You may not have noticed, but there’s a war being waged in shops, banks and businesses across the world. On one side is cash: the reassuringly tangible notes and coins we use every day. On the other is digital money, represented by mobile phones, computers and electronic cards.
For years now, digital money has been claiming ever more territory from cash. But now it’s on the cusp of an almost all-out triumph. Thanks to government support, advancing technology and commercial incentives, digital money is about to completely change how we pay for things. In the process it will disrupt many established businesses and create exciting opportunities for investors.
Governments love the idea of digital money because, in theory, it should be easier for them to monitor and therefore to tax. That’s one reason why legislators around the world have spent the last decade making things harder for users of cash and easier for those who favour digital payment.
France, Greece and Spain have all put limits on the maximum size of cash transactions to try to cut tax evasion. Britain’s anti-money-laundering rules, introduced in 2003, make it hard to use cash for any payment above £10,000.
Meanwhile, new legislation has also made it easier for companies that are not banks to act like banks. Digital payment firms can now transfer money, settle bills and debit accounts, without having to go through all the regulatory rigmarole of becoming a bank. In most cases this ‘light touch regulation’ is made possible by the fact that the new firms don’t actually hold the money, they just process it.
European Union standardisation rules have also created opportunities. For example, previously in France only banks could convert currencies. Now the sector has been opened up and internet-based foreign exchanges are moving in for the first time.
It’s not just governments. All sorts of businesses see commercial advantages to digital money too. Consequently, digital money has become part of daily life in Britain. According to Intelligent Environments, a financial software provider, 25% of British adults access their bank account online every single day, compared to just 3.5 million who made use of online banking in 2000.
In total, 81% of people with a bank or building society current account use online banking, while just 45% visit their local bank branch once a month or more. The same is happening in the high street. In 2011, online retail sales rose by 14% to more than £50bn, accounting for 12% of total spending. Consultancy Deloitte says the trend is increasing and expects online sales to rise by 17% this Christmas compared to last year.
The war in your wallet
But the most interesting battle in the war between digital money and cash is the one taking place in your pocket. That’s because one of the key advantages of cash is that it’s convenient to carry around to buy stuff on the move. But even this advantage is being eroded by smartphones.
Improving phone technology means that more and more people – in America it’s 50% of the population – now have a device that can act as a credit card, mobile bank and online shop sitting in their pocket.
In Britain earlier this year, Barclays launched Pingit – a smartphone app that allows customers to hook up their bank accounts to their phone and send money to other people by text. Banks then began offering customers a small electronic sticker, which you stick on the back of your phone. This allows you to turn your phone into a bank card, and for small payments – under £15 – you can pay by just wafting your phone over a terminal.
These technologies are brought together in a ‘mobile wallet’ – a piece of software that makes it easy for the user to jiggle between credit cards, smart card, loyalty schemes and bank accounts. Google has developed the Google Wallet to work on some of its devices, while three telecom firms – Vodafone, Everything Everywhere and Telefónica UK – are working on a mobile wallet dubbed Project Oscar.
Interestingly, this is one area where the developing world is already ahead of the developed world. One of the earliest examples of the successful ‘digitisation’ of money didn’t use smartphones and took hold thousands of miles from Silicon Valley. In Kenya, mobile banking has been a huge hit since its launch in 2007.
In a country with poor transport infrastructure and where local bank branches are few and far between, the benefits of digital money are obvious. Around 14 million people now send and receive money via M-Pesa, a telephone-based banking system.
It allows users to make transfers, deposit savings and pay bills without having to use a branch. The mobile network handles the transfer and when users want to receive or deposit physical cash they can do so at agents, found in participating shops. Kenya never built up the bank branch infrastructure common in the West – now it’s leapfrogging to the next stage.
Turning your phone into a till
Digital payments are about more than just making it easier for us to spend. They can also make it easier for small businesses and tradespeople to make money by widening the range of payment options they can accept. Across Europe and America firms have developed gadgets that fit onto a mobile phone and allow a businessperson to take payment from a credit or Visa card. These new gizmos have already started to take on ‘normal’ card readers.
