the stock market is rewarding the value that their company is worth," said Raymond Sobczyk, Senior Associate at The Strawhecker Group.
He added that the fundamental economics of recurring revenue built into the payments industry has been an attractive model from an investor standpoint. CB Insights venture capital data confirmed that funding to private payment companies increased 37 percent year-over-year and was on track to reach $3.7 billion via 260 deals completed in 2015.
"If you look at payment processing IPOs in the last few years – Worldpay, Evertec, Vantiv, First Data, Square – most of these firms' first choices would be to get bought, but for various reasons that didn't happen," said Steve McLaughlin, Managing Partner at Financial Technology Partners LP.
He said First Data Corp. was simply too large to get acquired from its largest backer KKR. Its IPO on the New York Stock Exchange in October raised $2.6 billion. Similarly, Worldpay Group plc, backed by Advent International Corp. and Bain Capital LLC, rejected buyout offers from Ingenico Group, Wirecard AG and JPMorgan Chase & Co. before its debut on the London Stock Exchange reeled in £2.6 billion.
Sobczyk noted that KKR borrowed capital to purchase First Data in a leveraged buyout in 2007. The deal effectively changed First Data's capital structure, he said. The financing became debt on First Data's book, and debt as interest in repayment of debt. "Prior to the KKR leveraged buyout, First Data was very much an acquisitive company, globally speaking, acquiring companies on a frequent basis," said Jared Drieling, Business Intelligence Manager at The Strawhecker Group. "After the KKR deal, that was significantly constrained where there were not many deals being pushed through, and if they were, they were smaller in size and very much strategically focused."
McLaughlin believes the infusion of public currency will enable First Data to once again aggressively pursue acquisitions. "If you look at what Global Payments has done with APT, PayPros and Ezidebit – and now our Heartland deal for $4.3 billion – they were able to fund these acquisitions primarily with cash," he said. "And you look at what Vantiv did with Mercury; that was all cash." Cash deals of this magnitude are less frequent in private companies, especially when exit strategies are at play.
TransFirst Holdings Corp. LLC filed a second SEC statement in October 2015, one year after Welsh Carson Anderson & Stowe sold the company to Vista Equity Partners. "TransFirst announced that they were going to seek an IPO a year ago, and that put investors on notice that they were for sale," Sobczyk said. After holding the investment for a year, the new filing may or may not result in TransFirst going public, he said.
Square's IPO told a different story. "Square is the only one of these firms that's really burning capital, and they really needed to go public not so much to get liquidity for their shareholders, but to get capital to grow their business, because without capital they can't grow, they can't stay in business," McLaughlin said. "Square basically defined the fact that you don't need to have any income to go pubic. You just have to have growth and a huge vision."
Timing of IPOs is not a precise science. Any number of factors can impact pricing on launch day, and the process itself can be lengthy and costly (for more details, see the accompanying Baker & McKenzie graphic titled The IPO Process and Typical Timing). On average, companies spend several million dollars to hire additional administrative, finance, legal and regulatory personnel for the initial IPO setup, and once launched, to fulfill regulatory requirements, including filing of quarterly earnings reports.
"For some companies it would be cost prohibitive," McLaughlin said. "If you're a small, low-growth low-earnings company doing $10 million in earnings, it's probably not going to be a wise idea," McLaughlin said. "But for larger companies that can generate at least $30 to $40 million in EBITDA [earnings before interest, taxes, depreciation and amortization] per year, the cost of being public is manageable."
As to what constitutes a potential IPO candidate, Paul said, "I think you've got to have a basic business foundation and a basic model and strategy that shows you've got traction and a compelling business model that will give you a decent valuation."
During the self-assessment phase, companies must determine whether the product or service they offer is unique, whether they are capable of reaching the size and scale necessary for a public company, whether leadership can manage such an undertaking, and how the proceeds will be used.
Since early stealth mode startups often possess trade secrets that are unique to the marketplace, many opt to delay an IPO in order to protect the valuation of the company. "They want to make sure they have a first-to-market strategy and blanket the market before they attract the attention of potential competitors," Paul said.
Another benefit of waiting is the flexibility to innovate outside the radar of public investors. "If you're private, you can make longer term strategies and stick to those without the burden of having to hit quarterly expectations," Drieling said.
