The future of retail banking is happening in... Africa?

I recently read a Time magazine article of industry innovation so remarkable that I had to re-read it a couple of times just to ensure I grasped the entire concept. This is a story of how a simple financial product is taking hold and emerging as a potential game changer to the retail banking industry. The most remarkable part to this story is where its occurring, which is not on the corners of Wall Street, but in the main streets of Kenya.

The article centers around Safaricom, the largest cell phone company in Kenya, which has been at the forefront of the growth in mobile phone subscribers in Africa, who now number 506 million people up from zero a decade ago. There are now more mobile phone subscribers than there are landlines, a development that is heavily encouraged since GDP growth in developing nations has been shown to increase from 0.6% to 1.2% for every 10 mobile phones per 100 people.

The major hub of innovation in mobile technology revolves around text messaging, due to its relative simplicity and low cost. Some of the most innovative text message services now available include Mxit, a South African text message-based social network; and mPedigree, a Ghanaian service that determines counterfeit medication based on text messages users send with product bar code information to a central number.

In 2007, Safaricom launched M-Pesa, a money-transfer-by-text-message service. The concept is really simple, "[a] Safaricom subscriber takes cash he wants to transfer to another person, along with the recipient's mobile number, to a Safaricom agent [like Maina]. The agent takes the sender's money and, for a small fee, uploads the value to his or her prepaid phone account, then sends on the credit to the recipient's phone account." A remarkably simple way of transferring small sums of money (as little as $1.20) from one individual to another without the need for a bank account or money transfer agent.

The growth of M-Pesa has been extraordinary. Of Safaricom’s 16 million customers, 12 million have M-Pesa accounts, in a country with 39 million people, which equates to a 30% penetration rate from just one service provider. The company has found that people use their M-Pesa accounts as savings accounts, where they upload money to their accounts and just leave it there, totally secure. This observation has led Safaricom to partner with one the largest regional banks, Equity Bank, to link customer mobile phones to bank accounts which they can then use to access their money from ATM’s and debit cards.

That all this innovation is happening in Africa is perhaps very telling of the direction the world we live in is moving towards. China, India and Brazil today provide the sort of business and technological leadership that was once the exclusive domain of the Western nations. The growth of M-Pesa in Kenya stands in stark contrast to the sub-prime mortgages that ignited the worst recession since the great depression, as the true difference between creating innovative products that can have a dynamic impact on the marketplace, and those that work to produce superficial progress.

Is the time for banks to apologize really over?

Bob Diamond, the head of British banking giant Barclays Bank, appeared before a British parliamentary committee where he boldly defended the banking system against continued attacks for their role in bringing the world’s economic system perilously close to destruction. In his testimony he stated:

“There was a period of remorse and apology for banks. I think that period is over,” Diamond told the Treasury Select Committee.

Though Mr. Diamond’s statement was received with derision from all those who continue to feel the painful hangover caused by the decisions of these large financial institutions, his words got me thinking: is the time for remorse and apology over for this industry?

Since the 2008 fall of Lehman Brothers, there have been important steps made by governments around the world to change the ways of the industry. In the United States, there was the Financial Reform Bill of 2010, which created a passage way to reforming the system (rather than being the agent of change in itself that was initially hoped for). Amongst other things, it allowed for the creation of a 10-member Financial Stability Oversight Council whose primary responsibility is to keep a watchful eye over risks in the entire financial system. A very necessary first step, considering how regulators, including the Federal Reserve, were all so oblivious to the risks being created.

The bill also allowed for the creation of the Bureau of Consumer Financial Protection, which will regulate financial products like mortgages, credit cards and student loans. A step that many hope will bring an end to some of the most predatory lending practises engineered by financial institutions in the past.

But the question of whether the time for remorse and apology from banks is over is largely dependent on how much banks have learnt from their mistakes and changed their ways.

Too Big To Fail

The preliminary evidence so far seems to indicate that the largest banks, or at least those that survived, have not taken very many lessons to heart. By some indications the financial risks posed by these institutions is as high, or even higher than it was in the period leading up to the crisis. And perhaps the biggest reason for this is that not enough has been done to eliminate the risks posed by those institutions that are too big to fail.

A recent report issued by Neil M. Barofsky, the special inspector general for the Troubled Asset Relief Program, stated that Citigroup, which received multiple bailouts beginning in November 2008, continues to pose a systematic risk to the financial system. The hazards that existed prior to the crisis continue to exist at the largest financial institutions and bank bailouts in the future may continue to be required. A very sober and humbling assessment by the agency in charge of the largest industry bailout in history.

