“Recessions are not necessarily a bad thing… I’ve been through a few of them. And what tends to happen is if you have a boom that goes on too long, you get a misallocation of capital. It starts raining money on fools, basically.” Elon Musk, May 16, 2022.
June 10, 2022
Recessions bring pain. They also bring opportunity. They reset capital allocations. This is part of the natural workings of free markets, which have rendered global capitalism, as Alex Gorsky said, “the greatest engine of prosperity that the world has ever known.”
In the current malaise, where do the greatest opportunities reside? While much has been written about moving from “growth” to “value” investments, are there nuances across software as a service (SaaS) and fintech verticals that may not be broadly recognized? Moreover, how do SaaS and fintech companies in Africa present unique opportunities?
Historical Context
The “gloom” associated with the pending recession has been broadly trumpeted. Sequoia issued a warning memorandum to its portfolio companies: “We do not believe that this is going to be another steep correction followed by an equally swift V-shaped recovery like we saw at the outset of the pandemic.” It noted that sustained inflation and geopolitical conflict eliminate “quick-fix” policy solutions such as reducing interest rates or quantitative easing. Lightspeed stated that “the boom times of the last decade are unambiguously over.” Netflix, Robinhood, Klarna, Meta, Uber, and others recently announced layoffs or slower hiring. The list goes on.
Markets have been quick to respond. In 2022 alone, the S&P 500 information technology sector decreased by approximately 20%; its value index is outperforming its growth index by 17%. Per EPFR, over $48 billion has left growth stock funds, and more than $13 billion has migrated to value stock funds.
History has provided us a framework to navigate what many consider an inevitable recession. We looked back at the last five recessions since 1980 as a guide. The five recession periods we identified troughed at the following dates:
- July 1980 (the “energy crisis” recession);
- November 1982 (the “Iran/energy crisis” recession);
- March 1991 (the “Gulf War” recession);
- November 2001 (“Dot-com” recession); and
- June 2009 (the “Global Financial Crisis” recession).
Our analysis compared the Russell 1000 Value and the Russell 1000 Growth indices. As shown in the graph below, “value” stocks have outperformed “growth” stocks for approximately 60 months (five years) following a recession.
Software as a Service (SaaS)
In August 2021, the median public B2B SaaS company hit a record high value at 16.9x its current run-rate annual recurring revenue (ARR). At the end of February 2022, the median public SaaS valuation multiple had dropped 37% to 10.7x ARR.
Interestingly, despite losing nearly 40% of their value, operationally, many public SaaS companies continue to perform along historical trend lines. This suggests that the recent decline in public stock prices is not an indication of any current systemic weakness in the SaaS industry or business model. Instead, our view is that the recent market tumble is a valuation reset driven out of fear of future operational challenges, as well as macro-economic and geo-political influences.
The chart below illustrates that growth rates across the deciles for public companies in the SaaS Capital Index (an index of 92 public SaaS businesses) remain virtually unchanged between the all-time-high valuation mark of August 2021 and February 2022. Meanwhile, virtually all companies were subject to a valuation reset, with the previously highest valued companies subject to the largest percentage declines. This suggests that the stock movement may be a reassessment of future risk and exogenous factors. SaaS companies’ growth rates will likely slow in a recession as they drive towards profitability, but EBITDA-positive SaaS companies are well-positioned to survive the economic downturn. We believe significant opportunities exist in EBITDA-positive SaaS companies that remain poised for steady growth.
Source: Pitchbook/ SEG
Fintech
Fintech revenue multiples have been steadily rising for three years until the end of 2020. After closing Q4 2020 with a median EV/revenue multiple of 15x, companies in the data set developed by Software Equity Group peaked at 19x in the first quarter of 2021 before taking a dip nearly back to pre-pandemic levels.
While the overall trajectory of EBITDA multiples was not dissimilar to their revenue counterparts, the median EBITDA multiple for fintech’s was 38.7x in Q4 2021, 50% higher than pre-pandemic levels, showing the importance of profitability when evaluating companies within this sector. Similar to SaaS companies with healthy EBITDA margins and solid growth, opportunities exist to invest in fintech businesses that are leveraging the undeniable tailwinds of digitization and mobile money.
Africa: The Best of Both Value and Growth?
We believe Africa represents the unique confluence of value and growth opportunities, particularly in the SaaS and fintech verticals.
