A Fintech IPO to Watch and a Very Complex SPAC Deal

In this week's installment of Industry Focus: Financials, host Jason Moser and Fool.com contributor Matt Frankel, CFP, take a closer look at recent fintech IPO Flywire (FLYW 2.40%) and why it could be a smart stock for investors to keep on their radar. Plus, we recently received some details about $4 billion special purpose acquisition company (SPAC) Pershing Square Tontine Holdings' (PSTH) potential deal. To say that the deal is complex would be an understatement. And finally, QTS Realty (QTS) is being taken private, and Matt and Jason discuss why there's so much excitement in the data-center space right now.

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This video was recorded on June 7, 2021.

Jason Moser: It's Monday, June 7th. I'm your host, Jason Moser and on this week's Financials show, we'll take a look at another fintech IPO in the space that just came out. Is it Bill Ackman or is it Bill SPACman? We've got a big acquisition of the data center REIT space to talk about. We'll wrap it up with one to watch for you. Joining me this week as always, it's Certified Financial Planner, Mr. Matt Frankel. Matt, how's everything going?

Matt Frankel: Just great. I'm back in my office and ready to do the show.

Moser: Back in the office, nothing wrong with that. Good to see. Matt, we've been talking about this before we started taping and we've talked about this off and on a decent bit over the past several quarters, it feels like. We got another FinTech IPO. I'm of two minds here, Matt, because on the one hand, well listen, we love this space, we love to talk about it. FinTech is a fascinating opportunity for investors it seems like. It's also one that it's been around for a little while now. We've been using that word FinTech for some time and now we have another FinTech IPO that's just come public here. Flywire, which just came public here recently. Flywire is another FinTech IPO, that's good. But then it also begs the question, what did they do differently? We're going to get to all of that. Really, we wanted to take a big picture, look at this business, understand what they do, and come up with some things we like about it. Maybe some of the things we're not so sure about, give listeners a general idea of what this business is all about. What's first and foremost? Let's talk a little bit about what Flywire actually does. What is Flywire in the business of?

Frankel: Flywire is a payment network. Think of them like Square. They're the intermediary between a merchant and its customers, this is a crowded space. Not only do you have giants like Square, but there are a lot of other little payment networks that we've talked about on the show even. Like you said, you really need to look for what differentiates these. In the case of Flywire, it's what they process payments for. They're very specialized in terms of the industries they focus on. Specifically they focus on the education industry, such as processing payments for universities, the healthcare industry. Four out of the 10 largest healthcare systems in the U.S. use Flywire to process their payments. Business-to-business payments, which is a really broad market, that's probably the biggest one they focus on and probably the biggest opportunity, but the one that's most crowded.

Moser: That's that B2B that you would always say. We even see B2B with companies like MasterCard, Visa talking about that B2B opportunity as well.

Frankel: That's the biggest market I'm talking about, but it's also probably the least likely for them to really develop a big share of. But you have education, healthcare, and travel is the other big one they focus on. These are pretty big markets and Flywire knows that Square is still going to be Square. They are the big players in this space for the moment, PayPal is still going to be PayPal. Education payments are this $660 billion market opportunity by itself, travel is $530 billion a year, changes hands every year for travel, healthcare is $500 billion in size. These are some pretty big niche markets. If Flywire can really take share of it, I mentioned four out of the 10 leading healthcare systems in the US use Flywire, there's a lot of potential here.

On one hand, the whole payment processing space is getting crowded. All the big players in it are growing very fast. At some point, there's going to be a lot of competitive pressure here, but I do like that they specialize. I can't really think of many other of the big payment processors that really specialize. There's Shift4 Payments is another one. They specialize in the hospitality industry like a lot of restaurants and stuff like that. They're pretty specialized, but I don't know if anyone who specializes in education payments or travel payments or healthcare payments, especially to the extent that fly wire does. Such a unique company.

Moser: I'm glad that you said it because when I was looking through the S-1 trying to get a grip on what they do and what makes them different, that seems like to me that was at the top of the list. To your point, it is a small business. They generate $150 million in trailing 12-month revenue. It is a tiny little company and it's a small cap stock, $3.2 billion market capitalization. But the thing that stood out to me was that specialization. They call that out, they say it is a vertical-specific software and that is backed by what they call deep industry expertise. I mean, on the one hand, I appreciate that but you mentioned the S-word earlier, Square, and that is a company we talked about a lot on the show. I think you and I both own shares still at Square. Very happily going to let those shares just keep on doing their thing too, because one of the things that attracted me to Square among other things was that I get that idea of vertical-specific software. I mean, whether you're a retailer or a restaurant or something else, it does seem like Square is really providing the products and services for those specific verticals. The thing with Flywire, and you touched on this. It seems like Flywire is focused on some different market opportunities that Square isn't necessarily focusing on. Maybe that's the opportunity. I don't know.