Business As Usual

In the meantime, some of the largest banks in the nation are back to business as usual, and business for some couldn't be better. On Friday, J.P. Morgan Chase got the banking industry's earnings season off to a fast start when it reported 2010 profits of $17.37 billion, up by 48% from a year earlier when it earned $11.73 billion, making 2010 its most profitable year ever.

J.P. Morgan Chase also disclosed that it had set aside $28 billion for employee remuneration and bonuses in 2010. Though this figure shrank slightly from 2009 (by 2.4%), it still equates to an average payout of $369,651 per employee (though it should be noted that the average employee is unlikely to receive that amount). And it is here that the reason why the period of remorse and apology for banks is not yet over. Banks like J.P. Morgan continue to do business today, just like they did yesterday. There has been little in the way of reason for them to change their business practises. They continue to grow in size, take large amounts of risk, and incentivize their employees in the same manner as they did prior to the crisis.

Until the risk/reward balance of the banking industry gets into closer alignment with what’s found in the rest of the economy, where businesses do not have the support of public bailouts and therefore have little reason to take undue risks or compensate their employees in a manner that encourages excessive risk taking, its likely that public outrage at banks and their leaders will continue to boil over.

The New Dot-Com Bubble... Social Media Edition

Wow, did the dot-com bubble really happen that long ago? Long enough ago that smart investment professionals, with tons of money are willing to enable the next dot-com bubble, namely social media. The attention and investment dollars that have swamped this sector recently certainly seem to suggest that its 1999 all over again:

“Facebook worth $50 billion after investment” -- CNN Money

"New Investment Fund Values Twitter at $4.1 Billion" -- Wall Street Journal

"LinkedIn plans to go public in 2011" -- Reuters

For those of you that can’t remember (or just have really good selective memory), here is a quick recap of how much fun this party was the last time around, and a few of the high wire acts that took our portfolios for a wild ride.

Round 2?

So do we have a bubble brewing? The growing mountain of evidence all seemingly point to, yes. Facebook, which just raised $500 million at a valuation of $50 billion, is now worth more than Yahoo!, eBay and Time Warner, and is a mere $30 billion away from catching up with Amazon. This sky high valuation seems to be primarily based on user growth, given that Facebook has added over 500 million users, eclipsing the likes of Yahoo! Mail with its 273.1 million registered users. Now, the last time we decided to value businesses based on clicks, eyeballs and anything other than cold hard cash, we collectively lost $5 trillion, yes that’s with a capital-T!

In early 2000, Yahoo’s stock price hit a peak split-adjusted stock price of $125.03 giving the company a nose-bleed market cap valuation of $132.5 billion. As of today’s stock market close, Yahoo’s shares go for $16.60 giving it a far more modest market valuation of $21.64 billion. This steep drop in valuation has moved in the opposite direction of the company’s financials, where in 2000 Yahoo reported net income of $70.7 million on annual revenues of $1.1 billion, versus 2009’s reported net income of $600 million on revenues of $6.5 billion. A lot of heady thinking in the bubble years of 2000 spoke of new “investing paradigms” which promoted new and novel ways of determining business economic value. As it turned out no matter how rose-colored one’s glasses became about the likes of Yahoo, the value of their businesses still came down to their cash flow generating capabilities. A lesson that perhaps awaits those eager to jump into the social media fray.

This Time Around Its Different... I Promise

So, are we ready to believe that Facebook with its short 6-year history, is really worth $50 billion (pre-IPO mind you)? Well, this time around there are at least a couple of differences that make this round of wishful thinking slightly different.

First. A lot of the higher profile companies, who are presumably readying themselves for public market offerings, are in fact profitable businesses. Just like the flow of evolution in nature, the young have seemingly learnt lessons from the old. Based on information obtained from their private placement documentation, Facebook is on track to earn $400 million in profit on revenue of $2 billion in 2010. A neat 20% profit margin that handily trumps just about anything that was served up in 1999.

Second. All the bubble activity so far has to been confined to the realms of private equity dealings. Unlike the last time around, these new age social media companies do not seem to be in a terrible hurry to cash out by means of an IPO. In fact, all the bubble activity that is currently brewing is happening within the office walls of New York City hedge funds, Silicon Valley venture capital firms, and Russian investment houses (yup, that’s right, Russian investment houses!) Following the aftermath of the dot-com crash, there was some rhetoric on how it was the incessant bidding up of prices by ‘John Doe’ investor that really inflated the bubble. This time around ‘John Doe’ private equity guy seems to be priming the pump all by himself.

How Does This End?

