Fintech from a public markets perspective: An interview with Andrew Walker from Rangeley Capital

SPACs, Neobanks, BNPL, PFOF, and much more

This past week, I had the chance to do a Q&A with Andrew Walker, a PM at Rangeley Capital, a special situations and value hedge fund. I had interned at Rangeley Capital in the summer of 2016, and loved my summer there. Andrew reads and thinks extensively across the corporate world, and in this Q&A we focused on a variety of fintech and fintech-adjacent topics, including SPACs, Neobanks, BNPL lenders, PFOF, and more. Enjoy, and let me know if you have any thoughts or feedback!

Andrew, thanks for taking some time to do a Q&A! Can you tell us a little bit about your background and current job as a PM at Rangeley Capital, as well as your newsletter, Yet Another Value Blog?

Hey, thanks for having me. I have a reasonably basic background: I spent some time at McKinsey, JPMorgan, and Bain Capital Credit. I switched over to Rangeley Capital ~5 years ago, where I run a fund focused at the intersection of value and special situations. I also run a blog, Yet Another Value Blog, where I write about anything in the world of finance that is catching my eye. Recently, I launched a subscription service on the blog, where once a month I post an edgy / actionable stock idea that I’m currently focused on / invested in.

Recently, you’ve spent a good amount of time researching SPACs. What do you see as the advantages and disadvantages of a SPAC for a growth or early-stage tech company considering options for liquidity? 

For early stage companies, you get certainty of valuation and an influx of cash. The fact you can provide projections in a SPAC merger (which you can’t in an IPO) also lets you lay out your growth plan much more clearly for investors. I think for very early / very growthy companies, you’ve also seen the market is willing to give a much higher valuation than private markets have in the past.

On the other hand, what do you consider when investing in a SPAC? Some financial analysts and writers have suggested that a SPAC is primarily beneficial for the management of the SPAC, vs. all other stakeholders - what’s your take on that?

In general, SPACs have been losers for investors. There are a variety of reasons for that, but it’s generally because of two interconnected things: fees and incentives. An example might show this best. Consider a recent SPAC, Plum Acquisition. They raised $300m in their IPO ($345m if you assume the underwriters exercise their overallocation option, which I will). The sponsors put in ~$9m into the company; in exchange, they get founder’s shares that will convert into 20% of their company’s stock if the company completes a deal as well some warrants; however, both the founder’s shares and warrants will be worthless if the company doesn’t find / approve a deal.

Think about that dynamic: the founder has put in $9m. If the company approves a deal, they get 20% of the stock. Right now, the stock consists of ~$345m of cash, so if a deal is approved (and we assume the deal is value neutral), that $9m is worth just under $70m ($345m * 20%). If there is no deal, the founder’s shares are worthless. The founders are incentivized to get any deal done with that payout structure; if a deal is approved, they’re rich; if they can’t find a deal, they’re broke. Even if they find a bad deal, the founder’s make out really well. Say they announce a deal where they buy a company that’s actually worth $200m with the $345m. The founder’s 20% stake is now worth ~$40m versus the $9m they put in. That’s a fantastic result for them! 

For shareholders, however, the result is a lot worse. Because the founders take so much of the economics, the SPAC needs to announce a really good deal just for the shareholders to break even. And because the SPAC is just a blind pool of capital with no operational synergies for a merger, SPACs generally must pay top dollar to buy a company. So SPAC shareholders are fighting against a bad incentive structure, a huge headwind from the fees, and the fact whatever deal they do will likely be subject to the winner’s curse.

Still, from an investor’s point of view, investing in predeal SPACs can present an interesting risk/reward. Because you can always redeem your SPAC shares at trust value ($10/share) when they give you a deal, you can get a “free look” at the SPAC merger. If the team announces an incredible merger and the stock rocket ships (like what happened with literal rocket ship company SPCE), you can sell your shares for a big gain. If they announce a bad deal, your downside is protected and you can just get your money back. What I like to do is try to find management teams with a history of value creation where their stock is trading very close to trust value pre-deal; I think it creates a lot of free optionality. I actually walked through two recent examples in this post.

Switching gears, what trends in financial services and fintech are you finding interesting as an investor these days?

One thing I’ve been really interested in is how a lot of start ups seem to be encroaching on traditional finance / bank territory. Venmo recently rolled out a credit card, Robinhood is attacking traditional brokerages, etc. Traditional banks have a huge regulatory and fixed cost structure, and a lot of fintech is growing incredibly quickly by just leaving all of that behind. I wonder if that increases systemic risk for our financial system, or if ultimately these banks are dead men walking as cheaper / faster moving start ups with lower cost structures destroy them. I’m not sure.

You recently wrote a bit around a high-level idea on Virtu - can you discuss your thoughts around that and Virtu’s relationship with fintech players like Robinhood?

