By James Eyers
It was not long ago that the buy now, pay later sector was in an existential crisis. Valuations had been eviscerated by rising interest rates, and there were plenty of questions about whether a sector born of an era of ultra-low borrowing costs could survive.
Since it completed its mega-deal and listed on ASX, Block had mostly underperformed, while Zip shares were pulverised as investors lost faith in the fintech vision. There was widespread concern that higher rates would shoot bad debts higher, and regulatory scrutiny has been growing.
Both companies spent the past few years attacking costs, responding to demands from a skittish market, trying to reassure shareholders that they could stand on their own two feet without the need for additional funding that investors were unwilling to provide.
The latest earnings briefings from both companies revealed a shift in sentiment. Investors were asking about growth plans. It was like 2018 all over again.
Although buy now, pay later share prices made some gains in January, momentum gathered pace a week ago when Block chairman Jack Dorsey presented plans to turbocharge the features of Cash App, which is used by more than 50 million people in the US. This includes incorporating Afterpay alongside deposits and other banking products. Its stock jumped 17 per cent on the ASX last Friday, and has maintained gains this week.
Then it was Zip’s turn. It also pointed to top-line growth in the US. Zip shares rose 14 per cent this week, and are 35 per cent higher over the past month.
“We have been through quite a transformation over the last two years, and we have made huge progress strengthening the foundations,” Zip chief executive Cynthia Scott told AFR Weekend. “We have been driving not just growth, but profitable growth.”
It’s been a roller coaster ride for investors in the space. Having obtained a valuation of $US45.6 billion in 2021, making it Europe’s most highly valued technology company, Klarna’s private market valuation sank to $US6.7 billion in 12 months after the fintech bubble imploded. Reports this week suggested Klarna could be targeting a valuation of $US20 billion ($31 billion) – triple the low.
Commonwealth Bank owns 5 per cent of Klarna, a defensive play giving it exposure to e-commerce trends as Afterpay continued to ramp up customers. CBA’s holding could be worth $1 billion, more than three times what it paid for the stake in late 2019.
More specifically, analysts are considering whether one of the core innovations of buy now, pay later – the ability to control credit dynamically, given the loans have a short duration of about 40 days and allow providers to switch access on and off depending on customers’ repayment record and what they’re spending on – has allowed players to limit credit losses and maintain margins.
“The whole sector is definitely now seeing a renaissance in valuation and margins,” says Jonathan Higgins, who monitors payments stocks at Unified Capital Partners and has followed Afterpay and Zip since listing. “Zip has flagged strong momentum in the US, and bad debts are well controlled. As long as bad debts don’t spike, [Klarna] would likely go pretty well in an IPO.”
At Afterpay, loan losses were running at 1 per cent of sales, Block chief financial officer Amrita Ahuja said last Friday, in line with the historical loss rates when Afterpay was an ASX-listed company. At Zip, bad debts are 1.9 per cent of sales, just below its internal target of 2 per cent or less. In the faster-growing US market, Zip’s losses are 1.4 per cent.
“We have a demonstrated ability to manage credit through the cycle, and part of that is the duration of the book is shorter, while the way we manage credit is very dynamic,” Scott said. “We can assess the back book, and make adjustments as necessary, which is what we have done in Australia and the US.”
Others are similarly placed. Nasdaq-listed Affirm – founded by Max Levchin, one of the original creators of PayPal alongside Elon Musk and Peter Thiel – is also in recovery mode. Affirm shares on the Nasdaq are up 200 per cent from a year ago at $US37.50 – still a long way from their November 2021 peak near $US176, but much higher than the $US8.62 low they plunged to in December 2022.
Klarna, meanwhile, said in its full-year earnings report this week that it had made a gross profit of $US1.1 billion, without sacrificing top-line growth. Indeed, it said more sales had gone through its platform than at any time in its history, while net losses shrank 29 per cent to just 0.38 per cent of sales.