Though a social media bubble is probably at some stage of inflation, and fears of another bubble igniting grounded in reality, it should not be forgotten that this is happening in the midst of an economic downturn. It is likely that large amounts of investment dollars from everyday investors, which would be needed to sustain the bubble in the public markets for any meaningful length of time, have simply vanished over the last 2 years. Buried under the ruble of Lehman Brothers and a 9.3% unemployment rate.

The Top 3 Business Stories of 2010

Now that we have ushered in 2011, its time to reflect on what I thought were the top business stories of 2010. In rank order, here are my top 3 picks:

1. GM goes public

On November 18th, General Motors stock started once again started trading under its old familiar ticker symbol “GM”. This was the end result of a $23.1 billion IPO that ranks as the largest in business history. There are plenty of aspects to this story that I find remarkable, the first being the undoubted success of its IPO given that it had filed for bankruptcy on June 1, 2009 a mere 1 year and 5 months earlier.

The bankruptcy of GM was truly one of the true low points during the great economic crisis that has griped the worldwide economy over the last 2 years. A $50 billion taxpayer funded bailout, that some had initially hoped would keep the automakers out of bankruptcy court, proved unable to do so. At the time of its bankruptcy filing, GM was still unravelling from its latest $9.6 billion annual loss, another notch in a pattern of losses that had seen it lose a total of $72 billion since 2004. The age of American manufacturing prowess it seemed had truly come to a end.

Fast forward to 2010 and GM seems to be firing on more than just a couple of cylinders. In addition to its blockbuster IPO, the company announced earnings of $4.2 billion for the first 3 quarters of the year, including $2 billion it earned from July to September which was its largest quarterly profit in 11 years. Wall Street seems excited to have a healthier GM back, boosting its stock 7.8% since its IPO, and some analysts predicting that the company will generate nearly $40 million in free cash flow a day for the next five years.

Although taxpayers are yet to be fully reimbursed for the cost of the bailout, the comeback story of this iconic manufacturing company is my pick for the top 2010 business story.

2. BP and the Gulf oil spill

On April 20, 2010 of the Gulf Coast, the Deepwater Horizon drilling rig (principally owned and operated by BP) exploded killing 11 men working on the platform and injuring 17 others. The fatalities and injuries that occurred on that day would probably have been enough to make this one of the worst of oil exploration disasters in history. However, it was the uncontrollable spew of crude oil into the Gulf that occurred over the next 3 months that truly took this story to the very pinnacles of corporate disasters ever witnessed.

To say that BP had a tough year would be a great understatement. The company is expected to pay more than $40 billion in clean up costs, government fines, lawsuits, legal fees and damage claims. In an effort to bolster its finances the company has cut its dividend, issued debt and sold off more than $21 billion in corporate assets.

The reason I found this story so intriguing was how avoidable the calamity of that occurred after the initial explosion really was. As it turns out had a $500,000 remote-controlled device, known as an acoustic trigger been installed, it would have triggered underwater valves or explosives to shut down the well in the event of a catastrophe.

According to the Wall Street Journal, BP actively deploys these devices on rigs around the world, such as Norway and Brazil (which require them) and the U.K. (which does not). BP chose not to equip oil rigs off the coast of the U.S. with acoustic triggers because U.S. regulations enacted in 2003 do not require companies to do so. The original draft of those regulations did require this backup safety measure, however in 2003 after closed-door meetings with energy company executives then-Vice President Dick Cheney lead an effort to scrap this requirement. Surprise, surprise!

Though BP as a company will probably survive this disaster and its aftermath, I chose this story as my 2nd pick for 2010 because of how well it illustrates the impact small measures can have on the long term prospects of any business.

3. Apple’s meteoric rise

In 1997, at the Gartner Symposium and IT expo, Michael Dell (CEO of Dell Computer) told an audience full of IT executives when asked how he would fix a then-troubled Apple Computer, Inc:

"What would I do? I'd shut it down and give the money back to the shareholders".

Fast forward to 2010, and a rejuvenated Apple Inc. surpassed its long time nemesis, Microsoft Corp. to become the most valuable technology company in the world with a market cap of $296 billion. As of the end of the year, Apple seems to be headed on a stock trajectory that could perhaps see it challenge Exxon Mobil Corp. as the most valuable company in America (Exxon market cap = $369 billion). For the record, Dell Inc.’s current market cap stands at $26 billion, making Apple 11 times more valuable. Eat that!

I love comeback stories, and over the past decade no company has done as great a job at turning its prospects around as Apple Inc. The Steve Jobs led enterprise has done an almost unbelievable job at revamping and innovating their product line, in the process managing to lift an entire industry with them. Becoming the most valuable company in America would really make this comeback story complete, in the meantime they are my 3rd most compelling business story of the year.