Kunaal Arya

Financial Technology Market and M&A

I've been studying the financial technology sector over the past few weeks. I have found that it is a niche sector, making it hard find a lot of sector data and statistics on. But I have been analyzing the breadth of companies within this sector. It includes anything related to financial services being offered faster, smarter and more efficiently. These services can be from a new technology related to allocating trades quicker, to trading algorithms developed by the financial equivalent of rocket scientists. 

What's different in this market, compared to others is that there are no major worldwide players. For example, in computers, IBM, Apple, Dell, HP, and Sony control over 80% of the market share. In mobile phones, Apple, BlackBerry, Nokia, Samsung, and Motorola control over 80% of the market share. But in the financial technology industry, it could be any company. Thomson Reuters purchased Vhayu to integrate their algorithmic trading analysis software into Thomson Reuters' Quantitative and Event Driven Trading solutions. Bloomberg acquired Brainpower, which allowed it to offer more analytical software to the many hedge funds already using Bloomberg's software. These are large companies providing a large breadth of data services. Although, the major players are companies such as Fiserv and Sungard, there are still many other companies in different industries like Bloomberg and Reuters whom want to offer services in the growing financial technology sector. Looking at the different types of buyers of fintech sector, you can see the variety. Exchanges and indices, such as Euronext, and Dow Jones Market; business solution provider, IBM; research and analytic providers, Factset, Morningstar, Bloomberg, and Reuters; and financial IT providers such as Fiserv, and Sungard. These are just a small number of the well known brands, and there are many more buyers, showing the potentially large growth of the sector.

But getting into M&A for these types of firms, can serve to be difficult. Looking at both sides of the puzzle can offer an array of directions the firms can take. A number of questions need to be addressed.

Does the seller's business sell a unique service? Does that unique service have a strong business model? This will help determine if the buyer would be buying the company to give a value added service to the customer, or as a means for profit, or both. 

Would a suitable buyer be able to the take the company to the next level? Would it purchase the business for the knowledge and brainpower the employees have? Or will it purchase it for the patents? Would it fire the current employees and outsource? or would it require employees to move to the corporate headquarters? Would the CEO and executive leadership be joining the buyer, or be free to leave the organization? Or would there be a timeline of when the executives could leave the firm. And will there be stock options and other corporate benefits offered? From these questions, covenants for employees would need to be addressed in the M&A agreement.

Will the buyer be incorporating the firm into its own services? or will it be purchasing it as a subsidiary? Will the buyer be paying in cash, shares or both? Will there be stock options or warrants involved? 

These are all standard questions, but the main question will be, can the company culture and values continue strongly in a larger, more bureaucratic organization. These will be two significantly different cultures, combining into one. Small companies in a growing industry have a very different culture. They're small, mobile, quick to adapt to change. Their employees carry extra responsibilities. But if the buying company doesn't have a culture to support that system. If they instil their own culture into the employees, and employees have a negative response, they can lose the brainpower behind the purchase. 

The financial technology M&A market declined significantly during the recession, but as the overall M&A increases as it is now, financial technology M&A will rise at a very strong rate. Looking at the sector, there are many small players, and as the major players increase the services and technology they  want to offer, the quantity of acquisitions will rise. Industries have the tendency to grow significantly, and then consolidate to a small number of major players, and I anticipate this to continue in the growing financial technology industry. 

The Quickest Change

"Whoever can handle the quickest rate of change is the one who survives." - John Boyd

I recently read the blog of Robert Greene, author of 33 Strategies of War. He is a personal favourite author of mine, and discusses strategies of War and Power throughout the past thousands of years. I came across an old post discussing John Boyd's Infamous OODA loop. John Boyd was one of the most brilliant minds in the U.S. Military, most known for the creation of the F-15 and F-16 fighter jets. 

The OODA loop is a set of 4 processes, Observe, Orient, Decide and Act. You observe the situation, you orient yourself with it through your values, principles, and belief "filter" and decide on an action, and finally act on that option. It sounds simple, but it's much more complex than that because you have to calculate for counter measures to that action, and counter measures to those counter measures. Basically looking at every effect of that action that you take.

Take a look at the OODA Loop Diagram or a more practical understanding of the OODA Loop here.

To get to the point, Robert Greene discusses in this blog post, the effect of the OODA loop, and it the outcome of it being applied. The OODA loop, is a critical, and difficult decision making process. Through mastering it, results in creating chaos for the enemy, and through speed and agility coming out on top over the competition. We can see how this can apply to everyday business. 

There were a few points in Robert Greene's discussion which piqued my interest in relation to the current recession and the crisis.

"A fighter pilot is in a unique spot. He is a rugged individualist who can ultimately only depend on his own creative maneuvers for survival and success. On the other hand, he is part of a team, and if he operates completely on his own strategy, his personal success will translate into confusion on the battlefield."

