America’s horse in the buy now pay later race is going public

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You will be forgiven for struggling to keep up with the wave of new buy now pay later firms that are popping up around the world. Australia alone seems to have at least half a dozen who are publicly listed and driving reasonable adoption with merchants and buyers. There are however three firms that stand out as leaders of the pack. The original was Klarna, born out of Stockholm 15 years ago, then there is the Australian leader and fast growing Afterpay, and third is America’s Affirm, who last week published their prospectus in preparation for a Nasdaq listing.

Affirm launched in 2012, and following the path of Klarna many years earlier, Affirm’s mission is to give consumers a trusted way to access payment terms when shopping online, without the compounding interest or fees incurred by traditional credit card products. Equally much like Klarna, Affirm began with a simple buy now pay later proposition, and has since launched complimentary products such as a virtual card, a savings account and a shopping experience via an app enabled marketplace.

Through its integrated checkout experience customers will be given the option, depending on ticket size and merchant, to secure 0% APR instalment payments, or a fixed and unchanging interest and repayment period. Affirm does not charge compounding interest or late fees, unlike traditional credit cards. So customers always know how much they will be due to pay, even if they make a payment late.

Affirm’s virtual card proposition is really clever. By providing customers with a Visa enabled card, it doesn’t matter if the merchant is an Affirm acceptance partner or not, the buyer can still take advantage of making instalment payments from their Affirm account. 

So what about the size of the market? Well in Affirm’s prospectus it quotes market research by eMarketer, which believes global ecommerce will be a $5.8 trillion industry by 2023. And within that, pay later is the fastest growing payment method. While Klarna is 15 years old, we’re still relatively early in the adoption curve. 6% of online purchases in EMEA are made using a pay later product, while in the US it is only 1%. The latter is Affirm’s home and only market, barring a small amount of business in Canada. Klarna and Afterpay have made serious efforts to enter North America in recent years.

So where do the three stack up in terms of adoption? And what can we ascertain from Affirm’s prospectus in terms of their chances of further growth and success? While over time the three have launched some unique products, there are three common metrics which allow us to compare their current scale - the volume of payments made through the platform, the number of buyers registered and the number of merchants accepting payments. These data points show Klarna’s time in the market, but also the impressive growth of Afterpay which launched two years after Affirm and in a smaller market (Australia v United States). 

Volume in USD
* Affirm and Afterpay 12 months to July 2020

** Klarna 12 months to December 2019. Active Buyers were only counted from active users of the Klarna app, not all payments processed via the Klarna checkout product.

So Affirm has its work cut out if it wants to be the market leader in this category. One reason to be bullish about its ability to accelerate growth is its status as the native American player. The United States is the prized market for commerce enablers, and as stated only 1% of ecommerce payments are facilitated by pay later payment methods today. As both ecommerce and pay later product adoption grows, Affirm should feel well positioned to capture that growth. One question is whether Americans want to move away from credit cards, where the lack of interchange regulation means cardholders receive great benefits and points programmes. 

There are also a number of risks to Affirm’s ability to be successful post IPO. First and one that has rightfully been called out by many since they published their prospectus is their revenue concentration in one single merchant. Remarkably 28% of Affirm’s FY20 revenue came from Peloton, and this grew to 30% in the last quarter. Peloton customers are putting big ticket sizes through Affirm to purchase the $2,000 exercise bike in instalments. Of 6,500 merchants, to have 30% of your revenue predicated on one partner is a considerable risk. That customer has strong leverage to reduce fees, or if Affirm loses that business then that’s a big chunk of revenue lost.

Another risk is the breadth of competition. Not only from like-for-like players such as Klarna and Afterpay, but also PayPal who have just entered the space with an interest and fee free pay later solution to compliment PayPal Credit. There are 346 million active PayPal accounts globally, so if a customer can use their PayPal account to make instalment payments, they are less inclined to sign up to a new service to achieve the same outcome. 

Equally other large payment incumbents are moving into this space. The card schemes are not going to let this category come and eat their cards payment volume without a fight. Both Visa and Mastercard have announced partnerships with TSYS to enable its issuing bank partners to enable instalment payments for its cardholders at checkout. Meaning customers of participating banks will not need to sign up for Affirm or another provider to gain access to installment payments.

This competition is what makes the shopping experience so important for these pay later products. Affirm is investing heavily in their marketplace in app, with personalised offers which learn from users behaviour. Over 30% of Affirm transactions occurred last financial year through the marketplace, which is a point of differentiation. They will be looking to grow this number as a moat.

Another notable risk is potential increased regulation on the sector. In many markets, Affirm and their peers avoid direct regulation as their products do not incur compounding interest or fees, which is the benchmark for most local regulators to consider it a consumer credit product. However, media reports of young people getting into unsustainable debt through the use of pay later products are triggering regulators, such as the FCA in the UK, to investigate their stance on this regulatory framework. 

And finally, Affirm are reliant on third party loan origination partners to fund the advances made to merchants. Should market conditions change, or defaults rise, these lenders could choose to pull its support and Affirm would be left without an appropriate level or terms of finance to meet the demand for billions of dollars worth of transactions. As issuing banks and even PayPal move into this space, they will hold a competitive advantage on access to deposits. 

In efforts to combat this, Klarna has already chosen to go down the path of becoming a licensed bank in Sweden, and is growing horizontally through cards, savings and other banking solutions. Affirm launched a savings product in 2020 where the money will be held in a Cross River Bank account, in efforts to lower the cost of finance. While they are also testing their own loan origination in Canada, where they have dabbled in $36 million worth of loans. Over time Affirm may look to become less reliant on its banking partners.

So while there is a lot to think about in terms of the market they play in, and the competitive landscape, there is a good story to tell when you review the financial indicators. In FY 2020 Affirm grew annual gross merchant volume by 77% to $4.6 billion, while active customers also grew 77% YOY. Meanwhile contribution profit grew to 3.9% of GMV. For comparison Afterpay remained flat in the same period at 2.3%. This means Affirm is securing a higher merchant rate and better managing financing costs (interest and losses), which indicates better marginal economics. On revenues, Affirm reported $510 million last financial year, showing 93% YOY growth.

For mine the key for Affirm will be sales execution. There is a window of opportunity available to them right now, before Klarna and Afterpay gain traction in America, before PayPal captures too much of the market, and before the card schemes and the incumbent issuing banks get their technology in order. If Affirm can really put their foot down in America’s lucrative ecommerce market over the next two to three years, there is plenty of growth ahead of them. Signing Shopify to an exclusive deal in July was a big win, considering over $10 billion passes through Shopify stores globally every month. It took us a decade to get here, but this category is hitting its inflection point, I’m certainly watching with great interest to see who the winners are.

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