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There are four questions that get asked quite often about IOU and sometimes they aren’t questions, rather they’re statements. Is IOU a BNPL company? Does IOU have a MOAT? Why hasn’t IOU made any significant progress? Why did IOU spend so much to acquire a 42% stake in IDSB?

Is IOU a BNPL company?

The reason that this is such an unknown factor for most people is because IOU came on the radar after they announced the addition of BNPL to their platform. This is an obvious reason for confusion. If you only know it as a BNPL business then of course that is all you will see it as. The broader market is in the same boat. The share price has languished under 10c for most of the company's life while listed under the ticker code ICU and trading as iScentric.

Let’s have a bit of a look at iSentric to gain a better understanding of what IOU has been built upon. Straight from the iSentric website:

Established in 2003, is a well-known Bulk SMS provider and a pioneer in digital commerce in Malaysia. The company strives to promote the development of mobile ecosystem and focuses on providing a series of products and services in the fast-changing B2B and B2C business areas. These efforts aim at helping consumers, small and medium traders (SMEs), enterprises, financial institutions and government organisations to fulfil their needs for digital commerce.

After iSentric acquired a mobile gaming company from Indonesia the business was going in two different directions. A content generation platform utilizing celebrities and also a mobile gaming business. This was on top of the existing digital/mobile platform that the company had developed.

After a review of the operations and the market trends the company decided to focus on payments. Subsequent to the review, the company later wrote down the mobile gaming acquisition as revenues started to decline. It is my understanding that the new direction of the business caused a dispute between the old board. The result was the ousting of several board members as the new direction of the company was decided.

So what did the company establish from market trends analysis and what was the new direction for iSentric?

Digital Payments came out as the fastest growing financial service sector in Malaysia and Southeast Asia. This was followed by Digital Remittance (bill paying) and then digital lending in the form of loans and microlending/BNPL.

iSentric had already built significant relationships with banks and telcos within Malaysia and Indonesia. Enhancing those mobile banking and digital payments was a logical step for the company. iSentric is a registered merchant for the Financial Process Exchange (FPX) payment gateway. This is a Malaysia-centric payment gateway that provides real time transaction settlement and works with most banks in Malaysia. iSentric also has payment processing capabilities using the Visa and Mastercard payment networks. In 2018 iSentric was already processing 17 million transactions for banks and telcos.

As the new direction for the company was established, a major rebranding of the digital payments and mobile banking platform was the next logical step. This is when the iSentric Mobility2u platform was rebranded as the IOU Pay Platform. The company also added enhanced digital payments to include Bill Payments and BNPL.

As of December 2021 the IOU Pay Platform is processing 85 million transactions. That’s a 400% increase over 6 months since the new version of the IOU Pay Platform was launched.

In terms of BNPL merchants, the company currently has 2,613 merchants active since the launch in June. On average that’s 435 merchants added every month.

Returning back to the question; Is IOU a BNPL company? Yes and No. IOU is a fintech company providing digital commerce solutions and BNPL is one of the payment methods available. As the BNPL business grows so too does the digital transaction business.

What is IOU’s Competitive Advantage (MOAT)?

This is one of the most interesting questions to consider. A competitive advantage in the financial services industry is rather difficult to obtain. When we think about credit cards there’s only two players; Visa and Mastercard. The competitive advantage that they have is that they own the payment networks that they operate on and over time they have created highly recognisable brands. AfterPay has created that highly recognizable brand in Western Countries but it has yet to do so in Southeast Asia. The issue that APT and Z1P face now is that they have spent large amounts of capital to grow their brand recognition. This has resulted in excessive losses which are now starting to make the market question the investment outcomes. APT was thrown a lifeline by being acquired by Square.

The pandemic created an opportunity for BNPL to grow. It has grown quite a lot and yet still lags behind credit cards for now. Credit cards play a role in SEA however they are not so entrenched that they cannot be displaced. BNPL and digital payments will dominate this region over the next 5 to 10 years. There are several big players that operate BNPL as part of their business model. Competition is already heating up. The same issue that is plaguing western BNPL operators is also going to be an issue for Asian BNPL operators. Companies that run at losses do not last forever.

Is growth a competitive advantage? I would say yes, but can it be sustained? Funding is not difficult to acquire at the moment, but will funding always be available if the target is continuing to lose money? When chasing growth as the competitive advantage it means spending more money than the other guy. This becomes a game of chicken, who will flinch first?

When you consider a longer term game spanning 5 to 10 years, sustainability becomes an important factor. Imagine being the only company in the sector that operates at a profit. “Attack him where he is unprepared, appear where you are not expected. The supreme art of war is to subdue the enemy without fighting. Supreme excellence consists of breaking the enemy's resistance without fighting.” - Sun Tzu

Outlasting the competition with a more profitable strategy could be considered a competitive advantage. Not to mention the diversified income streams that IOU has created. I cover competitive advantage more in the final question regarding the IDSB acquisition.