Frankel: The way the company puts some sectors that have been left behind by the evolution of the payment industry. As you mentioned, it's a pretty small company, $150 million in trailing 12-month revenue roughly. In 2020, they did about $132 million in revenue but they're growing fast. That's 39% growth over 2019, which given the pandemic, that's pretty impressive.

Moser: Yeah.

Frankel: I have to imagine as a whole, education payments are down in 2020.

Moser: I would imagine.

Frankel: A lot of their travel, especially when they focus on travel payments. Some of their core markets got a pretty hard hit in 2020 and for them to still grow revenue at 39% is pretty impressive. Just to give you an idea, you said it's a small company, which is compared to some of these big FinTech. They processed $7.5 billion in volume in 2020. It's crazy how big the FinTech industry has got that we consider to be a small company. PayPal's over $1 trillion in annual volume. Their client retention rate is 97%, which is pretty impressive. Over the past three years, their dollar-based net revenue retention rate, which is pretty much, that just means how much existing customers are spending, has been 118%. Meaning that the average customer that spends $100 with them a year-ago, is now spending $118 with them.

Moser: Right.

Frankel: That's the thing with these payment companies. One thing that all investors should know in the FinTech space, there's no real reason for a company to be loyal to one payment processor or another. A lot of companies use several different payment processors for their needs. There's no reason a company couldn't use PayPal for its online payment, Square for some of its payments, Flywire for some of its payments, it's really tough for them to compete on price. Pretty much all of the fee is passed through from the payment networks like these are Mastercard and things like that. Each of these FinTech companies gets $0.10 out of every transaction. The real differentiation is the software, as you mentioned the vertical-specific software. As companies see value in Flywire's, vertical-specific software, they might be gradually shifting some of their payment needs over from PayPal to Flywire or things like that. Which is where you're seeing this dollar-based net revenue retention rate over 100% coming from. Customers are seeing more value in the product so they are shifting more of their needs over to Flywire overtime, which if that trend continues, things could get very interesting for this business.

Moser: Yeah. I mean, it is very early days. I mean, this is a business certainly that we're just starting to learn more about. I'm more than happy to give it a few quarters to better understand the business. See how management behaves as a publicly traded management team. I don't feel like there is any rush to buy shares in a business like this but by the same token, it is something that absolutely compels me. I think this vertical-specific software, I think there's something to that end. What's something that you feel like you're going to need to keep an eye on with a business like this? This is going to be a business we're going to be talking about I think fairly regularly on the show. It's one that seems like it has a lot of potential in the space. What's something you're going to be keeping an eye on with a company like this to try to judge whether it's something that's worthy of taking that next step as a possible investment?

Frankel: I mean, a few more quarters of that +100% revenue retention, that will definitely be a positive if they can keep this growth rate going. I want to see what they're doing in 2021 now that the big part of COVID is behind us, the big effect on the business. As education ramps up again and travel ramps up again and things like that, I want to see how their business does. I will say, with the vast amount of FinTech IPOs recently, a company is really got to knock my socks off for me to get in on the IPO level these days. I mean, I don't know about you, but it really has to wow me from the get-go for me to get in on the IPO. There have been a few that I've been really interested in, but Flywire is what I might have to keep on my radar. It's an interesting company. Like I said, the specialization is really at a different level for most other FinTechs.

Moser: Yeah.

Frankel: But it's one that I'm watching, but it doesn't knock my socks off at this point, but I'm watching.

Moser: I like that. I think that's a good checklist item that investors out there are looking to build your process and enhance your process and make it better. Maybe that line of, knock your socks off. Does this business knock your socks off? Because at the end of the day, Buffett talks about those punch cards, something like 20 holdings. Basically, you could buy shares in 20 companies, you get to punch off that card to get 20 of them. I mean, that really makes you look at it through that lens. It needs a knock your socks off quality. I like that. Who has that?

Frankel: I mean, I don't have the exact IPO market stats in front of me right now but I know over the past 12 months in stacks alone, we've had over 400 go public.

Moser: Yeah.