“There has been massive growth in supplying payments services to tradesmen such as plumbers or… market stallholders, which until recently could accept payment only in cash or by cheque,” says The Economist. “In outliers, such as America and Sweden, it’s estimated that the new devices have increased the total number of credit card readers by 15%.” There are many reasons for the rapid take up.
“Cheques are bouncy,” says The Economist. “Although cash has its attractions – foremost of which is that it is easily hidden from the taxman – carrying large amounts of it is risky, and customers can spend only as much of it as they have in their wallets.” These new mobile readers are also very competitive on cost.
Take America. There the charge is being led by Jack Dorsey, the tech superstar founder of Twitter. His new company, Square, gives its reader away for free and charges just 2.7% of the payments being processed. A normal reader would cost hundreds of dollars and charge minimum fees that wouldn’t suit many small business people.
In Britain, Dan Wagner, one of the country’s first internet entrepreneurs, has set up a new firm, mPowa, to take advantage of the opportunity. Unlike Square, mPowa’s device also has a chip and pin mechanism, a security feature that Wagner thinks will make a difference. Moreover, Wagner is selling to both sides of the market.
MPowa offers ‘white label’ versions of the technology, which banks or telecoms firms can then offer to their customers, or directly to end users. In many ways the slogan ‘inventors of the sell phone’ says it all. The idea, says Wagner, is that businesses can send out their sales people to meet customers and take payments wherever they find them.
An equally useful and perhaps better-known form of digital payment is the humble pre-paid ‘smart card’. So far, these are most commonly used in public transport, as with London’s Oyster card. Customers like them because they don’t have to scrabble for change, while travel firms like them because it avoids the hassle of their drivers and depots handling physical cash, which can be lost or stolen.
But the smart card is capable of so much more. British startup sQuid develops bespoke digital payment cards for local authorities. One early client was Bolton council, says chief executive Adam Smith. “They wanted to help disadvantaged children by giving them money to do ‘constructive’ activities, such as sport.” So sQuid developed a card that could only be used to pay for certain goods or services.
“If they gave them cash there was no knowing what the children would do with the money. Our cards helped the council control that spending.” It’s easy to imagine central government one day seeking a similar control over benefits.
Be the bank
Digitised money is now blurring the lines between finance, telecommunications and internet firms, notes Tom Bulford in his Penny Sleuth newsletter. In Britain, Google “has been authorised by the Financial Services Authority to transfer money through smartcards and other electronic means”. In Canada, “mobile network operator Rogers Wireless has applied to become a bank”. This is bad news for our beleaguered banks, as more innovative firms lead the way with digital money.
Google, which designs the Android operating system for smartphones, isn’t just interested in processing payments. Knowing how people bank and spend their money also offers vast advertising opportunities. However, several banks are fighting back. Some have launched sophisticated digital money services, while in America, Citigroup and MasterCard are partners in the Google Wallet.
Across the world, a host of smaller firms are trying to develop niche digital alternatives to cash, says The Economist. Many “have relatively humble ambitions. Some are trying to grab thimblefuls of the huge flows of money that wash around the world by concentrating on particular areas”. However, most of these rely on the existing network of banks and payment processors to handle and move the cash. We look at how to profit from this below.
Gold shines while paper fades
While the rise of ‘digital cash’ may mark the beginning of the end for paper money, things look far more promising for physical gold, the oldest currency of them all, writes Matthew Partridge. Dealers report that sales of gold coins have gone up dramatically since the US presidential election took place at the start of last month. The US Mint reports that in November sales of “American Eagle” bullion, the most popular range of gold coins, were three times higher than at the same time last year.
Some of this is undoubtedly a knee-jerk reaction to Barack Obama’s re-election by his most committed opponents. This ‘run for the hills’ reaction was reflected in the fact that gun sales were also sharply higher.