Why hasn’t IOU made any significant progress?

IOU has in fact made quite a bit of progress. It’s important not to mistake the current share price with the progress of the business. In the response to the first question I touched on the changes that have occurred to the business over the last 12 months. I also mentioned that as of December 2021 the IOU Pay Platform is processing 85 million transactions. That’s a 400% increase over 6 months since the new version of the IOU Pay Platform was launched.

In terms of BNPL merchants, the company currently has 2,613 merchants active since the launch in June. On average that’s 435 merchants added every month.

In relative terms, Atome is probably considered the BNPL market leader in Southeast Asia. The company took about 18 months to onboard 3000 merchants spread across 4 countries. At the end of six months IOU is about to reach that number in 1 country.

Let’s review, we have a fintech company that has pivoted from content creation and mobile gaming to focus on the fastest growing payment methods in the region that it operates. In 12 months the digital payments and mobile banking sector of the business has grown 400%. In six months the BNPL sector of the business has already achieved something the market leader took 12 months to achieve. After excluding the business development costs, the operational expenses have remained controlled. The next step would be to secure a funding facility to support the rapid growth of the BNPL business sector.

Why did IOU spend so much to acquire a 42% stake in IDSB?

This is a contentious topic and something that not everyone agrees upon. The major issue for those that disagree with the decision is that it was too much of available cash reserves (around the 80% mark). In my opinion there’s far too much focus on the amount spent rather than what the company gets from the acquisition. I’ve already covered in previous posts the payback period and the potential future value of the acquired asset. There’s very little risk of a write down. I want to focus on the other aspects of the acquisition that provide a different kind of return.

BNPL is a two sided market. In order for a company like IOU to succeed, they require a vast majority of merchants and customers. As we’ve seen, IOU has been about to establish a number of master merchant and merchant referral agreements in its short time of operating BNPL services. This is likely due to the iSentric business relationships with banks and telcos which have existed since 2003. The issue that IOU faces is that it has been operating white label services, essentially providing a backend platform that makes it invisible to the consumer. Meaning IOU and iSentric are virtually unknown to the consumer. On average a consumer needs to see a brand advertised 7-8 times before they will consider using the product or service. As BNPL grows in popularity, the landscape becomes more competitive. Consumers are shown ads for multiple different providers. This makes it difficult and more expensive to reach the target demographic.

IOU has launched an influencer campaign which has yielded great success to date. If we look back at the previous iSentric business model, content creation with celebrities was a major part of that. While IOU no longer operates this model, it’s clear that the experience has provided benefits for the new business model.

One of the other areas that IOU has been quite adept at is credit scoring. With eKYC built into the IOU Pay Platform, understanding the ideal low risk customers has also paid off. We’ve seen no bad debts to date.

The IDSB customer database is made up entirely of civil servants. These customers generally have better credit ratings which allows them to be automatically signed up to the IOU+ account type which allows them access to RM10000 or A $3299. According to various reports, the IDSB customer database is made of 50,000 civil servants. The ability for IOU to cross-sell and instantly approve these customers for the maximum account spend gives IOU a competitive advantage in the Malaysian market. While choosing the focus on expansion in Malaysia has been viewed as a bad move, the reality is that IOU has the opportunity to acquire 50,000 customers with an account total of $3299 instantly. At a 100% sign up rate that would equal $164,950,000. IOU paid $41.3m for this opportunity. With payback periods up to 6 months, it’s possible for these customers to spend this amount twice per year if not more if they were so inclined.

Malaysia’s GDP in 2021 was $359b USD, Nearly 45% of that figure is made up of retail sales. By the end of 2022 GDP is expected to reach $440b USD. Focusing on achieving a strong position in Malaysia is far from a mistake. IOU has the ability to become a billion dollar company while operating in Malaysia alone. It has a far better chance of achieving that by being profitable in the process.

I fully expect that not everyone will agree with my opinions and that’s ok. I’m comfortable with my investment decision. I’m also quite happy for the company to hold off expanding in T2 and T3 until they have a strong foothold in Malaysia. If IOU was only operating in BNPL in Malaysia while providing digital transactions and mobile banking in the other areas of SEA for the next 12 months that would not bother me when you consider the amount of income that can be leveraged from the IDSB acquisition. In fact Warren Buffet has a quote that I believe is quite an adequate description for the IDSB acquisition, “Opportunities come infrequently. When it rains gold, put out the bucket, not the thimble”.