Would it be relative to say that executives were operating completely on their own strategies. And they obtained personal successes, but it resulted in confusion on the battlefield. The battlefield being the market, the industry, the businesses, the global economy. When the market crashed, it was confusion, people were confused across all the industries, but they were confused, and still are confused as to what happened and what will happen and why. They were confused as to why people who could not afford were given the money to buy homes. They were confused as to why there was a lack of government regulation, lack of systemic control. They were confused of why these CEO's were walking out of companies with golden parachutes. But that's why. The CEO's and top level executives had their creative maneuvers for survival and success, and had personal success which confused the battlefield. The reason they did this was due to the ability to think faster, and adapt through change through mastering the OODA loop pattern of decision making.

"The battlefield itself is so incredibly fluid that the pilot cannot think in traditional linear terms. It is more like complex geometry, or three-dimensional chess. If the pilot is too slow and conventional in his thinking, he will find himself falling further and further behind in the loops. His ideas will not keep pace with reality. The proper mindset is to let go a little, to allow some of the chaos to become part of his mental system, and to use it to his advantage by simply creating more chaos and confusion for the opponent. He funnels the inevitable chaos of the battlefield in the direction of the enemy."

The battlefield as I described above is too fluid to think in traditional terms, hence why these CEO's and Executives had to allow this chaos to become part of their system to create more confusion for competition to come up on top. They funneled the chaos into the economy into the direction of other banks and other parties to come up on top. Hence why banks such as Lehman Brothers went down, and banks such as Goldman Sachs are still at the top. Goldman Sachs had the ability to create the chaos and keep up with their decision making processes. Whereas Lehman Brothers was the pilot that was too slow and conventional in their thinking, falling further and further behind in the loops.

"Changes are occurring too fast for any of us to really process them in the traditional manner. Our strategies tend to be rooted in the past. Our businesses operate on models from the 60s and 70s. The changes going on can easily give us the feeling that we are not really in control of events. The standard response in such situations is to try to control too much, in which case everything will tend to fall apart as we fall behind. (Those who try to control too much lose contact with reality, react emotionally to surprises.) Or to let go, an equally disastrous mindset. What we are going through requires a different way of thinking and responding to the world"

Here Robert discusses the impact on today's world. We are falling behind due to our old mindset, and our slow adaptation to change. Over the past 10 years, Mergers and Acquisitions has had record setting years, meaning that industries are consolidating. Companies are becoming bigger and bigger. This makes it harder to move faster, and react to changes quicker. Hence, the feeling of not really being in control of events, and the effect of trying to control too much, and falling apart as we fall behind. We can see this as we see companies collapse and go under government support, because they have become "too big too fail" and have become monstrous companies who cannot remain competitive due to their sheer size. 

A good example of this is General Motors. It was too big, with too many brands and products, that when attention had changed its focus from Large SUV's to small cars, they were too big to apply that change. Companies such as VW, Toyota and Honda, were smaller and able to initiate that change in a relatively short time period and GM couldn't. This is the problem with companies in North America, the focus has been removed from the speed and execution and placed on size and technology. Vietnam didn't win the war with the U.S. based on technology or power. And Napoleon didn't win his wars through larger armies, but smaller more agile ones.

The focus has to come off of teaching people to become managers, and more towards becoming leaders, by having true decision making skills. Decision making skills that have been proven correct throughout thousands of years.

For more information on the OODA loop, visit Robert Greene's blog, and the OODA Loop's Wikipedia Page. 

Source:  

OODA and You. Power Seduction and War. Robert Greene.

http://www.powerseductionandwar.com/archives/ooda_and_you.phtml

OODA Loop - Wikipedia

http://en.wikipedia.org/wiki/OODA_Loop

Strategy of Time

I just finished a book called The Time Paradox, by renowned psychologist Philip Zimbardo. I came across a lecture by him on fora.tv a few months back, and haven't had time to get to the big till this past 2 weeks. Basically what he goes over the different time zones that people live in mentally. There is past, present, and future. And sub-time zones within each, Past Negative, Past Positive, Present Hedonistic, Present Fatalistic, Future Oriented, and Future Transcendental. The book mostly goes over experiments proving that these time zones exist, but also some applications to the real world. 

Now what intrigued me the most was the application to the business. With all the time zones, the only two applicable to business are Present Hedonistic, and Future Oriented. And there can be a huge difference between companies being led in a Present Hedonistic way and a Future Oriented way. Take a look at the number of companies that crashed, they were hit by bad decisions, and had to be run in a present oriented way instead of a future oriented way, and through that a lot of them couldn't survive.

The best example of this variation would have to be Ford Motor Company vs. GM/Chrysler. Before the recession, Ford had to undergo it's own restructuring and had used future oriented leadership to be where it is today, about to become the world's number one automaker. Ford had witnessed the problems it had and looked forward and worked towards the future. It set goals of keeping products costs down, and achieved those goals by designing quality products that customers wanted, and creating a global models, where they had 6 models across the world, instead of 6 different models per geographical area. This gives them much lower cost, and the ability to produce in countries with cheaper labour. Whereas General Motors and Chrysler, were focusing more towards present. They focused on trying to conserve cash as quickly as possible instead of creating global models as Ford did. Both realized this too late, when the price of gas increased, they only had gas-guzzlers to offer. GM started working towards the future, but hit at the wrong time, and did not anticipate a decrease in demand. They thought that the 16MM cars sold a year would keep growing, whereas demand was at it's peak, and they didn't account for a recession.