More remarkably, Zip appears to have turned itself around. This came after co-founder Larry Diamond heeded an early warning from Wall Street doyen James Gorman, a fellow Australian, in October 2021: it was a Darwinian moment, and only the fittest buy now, pay later players would survive, Gorman cautioned.
This week, Zip announced positive cash earnings of $30.8 million for the half, flipping around a similar level of loss a year before, after it took a knife to costs and pared back growth, although not quickly enough to save the share price in 2022.
At Block, Dorsey has also been intensely focused on cost-cutting, aiming to be a so-called Rule of 40 company – delivering a combined growth rate and profit margin that exceeds 40 per cent.
‘Customers still see value’
Meanwhile, the buy now, pay later minnows that chased Afterpay and Zip onto the ASX when capital was abundant have withered on the vine. Zebit, Payright and Splitit are delisted, while Openpay and IOUPay have shut down. Latitude has exited buy now, pay later. Humm has struggled as a subscale player amid regulatory scrutiny.
“I would not expect the sort of hyper-growth we saw when capital was flooding BNPL. But with many of the unprofitable players exiting the market, those that have survived will now be able to execute their long-term visions, to continue to disrupt the incumbents both in Australia and the US,” said Tobias Yao, portfolio manager at Wilson Asset Management, which was a cornerstone IPO investor in Afterpay.
“Most investors continue to be sceptical about the longevity of the BNPL sector. However, that overlooks the cost improvements made by the key players over the last couple of years.
“Customers still see value in the products, and the BNPL players that are left will have the advantage of being able to operate in a significantly more rational market. We might not see astronomical growth, but we are seeing profitable growth.”
Surprisingly for the sector’s many bears, top-line sales going through the surviving platforms continue to move higher. Last year, Afterpay processed $US27 billion, up 25 per cent in its fourth quarter. Zip said this week that first-half transaction volumes were up almost 10 per cent to $5 billion. Klarna and Affirm are also expanding.
Block’s performance prompted Wall Street analysts to upgrade their outlook this week. “We believe [Block] is emerging as a unique asset in the very early stages of a new era of discipline and efficiency,” said Jefferies analysts led by Trevor Williams. “Despite its commitment to a leaner cost structure, we think the top-line story is set to improve … as product velocity ramps up and the re-focused go-to-market strategy bears fruit.”
The desire of consumers to tap pay-in-four loans has also attracted the attention of Apple. It is making buy now, pay later loans directly from the Apple Pay digital wallet, using the tech giant’s own balance sheet. PayPal has also entered the space.
Just as when Afterpay was touting its US opportunity in 2017, players are pointing to buy now, pay later’s overall tiny proportion of payment volume to support the idea that growth is just beginning.Buy now, pay later is dwarfed by the volumes – and market capitalisation – of the US credit card networks.
During Zip’s briefing this week, Scott pointed to total annual payments in the US of $11 trillion, telling investors that unsecured, short-term credit at the point of sale represented less than 2 per cent of this, with 100 million adults underserved by traditional finance. It’s the same market that is so attractive to Dorsey.
The average US household has $6000 in credit card debt. The buy now, pay later providers want to lure these balances to them, and it appears US consumers are open to the idea.
Data on the latest US holiday shopping season showed US spending with buy now, pay later products hit $US9.2 billion in November, the largest month recorded, driven by the Cyber Monday sales. Online buy now, pay later spending during the holiday season in November and December hit $US16.6 billion, up 14 per cent year-on-year.
The products are, inevitably, attracting attention from regulators, which remains a key risk for the sector. In a report published this week, researchers from the Federal Reserve Bank of New York found financially fragile consumers were nearly three times more likely to use unregulated buy now, pay later loans.
“More fragile households tend to use the service to make frequent, relatively small purchases that they might have trouble affording otherwise,” it said. “Financially stable households tend to not use BNPL as frequently and are more likely to emphasise that BNPL allows them to avoid paying interest on credit-finance purchases.”
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