Will Visa Be the Death of Afterpay?

Peppering the headlines this week was Australia’s favourite buy now, pay later stock, Afterpay Touch Group Ltd [ASX:APT].

Not only is the company dealing with financial regulator AUSTRAC and a management reshuffle, but they also might have to contend with giants like Visa and Mastercard.

This melting pot of uncertainty has done a real number on the stock…

Graph showing Afterpay stock level
Source: Bloomberg

In the last two months, the $6 billion company has fallen 22%, then risen 17.5%, then dropped 22.8%, then risen 42%, then dropped 19.3%, only to rise…again.

Who said big stocks can’t dance?

The Afterpay story has also been talked to death. It’s overvalued. They encourage unstainable spending habits. Visa will kill them.

So why am I writing about the company today?

Well, I want to take a look at Afterpay from another angle. One that’s not getting enough light in the mainstream.

Think Visa will kill Afterpay? Think again…

Give them a hand and they’ll take an arm

We humans are terrible at delaying gratification.

We want everything now. Whether that’s food, comfort, stock market returns or any type of pleasure.

Our small Pomeranian, Lucie is the same.

She is the definition of gluttony. She always wants treats. And when she gets them she’ll never share, not that I would want her to anyway.

That’s why Afterpay is such a wonderful business, I tell my wife in hindsight.

It gives us yet another chance to binge on a quick hit of endorphins. You get to buy that expensive watch or that coat for winter, and hey, it doesn’t break the bank either.

Give people the ability to spend, and they will.

The best example I can think of is the housing market. It’s a market that can be divided up into owner occupiers and investors.

But maybe a more apt description is ‘emotional dreamers’ and ‘thrifty return seekers’.

It doesn’t matter how much banks are willing to lend, property investors aren’t going to buy anything if they don’t think they can make a profit.

Owner occupiers on the other hand, are willing to borrow everything and anything to secure that dream purchase.

It’s why house prices tend to rise or fall, depending upon income levels and the bank’s willingness to lend.

Buying a Gucci bag probably isn’t as emotional as buying your dream home, though. But there are similarities that allow Afterpay to exist.

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Does Visa’s entry change things?

Isn’t it interesting that Afterpay is larger (in market cap) than the others…?

I’m talking about names like Zip Co., Splitit and Flexigroup.

Put those three together and it doesn’t even total 30% of Afterpay’s market value.

The fees they charge vary slightly. And the product they focus on (credit vs debit) might be different.

Yet all four provide basically the same service. They allow users to buy things now, and pay for them later.

They are the liquidity providers that let customers afford or at least feel better about buying high priced items.

And yet one is far bigger than the rest combined…

Now, with a titan like Visa Inc. [NYSE:V] entering the fray, everyone including Afterpay looks doomed.

That’s how The Australian Financial Review (AFR) portrayed it anyway…

For investors in Afterpay, the most worrying thing in Visa’s announcement that it’s entering the buy now, pay later space isn’t necessarily the specific threat of competition from one of the world’s biggest financial services companies.

Rather, the most concerning aspect of the announcement was a number: $US1.2 trillion ($1.7 trillion). That’s Visa’s view of the buy now, pay later sector, which it prefers to describe as the “instalments” market.

If it’s a market large enough for Visa, then won’t it be large enough for a whole host of new ‘buy now, pay later’ start-ups, hungry to claw market share away from Afterpay?

This was an idea investors ran with, selling Afterpay down 21% within the next two days.

SmartCompany noted that Visa ‘would be trialling new ‘instalment payment capabilities’ with selected merchants across the world. Businesses will be able to offer customers a buy-now-pay-later service via the Visa cards they already have, without using a third-party app.

I mean, how can Afterpay compete…

Visa’s got more money, a larger payment network, more users and more brand awareness.

Are investors waking up to the idea that Afterpay’s growth will be extremely lumpy in the years to come?

‘Buy now, pay later’ is a nifty idea. But how valuable can a layby stock really be?

This is no Layby

Maybe Afterpay is a bit misunderstood…

It’s not a layby stock.

Afterpay doesn’t just allow users to justify a purchase that they maybe shouldn’t be buying in the first place.

In fact, Afterpay is a company most valuable to merchants.

It’s a lead generation platform. Think of it like Google.

Pay for an ad on Google and you receive traffic to your website or business. Hopefully some of those leads follow through into buying customers. Afterpay is very similar.

