The second half of the year kicked off with a flurry of fintech M&A, with more than half of the $500 million+ deals so far seen in 2023 having taken place in just June and July.

In the past few months alone, money-saving app Snoop has been scooped up by Vanquis Banking Group; Visa splashed out $1bn to acquire Brazilian startup Pismo; and headlines have been dominated by rumours that Monzo is plotting to purchase Danish challenger bank rival Lunar.

The general consensus appears to suggest that the macroeconomic landscape – with sky high interest rates, widespread deceleration in economic growth and VC funding levels experiencing the biggest dip in years (to the tune of a 49% July YoY depreciation) – is leading many fintechs to seek out a speedy exit. Those companies that had high valuations just a couple of years ago are now finding themselves at the end of their runway, and struggling to raise capital without the  risk of lowering their valuations. And those with more funding to play with are capitalising on that fact, knowing they can grab a bargain in tricky market conditions.

As a result, we’re seeing an increased willingness from smaller outfits to merge with or become acquired by their larger and often better-funded counterparts. It’s something we’re increasingly hearing from our clients too, with many having acquired more boutique firms – often direct competitors located in different markets – as a means to growth and/or customer acquisition in an otherwise testing marketplace. Fintechs that have “come of age” in the last few years are flexing their M&A muscles to strengthen revenue streams and set themselves on a stronger path to profitability.

But whilst the second half of the year has started with a flurry of M&A, activity is still down on a year-on-year basis. According to S&P Global Market Intelligence, 128 fintech M&A transactions were recorded in the first half of 2023, compared to almost double in January to June of 2022, at 248.

So what does the closing third act of 2023 hold when it comes to fintech M&A?

AI M&A to rise up the ranks

The segment which is perhaps most ripe for consolidation by the fintech sector is AI. As with the emergence of any new technology, incumbents are grappling with whether to “buy or build” their generative AI capabilities. And for many, buying smaller outfits is the most efficient and profitable answer.

Take Ramp, for example, who in June acquired Cohere.io, an AI-led customer support platform, for an undisclosed sum. Or neobank Albo, who purchased Delt.ai, enabling it to become the only digital bank to offer debit and credit products for both consumers and SMBs.

This spate of acquisitions demonstrates two things: firstly, that the value of any company able to innovate and build large-scale generative models is likely to soon peak – that’s if it hasn’t already. Secondly, that many firms believe this technology will soon play an absolutely central role to their offerings and processes.

But at the same time, AI is also shaking up the fintech M&A market by (in theory) improving efficiency when it comes to deal sourcing, valuation, due diligence and post-merger processes – something to also keep an eye on.

Other segments which are similarly crowded, in which we can expect to see further M&A activity, include BNPL (think along the lines of Square’s acquisition of AfterPay) and neobanking (see MHP Group client Papara’s acquisition of Spain-based Rebellion, or Monzo’s eyeing up of Lunar).

Floodgates are opening

There is certainly a “wait-and-see” sentiment lingering in the fintech sector, as potential sellers wait on the sidelines to gauge the correct timing to make a move. On the other hand, anecdotally speaking, we’re seeing that many buyers are waiting for more favourable valuations to take hold, for example through more downrounds which we saw plenty of in Q1.

And sellers and buyers alike will want to avoid getting washed out in a crowded market once deal flow does resume to normal levels – so the benefits of being a first mover should also not be underestimated.

In that sense, the floodgates have arguably already opened and if we are to take June and July as an example, we should expect the pace of M&A activity to pick up even more towards the end of the year and beyond.

Higher interest rates will continue to dictate the market

The M&A shopping spree which characterised mid-2020 to mid-2022 was partly driven by firms wishing to take advantage of low interest rates, so it’s little surprise that activity is down compared to last year.

But most central banks are believed to be nearing the end of their most aggressive interest rate rising cycles in decades in response to soaring inflation, with the Fed hiking to 5.5% in August and markets pricing in a fifteenth – and potentially final – rise by the Bank of England this month.

Interest rates are intrinsically tied to M&A deals as many buyers finance all or a portion of their purchase of target companies with debt. So as the economic landscape stabilises, interest rates level out and monetary policy (hopefully) continues to curb inflation, it’s likely that buyers will feel more comfortable spending their money. It’s unlikely we’ll reach 2020 levels anytime soon, but should rates decrease, we can expect to see another flood of deals to the market.

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The reality is, as the gap between the highest price a buyer is willing to pay and the lowest price a seller is willing to accept narrows, we can expect to see even more fintech M&A in the remaining months of this year. The next few months will prove to be a critical period in which we will be able to tell which players can thrive, and which might crumble under market pressure.

This will be compounded by continued caution from venture capital firms who are reportedly sitting on $271 billion in dry powder, as well as zombie IPO and SPAC markets – not fully dead thanks to CAB Payments’ IPO in early July and Ashington Innovation’s London float in June.

The result will be a fintech segment that looks very different in 2024, with fewer players but many with more diverse offerings and broader global reach.