A rising tide of popularity has lifted the initial fortunes of all stocks within the rapidly expanding buy now pay later (BNPL) subsector. But with the initial euphoria now cooling, the market is increasingly kicking the tyres of these BNPL operators’ services to find out which ones will stand the test of time.
Having lots of customers is one thing, but will that future-proof these businesses, and guarantee decent returns to shareholders? Share Café has lifted the hood on the business models of key providers to try and find out: These include BNPL goliath and ASX20 stock Afterpay (ASX: APT), Zip Co (ASX: ZIP), Openpay (ASX: OPY), LayBuy Group Holdings (ASX: LBY), Splitit (ASX: SPT), Sezzle (ASX: SZL), and Zebit Inc (ASX: ZBT).
While all BNPL operators offers consumers the same basic proposition – interest free, instalment-based payments for goods and services – their target markets, pricing, margins, profitability and hence future sustainability differ substantially. Two of the BNPL’s earliest market entrants are credit card payment disruptors Afterpay (ASX: APT) and Zip Co (Z1P), both of which captured the market’s imagination by letting consumers access small amount of credit instantly while sidestepping traditional payment types.
Equally pleasing to consumers, they could tap these two BNPL services while sidestepping credit cards, traditional financial institutions – and lots of paperwork. That’s great, but rival BNPL operators also claim to offer this, so what’s the difference?
To find out, you have to drill down beyond the reason why BNPLs came to market, and explore how their unique businesses compare against some key financial measures.
Key metrics to look out for
Firstly, some quick insights. BNPLs tend to have sizable refund facilities which they draw on to operate, and how they use these facilities goes a long way to explaining their future financial performance. In most cases BNPLs will pay the merchant first, and then have the customers repay them over time. Generally speaking, the higher the repayment (amount) and frequency, the better the receivables turnover should be. Think of receivables turnover ratio as a measure of how efficiently a firm uses its assets.
When looking at receivables turnover, it’s important to note that Afterpay, Sezzle Inc and Laybuy have the shortest repayment terms and the highest repayment frequency; for example typically four interest-free payments over six weeks. As a result, they tend to have the highest receivable turnover, and hence business models that are more capital-efficient.
Another key metric to track when comparing BNPLs is net transaction margin (NTM), which reflects a company’s gross profit (as a percentage of gross merchant volume) after factoring in losses and funding costs. The higher the NTM the better. The beauty of the NTM is it reveals to investors the business model’s operating profitability and it the direction (trend line) in which it’s heading.
Then there’s the cost income ratio which is the ratio of total operating costs (excluding bad and doubtful debt charges) to total income (the sum of net interest and non-interest income).
Based on last year’s earnings results, Zip Co has the highest NTM, albeit on low turnover relative to its peers. In the case of LayBuy and Sezzle, NTMs are at the lower end, reflecting lower gross profit per transaction.
Business models: A snapshot
Afterpay offers a variation to the traditional lay-by model by allowing consumers to pay for products in four instalments while being able to use the product straight away. Afterpay removes the need for the retailer to track and hold stock and payments in return for a small percentage-based fee.
Underscoring Afterpay’s model is its superior capital efficiency and the uniqueness of its model to capture value. It’s Afterpay that ‘owns’ the customer who pays the instalments to Afterpay rather than the retailer. Its initial core target markets were tilted towards discretionary consumer markets, which typically have high gross margins, which in turn makes Afterpay’s merchant fees more supportable.
Afterpay effectively becomes the ‘destination’ for the consumer who can efficiently compare product offerings at the Afterpay website. This leads to a continuum of lower customer acquisition costs, better credit quality over time, and greater brand awareness and loyalty.
Afterpay’s net transaction margin (NTM) is derived by taking its fee income from sales and subtracting bad debt and receivables warehouse funding costs to reach an operating profit margin on each transaction. As a percentage of underlying sales, Afterpay’s NTM remained strong in the first half full year 2021 at 2.2%.
Here in Australia, the main differences between Afterpay and Zip Co’s business models are that Zip Co lends longer and charges a $6 monthly account fee. By comparison, during FY20, Zip Co achieved a strong cash gross profit margins of 50% in Australia and NTM of more than 2% in the US alone.
The Mid- and Small-Caps
A leading BNPL provider in the US, Sezzle has since 2016 grown to around 27,000 active customers transacting with 3321 merchants. The company does not charge consumers interest or other fees, with the bulk of revenue coming from fees paid by merchants. However, there are reactivation and rescheduling fees for consumers who can’t make payments on time.
By comparison, small-cap BNPL rival Splitit came to the market by empowering consumers to use their existing credit card without going to new debt to spread payments over time. Based on Splitit’s research, this is exactly what consumers were telling management they wanted. Splitit CEO Brad Paterson told ShareCafé that the company has consciously differentiated itself from other BNPL operators by servicing a different end of the market.
For example, the average order value is four times that of other BNPL options. “The magic of Splitit is that the consumer – who pays neither applications nor fees – never leaves the retailer’s site,” says Paterson. “100% of our revenue comes from retailers, and the service is available to 1.8 billion credit card holders.”
Formerly called FlexiGroup, Humm Group is another small-cap in the BNPL space with Hummpro, a BNPL option for SMEs. The company’s cost to income (CIR) ratio is expected to increase to support its UK and Canada launch.
Micro-cap BNPL stock Openpay Ltd recently entered the US$55.8 billion US and UK veterinary markets in partnership with cloud-based product leader in global veterinary software, ezyVet. Expanding Openpay’s entry into the healthcare sector, the newly inked partnership will enable any of ezyVet’s practices in the US (by early FY22) and UK (late in FY21) to offer payment plans to pet owners seeking to spread the cost of their veterinary procedures and treatments.
Here in Australia, Openpay was the first BNPL player to enter the hospital segment of the Healthcare vertical via a major partnership with St John of God Health Care. The initial launch across three hospitals allows patients to spread their hospital costs for elective surgery procedures, across plans ranging from two to 12 months.
Also at the microcap end of the BNPL sector is Kiwi company LayBuy, which launched in 2017. Having entered the UK market in 2018, LayBuy claims to be one of the most capital-efficient, with weekly payment cycles resulting in it turning capital around 24 times annually.
LayBuy managing director Gary Rohloff told ShareCafé that when fully drawn, the funding line enables the business to achieve a NZ$4 billion annualised gross merchandise value (GMV). In contrast to other BNPL operators, 85% of LayBuy’s transactions use a debit card, never charge interest, and are currency agnostic.
Another ASX-listed BNPL tiddler (market cap $231 million) is relative newcomer IOUpay Ltd which is aggressively targeting the South East Asia e-commerce sector. Catering for top-tier customers, IOUpay currently processes more than 18 million transactions a month in Malaysia and Indonesia. IOUpay’s share price recently rallied on news it had signed a strategic agreement with Malaysia’s MYP1 to integrate with its Smart POS system.
Then there’s Zebit Inc (ZBT), which while technically not at BNPL stock, is an E-commerce company offering a one-stop shopping retailer in the US. Founder and CEO of Zebit Marc Schneider told ShareCafé that Zebit was created to help disintermediate the predatory financial providers that prey on the country’s 120 million US credit challenged consumers, and offer the ability to pay over six months.
What will ultimately separate future winners from losers in the burgeoning BNPL sector is how profitable and durable their business models will be as the market becomes more regulated, increasingly crowded, and more commoditised. Watch this space.