Even before COVID-19, the buy-now, pay-later (BNPL) sector was surging in both user popularity and on the stock market in terms of share prices, but BNPL is having a good pandemic, as the lockdowns and social-distancing requirements in many countries push more people into online shopping.
A March report from Worldpay, a subsidiary of financial services giant FIS, showed that the number of Australians using BNPL products like Afterpay or Zip Pay has more than doubled in the past year, to the point where nearly two million people (or one in ten) now use such platforms.
The report predicts that the number of BNPL users will pass 4 million by 2023, by which time Australia’s ecommerce market will be worth US$47 billion. The share of BNPL payments of ecommerce transactions will jump more than 166% in that time. BNPL currently accounts for 8% of global e-commerce transactions – the Worldpay report projects that proportion to more than double by 2023, to 17%.
The COVID-19 pandemic keeping many people at home appears to have boosted online shopping, with government stimulus packages also flowing through into BNPL use. In Australia, Australia Post said in May that the online shopping volumes it was handling were up 80% compared to last year. In the UK, while May’s retail sales fell by 11% year-on-year, online sales jumped 50%, according to UBS; and it was a similar story in the US, where retail sales were down by 14%, but online surged 31%.
That is great news for the BNPL providers, which are benefiting from the rising e-commerce spending, direct government stimulus and increasing use of debit cards as opposed to credit cards.
The BNPL sector is a bit misunderstood. It isn’t just millennials splurging on that latest dress, or pair of sunglasses, on the never-never – that would not work. Indeed, a single overdue payment sees a user locked out. Investors need to get their heads around the fact that BNPL services help retailers hugely – paying them upfront for shoppers’ orders, bringing them higher order sizes, increased conversion rates (from ‘add-to-cart’ to actual sales), lower return-of-goods rates, increased referrals, and increased return customers. The sector’s true value is based more on what it offers retailers than what it offers shoppers. If shoppers can spread the spending over time, and pay in instalments, they are more likely to spend more – that’s the secret sauce of BNPL.
1. Afterpay (APT, $67.50)
Market capitalisation: $18.1 Billion
12-month total return: 155.8%
Estimated FY21 dividend yield: n/a
Analysts’ consensus target price: $40.98 (Thomson Reuters), $43.49 (FN Arena)
The rise and rise of Afterpay continues to confound the share market. It still has not made a profit (and is not expected to until FY22), but it is valued at $18.1 billion, enough to put it inside the S&P/ASX 20. Like most stocks, Afterpay was hammered by COVID-19. From a February peak of $39.87, APT was trading at $8.90 on the day (23 March) that a floor was established under the Australian market – a floor only visible in hindsight. At $67.50 now, a hypothetical buy at that price has returned more than seven-and-a-half times an investor’s money.
At these levels, APT’s valuation is sky-high. Technology investors focus mostly on how quickly Afterpay can increase its revenue, instead of its profit. That revenue is driven by the size of its customer base and its merchant network, driven by the transaction numbers pushed through its system and the average value of those transactions per user. Being unprofitable, Afterpay is typically valued on a multiple of its enterprise value (EV)-to-sales, a ratio commonly used to value high-growth tech stocks. (Enterprise value is the sum of the company’s market capitalisation, plus its debt, plus any cash on the balance sheet.) But even using this measurement, APT is very difficult to value.
According to Yahoo Finance, APT’s trailing (historical) EV-to-sales ratio is 54.9 times, while the forward (June 2021) consensus-based 12-month forward EV-to-sales ratio of 24 times.
As broker RBC Capital points out, that compares to the median of peer US stocks, at 16.2 times. Then again, Afterpay’s expected sales growth in 2021 is about 62% – well above the median growth rate of 27% for the US tech stocks.
Afterpay is growing very strongly overseas. In May, it said it had passed more than five million customers in the US. Last month, it passed one million customers in the UK. It is now launching into Canada. Broker RBC Capital estimates Afterpay had 9.8 million customers as at the end of June, with gross merchant value doubling on the prior year to $10.6 billion. And it is only touching the surface of growth in its target markets. Chinese internet giant Tencent taking a 5% stake in the company in May showed the market that Afterpay’s growth plans have very solid backing. Its current US user base of 5 million represents just 2% of the population.
But what’s it worth? That is the million-dollar question. Here’s what the brokers think, courtesy of FN Arena.
- UBS – has a target price on APT of $25.00, which it lifted from $14 today – and rates it a ‘Sell.’
- Citi – has a target price of $64.25 – and a rating of ‘Neutral.’
- Ord Minnett – has a target price of $64.70 – and a ‘Buy’ rating.
- Morgans – has a target price of $46 – and a ‘Hold’ rating,
- Morgan Stanley – has a target price of $36 – and a rating of ‘Equal-weight.’
- Macquarie – has a target price of $36 – and a rating of ‘Outperform.’
You can see the problem – even the brokers that are bullish on Afterpay have target prices that the stock has well and truly overshot. There are plenty of risks, from potential rises in bad debts, to market competition, to heightened regulatory scrutiny. Another crucial risk is that Visa and Mastercard simply move in and take over the BNPL market – although at the moment, they seem keen to partner with individual firms. Buying APT at these levels is only for the truly gutsy – or truly convinced.