Frankel: Then we've had a lot of companies go public the traditional route. There has just been a flood of these IPOs coming to market. Like I said, that really needs to stand out from the pack. In a normal year when only the cream of the crop is going public, that's not what's happening right now. I did not say that Flywire isn't the cream of the crop, but I feel like there are just so many companies going public at a very high valuation compared to historic multiples. I mean, you said at trailing 12-month revenue of about $150 million. Maybe Flywire is trading for 20 times revenue and not profitable and growing at 39% year-over-year, which is great, but that's still a pretty rich valuation for a company like that.

Moser: Yeah.

Frankel: I think we said a few weeks ago that the IPO class of 2020 and 2021, like any class you have the top 5% that you want to pay attention to, and are going to go onto Ivy League schools and stuff like that. Those are the ones you want to focus on out of this group and Flywire maybe and maybe not but I would like to see a few quarters of how it's doing while it's actually a publicly traded company and we get to really get more frequent updates and see how the business is doing.

Moser: Well, speaking of SPACs, a billionaire investor and investor we all know fairly well through the headlines and whatnot here through the years, Bill SPACman, actually just Bill Ackman, I was just having fun with the Bill SPACman. Listen, Bill Ackman, he has a SPAC and he's got his blank-check company, Pershing Square Tontine Holdings. It seems there's a lot going on here these days with Mr. Ackman, but there is a SPAC deal where he is looking to buy a sliver of Universal Music Group, which recently went public. I wanted to get your thoughts on where exactly you think Ackman's headed with this Pershing Square Tontine Holdings, and if you feel this Universal Music Group investment is a sensible one?

Frankel: I could spend the entire episode breaking down this deal, it's that complex. [laughs] First of all, it's not official yet, Ackman confirmed that these talks are happening and gave details of what it would look like. It's not confirmed, we all know that it's going to happen, and they don't even know if they can do everything that Ackman wants to do. Take this with a grain of salt. There's three big components to what Pershing Square Tontine Holdings is doing. No. 1, they're buying 10% of Universal Music for $4.1 billion. It values that company at $42.5 billion including debt. Massive and huge right when he said it was targeting an iconic company before we knew what it was. That's a pretty iconic music business. They have some of the biggest artists in the world, they have the best intellectual property in music. There's a lot of value there, no doubt about it.

Moser: Sure.

Frankel: Unlike most SPACs, this is not an acquisition, they're just buying a 10% stake, and Universal is actually going public on its own, on the Euronext, so in Europe, they're getting going public. Just to break that part of the deal down, Pershing Square Tontine raised $20 a share in its SPAC IPO. This part of the deal's consuming about $14.75 a share, a little less than three-quarters of the SPAC's capital is going into the Universal part of the deal. The average analyst values Universal at about $50 billion, so Ackman's getting a deal. That's about 15% more than Pershing Square's paying for its stake. It's a pretty good deal if the [...] and that's what it's actually worth. That's part one.

With the other $5.25 a share, there were about $1.5 billion all together that Pershing Square Tontine will have, that's going to stay in the SPAC. Pershing Square Tontine even after the universal acquisition and spinout of shares, there's still going to be searching for a deal with that other $1.5 billion. Pershing Square itself has about $1.6 billion in money, it could commit to that if it wanted to, so Pershing Square Tontine will still have $3 billion or so to look for another acquisition target. But since they've already found the Universal one, it removes a lot of the constraints that most SPACs have, in that specifically, there's no time limit now.

Moser: Yeah.

Frankel: Most SPACs have two years to find a deal. They found the deal, they found the Universal deal, so with the rest of the money, they could take their time, that could sit for 10 years until they find another deal. That's a big advantage and remember Buffett said, give me money and tell me I have to find the business in two years, I'll do it. But I'd rather have all the time I need to find the best deal.

Now, that's part two. There's still some money in a trust that Ackman could use to acquire another business. Part three, and this is the most interesting part in my opinion, is the SPARC, S-P-A-R-C which stands for Special Purpose Acquisition Right Company. Say that three times fast. [laughs] For every square of Pershing Square Tontine that investors hold, they're going to get one SPAR, special-purpose acquisition right. This is a security, it's similar to a warrant that allows them to buy a share in that SPARC that is being created at $20 a share, but only after a new merger target is announced. Think of this as like Ackman's next SPAC, except it's different in that, it doesn't even exist really until a new merger target is announced. So, shareholders are essentially getting a warrant to buy one of these shares at some point in the future, and this component itself could have a good bit of value that Pershing Square Tontine warrants themselves right now trade for $6 a share roughly, and they have a higher exercise price $23, whereas these would have a $20 exercise price. These won't have any redemption clauses, they won't have any time constraints.

