Pipe dream of payment plumbers springs a leak

Unlock the Editor’s Digest for free

Roula Khalaf, Editor of the FT, selects her favourite stories in this weekly newsletter.

Payments for consumers are a doddle these days. Tap a card or smartphone and voila! In the background, the pipes and plumbing that make this possible have grown increasingly complicated and fragmented. Financial technology has shaken up the sector, making payments easier for customers and cheaper for merchants. 

The once humdrum back office banking function has become an independent sector hungry for external investment. Share prices for new entrants like Adyen of the Netherlands and Block of the US soared during the pandemic as online payments boomed.

The inevitable comedown arrived in 2022. A tech sell-off and worries about consumer weakness have dragged shares down. Italy’s Nexi is one casualty. Shares have traded below its 2019 listing price for most of this year. Speculation of a private equity bid sent them soaring last week.

Payments remain an emerging theme for investors. Change is inevitable, because the basic infrastructure has changed little in the past few decades. At its core, a payment is a communication between two banks; that of the merchant (known as the acquirer bank) and that of the customer (called the issuer bank). In between the two sit the card networks, the rails that allow banks to communicate. The best-known and biggest are Visa and Mastercard. National networks exist too, like UnionPay in China. 

A remaining challenge for fintechs is to break the power of the duopoly of Visa and Mastercard at the heart of retail payments. As Ron Kalifa, who ran Worldpay after it was hived off from Royal Bank of Scotland, notes: “It takes an awful lot of engineering to connect every customer with every retailer in the world in the way Visa and Mastercard have done.”

Most payment fintechs started the journey of disruption at the other end of the payment journey. They disrupted the way merchants accepted transactions. Take Jack Dorsey’s Block (formerly called Square). This started out providing small businesses with simple tech to take card payments. PayPal specialised in online purchases.

Fintechs have started to eat into the business of acquirer banks by taking on more of their job at lower cost. 

The work comes in three parts. The merchant typically pays 1-3 per cent of the transaction’s value. First is the processing fee charged by the acquirer for supplying merchants with the sales terminal and undertaking the payment. Next are network fees. These go to the likes of Visa and Mastercard. The final payment goes to the issuer bank, which bears the risk that the customer cannot afford to pay.

Fintechs have done a good job on the first set of fees. But competition is eating into their profits. They are trying to take on the big card networks with direct bank-to-bank systems. But this is a gargantuan task.

Consolidation is needed and a likelier next step. Valuations are lingering close to decade lows. That creates a role for private equity given its vast sums of “dry powder”, as uninvested capital is called.

Cheaper, simpler payments are an inevitability. But complex manoeuvres will be needed for investors to capture much of the upside.

Cipriani: a cocktail exclusivity and growth

An invitation to sip Bellinis at a members’ club sounds like a fun experience. Being asked to invest is a more complex proposition. Those considering a punt on Cipriani’s new €500mn club venture will hope the high-end Italian hospitality group performs better than New York-listed rival Soho House. Its share price has dropped 40 per cent since listing in 2021.

Cipriani runs the historic Harry’s Bar in Venice and the high-end Casa Cipriani clubs in Milan and New York. It has teamed up with Optimum Asset Management to raise a €500mn real estate fund. This will buy properties in megacities around the world to house new Casa Cipriani clubs, which will be managed by the Venetian family company.

Members’ clubs find rapid growth tricky to pull off. It requires marrying a perception of exclusivity with mass-market appeal. LVMH, the French luxury behemoth, has bags of experience doing this.

Rapid expansion involves high upfront costs, which damp financial returns. Soho House, whose revenues increased 18.5 per cent to $290mn in the second quarter of the year, has historically struggled to turn a pre-tax profit.

Its free cash flow has been negative, although that should improve in the next few years. Debt at Soho House has risen to $590mn, some 15 times next year’s expected ebitda. 

Clubs can earn profits in other ways. The first is to be old, established and have a small number of locations. A parallel in the luxury sector might be Hermès: capacity constrained with high pricing power. While no shortcuts exist for this, Cipriani has some form. 

Another model couples a high-end hotel with a members’ club added on top. Well-managed rooms and meals should generate strong returns, raising the value of underlying properties. The membership fee — a rumoured €4,000 a year for Casa Cipriani in Milan — simply squeezes extra value from the brand.

Cipriani will hope to do this. Balancing growth and exclusivity is tricky. But its unique heritage should enable it to achieve success.