#028 - Afterpay

Australian based BNPL competitor.

Afterpay - (ASX: APT)

Afterpay is a leading BNPL provider based in Australia but rapidly expanding in the US and other international markets. Afterpay has seen tremendous growth and profitability in its core market.

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Please note that this article does not constitute investment advice in any form. This article is not a research report and is not intended to serve as the basis for any investment decision. All investments involve risk and the past performance of a security or financial product does not guarantee future returns. Investors have to conduct their own research before conducting any transaction. There is always the risk of losing parts or all of your money when you invest in securities or other financial products.


Industry Overview

Afterpay competes in the BNPL space with other competitors like Affirm, Klarna, Quadpay (recently acquired by Zip), and PayPal. Much of my original thoughts on the BNPL industry can be found via my shallow dive on Affirm.

Why BNPL?

BNPL gives consumers more flexibility to make purchases on their terms and not the terms of credit card companies. Critics of this industry are quick to say that “consumers don’t have the cash needed to complete these transactions” and therefore BNPL companies provide sources of funding to consumers who may not be able to repay this debt. Providing funding to consumers who cannot repay debt is not a good business model. Critics believe these companies have too much credit risk and therefore are not quality investments.

While this may be partially true as some percentage of the customer base will always be unable to pay back debt, I think the amount of consumers that aren’t able to repay or don’t have the sources of funds is likely lower than critics believe. Understanding the loss ratio is critical to understanding the credit risk of these companies. For example, Afterpay has loss rates less than 1% of GMV. These loss rates are declining over time as consumer frequency grows and “delinquent” customers are weeded out.

BNPL offerings allow consumers to space out payments. Just as businesses want to space out payments of liabilities, consumers want to do the same. If consumers can delay the full payment by a couple weeks or more than a month, consumers can budget better and potentially reinvest this cash elsewhere before paying back their purchase.

There are also numerous benefits to merchants. Merchants like offering BNPL products because it increases conversion rate, average order value (AoV), and reduces friction in the transaction process. Consumers are likely to make more and larger purchases if given a more flexible payment option. Therefore consumers will buy and spend more often.

Competition

There are numerous competitors in this industry as I’ve mentioned above. I think this industry will slim down to a handful of competitors. I believe there are network effects embedded with the BNPL business model so its all about capturing the largest number of merchants and customers today and creating a sticky platform so these users don’t switch to competitors. Merchants and customers will gravitate towards the BNPL companies with the largest and broadest scale.

Business Overview

Afterpay is an Australian based BNPL competitor, and is focused on Australia, New Zealand, US, Canada, and the UK (called Clearpay in the UK). Afterpay has a mature Australian market and is looking to expand in the US, Europe and Asia.

Afterpay’s business model is similar to the rest of the BNPL competitors. Afterpay allows customers to pay for a purchase and split it via 4 equal payments over 6 weeks (time of purchase, time of purchase + 2 weeks, time of purchase + 4 weeks, time of purchase + 6 weeks).

One primary difference between Afterpay and Affirm is that Afterpay never charges interest to consumers which is a major difference between Afterpay and Affirm.

“Customers are never entrapped in revolving debt and never incur interest.”

- Afterpay’s 2021 Half Year Report

Affirm charges interest depending on the purchase price as well as how many payments consumers need to pay for a purchase. While Affirm’s customers only accumulate simple interest (interest does not compound over time), I believe this is still a noteworthy difference because these BNPL companies are competing with credit cards. Credit card companies typically charge interest on both the principal balance as well as the interest balance. Instead of charging interest, Afterpay charges a late fee (which is fixed, capped, and does not accumulate over time). Customers who miss a payment can’t use Afterpay until payments are up-to-date.

Afterpay has three primary revenue sources, merchant fees (the majority of revenue), late fees (a small and decreasing portion of revenues), and a “Pay Now” business line which provides various services to other businesses such as compliance, fraud protection, and more. The “Pay Now” business is a small (1.9% of total sales and declining y/y) and unimportant revenue line so we’ll be focusing on merchant and late fee revenue.

Total Addressable Market

The retail market is likely one of if not the largest market in the world. Affirm’s management team highlighted more than $5 trillion in global retail spending. While BNPL companies typically take between 3% and 6% of a transaction, this is still a massive opportunity for these companies. 5% of $5 trillion is still a massive market to go after. Even after accounting for other costs, the profit pool is likely in the tens if not hundreds of billions of dollars for this industry. While not all of this will accrue to the top competitor or even the top handful of competitors, investors can gain comfort knowing that there seems to be a long runway of growth for this industry.

Competitive Advantages

  • Scale + network effects

    Similar to Affirm and other competitors, the BNPL space is in the land grab phase where companies are trying to invest in marketing and sales to capture both merchants and consumers. As more customers adopt Afterpay, more merchants are likely to adopt Afterpay. As acceptance grows, more customers will adopt Afterpay and the cycle continues.

    While I don’t think this will be a winner take all market, this industry will slim down to the top handful of competitors as merchants only want to work with the top handful of BNPL providers.

    Only the top competitors will be able to branch out into other business lines such as banking, advertising, or other business lines accretive to a BNPL offering.

  • Sticky and loyal customer base (both consumers and merchants)

    Consumers may start to develop habits that make Afterpay the preferred payment option at checkout (both online and offline). More consumers are also starting their shopping journey on Afterpay’s Shop Directory.

