Insiders say Morgan Stanley's $13 billion E-Trade deal could kick off a buying spree for wealth-management fintechs. Here's why banks are ready to 'open up their pocketbooks' and what it means for startup valuations.
- Venture and growth-stage investors tell Business Insider Morgan Stanley's planned acquisition of E-Trade for $13 billion is a sign of further dealmaking to coming in 2020 for fintechs in the wealth management space.
- The deal shows banks' recent willingness to look externally for ways to evolve or expand their process, even if it's a steep price tag, investors said.
- Banks also might not be the only acquirers, as insurance or tech companies could be in the market as they look to jump start their digital strategy or expand deeper into consumer finance.
- To be sure, some warned that a windfall of deals isn't guaranteed as fintechs value prop to incumbents isn't always clearly obvious.
- Another potential hiccup could be the high valuations fintechs have achieved despite proving out profitable business models. As a result, some startups valuations could face a "reset."
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Investors are licking their chops at the plethora of deals they expect to come following the biggest takeover by a large US bank since the global financial crisis.
Morgan Stanley's plans to buy E-Trade for $13 billion could kick off a frenzy of dealmaking for fintechs in the wealth-management space, according to venture and growth-stage investors.
Thursday's deal between the prestigious investment bank and the discount brokerage indicates banks growing inclination to look outside their own walls for ways to attract new clientele and diversify or evolve their offerings, investors said.
Peter Johnson, head of fintech investing at Jump Capital, told Business Insider traditional financial firms are coming to that realization following years of struggling to create their own digital strategies.
"I think banks are going to be more willing to open up their pocketbooks," Johnson said. "They've been trying to build this for the last few years; most of them haven't gotten much traction. Now I think they are really going to start looking at buying."
Jennifer Lee, a principal focusing on fintech at Edison Partners, told Business Insider the trend of Wall Street banks looking to broaden out their wealth management businesses by attracting a wider base of customers isn't new. Tech innovations have led to improved efficiencies in trading, which have cut into banks' revenues.
As a result, Lee said there is "definitely" an appetite for banks to scoop up fintechs in the banking and wealth management space.
"I think it is just the beginning," said Lee of the Morgan Stanley-E-Trade deal. "Now it is absolutely the zero hour where traditional players are saying we do need to raise our game. For those who have maybe done less in the last few years than others, they know they need to step up their game."
Monica Desai, an investor Kleiner Perkins, also pointed to PayPal's acquisition of Honey and Visa's plans to buy Plaid as further representation of established companies looking to recurring revenue streams such as payments or wealth management and a diversification of their client base.
"The dynamic seems beneficial to both parties involved as fintech enters a new stage and these companies can amplify their reach," Desai told Business Insider via email.
Wealth management and banking fintechs will be hot targets for banks
It's not just a matter of how motivated the buyers are that has investors believing the industry is on the precipice of a flurry of deals for fintechs.
Many of the consumer-finance startups have finally grown to be big enough to be considered an interesting and impactful acquisition target, Johnson said.
Brad Bernstein, managing partner at FTV Capital, told Business Insider any fintech with cost-efficient self-direct trading is a potential acquisition target as those capabilities are starting to become table stakes in the wake of the Morgan Stanley-E-Trade deal.
"Everyone is going to have to offer this type of a low-cost, basically free, online-brokerage account," Bernstein said.
Lee said fintechs focused on both wealth management and banking will all appear to be attractive options for banks. However, the goal won't just be to add the ones with the most assets under management or the largest client base.
Traditional bank's success in casting a wider net over Main Street consumers is about ensuring the products and offerings remain dynamic, she added.
"It's an engagement equation that you are solving," Lee said. "How do I keep up the engagement? How do I minimize churn? How do I keep these customers engaged in an era where we are all digital first? … That is not just buying AUM and customer base. That is actually offering more on top of that."
To that point, banks desire to appear as cutting-edge as possible is top of mind thanks to the ease at which customers can now move money around, Dana Stalder, partner at Matrix Partners told Business Insider via email.
