Fintech founders are always happy to tell you how they are “democratizing” the world of banking and finance and if you’re willing to not interrogate that verb too closely, the claims are broadly true: a popular app can make certain financial activities more widely accessible and often at lower cost (think Robinhood’s commission-free stock trades).
Yet for the first many years of fintech’s existence, even most of the “democratized” companies and services have still felt elite. They often require a degree of technical sophistication and are typically aimed at people with a decent amount of disposable income to invest or spend.
That dynamic is evolving, as illustrated by this week’s blockbuster announcement that Walmart has bought (subject to regulatory approval) the neobank One and the wage-access firm Even. In the classic build-or-buy question that expansion-minded businesses face, Walmart has clearly landed on buy. On the build side, H&R Block just launched Spruce, a mobile banking platform with features—such as no monthly fees and early paycheck access—designed for low-to-moderate income customers. This is how the Spruce press release begins:
Living paycheck to paycheck is one of the biggest sources of economic stress for Americans today—and these anxieties impact mental and physical health. Two-thirds of the U.S. population struggle with one or more aspects of their finances, including spending, saving, and planning.
Workers of the world, unite! You have nothing to lose but your Earned Income Tax Credit!
What’s fascinating about fintech is that not only does it apparently allow a company like Walmart to enter the banking sector from which regulators have repeatedly repelled it for decades, but also creates new competition between companies that weren’t previously competitive, in categories that they weren’t even known for. Admit it, did you ever imagine Walmart and H&R Block going toe-to-toe to see which one could sign up more working-class savings accounts?
Walmart has coveted the financial services sector for decades, only to be rebuffed by regulators and legislatures in almost comical fashion. In 2002, for example, Walmart tried to purchase a tiny, bankrupt industrial bank in Orange County, California. The state legislature promptly passed a law to prevent nonfinancial companies from owning such charters. A similar effort in Utah created so much opposition that Walmart withdrew its application.
While obviously Walmart has the resources and customer base to create a massively powerful financial services business, it’s still far from clear that the pieces add up. Sure, a shopping relationship with Walmart presents numerous opportunities for other financial transactions—check-cashing and store credit/Buy Now, Pay Later are clear but also health insurance, car loans, even stock trading—but the big unanswered questions are: 1) To what extent do Walmart customers want or need those services? and 2) For those who do, aren’t they probably already being served by some other app or bank?
Still, two things set this week’s announcements aside from Walmart’s thwarted efforts of the past. The first is a different regulatory playing field. A longstanding principle in US financial regulation—with a history that goes back to medieval Europe—is separating banking from commerce. There are various rationales for that, the strongest of which is probably that commerce is intrinsically risky and it’s unwise to expose banks to that risk. One refrain heard in Walmart’s earlier financial forays was “What if there had been a Bank of Enron?”
For better or worse, One Finance, which Walmart intends to buy, isn’t legally a bank. Like most fintech companies, One Finance partners with a FDIC-insured bank—in this case, Coastal Community Bank—to provide services like loans and credit cards. That practice is subject to abuse, in what consumer groups call “rent-a-bank schemes.” But it’s not currently illegal, and it’s hard to imagine Congress changing banking law any time soon. Walmart’s intended purchase should receive regulatory scrutiny, but from a legal standpoint it’s not obvious what federal regulatory authority is in a position to block it.
The second thing that stands out about Walmart’s move is that Even is focused on hourly workers. It seems axiomatic that the new Walmart financial machine will be test-driven on the 1.6 million Americans who work for Walmart. That’s a very strong starting base. This might just be the way that fintech goes mainstream.
Will Root Be Delisted?
The Root story seemed so compelling, its tech and data promise so pure. Instead of using credit ratings to determine auto insurance rates, Root would use “telematics,” data gathered from drivers’ smartphones, to calibrate the right rate. Launched in 2015, the company immediately attracted venture capital from the coasts, while its Columbus, Ohio, headquarters gave it heartland cred.
When Root’s inevitable IPO came around—with all the investor world buzzing about the “insurtech” miracle, especially after Lemonade’s explosive debut—the legendary Goldman Sachs was chosen to lead it. The October 2020 IPO raised $724 million and gave the company a market capitalization of $6 billion, which was more than Lemonade had been worth on its first day of trading in July that year.
And even after the IPO, Root seemed to be hitting an innovative stride. Last August, for example, Root announced a partnership with the online car sale platform Carvana, which included a $126 million investment from Carvana.
All along, though, there were troubling signs. When Root filed its S-1, it revealed that the company had lost a head-spinning $600 million since 2018 (today the company’s total losses are over a billion dollars). Moreover, the company admitted in the filing that it was losing money because it wasn’t charging drivers enough. In March 2021, Bank of America Securities analyst Joshua Shanker initiated coverage of Root by slapping an “Underperform” rating on the stock. Shanker predicted that Root will not be cash-flow-positive until 2027, and thus “will require not insignificant cash infusions from the capital markets to bridge its cash flow needs.”
It was therefore not surprising this month when the company announced it is laying off 330 employees, or about 20% of its workforce. In a blog post Root CEO Alex Timm blamed—what else?—“supply chain and inflationary pressures,” but it’s clear that the company’s problems are largely internal. (Root did not respond to FIN’s request for an interview.)
One flashing red signal is that arguably the single advantage Root once had—rapid growth—is slowing down. Consider: Root saw a 150% increase in auto policies between 2018 and 2019. But lately it is barely growing at all. As one insurance trade publication notes:
Root reported just 380,836 auto insurance policies in force as of Sept. 30, 2021, compared to 322,423 over the same period in 2020. Renters’ policies reached 9,143 during Q3, compared to 7,367 over the 2020 third quarter. Lemonade, by contrast …reported in excess of 1.36 million customers as of the 2021 third quarter, versus more than 941,300 over the same period in 2020.
As a cash preservation tactic, the layoffs make some sense, but they are unlikely to fix more fundamental problems with Root’s business. While Lemonade is also not having a great time in the market, investors are driving away from Root in a hurry:
As of trading close on Friday, Root’s market capitalization is a mere $450 million, or less than 10% of what it is was 15 months ago. Moreover, not only is $450 million less than the amount that Root raised from venture capital, it’s less than half the amount that Root has already lost. If the stock continues to head in the direction it’s been going since the IPO, Root faces a serious prospect of being delisted from Nasdaq.
Fintech’s Ludicrous CAC Edge
Usually when people list the advantages that digital financial services have over traditional banks they talk about speed, ease of person-to-person or cross-border transactions, and (especially in the COVID era) contact-free transactions. But there is a killer advantage that is seldom discussed, and is highlighted in the ARK Big Ideas 2022 report released this week.
The rapid growth of digital money apps is well-known; FIN mentioned back in March (leaning then, too, on an ARK slide) that it took Venmo and Cash App only a few years to hit 60 million active users, whereas it took J.P. Morgan Chase several decades (and multibillion-dollar mergers) to reach the same milestone for deposit holders. The hiding-in-plain-sight corollary is that the cost of acquiring customers is astronomically, ludicrously lower than it is for banks. Here is the chart:
