The Rise – and Crash – of the Israeli Anti-fraud Tech Star

Forget about Black Friday: Global supply chain problems, EU regulations and the end of the pandemic boon spell major problems for Israel’s Riskified

Omri Zerachovitz
Yosef Harash
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Riskified's IPO was massive, but since then problems have plagued the Israeli anti-fraud tech firm
Riskified's IPO last year was massive, but since then problems have plagued the Israeli anti-fraud tech firmCredit: CRC Media
Omri Zerachovitz
Yosef Harash

A band was founded at the anti-fraud software company Riskified three years ago, called “The False Declines,” a wink at the company’s business, which works to prevent false declines of online credit card purchases. Riskified would probably like to give a similar name to the sharp downturn of its stock in recent months – that is, to believe that it is the result of a misunderstanding, a mistaken analysis of reality that led investors to make erroneous decisions.

Riskified is currently valued at a disappointing $1.3 billion. It had hoped to be in a different place – it had ridden the coronavirus to a massive IPO, with a growth rate of 54 percent it had reached a valuation of $3.3 billion, briefly peaking at a valuation of $5.9 billion.

Anyone involved in the capital market knows that after such a big rise, there can be declines. But it is doubtful that anyone in the company thought that it would be so painful, and that the company would fall back two years – to a valuation that was lower than its price at the last round of funding raising.

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Riskified isn’t alone; many stocks have experienced falls in recent months; however, its fall has been steeper.

There seems to be no single reason for the company’s situation. It hasn’t missed its stock-price forecasts, the things that worried the investors were there before and also appeared in the company’s prospectus and in conversations with analysts, and the tailwind from the coronavirus was expected to continue, at least partially. And yet, the investors are skeptical about the Riskified’s future growth rate, as can also be seen by the so-called price-sales ratio - or the ratio between its valuation and its predicted income from sales over the past 12 months. Currently it is traded at 5.5, but after subtracting the money it has in cash – $530 million – this drops to a mere 3.2.

Although the capital market can be cruel, the rapidity with which investors turned their back on Riskified, after a warm (yet brief) welcoming, makes one wonder: Are the challenges with which Riskified is now dealing with grown more severe over the past months, or are these just the birth pangs of a company now taking its first steps into the public market.

The challenge of forecasts

Riskified was founded in 2013 by Eido Gal and Assaf Feldman. The two had worked together briefly at BillGuard, which monitored irregular behavior in bank accounts and credit cards, but this was not their first experience in this field. Gal, 36, worked for a short time at the Israeli firm Fraud Science, which was purchased by PayPal. Feldman (49) is a graduate of the Media Lab program at MIT, during which he focused on the field of credit.

Riskified’s CEO and co-founder, Eido Gal and Assaf Feldman, co-founder and chief technology officer in 2017.Credit: מריה פלדמן

Riskified’s solution makes it possible to differentiate fraud attempts and legitimate purchases by analyzing consumer behavior, and thus reducing the number of rejected transactions. The learning-based system uses ongoing and cumulative tagging of transactions as “good” or “bad.” The company also analyzes data that consumers feed in during purchase – how long they spent on a site, what pages did they call up beforehand – and at the end of the process, it presents the merchant with the result: Yes or not, or if the order is approved or not.

Riskified has thousands of clients, and the sales process is lengthy. According to an analysis by J.P. Morgan, for major clients, it can take Riskified between 25 and 55 weeks from the moment a relationship is first forged until an agreement is signed. Add to this another 18 months in which Riskified makes major efforts to increase a client’s activities. According to the bank, this poses a major challenge in formulating a solid forecast for the company.

Online commerce took off due to the pandemic. Shops were closed and more people made online purchases. For Riskified this was great news, and to a certain extent even a lifeline, because in the first quarter of 2020, its growth rate was single-digit – 9 percent – which is usually considered low for a company at its point.

The pandemic pushed the growth rate to 54 percent in the quarter before its IPO but since then, it has been in constant decline, which is expected to reach 18 percent in the quarter that just ended. According to its forecasts, it will end the year with earnings of $227 million with a negative EBITDA (earnings before interest, taxes, depreciation, and amortization) of around $25 million.

“One of the reasons for the decline in growth is the bonanza in online commerce in 2020 and at the same time there are assessments that there was a decline in purchases on Black Friday and Cyber Monday, this November,” a source familiar with the field said. In the third quarter of 2021, online sales in the United States were 13 percent of all sales – as opposed to 13.8 percent in the same quarter in 2020. At the height of the pandemic, in the second quarter of 2020, online sales were 16 percent of all sales.

