Out with the old in with the new

April 8, 2021


‘Utility: the state of being useful, profitable or beneficial’

Ask any respectable scientist or engineer how they achieved distinction, and they will likely tell you that they stood on the shoulders of giants. Such is the nature of their fields – you build upon the work of your predecessors. However, it would be a mistake to think that this is the only approach to development. Sometimes the best solutions come from scrapping the previous script, redefining the problem and standing on your own two feet.

Take the modern banking system as an example. While it has been tweaked and nudged into the digital age, the system is still – at its core – an iteration of a centuries old industry. If you look closely enough, not a lot has changed from the principles set out in the 15th century (and still employed to this day) by the Banca Monte dei Paschi di Siena. It is a rather extraordinary idea when you think about it, and one that stokes an interesting discussion internally when we ask ourselves what if we had the luxury of redesigning the system from scratch? Would we arrive at the same modern day setup? Would we see a need for a network of bank branches, for instance? Would utility bills and signatures be our preferred means of identity authorization?

In our view, it is a resounding no. But such is the consequence of an iterative process and a series of shortsighted ‘quick fixes’ that seldom appear shortsighted at the time (e.g. replacing cheques with debit cards); they assume a very different perspective when we take a step back. If we deconstruct ‘banking’ into the core utility on which it was designed – the store of wealth and the transfer of money – then it becomes apparent that the major providers of utility in most markets are no longer the banks. The value proposition is shifting from ‘where is the safest place to store my money’ to also include ‘what is the most seamless and cost effective way to transfer and manage my money’. The once dominant financial institutions are seeing their power eroded by technologically enabled disrupters, leveraging off mobile solutions, data and APIs.

Somewhat surprisingly, one of the best examples of this trend can be found in Kenya. It is rare that the markets in which we invest harbor a best in class operator – particularly in disruptive sectors, and in a global context – but mobile network operator, Safaricom, is one exception. Through their mobile money network, M-PESA, they have almost single handedly brought more than 30 million Kenyans into the digital payments age, in what has been one of the world’s greatest advances in financial inclusion1.

M-PESA, as the name suggests (M = ‘mobile’; PESA = ‘money’ in Swahili) was one of the earliest mobile money products in an industry that has since ballooned to include more than 1 billion people globally, of which more than 50% are located in Sub-Saharan Africa2. The idea is simple – a digital wallet that is linked to a mobile phone. There are no banks involved. No account numbers. No etching your name onto the back of a card. An individual’s e-wallet links directly to their SIM, meaning a phone number is all that is needed to send and receive money.

If you lived in Kenya in 2005 there was a 70% chance you didn’t have a bank account3. Today, as an adult in Kenya, there is almost 100% chance that you have an M-PESA account and have transferred money digitally to somebody else in Kenya. In 2019, the total value of transactions that ran through M-PESA was almost 15% higher than Kenya’s entire $96 billion GDP. That is a whopping 8 billion unique transactions, or more than 150 transactions per person. For context, in the same year Germany recorded less than 60 cashless transactions per person4. Money enters and exists the M-PESA ecosystem through a network of ‘agents’, which mainly comprises authorized dealers, but also includes retailers such as petrol stations, supermarkets and registered SMEs. There are over 200,000 of these agents – that is more than every bank branch, ATM, currency exchange and microfinance institution in Kenya combined5.

Source: World Bank; Vergent Asset Management LLP

Note that Safaricom changed the definition of M-PESA users in 2013 from ‘Total Number of Users’ to ‘Users that have used M-PESA at least once in the last 30 days’. Under the former definition, there are over 30m M-PESA users today.

The early signs of M-PESA’s infiltration – and to some extent, redefinition – of the banking system are clear. Consider M-Shwari, an application built on M-PESA through which consumers can apply for up to KES 50,000 (roughly USD $450) in short-term loans. When M-Shwari launched in November 2012, approximately 700,000 Kenyans had an outstanding personal loan. Just three months later, M-Shwari had signed up a staggering 2.9 million customers, which rose to 5 million by the end of the year and almost 10 million a year later6. For the bank that underwrites the loans – NCBA Bank – just under 50% of all loans disbursed in 2019 were through M-Shwari 7.

