How to value the stocks of digital banks: J.P. Morgan

The addition of digital banks, finance-embedded internet companies, and other challengers to incumbent banks creates a puzzle for stock analysts: how to figure out what these companies are worth.

Most of these new entities are not publicly listed, although that is changing, with upcoming IPOs from the likes of Kakao Bank, Paytm, Bukalapak, and Grab’s SPAC acquisition – not to mention the possibility of a restructured Ant Group.

Public or private, these challengers are all getting bank licenses, which means they need to be weighed by anyone researching financial institutions – because fintech is now having such a profound impact on business models of incumbents.

But how do you work out the relative value of a challenger bank fresh out of a regulator’s sandbox with incumbents with decades or more of history?

Old principles, new metrics

Harsh Modi, Singapore-based co-head of Asia ex-Japan financials research at J.P. Morgan, says the longstanding principles have not changed: what’s the net present value of a company’s forecasted cashflow?

What’s different is that the pragmatic tricks to condense many factors into a few metrics, such as price-to-earnings or price-to-book, don’t work for challengers with little history, or whose business trajectories vary.

“The nature of the cashflow is different,” Modi told DigFin. His team has recently put out a report, “Asia Digital Finance”, exploring this changed landscape.

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“Challengers are all at different stages,” Modi said. “Some have achieved scale in payments and are now moving into lending. For them, it’s about whether they can build a credit book or a deposit franchise. We’ll look at data points around the type of revenues they can generate from their balance sheet.”

But for other companies at an earlier stage, what’s important are data around monthly average users and similar growth metrics. “We look at user downloads, conversions from payments to loans, or how many customers have been KYC’d,” he said.

Learning curve

The variability means there may not be much investor consensus on these companies. “Everyone’s learning,” Modi said. “Regulators, incumbents, fintechs, analysts. As challengers move from the sandbox to the real world, valuing them is ultimately about asking what is the long-term cash generation and market share they can make.”

Conditions vary in each market, as do the nature of challengers, which could be standalone digital banks or might come from an e-commerce company, a telecom operator, a ride-hailing app, or an industry sector platform.

Regardless, any licensed bank – incumbent and challenger alike – will have to manage three factors. First is the interest-rate cycle. Modi says the market expects interest rates to begin to rise in 2022, leading to different economic conditions.

Second is the bank’s asset-quality cycle. For challengers, unless they’ve already built up a credit portfolio, this won’t take shape till 2023 to 2025, making it harder for analysts to gauge winners and losers.

Third is cross-selling. Banks, both challengers and incumbents reinventing themselves, are chasing “user engagement”. Doing it right generates data-driven insights and personalization, rather than mis-selling, and affecting business by zealously overselling particular products.

What’s not in doubt is that finance is undergoing an upheaval thanks to technology. Customer service, once lip service among incumbents, is now the only way for consumer banks to make money, now that many of the sector’s cozy oligopolistic advantages have been competed away – usually with regulators cheering on tech-savvy challengers.

“Sure, customers still trust banks, but that’s not the point,” Modi said. “They’re now also willing to trust non-banks,” from food-delivery services to social media companies.

These tech players have been feeding people bite-sized payment options, winning their trust. They are now moving into more ambitious financial services. Getting a bank license, and therefore the blessing of local regulators, is the path to scale – and for incumbents, digitalization is the only way to defend their existing business.