It’s a really interesting case. I mean, Robinhood lets you trade for free. There’s an old quote in marketing, “if you’re not paying for it, you’re not the customer; you’re the product being sold.” What Robinhood is really selling is access to retail trading flow. That’s incredibly valuable to market makers, as retail order flow is likely to be random and not some whale with insider knowledge placing a huge trade that the market maker is likely to lose money on. So it sounds awful when you hear “Robinhood is making money by selling this retail order flow,” but it really does work for everyone. Robinhood gets paid for the order flow and can offer retail traders free trading, retail traders get improved execution and free trades, and market markets like VIRT get a big stream of trades that they know doesn’t include any “advantaged” trade that they’re likely to lose on (Matt Levine has a nice piece diving further into it here). So I think the relationship is a win/win/win, though policy makers probably do need to do some thinking around if it’s a good thing that Americans are getting encouraged to trade incredibly risky securities.

As a professional investor, what changes are you seeing in how your ideas play out or on the general dynamics of the markets as a result of increased interest in equity markets from retail investors over the last year?

Stocks with “sex” appeal seem to be moving a lot more and with a lot more volatility than just a few months ago. And it’s a lot scarier to be short something. No one wants to be caught up in the next Gamestop. What’s interesting is how many stocks / companies have seen their share prices go parabolic on very little fundamental news. For example, this year Viacom and Discovery have more than doubled this year as investors got excited about their streaming services. Those companies definitely have interesting assets and the early results are encouraging, but even if you assume that those companies manage to hit their long term subscriber targets, the market is valuing them at a level above where Netflix currently trades. That makes no sense; Netflix has huge scale advantages and there’s no guarantee that these companies will be successful with their nascent streaming plans. In fact, it’s a guarantee that a couple of them will be losers because people are not going to subscribe to 10 streaming services. 

Do you have any thoughts on the recent wave of neobanks, most prominently Chime and (partially) Robinhood, and how you’d look at them as an investor? I imagine there will eventually be a tension in the public markets between evaluating them as tech/growth companies vs. as financial institutions, which have traditionally commanded significantly lower multiples.

Definitely a struggle. Something like Lemonade blows a lot of investors’ minds, including mine. The market has valued it like a hyper growth tech company, but to a lot of people (again, including me) it looks like a boring insurance company with good marketing and a nice app. Yet Lemonade is valued at multiples of what companies much larger and with much more operating history trade for. It’s kind of weird to value an insurance company on revenue, but Progressive does ~$45B in revenue, will make billions in profit this year, and has a market cap of $60B. Lemonade does ~$100m in revenue, will burn hundreds of millions of dollars, and has a market cap of $6B. That’s a crazy valuation discrepancy, and I don’t really see anything LMND can do that PGR can’t; in fact, I kind of think PGR has a lot of risk management and underwriting skills that LMND doesn’t.

Have you looked at all at payments investment ideas recently? Are there any public (or to-be public) payments ideas that you currently like or are intrigued by?

I’m really interested in the Buy Now, Pay Later (BNPL) companies, though I can’t say I’m an expert. Something like Affirm (AFRM) has a $22B market cap; that’s within spitting distance of Discover Financial (DFS, which issues the Discover credit card). In the long run, I’m not really sure what assets or capabilities Affirm has that Discover doesn’t have, but there are a lot of assets and capabilities Discover has that Affirm doesn’t and that I don’t think they’ll have any time soon (if ever).

Ending on a different note, I remember from our time working together that I was really impressed by your ability to structure your investment research process and learn deeply about new sectors and companies in an efficient manner. Can you take us through your research habits and process at a high level? I think these are habits all our readers could learn from.

I appreciate that. I’m always working to improve my process! In general, my process is just lots of reading and curiosity. If someone smart is doing something, I try to read and investigate enough until I  can figure out why they’re doing that. That sounds pretty silly, so let me try an example that might show it best. A few years ago, John Malone (the original cable cowboy) got back into cable space by investing in Charter. Then the company started to direct all of their cash flow to repurchasing shares. That didn’t make much sense to me; everyone “knew” cable was going away as youngsters cut the cord and the cable bundle got underpriced by Netflix. I wasn’t sure why a smart investor like Malone was burning his money investing back into cable. So I did a bunch of work and saw that the real profit driver in cable wasn’t video; it was broadband, and cable had an enormous advantage in broadband because their assets were so advantaged versus the competition (like DSL).

So that’s a pretty simple example. But what I’ve found works for me is to see something that interests me on the public market; some type of quirk or curiosity or something that doesn't make sense. And then to just spend a ton of time diving deeply into that question by doing primary research; listening to interviews with high level execs, reading the company’s financial filings, etc. I think that’s pretty similar to what most other investors do, but I like to think I put my own spin on it by focusing a little more on looking for anomalies and really focusing on the financial incentives of the key players involved.