This company, like I said, could take 10 years to find a deal if it wants to. It eliminates a lot of the downsides to SPACs, like the big chunk of the company that the sponsor gets for free, it eliminates a lot of the biased toward the sponsor. The SPARC that is being created, and then I'll shut up after this point. [laughs] The SPARC that's being created will have up to $10.6 billion to put toward a deal. If you've got Pershing Square Tontine which is already the biggest SPAC ever created, with $4 billion, had a lot of money. This one will have up to $10.6 billion to commit to an acquisition deal, and the Pershing Square Tontine holders are getting these for free. I've read ten different parts of the parts estimates from different analysts since this was announced, they all ranged from about $27 to about $33 a share. Pershing Square Tontine is trading for like $23 a share. There's some upside potential the SPARC investors, especially, are going to have to be patient on, but hopefully, that broke it down a little bit, at least a little clarity to it.

Moser: That absolutely added a lot of clarity to it. You know what? It makes me think of, we've talked about this all throughout our SPAC series that we did earlier in the year, and really I think that your point that you continue to make is really spot on. These SPACs really are all about management. I mean, that is the key because in so many cases the blank check company is formed before any investment opportunity is ever really discovered. That all leads me to, of course, Bill Ackman from time to time is in the headlines for a bad investment decision that you made or whatever. I mean, financial media sometimes can be ruthless and they like to focus on the bad and never really the good. Let's be clear, Bill Ackman is a smart investor, he's had a lot of success. I mean, it strikes me that maybe Pershing Square Tontine Holdings would be one of those SPACs that I would actually consider being a part of just by virtue of the fact that you've got Bill Ackman really running the show there. I mean, he seems to have at least a vision as to what he's trying to do here.

Frankel: Every investor, Bill Ackman, Warren Buffett, any of the big ones, they make bad decisions from time to time but bet against Bill Ackman at your own risk.

Moser: I wouldn't do it personally. Like I said, the financial media loves to focus on the misses. He's obviously done very well for himself, you don't get to where he is with a bunch of misses.

Frankel: To make it even sweeter, he alluded on Twitter that there are going to be several of these spark vehicles and all of the original Pershing Square Tontine Holdings shareholders are going to get shares each one in perpetuity. Ackman wants to make his investors money. He wants to be hailed as the billionaire who makes everyone else rich too. He's made that very clear over his career that he wants to make other people rich too. It doesn't always work out, just like every investor. Warren Buffett's goal is to make all of the shareholders rich over time.

Moser: Sure.

Frankel: There was a Forbes article and I want to say 2015, they called Ackman the next Warren Buffett.

Moser: Wow.

Frankel: It was a cover story in Forbes about his investment in our News Corporation. He was essentially trying to be the next Warren Buffett with what he's doing. I'm a Pershing Square Tontine Holdings shareholder. If the current share price holds up in the mid-20s and I could start talking about it for a few days, I might even add to my position because everyone was hoping you would take Stripe public.

Moser: Yeah.

Frankel: That was the big rumor that big FinTech Stripe was going to go public through this and it didn't happen. That was really why it sold off at first. But if this holds, I might add to my position.

Moser: Now, one of the surest ways to add a spark to your portfolio Matt. I'm going to move on. Matt, there's a big acquisition here in the data center REIT space: Blackstone is acquiring QTS. We talk a lot about REITS on the show. You're very interested in the data center REIT space, you know QTS. What do you think about this deal, does it make sense?

Frankel: If the current trends keep up, investors are going to have any data center REIT to buy. I think Digital Realty has acquired at least two of them over the past few years. Now, Blackstone's acquiring QTS, there's only like five. There's Equinix, there's Digital Realty, and then there's a few smaller ones, like two or three smaller ones, QTS was one of the smaller ones. Blackstone's taking this private. It's the Blackstone's infrastructure and their REIT division. They have a private REIT, not a publicly traded REIT. Blackstone Infrastructure Partners is their infrastructure division. Those two divisions of Blackstone are buying QTS. They're paying $6.7 billion for which is a 21% premium over its share price, so congratulations to all QTS shareholders. [laughs] It's really not hard to see why they want this. QTS owns about seven million square feet of data space. The use of data is growing exponentially in America, throughout the world, but here, especially.

Moser: It is.

Frankel: Some really data-heavy markets are blowing up right now. Jason, you are the artificial intelligence augmented reality guy. That's your official job title I believe.

Moser: Well, augmented reality, immersive technology, more of the 5G stuff. Seth really focuses more on the AI, but AI is definitely a part of the universe that I'm studying and you're right. The data is just mind-bending. The amount of data that's out there and then further, the companies that are all just geared toward figuring out the best ways to work with that data.

