Deep Dive: Afterpay
(Ryan) What they do: Afterpay is one of the world’s leading buy-now-pay later payments providers. So the way it works: Let’s say I’m shopping at underarmour.com or Gymshark, and I find a few things I like. I’d add them to my cart, and go to checkout. Fill out all the shipping stuff and then it goes to my payment options. You can use a credit/debit card, PayPal, or Afterpay. Afterpay allows the customer to split an order into 4 separate payments interest-free. So the customer would pay 25% upfront, then 3 other payments every 2 weeks. It’s a microloan with no interest. Afterpay just takes a percentage of the total order, which it calls its Afterpay income margin and in H1 2021 it was 3.8%.
And the customer acquisition strategy really starts with merchant acceptance. So they sign on merchants who enable afterpay for customers. If you’re wondering, why the hell would merchants just give away chunk of their sale, it’s because this approach really incentivizes spending. Merchant’s average order size or basket amount really grows.
And apparently afterpay does sort of a small background check when someone signs up. If that person doesn’t pay by the due date, they get a late fee. If a late fee isn’t paid customers aren’t allowed to make any more purchases with Afterpay.
(Ryan) History: Anthony Eisen and Nick Molnar co-founded Afterpay in 2014 in Sydney, Australia. Molnar, who grew up in Sydney used to sell jewelry on Ebay in college and he apparently became the number Australian jewelry seller on Ebay. So he’s grown to be pretty good at marketing.
Anthony was his neighbor and they came up with the idea and launched when Nick was 28. And then early on encouraged the consumers to encourage their favorite retailers to adopt the solution, and a lot of them have. They’ve now reached more than 75,000 active merchants.
They went public in 2016 at a market cap of $125 million. That’s how quickly they grew.
Hard to evaluate industry because they are really going after consumer credit market, but also trying to kill credit cards (a large part of the consumer credit market) at the same time
Projections show for BNPL to grow at a high double-digit rate in the U.S. over the next decade, possibly hitting $300 billion in volume (these are all estimates though)
As of the Fed’s latest estimates, consumer credit card debt in the U.S. is a tad under $1 trillion
Transaction volume in the trillions
So, the market opportunity is large if Afterpay is trying to transition everyone from credit cards to BNPL
Competitors include Klarna, Affirm, PayPal. PayPal is probably the big one to watch since they have hundreds of millions in established users, and obviously the banks could step in and start doing this as well
(Brad) Management and Ownership:
Ownership & Leadership
1) 36% of the float held by insiders
2) 55% of the float held by institutions
3) Co-founder & CEO Anthony Eisen
— long career in Investment banking
4) Co-founder & Co-CEO Nick Molnar
— background expanding the Ice.com jewelry line into Australia
— VC background
5) CFO is the former SVP of finance at Visa & a former Schwab VP
Market cap of $21.44 billion, ticker APT in Australia but AFTPY if you need to use OTC in the United States
Since we are almost to the end of FY 21, and Afterpay is growing so rapidly, I’m going to just extrapolate the last six months of calendar year 2020 for these valuation metrics
Trailing P/S of 33.2
Trailing P/GNM (similar to a contribution profit for Afterpay) of 63.4
P/EBITDA close to 300
Was looking at SBC, had maybe 20 million in options outstanding vs. 289 million share count so not bad
You are definitely not buying this stock because of the valuation
(Ryan) Earnings: They use different terminology, so I’ll try to translate it to our standard metrics
Underlying sales, which is basically GMV was $7.6B, up 106% YoY
The take rate on that was flat YoY at 3.8%
H1 revenue was $323M, up 89% YoY. (TTM revenue was $554M)
Gross margin of 73.5%
Active Customers grew 80% to 13.1M
EBITDA margin excluding significant items was 11.5%
After tax loss was $61M (pre-tax was quite similar)
Active merchants in north america grew 141% to 18k. (big growth area for them)
Marketing expenses were about 22% of gross profit
(Brad) Balance sheet and liquidity:
Balance sheet & liquidity
1) $354 million in cash & equivalents
— $686 million in undrawn warehouse capacity gets them to their $1.1B in liquidity
— most of its revolvers are untapped
2) $93 million in interest bearing borrowings & convertible notes
— little over 1% of that is current the rest is not
3) interest carries rates of 1-3%… strong
Anecdotal Evidence/Customer Stories:
(Ryan) I think I’d rather have a cash back program but that’s just me.
(Ryan) Lead gen. There are 2 sides to this, the merchant side and the customer side. They’re the in-between. But if you look at it from the merchant’s view, they want to be as accepting of any form of financing they can. So they’ll probably accept Afterpay and Sezzle and Klarna, and Paypal, and so on. So the advantage is on the customer side. If customers access shops through them then that will be a big differentiator. Their website is almost like an Okta dashboard but for retail.
(Brett) network effect (similar to Mastercard, Visa, Paypal). Also, this isn’t a competitive advantage, but the team at Afterpay seems to be executing from a product and marketing perspective at a way better rate than the competition. Reminds me of Square.
(Brad) CFO is a superstar to complement the co-founders. Former SVP of finance at Visa is a competitive advantage on its own
Future growth opportunities:
(Ryan) Afterpay Card. This is a contactless Mastercard that can be stored in the Apple Wallet or Google Pay. There’s no reason this BNPL model shouldn’t work for in-person transactions. I know they’ve rolled this out in the US, not sure if they have rolled it out anywhere else.
(Brett) Acquisition of Setelah Bayer, a Singapore company that does BNPL in Indonesia, for $2 million. This is a tiny acquisition right now, but getting momentum from both sides of the marketplace is important for BNPL, so establishing inroads in these new countries is important if they want to keep up with the high sales growth rate
(Brad) Stimulus dollars will flow through to consumption to a certain extent. The extremely easy monetary/fiscal policy we have should be a tide that lifts all boats in this space. Genz crypto
Highlights and lowlights:
(Ryan) Highlights: I think people underappreciate how much of a stigma there is towards credit cards for people our age. The customer cohort should lean towards the better customers over time, lowering loss ratios. I like it that they haven’t just gone for the typical fintech super app strategy. They also benefit from some legal rule of not needing to call it a loan. Lowlights: I think Paypal/Venmo more specifically could come out with a successful competing product. And that would have an easy in-road to gen Z/millenial.
(Brett) Highlights: Good consumer trends from the younger generation (as Hayden Capital put in the report, the only ⅓ of Americans under 30 have a credit card) that makes me feel like it isn’t outlandish to expect over 100 million BNPL users in the U.S this decade, but the question is who will they go to, strong execution so far that seems to be working vs. the competition and solid unit economics. Lowlights: stiff competition coming in the U.S, and bad cash flow dynamics. Also, while calling it BNPL makes it seem different, you still have default risk from consumers. Lastly, I worry that it is just a product.
(Brad) Highlight — for the level of growth it’s posting a 73% gross margin & a positive EBITDA margin is encouraging & somewhat unique. This feels like an extremely asset-light model that can seamlessly scale if done right. Lowlight — how much of the e-commerce driven buying is driven by temporary tailwinds of stimulus & stay at home & in a world where we are shopping at Walmart again why wouldn’t Walmart make this part of its planned fintech offering? Race to 0 like Robinhood
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Disclosure: The authors and podcast guests are not financial advisors. Brett Schafer and Ryan Henderson are portfolio managers at Arch Capital. Clients of Arch Capital may hold securities discussed on this podcast.