While not the case years ago, the fact a person can now choose to open up a new bank account in a matter of minutes has put traditional firms on the defensive.
"There is no question that consumers are showing more willingness than ever to change their banking relationships," Stalder said. "Consumers are increasingly happy to form new banking relationship, and there is now lots up for grabs."
That's not to say all fintechs might be appealing. Jump Capital's Johnson said of the various subsets of consumer finance startups, robos pose the least-attractive option for banks.
"The offerings there aren't that differentiated and charging 25 bps for an undifferentiated service when brokers fees have gone to zero," Johnson said. "I don't think that that's exciting."
Insurance and tech companies might also look to wade into the fintech-acquisition waters
To be sure, banks might not be the only companies in the market for a fintech.
Large insurance companies have plenty of cash and a desire to update how they go about doing business. The success of insurtechs' application of technology has also pushed traditional players to consider new ways of attracting and selling to customers.
Large life insurance companies such as Prudential and New York Life, in particular, could seek to make a deal on the hopes of a boost to the firm via integration with a consumer finance app, Johnson said.
While not an exact comparison, Johnson cited Northwestern Mutual's acquisition of LearnVest in 2015 as an example of that strategy.
"Selling life insurance is hard, traditionally agent-based. How do you move that to a digital strategy?" Johnson said. "You help people manage their money online, and then you make life insurance as part of that."
In addition to insurers, Edison Partners' Lee said big-tech companies such as Amazon or Google could also be a potential landing spot for fintechs.
The newcomers could also go on the offensive, she added. Lee highlighted LendingClub's recent plans to buy Radius Bank for $185 million as an example of how the startups might be motivated to do some dealmaking of their own to diversify their products.
However, Pete Casella, a partner at Point 72 Ventures, is less bullish on 2020 turning into a flurry of deals between traditional players and fintechs. Instead, Casella told Business Insider it's much more likely for the fintechs themselves to look to team up where possible.
"I think you will see an acceleration of multi-product capabilities happening within the fintech space," Casella said. "Some of that may come from acquisition. Some of that may come from partnership."
That being said, Jump Capital's Johnson said it's unlikely to see full-on mergers amongst the largest of fintechs in an effort to grow in size quickly.
"Each individually is more attractive to a bank to buy than trying to figure out how you put two heavily-funded venture companies together," he said. "Those deals are never easy."
High price tags still need to be addressed
However, no matter how strong the environment is for fintechs to get acquired, the elephant in the room remains valuations.
Investors put $17.2 billion into mega-rounds - funding rounds worth more than $100 million - in 2019, helping fintechs valuations continue to skyrocket.
Morgan Stanley's planned acquisition of E-Trade shows high price tags aren't going to scare banks away. However, the discount brokerage is far more established than any of the new-age fintechs. E-Trade has nearly a forty-year history, including over 20 as a public company.
Many fintechs, meanwhile, are still burning investors' cash as they look to bring down customer acquisition costs and set a clear path to profitability.
Point 72 Ventures' Casella said the valuations of the largest fintechs have priced out the incumbents. Instead of trying to acquire a unicorn, he added, a bank would likely feel more comfortable putting that towards investing in their own tech.
Jason Gurandiano, global head of financial technology investment banking at RBC, echoed Casella's skepticism around getting a deal done for the highest-priced fintechs.
"I think you will see it on the margins for some of the smaller platforms that have either interesting tech or interesting talent but for whatever reason they haven't been able to scale," Gurandiano told Business Insider. "I think the large names that occupy the headlines, I think just given the scale of their valuations it's almost impossible to make the math work for a bank."
Edison Partners' Lee said it's likely that some startups valuation will face a "reset."
But, even if a fintech isn't in the black, Johnson said banks might be comfortable with the high cost on the assumption they can help turn things around.
"The banks won't look at what does revenue look like right now, but what can we do with this once we own it," Johnson said."That will be really significant for some of them."