2. Zip Co (Z1P, $5.74)
Market capitalisation: $2.2 billion
12-month total return: 87%
Estimated FY21 dividend yield: n/a
Analysts’ consensus target price: $6.50 (Thomson Reuters), $6.45 (FN Arena)
Zip Co has emerged as Afterpay’s main rival, underpinning its move into the US market with a deal last month to buy local BNPL business QuadPay, of which it already owned 14%. The new combined group will have operations in Australia, New Zealand, the US, UK and South Africa. It is a transformational buy, changing Zip Co from a domestic BNPL company to a global leader. Zip Co will have a combined annualised total transaction value of $3.0 billion and annualised revenue of $250 million. It will also boast 3.5 million customers and 26,200 merchants.
QuadPay also brings with it Virtual Credit Card (VCC) technology, which could be a real game-changer in the space. VCC allows customers to choose at the time of checkout a direct, normal payment, or a four-instalment, six-week interest free payment schedule. Each customer has a pre-set spending limit, so when they pay for something, the VCC seamlessly comes into play, through QuadPay’s ‘Anywhere App.’
Zip Co’s 31 May 2020 market update showed a 78% year-on-year increase in monthly revenue, a 63% increase in active customers to 2.1 million and a 46% increase in active merchants to 23,600. But the increase in scale that QuadPay brings is the real story with Zip Co. In particular, buying QuadPay is a very low-risk way of going into the US market.
However, it is the same problem as Afterpay – how do you value this? The trailing EV-to-sales ratio of 26.6 times, according to Yahoo Finance. Prospective numbers are very hard to find.
Taking the same look at brokers as with APT, the disparity is not as wide – in the FN Arena sample of brokers, we see:
- Ord Minnett – has a target price of $6.75 – and a rating of ‘Accumulate.’
- UBS – has a target price of $5.60 – and a rating of ‘Neutral.’
- Morgans – has a target price of $7.00 – and a rating of add.
That gives a consensus target price of $6.45, which implies that there is still some value in Z1P given the headwinds behind the BNPL sector and the transformative scale of the QuadPay acquisition. (Thomson Reuters has a consensus target of $6.50, from six analysts).
Zip Co looks to be a better buy than Afterpay at current levels, but the near-term value you can expect to realise is not seen as huge. Long-term is perhaps another story.
3. Splitit Payments (SPT, $1.385)
Market capitalisation: $770 million
12-month total return: 171.6%
Estimated FY21 dividend yield: n/a
Analysts’ consensus target price: n/a
Splitit (SPT) is a BNPL provider with a difference. Where the other BNPL businesses lend customers the full amount of a purchase at the checkout, and then allow that purchase to be paid off in instalments, Splitit allows customers to pay with an existing credit or debit card, holding the full amount on their card and taking an instalment each month.
The customer can apportion the total cost across as many interest-free payments as they like. The Splitit system charges their credit or debit card every month until their payment is completed. Thus, Splitit does not finance the consumer into the purchase, meaning it does not make short-term consumer loans. This means that worries about credit risk and bad-and-doubtful-debt build-up – concerns that have swirled around the other BNPL stocks – are not business risks for Splitit and makes its business model lower-risk than the others.
Splitit’s technology requires no application, registration or credit check: Splitit does not need to monitor and/or prevent payment defaults or bad debt-related risks, and is not subject to regulatory oversight or licensing requirements associated with providing new credit.
Splitit says that because it facilitates use issuers’ credit cards, it complements, rather than competes with, those credit cards. It says it is the only global payments solution that works using shoppers’ existing Visa or Mastercard credit cards.
Certainly, the major card issuers appear to be very happy to work with it. In March, Splitit announced a partnership with Visa, to help accelerate the distribution of instalment payments for merchants and to “explore further opportunities relating to new product development.”
The company followed that in June with the signing of a multi-year agreement – with an initial five-year term – with Mastercard, to accelerate the adoption of Splitit’s instalment solution around the world. Splitit will leverage Mastercard’s network of partners to extend and scale instalment functionality to consumers and merchants.
Splitit’s March 2020 quarterly numbers showed an 18% annual rise in sales (merchant sales volume, or MSV) to US$23.7 million, a 104% annual rise in revenue, to US$675,000, and a 108% annual rise in total merchants, to 862. North American MSV was up 336% year-on-year, while European MSV was up 548%.
Total unique shoppers surpassed 290,000 in May, up 18% from the end of the March quarter. There were 964 Total Merchants, up 12% from the end of the March quarter and the average order value (AOV) reached US$939 ($1,361) in May, up from US$737 ($1,196) in the March quarter. The company attributed this to consumers using the service for higher-value purchases including homewares, furniture, sporting goods and luxury retail.
This – apart from the credit difference in the business model – is where Splitit is most different to Afterpay. Afterpay’s average transaction value stands at $150. Splitit has an older customer demographic buying bigger-ticket items.
Splitit says its addressable market is “massive” – it says this is the US$3.4 trillion ($4.9 trillion) e-commerce opportunity globally, and the 1.8 billion-plus credit cards globally, with 70% of the available credit not utilised.
SPT has surged from 22 cents at the Coronavirus Crash trough (23 March) to $1.39. The trouble with SPT is that there are no major broker assessments to go on. The Israeli-founded, New York-based company does not make a profit, and the trailing December 2019 EV-to-sales ratio was 263.6 times, according to Yahoo Finance). Buying SPT is a leap of faith: investors buying now are banking on the company converting some of the potential market growth it sees, to eventual profitability.
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