As much as I admire $AFRM and consider it one of my core holdings, I’ve been taking a bit of profits on this insane rally and reinvesting in the amazing stories like $PYPL and $SQ which are bargains at these levels.

With a rapidly expanding ecosystem of consumers and merchants, Affirm is on track to join the ranks of $PYPL and $SQ and create one of the most dominant “Super Apps” in the U.S.

Founded in 2012 by Max Levchin, Affirm is on a mission to “deliver honest financial products that improve lives.”

Affirm is reimagining the credit card which for seven decades was “the ultimate buying bundle, a single product allowing you to put purchases of all sizes together in a one basket with the freedom to pay for them later.” As convenient as it was, the credit card also became the biggest financial burden for millions of U.S. consumers who, as of June 2021, had $787B of credit card debt outstanding, on which they paid over $120B of interest and fees last year. This is equivalent to $1,000 in fees per household.

Unsatisfied with the status quo, Affirm set out to create a product which fulfilled the promise of the credit card – buy now and pay later – but in a way that was fair and transparent. Thus, the Buy Now Pay Later (BNPL) product was born which today is a $100B industry worldwide expected to exceed $4T by 2030 propelled by the strong resonance with consumers’ distaste for debt. (The way to think about the industry is in terms of its e-commerce penetration. In 2020, BNPL accounted for 2% of U.S. e-commerce volumes. This compares to 4% in the UK and 10% in Australia.)

Affirm is the 3rd largest player globally after Klarna and AfterPay (Square). Its value proposition to consumers is simple: split the cost of your purchases over multiple installments versus paying all at once. This means more people can buy expensive products sooner – a Peloton bike, a Casper mattress, or a vacation trip through Expedia. It’s also great for merchants who have reported a 20-80% increase in sales by incorporating Affirm into their checkout, attracting more customers, converting more sales, and getting higher repeat rates.

Over 7M people shopped with Affirm in its 2021 fiscal year (ending June 30). Each customer spent, on average, $1,150 which translated into $8.3B of GMV for the year. Affirm monetizes its GMV in two primary ways: (1) merchant fees and (2) interest income.

** Merchant fees: Affirm charged its merchants, on average, 5.2% on every transaction for integrating its BNPL offering into their checkout flow, netting $429M in merchant fees. (For brands, this is essentially an alternative to performance marketing.)

** Interest income: While some customers may qualify for 0% financing when checking out with Affirm, the majority pay interest up to 30% APR depending on their credit score. Last year, Affirm earned interest on 60% of its GMV, netting $125M after transaction costs and credit losses.

What’s unique about Affirm is its focus on high-ticket items. Affirm’s average order value (AOV) last year was $550 vs AfterPay’s ~$100. On the one hand, higher AOV translates into significantly higher take rate. (Affirm’s net take rate, including merchant fees and interest income, was 7% vs AfterPay’s 2.2%). However, on the other hand, the focus on high-ticket items leads to low purchase frequency (Affirm’s customers transact, on average, 2.3 times a year vs ~15 for AfterPay) and, therefore, limited engagement with customers (30% of Affirm’s transactions originated in its app vs ~70% for AfterPay).

Therefore, Affirm has been gradually expanding into smaller-ticket, higher-frequency purchases like apparel and home decor, as can be seen from the increasing transaction frequency (from 2 to 2.3) and decreasing AOV (from $639 to $550) in the last two years. A major step in the direction of facilitating more frequent purchases was taken last year: Affirm signed a deal with $SHOP to provide BNPL capabilities for its 1.7M merchants. (To put it in context: Affirm at the time had 5,700 merchants.) The Shopify partnership began to bear fruit in early 2021, as the number of active merchants increased from 7M in December 2020 to 29M in June 2021; the customer base grew from 4.5M to 7.1M; and the revenue growth accelerated from 57% to 71%.

During the FY4Q21 earnings call, Affirm said the number of participating Shopify merchants was in the “hundreds of thousands,” suggesting the trend toward more frequent transactions will continue. Moreover, in late August, the company announced it would bring BNPL to $AMZN merchants, the news which drove the stock over 40%.

Partnerships with two leading e-commerce platforms create an enormous runway for growth, and I expect more major retailers and leading brands to choose Affirm over the coming months. (Affirm’s roster of partners already includes Walmart, Target, Neiman Marcus, and hundreds of billion-dollar brands.) In the hyper competitive, rapidly evolving commerce world, Affirm’s technology has proven highly effective at creating customized, flexible, secure, and delightful shopping experiences converting more customers and driving sales for brands and merchants.

While partnerships will continue to drive scale for years to come, behind the scenes, Affirm is developing a much more powerful self-reinforcing growth engine. Borrowing from AfterPay’s playbook (more merchants → larger product catalog → more customers → higher shopping frequency → better outcome for merchants → more merchants), Affirm is building a powerful flywheel and a strong two-sided ecosystem serving consumers and merchants reminiscent of PayPal and Square.