However, the fact that demand has not died down since suggests that it is also being driven by longer term, more serious concerns about the inflationary effects of the Federal Reserve’s quantitative easing (QE – money printing), as well as fears over the outcome of ongoing negotiations over the fiscal cliff and the sheer scale of America’s national debt and deficit. Overall, in the words of one analyst, “the man on the street is still pretty committed to gold”.
And it’s not just America. The Royal Canadian Mint recently stated that demand for its Maple Leaf gold coins also reached the highest level this year in November. In inflation-averse Germany, vending machines selling small gold bars – once a novelty – have become commonplace.
Asian demand for gold has rocketed over the past decade, driven by private investors trying to escape interest rates that are sharply negative in real terms (ie, they are well below inflation). China is now the largest single consumer of gold.
Private investors are not the only ones questioning the value of national currencies in the face of QE. While Chinese consumer demand dropped this year, gold imports into China from Hong Kong still went up. This implies that China’s central bank has been secretly growing its gold reserves. Given its size, even a small increase in the proportion of its reserves dedicated to gold could send the price soaring.
The best stocks to buy now
There’s one group of clear winners from the shift to digital money – the payment processors. You can almost see these being like the national grid for payments. The two biggest are Visa (NYSE: V) and Mastercard (NYSE: MA). Both firms were already benefiting from consumers in developing countries starting to use bankcards. Now, with mobile digital payments growing ever more rapidly, they can win even more customers.
True, they won’t have it all their own way: some smart card operators, such as sQuid, are keen to set up their own independent systems. But, on the whole, most entrants are happy to latch on to the existing infrastructure and innovate at the consumer end of the payment.
Of the two, I prefer Mastercard. For one, it’s marginally cheaper, trading on a forward price-to-earnings (p/e) ratio of 19.7 compared to Visa’s 20.5 – the five-year average for each is around 22. Secondly, a higher proportion of its sales – 58% compared to Visa’s 42% – come from outside the US. That matters: while the US may have led the world in digital money, much of the future growth will come from outside.
Mastercard is also making big strides in the next generation of digital money. It recently announced a deal with a Japanese mobile-phone operator to expand contactless payment options to users. This will allow Japanese customers to use their phones to make payments anywhere in the world. It also has a deal with east Africa’s biggest supermarket chain, which will turn the supermarket’s loyalty cards into pre-paid bankcards.
If you fancy taking a riskier bet on this theme, there are some interesting smaller firms. Optimal Payments (Aim: OPAY) is a payment processor with a £110m market capitalisation. Its Netbanx system handles payments for ecommerce, phone and mail order businesses. It acts as a middleman between these businesses, their banks, and their clients.
Its other business line is Neteller, which offers pre-paid cards and ‘eWallets’ (the online version of mobile wallets) for the online gambling market. Neteller allows gamblers to load money onto different sites to back their bets, then transfer any winnings to their bank accounts, without the sites taking their bank details, or the bank knowing where they’re spending their money.
For years the British part of the firm, Neovia Financial, struggled to make an impact. But a merger last year with Canada-based Optimal Payments seems to have transformed the business. Sales were up 31% in 2012, dragging the firm into a small profit. It currently trades on a forward p/e of 17.8. Broker Canaccord Genuity rates it a buy and has a 140p target price for the stock.
One way to play mobile digital money is eServGlobal (LSE: ESG). It develops software that helps big telecoms firms such as Orange and Vodafone to offer extra services to their customers. Traditionally it focused on simple stuff, like voicemail, but now it’s specialising in finance. CEO Craig Halliday has identified mobile digital money as a big area for his firm. “As the mobile market landscape evolves, operators, financial institutions and consumers are rapidly embracing new opportunities.”
Aside from developing mobile financial services to telecoms, it has also developed an international money transfer service, HomeSend, which uses mobile phones to send money abroad. It has developed a mobile banking platform for Indonesia called M-Coin, which allows those without bank accounts to transfer money and pay bills.
The best thing about eServGlobal is that by serving the big telecom groups it has access to a huge subscriber base. More than 250 million phone users have access to its PayMobile service, while 380 million can use HomeSend. It’s listed in Australia and Britain and covered by three analysts who all rate it a buy.