Africa has been called the world’s last great frontier for investment. The continent is home to a rapidly growing population, with over 1.2 billion people and an estimated GDP of $2.6 trillion in 2020. Africa is also home to some of the world’s fastest-growing economies, including Nigeria, Ghana, and Ethiopia. Despite its challenges, Africa represents a unique confluence of value and growth opportunities for investors. In particular, the continent offers significant potential for growth in the software-as-a-service (SaaS) and fintech industries. The SaaS industry is expected to grow at a compound annual rate of 21% between 2018 and 2023, according to research firm Gartner. This rapid growth is being driven by the increasing adoption of cloud computing services by businesses of all sizes. Africa presents a large untapped market for SaaS providers, with only 10% of businesses on the continent currently using cloud-based solutions. Fintech is another area where Africa presents considerable opportunity for growth. The continent’s mobile money sector is already worth an estimated $69 billion, and there are more than 500 million active mobile money accounts in sub-Saharan Africa alone. Fintech startups are providing innovative solutions that are making it easier for African businesses to access financing and make payments. There is also growing demand for financial inclusion among Africa’s unbanked population—estimated at around 50%—which presents a major opportunity for fintech companies that can provide affordable banking products and services..
Investors are certainly not oblivious to this opportunity. 2021 saw more and bigger investments closed in Afr0ica, as tech startups across the continent raised close to $5 billion. This amount was double the previous year’s investment, and nine times what was raised five years ago. Among the largest beneficiaries of the fintech capital were Opay, which raised $400 million; Flutterwave, which raised $170 million; TymeBank, which raised $180 million; Jumo and MNT Halan, which raised $120 million rounds; digital payments gateway MFS Africa, which gained $100 million; Zepz (formerly WorldRemit), which raised $292 million; Chipper Cash, which raised $250 million; Tala, which raised $145 million; and Wave, which raised $200 million.
As incremental funding for fintechs in Africa grows, so too will mobile phone usage and internet penetration. According to the GSM Association, mobile subscriber penetration across the continent is predicted to hit 615 million—half of the continent’s population—by 2025. It is also poised for greater growth as the adoption of lending, digital payments, banking, and insurance services grows.
Multiple examples underscore our thesis. M-Pesa, a mobile money service by East Africa’s biggest telco, Safaricom, does not require internet connectivity for its customers to send and receive money, as well as to pay utility bills—the wallet turns subscribers’ phone numbers into a proxy for bank accounts. The service recently surpassed voice traffic to become Safaricom’s top earner after the platform’s revenues hit $745 million for the financial year ending March 2021. Across the region (especially in Kenya), M-Pesa has served as an anchor for a raft of new services that are coming online. In 2012, for example, Safaricom laid the ground for the adoption of lending apps when it first launched M-Shwari—a mobile-based savings and loans product. Many more lending apps have since come to market, including Silicon Valley-backed Tala and Branch. These now-popular lending apps use customers’ mobile money transaction history to determine the amount of instant credit to extend to borrowers—funds that are then deposited in customers’ mobile money wallets. Such lending and banking startups have made credit accessible to most people with no credit scores and who were previously cut out by formal financial institutions due to a lack of banking history data.
Africa’s growth story is unlike any other on the planet. In addition, Africa is home to many “value companies,” with strong EBITDA margins in the SaaS and fintech verticals. This confluence, tucked away on a continent that many investors are cautious to enter, represents an opportunity that many have overlooked.
1K Africa, we partnered with several African companies that represent the confluence of both value and growth. Pay@ (our leading payments aggregator portfolio company based in Stellenbosch, South Africa), Digico (our digital ecosystem company that houses multiple fast-growing and disruptive technology companies), and Sybrin (our digital banking SaaS investment), all sit at the crossroads of both value and growth. These companies are not only delivering EBITDA-positive financial performance but also benefiting from Africa’s extraordinary demographic growth. As important, these companies are contributing jobs, economic freedom and financial inclusion in Africa. We hope that more investors recognize the opportunity to capture both value and growth in Africa’s SaaS and fintech vertical and, in doing so, bring greater prosperity to the continent.
President, CEO and Co-Founder, 1K Africa
Co-Founder & Chairman, FLC Credit Partners & Family Legacy Capital
DISCLAIMER:
The opinions and views expressed herein are solely those of the author and do not necessarily represent the view(s) of any affiliated institution or organization including without limitation 1K Africa, Family Legacy Capital Credit Management, LLC, Family Legacy Capital Management, LLC, and any investment fund, entity or vehicle managed by or affiliated or associated with any of them.