The upcoming launch of Affirm Debit+ Card helps prove the point. Powered by the same BNPL technology, the card will further transform the shopping experience, empowering consumers with greater control over their everyday spending and long-term financial planning. I doubt Affirm will stop there. Capitalizing on its existing technology, Affirm could bring BNPL to more parts of people’s lives, such as rent, food, healthcare, and other services, which account for 70% of the average American’s spending, thereby further gaining the share of its consumers’ wallets.

The rollout of the high-yield savings account is a sign that Affirm’s ambitions stretch far beyond commerce (and spending) and aim at building more trust and creating deeper relationships with its customers. Affirm is also getting into crypto and will soon unveil its new Super App.

Coined by Blackberry and proven by the Chinese social platform Tencent, the super app is “an ecosystem of related services under one roof with fully integrated financial infrastructure to engage these services.” According to Commerce Ventures, the super app ecosystem must meet three criteria: (1) have dominant scale across both consumers and merchants, (2) exhibit highly habitual and interactive behavior within the app, and (3) natively incorporate commerce and payments. The VC firm claims that, “in the U.S., no single player has achieved “super app” status,” but that $AAPL and $PYPL are the closest to “crack the “super app” code.”

Although there is a lot of work ahead for Affirm to become the dominant financial platform for consumers, the company has a unique advantage over its super-app peers: risk underwriting. Besides $UPST, Affirm is the only consumer FinTech which has spent ten years successfully honing credit underwriting capabilities – the hardest, but also most lucrative skill in financial services. These capabilities enable Affirm to extend any form of credit – from short-term interest-free “Pay in 4” to 60-month interest-bearing term loans – to any type of consumer, and do so profitably, at the most favorable terms for its own bottom line. (As of June 30, 2021, Affirm had $6.5B in funding capacity. Its participation in funding its loans decreased to just 4% in 2021, while its average interest cost decreased below 2%.)

With the underwriting technology at the core of its products, Affirm’s growth strategy comes down to (1) growing the number of users and (2) gaining the share of their wallets.

** Grow users: Alongside its existing partnership model, Affirm has been investing in direct marketing, having increased its sales & marketing spend 10X to 15% of revenue over the last year.

** Gain wallet: GMV per customer has been steady at $1,200 over the last two years, with AOV slightly down and transaction frequency slightly up due to Affirm’s push into lower-ticket higher-velocity items.

What does Affirm’s current share price of $130 say about investors’ expectations for Affirm’s user base and GMV? Discounting future cash flows at 7% and assuming exit EV/FCF multiple of 30X, the current stock price implies 30M (4X growth from today) consumers spending $6,000 per year with Affirm (5X growth) in five years. In total, this implies $180B of GMV vs $8B last year. (22X growth!)

At a first glance, the topline growth of 22X appears high. However, peeling back the onion, one would realize that the profitability of incremental dollars will be significantly lower than it had been. Affirm’s expansion into lower-ticket items will compress its take rate from 7% to less than 3%, while the rollout of the debit card will dilute profitability even further. (I expect Affirm to net less than 1% per transaction in interchange fees and conservatively assume no merchant fees on debit card GMV as the company further shifts the focus to transaction frequency.) Overall, we’re looking at 4X growth in the consumer base and a 2X increase in gross profit per consumer – from $60 in FY21 to $130 in FY26. (For reference: $SQ earned $53 in gross profit per Cash App user in 2Q21.)

Another way to evaluate Affirm’s prospects is through the lens of retail sales and, specifically, e-commerce growth. U.S. e-commerce is expected to grow from under $1B in 2021 (15% retail penetration) to $1.6B in 2025 (24%), according to eMarketer. Today, Affirm accounts for 1% of total e-commerce. Five years from now, $180B GMV will be equivalent to 10% of total e-commerce and 2.5% of total retail sales. While the former sounds overly ambitious despite Amazon and Shopify – half of the e-commerce market – being Affirm’s strategic partners, the latter appears reasonable, especially in light of the increasing number of traditional retail majors like $WMT and $TGT partnering up with Affirm.

Nevertheless, there’s a lot of execution ahead for Affirm. Moreover, the competition is intensifying, with $SQ acquiring AfterPay, Klarna aggressively expanding in the U.S., $PYPL demonstrating solid traction with its Pay in 4 product, $AAPL rolling out BNPL services in partnership with $GS, and most recently challenger banks using BNPL as a new customer acquisition channel. Finally, regulators are yet to agree on governance principles for the BNPL industry, which could restrict growth, impose capital requirements, and worsen unit economics. Affirm’s diversification of its offerings will help mitigate industry-specific risks; however, as the majority of its new partnerships and products are yet to formally launch, let alone gain scale, there are currently no data points to suggest Affirm will succeed.

That said, Affirm is a key player at the intersection of two enormous categories – commerce and financial services – undergoing a major transition and growing rapidly. It has built a strong, profitable business; has a devoted customer base (both merchants and consumers); and, most importantly, has a solid 10-year track record which, in the last 18 months, passed a very difficult test. Further announcements of new partnerships, integration with Shopify, progress on Amazon, and progress with the newly launched financial services will de-risk Affirm’s growth profile and elevate the stock to $200-250. (Here’s the link to my financial model for you to play with assumptions and do your own math.)