A cargo ship waits near a shore in California last year. The global supply chain problems are only one of Riskified's problemsCredit: MIKE BLAKE/Reuters

Add to this the problems in the supply chain, which have still not ended, which led many customers to “out of stock” messages when making an online purchase. Wayfair, for example, is one of the leading online retail furniture vendors in the world and a client of Riskified. In the third quarter Wayfair reported a decline in income of about 19 percent. Another thing bothering investors is regulation in Europe, which infringes on the need for Riskified’s products.

Conflict of interests or a winning model?

Riskified’s model is based on chargebacks (when a cardholder disputes a charge with their bank). In the case of fraud, the credit card company reimburses the customer, but it requires merchants to be responsible for compensation. If that happens frequently, the credit card company blacklists the business. So the business’ activity in the end is based on two things: its overall rate of approved transactions and the rate of transactions approved and found fraudulent. Riskified offers a chargeback guarantee – that is, it takes upon itself responsibility for chargebacks due to fraud, allowing more deals to be approved at lower risk.

If the rate of fraud is higher than what Riskified committed to – it takes payment on itself, and if it’s lower, it makes a profit. Riskified reported in its prospectus that the earnings of its ten biggest clients rose by an average of 8 percent after they began using the company’s products, and the chargeback expenses declined by 38 percent.

But some say this system creates a conflict of interests between Riskified and the business. On the one hand, Riskified wants to approve as many transactions as possible so the client will be satisfied; on the other hand, it profits from a reduction in losses – and then it doesn’t want to take unnecessary risks on itself. There are also cases that Riskified could have approved more transactions without bypassing the promised chargeback rate. The company believes that if clients were to feel this way, they would not remain clients.

Another Israeli company in this field, Forter, initially only offered the chargeback coverage but now offers another model in which it takes a fixed fee for each transaction. In exchange, Forter approves or denies the transaction for the business, and promises to lower the level of fraud. However, the risk is passed on to the client, and the rate of fraud doesn’t necessarily decline to the promised level. To reduce the risk Forter offers compensation if the fraud rate rises. The idea behind this model is to avoid an inherent conflict of interest and approve as many transactions as possible.

One of the challenges with the chargeback model is, as noted, the high costs that fall on Riskified if more refunds are required due to fraud. In Riskified’s financial reports these refunds are listed as part of the cost of earnings. This creates higher earnings, but lower profitability rates. In the last quarter, Riskified’s cost of earnings was relatively high and its gross rate of profitability was only 46 percent.

Investors and analysts were concerned that this low figure indicated that Riskified’s technology doesn’t sufficiently prevent fraud. In a conference call with analysts, the company explained that the gross profit was influenced by new clients and the mixture of their clientele in that quarter. For example, fraud is more frequent in tourism transactions, and more of these instances may have occurred due to an increase in tourism.

Still, it can’t be ignored that this is the lowest profitability rate since 2019 (46 percent). Riskified did warn on a call with analysts after the reports of the second quarter that the gross earnings in the last two quarters of 2021 would be lower, but investors may not have expected such a sharp drop – from 60 percent to 46 percent.

Headwind from Europe

One of the factors leading to a sharp drop in Riskified stock is concern over the impact of new regulation adopted by the European Union in 2018 called 2PSD which requires all financial institutions to share information about clients with each other. This regulation, now being implemented, requires businesses in Europe to comply with a high level of so-called “strong customer identification”. This is done by three means – personal information such as a password, property such as a phone or a credit card, and biometric data. Businesses that do so will not have to refund money in case of fraud. Thus, fewer businesses will need Riskified’s services.

Fifteen percent of Riskified’s activity was in Europe in 2020, and the company identified the regulation as a risk factor in its prospectus ahead of its IPO. The prospectus stated that there would be an impact but its effect would be difficult to assess, however the effect manifested itself quickly and has made its presence known in conversations with analysts.

According to Riskified, the impact will be at its highest in the middle of next year, after which it says it will return to stable growth.

Gal, Riskified’s CEO told us that, “Since the IPO we’ve done exactly what we said we would and as a company we’ll continue to meet the goals we have set for ourselves.

“Riskified is an excellent business, which gives a great deal of value to its clients. We are adding clients and deepening our connection to existing clients. Our client retention rate is among the highest in the field and our category is growing and expanding. We have no control over the fluctuation of the stock in the short term, but we are sure that in the medium- and long-term the stock will reflect the success of our business.”

And still, looking at the current price of the stock, one cannot ignore the question of whether the company issued its IPO at a problematic time where generous value could be had but uncertainty was too high? The European regulation was under discussion for a decade, and its implementation was decided more than two years ago, but it is uncertain whether the company knew at the IPO to provide a precise forecast. Add to this the global supply chain problems and the return to normal after the pandemic, new and less anticipated factors.

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