The acquisition of Afterpay by Square will provide additional glue for the Square super app. Volker Schloenvoigt (Principal, London) looked at the recent blockbuster deal.
If there ever was a person remotely interested in payments who wasn’t aware of Buy-Now-Pay-Later (BNPL) surely the last few weeks would have caused some stir. Hardly a day goes by when we see press releases about upgraded company valuations in this space (Klarna, one of the global leaders, is now valued at $45bn after the latest round of equity funding led by Softbank Vision Fund 2), a series of capital raises (tabby in the UAE raised $50m in Series B funding whilst UK-based Zilch raised $110m led by Goldman Sachs in another Series B round) as well as consolidation and market expansion (the same Zilch acquired lender Neptune Financial to accelerate the launch in the US, Discover invested $30m in Sezzle to bring BNPL capabilities in-house and Apple announced its own development of a BNPL solution with Goldman Sachs). There are many more deals and activities that could be quoted, but you get the point. A lot is happening in this space; there is much hype.
We have talked about BNPL on various other Newletter occasions before, including in this M&A column when we looked at the acquisition of Paybright by Affirm earlier in the year. So to keep it brief, BNPL appears to be a very attractive payment instrument to many customer segments, especially younger demographics. The Financial Times recently referred to some data analysis from Adobe Analytics suggesting that BNPL transaction volumes have tripled within one year. Cornerstone Advisors has estimated sales of $100bn with BNPL programmes in 2021 in the US alone (from $24bn in 2020). The core idea of BNPL is that purchases can be split over several instalments, and unless these payments are being missed, there is (usually) no fee to the end consumer. Fees are being paid by merchants who benefit from higher conversion rates (and supposedly bigger basket sizes) in return. Consumers can spread payments over a longer period than monthly credit card bill cycles, which is why these interest-free instalments are considered by many a consumer-friendly form of credit. But to provide some balanced argument, there is also increasing concern by regulators about the role that BNPL might play in pushing young and possibly vulnerable consumers into indebtedness. More regulation might come, but this is a whole debate in itself and should not be the focus of this particular article.
In addition to all the activities mentioned above, the acquisition of publicly-listed Afterpay, one of the largest global players in BNPL, by Square for $29bn in early August was undoubtedly THE deal to watch last month. The deal is expected to close in Q1 2022, at which point Afterpay shareholders will own 18.5% of Square. Although the deal, which implies a 30% premium on Afterpay’s recent stock price, was considered by some industry observers as expensive, it did not do the Square share price any harm; Square shares rose by 10% on the announcement.
Let’s have a look at Afterpay’s business first.
As the story goes, Afterpay was launched by neighbours Nick Molner and Anthony Eisen in Sydney, Australia. Nick was selling access jewellery on eBay and quickly became the second-largest jewellery trader on eBay Australia. By doing that, he noticed first-hand some of the challenges in e-commerce, namely low conversion rates and a tendency of younger customers to use debit cards for daily purchases making it harder to buy high-value items. Anthony introduced Nick to Touchcorp, a payment processing company. Turn the clock forward by a couple of years and Afterpay was born. That was in 2014. Afterpay is primarily targeting fashion and beauty retailers with an impressive list of merchant customers ranging from Estée Lauder, Armani, YSL and Lancôme to Swarowski, sunglass hut, Clinique, Marks & Spencer, Victoria’s Secret and the Kardashians (might be of interest to those of you that follow them). One of the main reasons the fashion and beauty segment is so attractive relates to a large share of emotional or impulse purchases, meaning consumers start browsing without a clear intent to buy. When deciding to make such impulse purchases, splitting the total purchase value into smaller chunks becomes very appealing. At the same time, the average transaction values, especially in fashion, are lower than in electronics, thereby reducing the risk of losses.
In terms of the business model, most BNPL related revenues (~85%) are generated by merchants. Afterpay charges a fee of 4-6% of the transaction value to the merchant (this would also cover any interchange fees due). Additional revenues are generated in the form of late fees when customers do not pay their outstanding balances on time. These late fees tend to be in the region of $7-10 per missed payment. By the end of the 2020 financial year, Afterpay generated revenues of AU$520m on total sales of AU$11bn. By the end of the latest financial year ending in June 2021, total sales have grown from AU$11bn to AU$21bn! As for one of the key risks, potential credit losses are managed well, for example by not allowing to use Afterpay again until prior balances are paid off, and are now well below 1% of total sales (only 5% of all transactions incurred a late payment fee). Today, Afterpay serves 16m active customers and offers its BNPL solution to more than 100,000 merchants. It operates mainly in Australia, New Zealand, the US, and many European markets under the ClearPay brand (also following an earlier acquisition of Spanish fintech Pagantis).
We recently talked about the Tidal acquisition by Square, posing the question of whether that was the start of the Dorsey super app. Well, the acquisition of Afterpay has just confirmed the belief that this is where Square is heading. Square has already created its ecosystem with merchants on one side and consumers on the other. Merchants are being offered payment processing services, and given that Square Financial Services holds a banking license, it can extend its offering to lending facilities. On the other side, there is the Square cash app which facilitates payment-related services to customers. Afterpay will provide additional glue between these two parts of the Square ecosystem. And this is where the super app idea comes back into play. For a super app to succeed, it must have the right providers (with the most desirable services) and the right consumers (with whom the providers want to do business). The super app then acts as a matchmaker. In the deal-related press release, Jack Dorsey said the following “Square and Afterpay have a shared purpose. We built our business to make the financial system more fair, accessible, and inclusive, and Afterpay has built a trusted brand aligned with those principles. Together, we can better connect our Cash App and Seller ecosystems to deliver even more compelling products and services for merchants and consumers.” He might not have mentioned the term super app, but this is surely where things are now heading.
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