Neobanks and Profitability: A Path to IPO?

The Substantial Venture Capital Investment in Neobanks

A significant amount of venture capital has been directed towards neobanks globally. Crunchbase data reveals that Starling Bank, headquartered in London, has secured over $900 million in funding.

Similarly, Chime has attracted $1.5 billion in investment, according to the same source. Monzo has raised close to $650 million.

Recent Funding Rounds

The expansion of funding continues, with e-commerce-centered neobank Juni receiving $21.5 million just last month. Novo, which focuses on small and medium-sized businesses (SMBs), secured $41 million in June.

Furthermore, Nubank has obtained $2.3 billion, and FairMoney has amassed more than $50 million in funding.

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Divergent Performance Among Neobanks

Despite a common tendency to categorize fintech companies offering banking services to consumers and businesses together, there are substantial differences in their market performance.

As early as August 2020, The Exchange highlighted that many neobanks were experiencing considerable losses. The prevailing understanding was that the influx of capital into the fintech sector was primarily aimed at aggressive growth strategies.

Shifting Towards Profitability

Recent financial reports suggest this assessment remains accurate. However, not all neobanks remain unprofitable.

Chime announced in September 2020 that it was generating positive, unadjusted EBITDA. This is a more rigorous profitability measure than the one recently used by Lyft to declare its profitability; Lyft reported positive adjusted EBITDA but still incurred a net loss.

Starling Bank also reported achieving profitability in October 2020. The landscape of neobank financial results has evolved since our initial analysis.

Positive Trends in Neobank Financials

The positive momentum continued in June with Revolut’s release of its financial performance data. While the company’s overall results for 2020 were negative, a closer examination of its quarterly performance revealed a fintech company increasing its gross margins and revenue.

By the fourth quarter of 2020, Revolut was nearing adjusted net income neutrality, which was a noteworthy achievement.

Analyzing Recent Data from Starling Bank and Monzo

Today, we will further investigate neobank financial results by analyzing recently published data from Starling Bank and Monzo. As we will observe, while some neobanks are successfully improving their financial standing and moving towards profitability—or even achieving it—others are still operating at a loss.

Monzo and Starling Bank Performance Analysis

Let's begin by examining the results from Monzo. Their latest financial reports can be found here, with 2020 results available here for reference. Monzo’s financial year concludes at the end of February, meaning their 2021 results cover the 12 months ending in early March of this year.

Consequently, the data currently available is somewhat past its prime. This is an unavoidable trade-off, granting us greater access to neobank financials than is typically possible with privately held companies. European neobanks regularly publish their results, offering valuable insights into the sector’s overall performance. However, this necessitates analyzing data from a point further in the past than ideally preferred.

Here’s a summary of the key data from the company concerning its most recent fiscal year:

Please note that the timeline progresses from right to left, and all figures are presented in thousands of pounds. For instance, a value of 10,000 represents 10 million pounds. Is that clear? Excellent.

Initially, it seems Monzo experienced substantial growth, with net operating income increasing from 35.7 million pounds to 62.2 million pounds, a 74% rise. However, revenue growth was more restrained, moving from 67 million pounds to 79 million pounds – an 18% increase.

Considering December’s revenue of approximately 8.75 million pounds, calculated from an annual run rate of 105 million pounds at the end of 2020, one can begin to project the company’s 2021 revenues.

The disparity between slower revenue growth and faster net operating income expansion appears linked to a shift in the company’s credit losses. What contributed to this decline in credit losses? Monzo deliberately reduced its lending activity during the previous fiscal year. As stated by Monzo, they “reduced new lending to [their] customers, which helped [them] stay within [their] risk appetite during the uncertainty of the pandemic.”

Regardless of whether growth is assessed through revenue or net operating income, the figures further down the table are more pertinent. While Monzo’s expenses grew at a slower rate than its net operating income, the underlying loss before special items was marginally higher in fiscal 2021 compared to fiscal 2020. Including non-recurring items, the loss was significantly greater.

Therefore, Monzo had a relatively positive fiscal 2021, characterized by slowed expense growth, limited credit losses, and revenue increases. However, the company did not demonstrate operating leverage; as revenues increased, losses did not correspondingly decrease.

This can be interpreted in various ways, but Monzo still appears to be a neobank in its investment phase. This means it continues to spend heavily to fund its growth, and historical growth has not yet generated sufficient gross profit to substantially reduce its losses.

Now, let’s turn to Starling.

It’s worth remembering that Starling achieved profitability in late 2020. However, the definition of “profitability” can be flexible for startups and unicorns. We interpret the term to mean cash flow positivity or non-negative adjusted EBITDA, as this is generally the intended meaning.

We have two datasets from Starling. The first covers a 16-month period from December 1, 2019, to March 31, 2021. This is due to Starling transitioning to a new fiscal calendar, resulting in somewhat unusual reporting. Regardless, the company provided the following information for that period:

• “For the period to 31 March 2021, our revenue rose by nearly 600% to £97.6 million, from £14 million for the previous period ending 30 November 2019, while our loss more than halved to £23.3 million from £52.1 million.”

This demonstrates operating leverage – a very positive sign. Strong growth coupled with decreasing losses is precisely what one hopes to see from maturing technology companies.

Starling also released a fiscal Q1 2021 update, covering the calendar second quarter. This provides relatively current data for Starling, significantly fresher than the information available for Monzo. Here are the key highlights:

This represents a nearly fourfold increase in revenues, alongside a favorable shift where Starling’s revenues exceeded its operating expenses in the June quarter – a feat it hadn’t achieved in the year-ago calendar Q2.

A more detailed breakdown of revenue is as follows:

Impressive, wouldn’t you agree?

What fueled these substantial gains in Starling’s income? A 50% increase in retail accounts, rising from 1.2 million at the end of June 2020 to 1.8 million at the end of June 2021, and a more significant doubling of business accounts from 180,000 to 374,000 over the same timeframe.

These business customers drove considerable lending activity at Starling, with total lending increasing from 836 million pounds in the year-ago June quarter to 2.3 billion pounds in this year’s calendar Q2. Specifically, the Bounce Back Loan Scheme and Coronavirus Business Interruption Loan Scheme generated substantial volume for Starling.

It’s important to note that Starling’s growth wasn’t solely attributable to corporate lending related to COVID-19; the company possesses multiple strengths. However, it’s evident that Starling actively participated in small-business lending, partly due to COVID-related programs. Capitalizing on opportunities is not inherently negative, although next year’s year-over-year comparisons may prove more challenging for Starling than its 2020 results.

Starling demonstrates that neobanks can achieve profitability and exhibit operating leverage. With Revolut’s strong performance in late 2020, it’s clear that at least a segment of the neobanking sector is financially stable enough to contemplate public offerings. Monzo still has progress to make, but its numbers appear less indicative of broader category concerns today.

Neobanks – perhaps the investments made in them will ultimately prove successful.