Frankel: AI devices are extremely data-heavy. The market for AI is expected to grow from $11 billion in annual AI device sales in 2019 to $90 billion in AI device sales by 2025, just a few years from now. That's huge growth and the point is things like that are going to drive the need for data centers. That's why you're seeing, as I mentioned, a company called Cyxtera is going public.

Moser: Yes, I remember talking about it.

Frankel: Which isn't going to be a REIT most likely, because I only own, I think, two of their properties. They lease and this is like a subleasing model. But Digital Realty has been a holding of mine for a long time. Just the amount of data-heavy devices. Just think of how many things in your immediate vicinity right now are connected to the Internet that wouldn't have been a couple of years ago. When I'm sitting at home, I could see a vacuum cleaner, a doorknob, [laughs] or doorbell. 10 years ago, you would never think that all these things would be Internet-connected. All of these things use a ton of data. How much data does your car use the car you drove 20 years ago didn't?

Moser: It's multiples upon multiples.

Frankel: My wife's car has a computer that's like the size of my laptop sitting on the window like this.

Moser: Sure.

Frankel: She has a Volvo and it has not self-driving, but it is really like driver assist, I guess you call it. That uses a ton of data. Things like this over time are going to really add to the need for secured, reliable places to store and transmit data. I think the data center market, it's already blown up over the past two decades. I think it's really just getting started. Obviously, you can't really buy QTS anymore because Blackstone beat you to it. [laughs] But Digital Realty is my favorite way to play this space. It's one of my largest investments and I think it will continue to be so.

Moser: Well, Matt, before we wrap up this week, let's give our listeners something to keep on their radar here. What is one stock you are watching this coming week?

Frankel: I am watching Latch and I could say just Latch now because they finally completed their stack deal. Latch, if you remember, we had CEO Luke Schoenfelder on our show not that long ago. Latch was acquired by a SPAC called TS Innovation Acquisitions. It was Tishman's buyer's stack. They just went public today, which is very significant because it means they now have access to the $450 million they were getting in that spark deal. Now they're going to have really deep pockets. They've recently announced that they expanded into commercial offices. They're pretty much an apartment building. They provide an apartment building operating system for the most part. That's their core business. They're expanding into office buildings. They are trying to expand into the Europe market, which has about double the rental housing units of the United States, by the way. Now they have the cash to really take on that market head-on. I'm really watching that one, the stock is actually down since the original spark merger was announced. They were discussing their first quarter business results on Wednesday, so I'm going to be paying attention to that. I own shares of Latch now. It's interesting to say Latch trades under its own ticker symbol, it's LTCH. That's one I am watching very closely.

Moser: Good stuff. I am going to be watching a company called Cannae Holdings, ticker is CNNE. Ever heard of Cannae Holdings, Matt?

Frankel: I have not.

Moser: This one was new to me as well, we had a listener who had asked a question for MarketFoolery and Chris and I talked about it one day. The more I dug into it, just a very interesting company with an interesting history. It split off from Fidelity National Financial back in 2017. It's not a SPAC, but it is a business. You talk a lot about how management really is the key. It does feel like management is the key here for Cannae as well. Bill Foley, who actually is running the show, hands around 3.7% of the business today. He's got some skin in the game. He is, I believe, the Executive Chairman and the one generally speaking, calling the shots there. Ultimately, it's a company that takes meaningful equity ownership stakes in businesses that they see opportunity. They own everything from shares of Dun and Bradstreet, which is data analytics, to a large collection of restaurants. They have FinTech and the company called Paysafe. They even have real estate in a golf course community, Matt, so just a lot of different investments there that fully are made through the years, and over the course of the last three years, the stock has done well and it's returned better than 80%, outpaced the market. Just an interesting business.

The question was in the line of is this the kind of Berkshire Hathaway-style investment minus the insurance operations? I think there's something to that. It's one that I am going to dig into, learn a little bit more just because it was a new one for me and interesting and it could be an opportunity for investors. So, we'll keep an eye on Cannae Holdings. But I think that is going to do it for us this week, Matt. As always, I really appreciate you taking the time to join us.

Frankel: Of course, it's always good to be here.

Moser: Remember, you can always reach out to us on Twitter @MFIndustryFocus, or you can drop us an email at [email protected]. As always, people on the program may have interest in the stocks they talk about and The Motley Fool may have formal recommendations for or against, so don't buy or sell stocks based solely on what you hear. Thanks as always to Tim Sparks for putting the show together for us. For Matt Frankel, I'm Jason Moser. Thanks for listening and we'll see you next week.