Trending Assets
Top investors this month
Trending Assets
Top investors this month
$10.5MFollowers
BNPL: If it walks, talks, and quacks like a duck...
Hi everyone - I hope my American readers had a great Thanksgiving! Today I wanted to air out my grievances on the "Buy Now, Pay Later" market and how investors in these companies (myself included) should reexamine the true nature of these business models.
Disclosure: I own some private shares of Klarna.
While 2022 can be characterized by a multitude of manias - the Buy Now, Pay Later (BNPL) hype stood out as a relatively quiet rumble relative to the enthusiasm found in other hot sectors like electric vehicles or cryptocurrencies. Proponents of this service championed that BNPL was an improvement over the existing credit card architecture where consumers succumb to sky-high interest rates and merchants are stuck with 3-5% transaction fees. BNPL businesses would charge consumers 0% interest (barring any late payments), yielding larger average order values (AOVs) for merchants. The value prop for merchants and consumers was obvious and drove a plethora of activity last year - featuring robust institutional adoption and mimicry from blue-chip financials. Affirm, for instance, was founded by Max Levchin - an alumnus of the PayPal mafia and a renowned entrepreneur in the FinTech space. Affirm IPO'd in January '21 at a valuation greater than $27B, or >30x forward sales, with backing from some of the largest venture investors and asset managers. In the summer of '21, Affirm would hit an all time high of ~$170/share, or a $46B market capitalization on a ~$1B run-rate.
If last year's market taught us anything: Life comes at your fast! As of this writing, Affirm ($AFRM) is down 90% from highs, trading around a $4B market cap and has yet to post an operating profit since becoming public.
I don't mean to beat up on Affirm in particular, this was a global phenomenon! Last summer, Klarna (highlighted above) was the most valuable private fintech in all of Europe, valued at $45B (>30x NTM sales) following a round led by SoftBank. Klarna was quick to remind investors of historical profits (and ongoing profitability in core markets) as their edge over competitors. Similar to Affirm, Klarna also highlighted the breadth and scale of their retail partners to reinforce their astronomical valuation. Nevertheless, the company continued to post mounting losses and charge-off rates amidst a tightening monetary environment. Klarna did not have to go public for the market to properly discount these losses: Earlier this summer, the company announced a new round of financing at a $6.8B valuation, or an >80% drawdown from the mark set in 2021.
Afterpay, one of the Australian BNPL vendors, stands out from industry peers in that they've successfully returned capital back to shareholders. Last August, the company was bought by Block (f/k/a Square) for $29B in stock, or 42x LTM sales. Even then, however, by the time the deal closed in February '22, investors received a meager $14B, as Block's share price cratered in tandem with competing fintech businesses. Since acquisition, Afterpay has allowed $142MM in bad debts, while only contributing $550MM to the top line.
At this point it's worth highlighting that BNPL was not a retail-driven phenomenon. Investors had sufficient reason to believe this trend had serious legs. Goldman Sachs ($GS), for instance, acquired GreenSky last year as a means of bolstering their suite of consumer banking services. PayPal ($PYPL), the north star of FinTech, also introduced a BNPL product, propelling their enterprise value north of $350B last summer. Apple ($AAPL), the world's largest company with a successful Apple Pay product - announced last year that they would provide a similar service to customers looking to pay for items over an extended period. The collective confidence of the world's largest company, largest fintech, and one of the most respected investment banks in the world endowed investors with the confidence that Buy Now Pay Later was here to stay. The reality, as we now know with the benefit of hindsight, was much more complicated than that.
What is wrong with BNPL?
For the sake of angry commenters, I want to emphasize that there is nothing fundamentally wrong with BNPL services, nor do I believe these companies will fall off the face of the earth. Consumer lending is ubiquitous within the global economy and some of the world's largest companies ($V, $MA) are in the business of extending short-term credit to individuals.
The concern I have with BNPL companies is their characterization as anything other than just a bank. Sure - companies like Klarna, Afterpay, and Affirm have transactional operating segments that take a 2-3% cut on all transactions made using their service - which leads many investors to believe that credit card businesses are an appropriate analogue (and thus should command comparable valuation multiples). The caveat with this reasoning is that BNPL companies are engaging in bank activities - providing point-of-sale credit without interest nor thorough credit checks. Traditional card businesses, by contrast, are marshaled by banks with strict guidelines on interest rates, credit limits, and determining general creditworthiness. The mechanism in which BNPL companies issue credit to their customers resembles that of a bank. In Klarna's case, the company collects customer deposits as a means to leverage their status as a licensed European bank and reduce their cost of capital. However, when interest rates are spiking as quickly as they are today, the debt markets don't really care how much in deposits you have.
Playing the Rebound? Caveat Emptor...
Again, with the benefit of hindsight we can comfortably say that any company trading 30x forward sales or higher is overvalued, much less a bank. Banks, more often than other stocks, are priced based upon their book, or net-asset value. Banks generate revenue from their asset base and are subject to stringent capital reserve ratios and lending standards. As a consequence, bank stocks (even the largest and most successful, i.e. JPM, BRK) don't typically command huge premiums to their book value (see below).
The digital origins of today's finance businesses has led some investors to question the merits of a Price-to-Book valuation method, particularly given forward growth expectations. That being said, Buy Now, Pay Later is indubitably a banking activity. Similarly, collecting deposits is a banking activity. Registering as a bank? Sure sounds like a banking activity to me.
If it walks, talks, and acts like a bank - it should be valued like a bank.
Thanks for reading!
Tom
Already have an account?