Rising stars on the IPO watch list in this category include San Francisco-based payment platform provider Stripe, which as of December 2015, had raised $290 million in venture-capital, placing its valuation at $5 billion, according to Dow Jones' VentureSource data.
London-based Powa Technologies Ltd., a mobile payment and customer data technology provider, reached $156 million in private funding in 2015, bringing its valuation to $2.7 billion. Powa continues to expand its global footprint through dozens of alliances, which include CT-Payment, POS Portal, UnionPay, Worldpay and Worldline, among others. It has also added tablet-based and virtual-store offerings to its suite.
Another one to watch is Amsterdam-based Adyen BV, a global payment platform provider that has thus far raised $266 million and is valued at $2.3 billion. With offices in North and South America, Europe and Asia, Adyen said it delivers over 250 payment methods and 187 transaction currencies to more than 3,500 businesses globally.
And Stockholm-based online payment processor Klarna AB has set its sights on the U.S. market. Whether Klarna will have the stamina or market timing to garner 30 percent of the online payments market in the United States, as it has done in Europe, is questionable. Klarna faces competition from entrenched players like Bill Me Later Inc. So far it has raised $299 million and is valued at $1.4 billion, according to VentureSource.
If it remains consistent with the past 25 years, the payments industry will continue to consolidate. "Even though it's consolidating, there are enough startup companies that find niches and provide a broad base of business supporting the industry," Sobczyk said. "If you look at the whole ecosystem, all the gateways and specialty companies that have arisen over the last five years, those will continue to get consolidated."
McLaughlin anticipates further consolidation of larger players through mergers and acquisitions. Global Payments' pending acquisition of Heartland Payment Systems Inc., which his firm advised on, illustrates this point. "But I think in terms of new investment money, you're seeing it in the mobile developer and international space, and also the loyalty space," he said.
Drieling noted changing market dynamics as a critical component. "A lot of traditional payment players are looking for guidance around understanding where the opportunities exist five or 10 years from now, and many envision an omnichannel environment where there is a blurring of lines between online and offline, and all of the payment systems and methods are interconnected through various merchants and platforms," he said.
Paul expects further monetization of data to add value and pointed to Square as an example. "I understand that they've started providing loans based on the theory that they've got a great feel for the actual cash flow of those businesses, much better than most," he said. "It's another example of the payments industry monetizing the data flow that they have."
Ian Pollari, Global Co-Lead of KPMG’s Fintech practice noted that "the speed and energy with which fintech innovation is impacting financial services is gathering global momentum on many measures." KPMG's Fintech 100 report identified payments as the part of the fintech sector most at risk of digital disruption.
"It is also positive to see the development of the fintech 'enablers,' which are seeking to provide services and capabilities to financial institutions," Pollari said. "This needs to form a core part of how incumbents seek to respond to the threats and opportunities that come from disruption."
Competition from Square and other technology-first companies presents a mixed bag for ISOs and merchant level salespeople (MLSs). The level of service from newly minted public companies may taper off, and further implementation of direct sales channels from within these companies poses a real threat. The consensus is that as ISOs started to demand pricing concessions and other terms, including portability, some super-ISOs and large processors began to go direct.
McLaughlin noted that companies like Global and Vantiv have been consistent with investment in players that represent a sustainable advantage. "That's where the focus is, whether it be thousands of integrations with software developers like Mercury, Internet/e-commerce technology like Litle or full gateway solutions like NMI," he said.
He added that these enterprises are putting less and less focus on the ISO community. And as a result, ISOs and MLSs are finding they must align with other super-ISOs or smaller processors such as Cayan LLC, CardConnect or Clearent LLC, for example, he said.
"At the end of the day if you process through Global or First Data, having most of the tech stack owned and maintained in-house is going to be critical" McLaughlin noted. "So you're really just doing the last inch with big processors."
The down side to all of this is that the larger payment players have been unable to cater to micro-businesses, which has left a vast market for Square, McLaughlin said. It has also created an opening for developer-centric businesses and mobile-first platforms to step forward. "That's left a huge market for guys like Stripe, NMI and Adyen – all of which are still private and growing fast," he added.
"Whether it's the developer community or international multicurrency transaction processing, a big part of these newer, faster growing markets have gone to new players," McLaughlin said. Even so, distribution and marketing niches – think nonprofit, government and rental sectors, for example – will continue to provide revenue opportunities for ISOs and MLSs as the industry consolidates further from all sides. 
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