As competition heats up in the Buy Now Pay Later (BNPL) segment, and operators set their sights on the huge US market, the risks are becoming heightened. The US market remains relatively under-penetrated compared with Australia in terms of these instalment payments systems.
Yet because of the attractive economics generated by first mover Afterpay ((APT)), with an interest income equivalent to 62% and a net interest margin equivalent of 52%, UBS considers it inevitable new entrants will emerge, along with well-resourced incumbents in associated segments, and this will subsequently reduce the economics currently enjoyed by participants, limiting their long-term growth potential.
There remains the possibility of regulatory intervention as such operators proliferate. UBS is of the view that the more successful Afterpay is the more likely it will attract scrutiny from regulators. Regulatory risks centre on whether Afterpay can continue to prohibit merchants from surcharging and whether it will be considered a provider of credit in the future.
BNPL is not currently considered credit and credit checks are not made and customers can sign up for multiple services. UBS also has evidence that BNPL uses are more likely to be indebted relative to non-users.
Around 64% of the BNPL customers the broker surveyed believe this is a credit line and 30% have used a credit card to pay down their balance. Merchant fees represent a 19-49% internal rate of return to Afterpay, UBS notes, and if customers are presented with the true cost of BNPL that could be risky to the growth outlook.
Citi envisages potential for 2-3 players to co-exist but, as is the case with most online verticals, this is a “winner takes most” market. Furthermore, PayPal’s entry to BNPL could shake up the segment, as it has a ubiquitous presence in the US and 190m active accounts.
PayPal is the largest new entrant in BNPL and, as UBS notes, follows the Shopify partnership with Affirm. UBS agrees low barriers to entry leave Afterpay vulnerable to competition though its first mover advantage has made it more defensive in Australasia.
However, Afterpay is spreading its wings, acquiring EmpatKali to establish a base and explore opportunities in Asian markets, which follows the acquisition of Pagantis, with an emphasis in southern Europe.
Ord Minnett assesses these expansions are unlikely to generate significant revenue until FY22 but should underpin the company’s ability to garner benefit from e-commerce, as well as the growing appetite for instalment payments, at the expense of traditional credit providers.
Zip Co Vs Afterpay
In contrast, Citi notes Zip Co ((Z1P)), along with its newly acquired Quadpay, remains at an early stage in market penetration and, while it should grow above system, it remains exposed to consumer discretionary expenditure. In this way, Zip Co is also more exposed to the entry of PayPal and Shopify in instalment payments.
PayPal has a similar product to Afterpay that allows users in the US to pay for purchases in four instalments over a six-week period with no fees/interest if paid on time. This is expected to launch in the December quarter of 2020.
The broker fears Zip Co may be too late entering the US market as Afterpay, Klarna and Affirm all have a sizeable lead. Citi highlights Zip is currently trading at a -56% discount to Afterpay on a forward enterprise value/revenue basis and, while acknowledging Afterpay’s valuation is stretched, considers the premium is justified because of stronger unit economics and balance sheet.
Moreover, Zip is expected to underperform Afterpay if a bad debt cycle eventuates in the near term and would need to raise additional capital or reduce operating expenditure if this transpired. In sum, Citi considers consumer adoption and engagement is key, and if Afterpay and Quadpay can continue to increase purchase frequency then merchants will add them as an option.
There is upside risk to the level of investment required in co-marketing and product marketing. In this way Afterpay may be in a better position as it has a large consumer and merchant network with a strong balance sheet. Quadpay has a differentiated offering, in that consumers can “shop anywhere”, but there is downside risk to transaction margins as it charges per instalment payment for using this option.
As the stock has surged 35% over the last month, Citi downgrades Zip Co to Sell/High Risk from Neutral/High Risk. While anticipating the trends in recently-acquired Quadpay will improve and customer numbers grow, the broker remains concerned that the revenue yield is too high and could come under pressure, particularly in the consumer fee front.
On the partnership with eBay, Citi envisages this is a good distribution agreement and upgrades small-medium enterprise (SME) receivables assumptions as a result ,while UBS highlights the execution risk in the UK with the ZipBiz (eBay partnership) launch.
UBS suspects the market may be under-appreciating, particularly retail investors, the capital intensity of Zip Co’s (and Afterpay for that matter) business in Australasia. The UK is likely to be the main swing factor in the broker’s forecasts, as it is yet to launch.
At the other end of the sentiment spectrum, Morgans believes the launch of ZipBiz and the eBay Australia partnership has positive potential for revenue yield, asserting the Quadpay acquisition and associated capital raising have provided the means for Zip Co to ramp up its offshore expansion to a presence in five jurisdictions.
On FNArena’s database there are no fence sitters for Zip Co, with two Buy ratings and three Sell. The consensus target is $6.75, suggesting 2.1% upside to the last share price. Targets range from $4.80 (Macquarie) to $10.28 (Morgans).
There are two Buy ratings, three Hold and one Sell (UBS) for Afterpay, with a consensus target of $81.72, that suggests 3.1% upside to the last share price. Targets range from a low of $28.25 (UBS) to $106.00 (Morgan Stanley).