    “And on average, we sent 27 million leads to our retail partners each month for the half or 45 million in the month of December.”

    - Afterpay’s 2021 Half Year Report

    This is just another example of how Afterpay helps merchants. As customers become more accustomed to not only using Afterpay as the preferred payment option but also as the starting point for their shopping journey, these habits will become long lasting and create a sticky customer base.

Financials

First, all financial figures below are represented in dollars. Second, I want to point out that the customer count is in millions whereas the merchant count is in thousands. Third, Afterpay Net Transaction Margin (NTM) is calculated by taking the gross profit and subtracting receivables impairment expense, NTM finance cost, and chargebacks & debt recovery costs.

Afterpay has seen some tremendous growth, but so has the rest of the industry. There is still a long runway of growth left and Afterpay has demonstrated its ability to make a profit in its mature Australian market.

H1 2021

  • Afterpay revenue = 374.2 million

  • Other revenue (late fees) = 35.1 million

  • Total revenue = 417.1 million

  • Gross profit = 306.8 million

  • Afterpay NTM = 213.9 million

  • GMV = 9.8 billion

  • Total merchants = 74.8 thousand

  • Total customers = 13.1 million

  • Afterpay revenue as a % of GMV = 3.8%

  • Afterpay revenue growth = 108.4%

  • Other revenue (late fees) growth = 7.7%

  • GMV growth = 106.3%

  • Merchant growth = 72.7%

  • Customer growth = 79.5%

  • Gross profit margin = 73.6%

  • Afterpay NTM margin = 51.3%

2020

  • Afterpay revenue = 433.8 million

  • Other revenue (late fees) = 68.8 million

  • Total revenue = 519.1 million

  • Gross profit = 384.8 million

  • Afterpay NTM = 250.2 million

  • GMV = 11.1 billion

  • Total merchants = 55.4 thousand

  • Total customers = 9.9 million

  • Afterpay revenue as a % of GMV = 3.9%

  • Afterpay revenue growth = 115.9%

  • Other revenue (late fees) growth = 49.2%

  • GMV growth = 111.8%

  • Merchant growth = 72.0%

  • Customer growth = 115.2%

  • Gross profit margin = 74.1%

  • Afterpay NTM margin = 48.2%

2019

  • Afterpay revenue = 200.9 million

  • Other revenue (late fees) = 46.1 million

  • Total revenue = 264.1 million

  • Gross profit = 204.5 million

  • Afterpay NTM = 119.3 million

  • GMV = 5.2 billion

  • Total merchants = 32.2 thousand

  • Total customers = 4.6 million

  • Afterpay revenue growth = 127.5%

  • Other revenue (late fees) growth = 62.3%

  • GMV growth = 140.0%

  • Merchant growth = 101.3%

  • Customer growth = 130.0%

  • Gross profit margin = 77.4%

  • Afterpay NTM margin = 45.2%

What’s Interesting

  • Demonstrated success and profitability

    Afterpay has demonstrated success and profitability of this business model in its Asia Pacific segment (a more mature market). Based off the 2021 half year report, Afterpay’s Asia Pacific segment had an adjusted EBITDA margin of ~54.3% and when accounting for corporate expenses, adjusted EBITDA margin was more than 39%. Afterpay is likely reinvesting these profits to capture more international markets the US and other Asian countries. Similar to other winner take all or winner take most industries, Afterpay is investing now for the potential to be a major winner in this industry.

  • Optionality

    From reading about Affirm and Afterpay, it seems as though these companies want to expand into other product offerings and become more ingrained in the financial lives of its consumer base and potentially merchant base as well.

    There are likely numerous future business segments that Afterpay could build and offer that would be accretive to its main BNPL business segment. Afterpay and other BNPL competitors could collect revenue from all the leads its giving away free to merchants. It could build out an advertising revenue stream from its Shop Directory.

    Other companies like Affirm are even looking to get into banking and become more integrated with the rest of consumer financial habits. Ultimately, it depends on the probability and magnitude of the success of these extra projects and what investors are paying (if paying at all) for this upside potential.

Future Questions

  • Existing markets pays for future markets?

    Since Afterpay already has an existing market in Australia and this segment is profitable, can Afterpay reinvest these profits into nascent like the United States or other markets and therefore beat competitors by being the first to reach a sufficient enough scale? Not sure if I’m stretching here, but this feels similar to Sea Limited investing the profits from its gaming business to build out the marketplace and payments business lines and ultimately win those markets and beat competition.

  • Offline expansion?

    While e-commerce has been a large tailwind for more than two decades now, the majority of retail spending still occurs offline.

    “Offline retail still does represent the vast majority of retail.”

    - Afterpay’s 2021 Half Year Report

    One of key questions I have moving forward is whether or not Afterpay will be able to have success in expanding towards offline purchases. While Afterpay’s management team has had success in its more mature Australian market, do these habits continue in other markets?

    “And as we accelerate into the physical world, we hope to prove that the product can work both online and off-line, similar to what we have seen in the early days in the Australian region.”

    - Afterpay’s 2021 Half Year Report

    If Afterpay becomes a habit for consumers when spending online, then it likely continues to be a habit when spending offline.

Conclusion

I’ve enjoyed studying Afterpay and am interested in studying it more closely in the future. I got the feeling that Afterpay cared more about its customer base and making sure their customers were treated fairly than I did for Affirm. I think this is noteworthy because these companies are trying to build trust and attack the credit card industry.


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