KCB Bank has enjoyed similar success. Just one year after launching KCB M-PESA, an almost identical short-term loan product, their customer base had more than doubled to 9 million people. That is one of the largest banks in East Africa, having taken 115 years to amass its first 4 million customers, taking just 12 months to add 5 million more8. It is quite remarkable to witness even the most established, multi-centurial banks such as KCB sliding down the value chain of their own industry.

As fundamental investors, we assess the strength of our companies through an array of qualitative and quantitative methods. Sometimes, however, it can be just as useful analysis to employ a far simpler framework. History has consistently proven (across both capitalist and socialist systems) the old adage that money is power. Less discussed, albeit a slight subtlety, is the opposite. Power is money – the idea that those with influence and control can lever their advantage in order to benefit financially. For some companies, we can gauge this power quantitatively by analyzing the take rate – the percentage commission charged per transaction. There are a number of factors that go into the take rate, but generally those with a stronger grip on their respective industries are able to demand a higher rate.

In this context, it is worth remembering that fundamentally, M-PESA is nothing more than a digital distributor. Consumers pay a small fee in return for the ability to distribute money to any other M-PESA user in Kenya. For financial products such as M-Shwari and KCB M-PESA, the underwriting banks pay for the privilege of distributing their products through M-PESA. The chart below compares the take rate that M-PESA earns on these financial products with some of the largest physical and digital distributors in the world. It is a surprising data point, but one which undeniably evidences the power that M-PESA holds over the Kenyan banking sector.

Source: Vergent Asset Management LLP

T-Mall includes fees for paying through AliPay. e-Bay is the blended rate for the US and international businesses. Kenya Banking Sector is calculated as the average yield for the last three years, adjusted for provisions for bad loans. Jiebei is an unsecured, consumer loan product. The rate given is on an annualized basis. Amazon is inclusive of 3P commissions, logistics fees and advertising fees.

What M-PESA has done for the financial development of Kenya has been nothing short of extraordinary. And what is most exciting is that we see this as just the start, the prelude to what is shaping up to be the most profound chapter of M-PESA’s story so far. As Ol’ Blue Eyes, Frank Sinatra, would say – “the best is yet to come”. M-PESA 2.0 will grow into its role as the core financial ecosystem in Kenya, and the global poster child for how technology and connectivity can expose the frailties of the modern banking system. We expect it will become much more than a convenient way to transfer money. Consumers will be able to pay for almost any good or service, settle bills and seamlessly send money from abroad; the government will collect taxes and pay public sector employees; banks will use it as their preferred channel to distribute credit, insurance and other financial products. Put another way, we believe M-PESA is on track to become the core provider of financial utility in Kenya.

We hasten to add that the next leg of M-PESA’s journey will not be all blue skies and rainbows. There will of course be storms ahead, as regulators and policy makers play catch up, and as the retail banking sector fights to stay relevant. Nevertheless, we are confident that M-PESA has what it takes to navigate these challenges successfully. Safaricom is, and has always been, our biggest bet. A company that from a small corner of Africa is spearheading one of the most powerful digital revolutions on the planet.

Vergent Asset Management
April 8, 2021

1. Source: Safaricom, company accounts
2. Understanding why mobile money has been so disproportionately successful in Africa could be the subject of another paper entirely, and we will refrain from doing it an injustice by skimming over the details here. For the curious reader, we highlight what we think have been the three key ingredients: i) markets that have low banking penetration; ii) economies that are heavily reliant on cash; iii) populations that exhibit high rural density.
3. Source: GSMA Report, 2015
4. Source: Deutsche Bundesbank data
5. Source: CBK data
6. Source: FSD Kenya
7. Source: NCBA company accounts; Safaricom company accounts
8. Source: KCB company accounts
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