This also applies to the financial companies, who put their resources towards creating exorbant profits in the present, not paying special attention to future risk. These companies knew that if prices of homes declined, then they would be hurt a great deal. Because they didn't focus on this aspect, a lot of major banks with years of history collapsed, are were supported by the government.

The lesson here, is to always think for the future, even if you think a company's present way of thinking will stay the same. A lot of GM employees have been there for years, and their children work there. This creates the same values and the same thinking, whereas bringing people from the outside can inspire change, and thinking which will apply to the future. Failing this simple principle can do this can harm a company a great deal. Thinking about future risks, and working towards that is a key to any business. Most businesses don't, but if there was one lesson companies were to maintain would be looking towards the future.

New Bull Market or a False Premise?

Ever since the lows back in March, the markets are up over 30%.

I can't help but be skeptical. Unemployement is high, housing has dropped like a rock, and continues to drop. So how have we hit a bottom in the stock market. Most of the increases in equity pricing have been from announcements from the Obama Administration, positive news from banks such as Citigroup and Wells Fargo, and news skewed by the media about housing.

The truth is that we're still doing worse, but we've slowed down our decline. The question is, did the value of equity a month ago include the risk of the economy getting worse, then as it corrected itself once news came out, the market overreacted and now have stocks overvalued? It's clear that at the bottom im March the market was heavily undervalued, but I also believe that is is overvalued now. I don't see a V shaped recovery possible with growth at a standstill. There are companies that are willing to expand, but without credit from banks nothing can happen. And as we go deeper and deeper into unemployment, it will only get harder, as there's less aggregate spending occuring across the world.

 

Click for bigger image. Source: www.dshort.com

Looking at the above chart, using history as a guide, in the Four worst bear markets we've had, there have been large bear rallies before the markets posted even greater  losses.

Yes, the banks are doing better, but they're still not lending, and I believe will be using accounting rules loopholes to make themselves better in today's light. With no lending, we will go further down the Bear's slide.

Leave A.I.G. Alone

 

It's funny when you read the news this past week, the amount of outrage, and media attentiong that AIG has garnered. The way the financial industry is run is different then the rest of the corporate world, and of course the general population wouldn't understand unless they are involved or knowledgeable about it.

So general population, I don't blame you for being upset about AIG's bonuses. I would be too, actually, I still am a bit because a company that is on the brink of failure, and using the government to survive shouldn't have to pay such big bonuses to employees.

But to understand a little bit more, you have to see how compensation works on Wall Street.

First, when you're hired at a starting position, youre given a base salary, plus a bonus. Over the years, your bonus grows at a much slower rate than your bonuses do. Until the point, where your bonuses make up a large portion of your income.

For example, hypothetically speaking:

        First Year: $60,000 salary + $10,000 Bonus = $70,000

        Third Year : $70,000 salary + $20,000 Bonus = $90,000

        Fifth year: $75,000 salary + $30,000 Bonus = $105,000

        Tenth year: $200,000 salary + $800,000 Bonus = $1,000,000

        Fifteenth Year: $250,000 salary + $1,250,000 Bonus = $1,500,000

        CEO= $1 Million salary + $15 Million Bonus = $16,000,000

Looking at above, you see your salary grow at a pretty good rate, those aren't actual numbers, I didn't source them from anywhere, but just to give you an idea.

The income will grow, and you will go from $70,000 - $105,000 within 5 years. That's a reasonable amount. You're doing some analyzing, working with companies, and after your five years, you start to climb up the ranks some more, gaining more responsibility, with your income going up.

What I am trying to say is that your bonus is part of your income. Not a performance bonus, it's stated as a guaranteed bonus. You're actually making $90,000 in your first year, but it is structured as $70,000 salary income, and $20,000 single payment bonus.

So yeah, when we read on the news, that billions are being paid in bonuses, yeah it looks bad, and we get angry, but these are guaranteed bonuses, as in part of the income.

Just put yourself in the shoe of an innocent executive, who makes $105,000 a year. $75,000 + $30,000 bonuses. Just like everyone else in the last 10 years, he has lived above his means, and taken out a mortgage for an extra nice house because of the money he was receiving and the bonus he was guaranteed to get. He may of done nothing wrong, but because of the uproar by the general population he will be in trouble, because he may need that bonus to make his ends meet, because they were guaranteed. But now he may in trouble, he may have to file bankruptcy, lose his house.

It looks like everyone just needs someone to blame. They found AIG and are letting out all their anger out against them. These executives are getting stuck with protests on their front lawns, with death threats against them. They have kids at home, families whos lives are now being threatened. Don't you think we've taken it too far? There's an article in the newspaper today about an executive who has chosen to return the bonuses he received, yet theres still an uproar in front of his house.

There are other people to blame without ruining the lives of innocent people. Blame the government like you've always done in the past.