Aussie merchants partnering with Afterpay get accesses to 2.7 million (Aussie users) active eyes. Hopefully, there’s a few thousand among them that become actual customers.

Then, the goal is to turn a few of those new customers into repeated loyal customers. And it’s all made easier through Afterpay.

Merchants do have to pay up for these leads, of course. Afterpay charges 30 cents, plus a 4-6% fee on each transaction.

But merchants take on none of the payment risk. They receive sales, up front, from Afterpay (less fees).

And this tends to result in higher returns than if they didn’t partner with Afterpay at all.

This is one of the reasons why Afterpay is so customer focused.

They don’t charge interest, only late fees, which are minimal at best…

They send reminders of upcoming payments…

They make sure everything runs smoothly for users…

They want to make them feel comfortable using Afterpay time and time again.

Afterpay ethics
Source: Afterpay Touch Group

It’s this strong customer relationship that Afterpay is selling to merchants after all.

And not only are their users growing in number, they also seem to be spending more money on top of what they already spend normally.

OK, but that only puts Afterpay ahead of their smaller competitors. Not Visa.

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The Millennial Edge

Hundreds of millions of people have Visa cards. You probably have one.

How is Afterpay going to overcome that?

I suspect they won’t.

The people who’ve not signed up to Afterpay but who have Visa cards (myself included) probably won’t become Afterpay users.

To be honest, they probably won’t even use Visa’s new instalment payments either. ECP Asset Management’s Damon Callaghan insightfully notes that MasterCard tried something similar in 2016.

‘…in 2016, MasterCard launched ‘MasterCard Instalments’ in Europe – a product equivalent to Visa Next instalments – off the back of consumer research that indicated consumers wanted more “flexible payment solutions to fulfil their needs while maintaining better control over their budget” . Since this launch, there has been some evidence of modest success in Romania, but limited evidence of traction in other geographies.’

Yet there are millions of users that love and use Afterpay. And they’ll probably have no desire to switch for Visa.

Why would they want to go through credit checks and signing papers when they can already buy things now and pay for them later with an app they’re familiar with?

I also posed this question to some of our wonderful millennials here at Money Morning.

Would they switch for Visa?

One of our great content writers, Leah, told me she wouldn’t…

‘I would have no problem at all using MasterCard, it would probably be even easier than APT, as you don’t have to bother using a whole separate app for repayment (like with Afterpay).  Granted you received appropriate text reminders from your Bank!

‘But for Visa/Visa Credit, I think that would make no difference, probably wouldn’t go into the effort to set it up just to use something similar to APT when I already have it.’ 

Molly, a brilliant copy editor here at Money Morning, told me something similar…

I personally wouldn’t [use Visa’s buy now, pay later option], I also don’t have a credit card…I just like using Afterpay here and there when I can’t be bothered paying something outright but know I can make the payments. I don’t use zip [Zip money that is] either.

Maybe both Leah and Molly will stop using Afterpay at some point and start using plastic. Credit cards just work better with mortgages and offset accounts, etc.

But behind Leah and Molly are a whole bunch of youngins, without credit cards looking for a buy now, pay later option.

My bet is most will use Afterpay, and then graduate to a credit card at some future time.

So does Visa kill Afterpay? I say, no way.

Afterpay has a loyal segment of the market that wouldn’t dare go into credit card debt.

Buy now and you’ll pay for it later

Even though Visa’s announcement doesn’t mean a whole lot for Afterpay, in my opinion, that doesn’t necessarily make the stock a ‘buy’.

On that point…

[No stock we talk about here at Money Morning is a recommendation to buy or sell. Our aim is to show you trends, industries and ideas that could lead to huge potential returns, and for you to go away knowing more than you already did. We’re not here to say you should buy this or you shouldn’t buy that.]

Afterpay is a wonderful business, though. They’ve found a niche, which they’re trying to rapidly dominate. They have an opportunity to expand internationally. And as long as they continue to focus on the customer, it’s hard to imagine that this company won’t continue growing.

But by how much…?

That’s the million-dollar question.

All too often, great companies trade for far more than they’re worth. Investors gravitate towards growth.

They overlay their own optimistic assumptions on top to justify paying 27 bucks a share for a company not yet profitable.

In the table below, I’ve put drastically optimistic assumptions on the Afterpay story…

Maybe the most optimistic is operating margins of 10%, from -14.8%, for the next five years. I wouldn’t be surprised if Afterpay continues to make operating losses for the foreseeable future as they continue to grow.

Yet even with my assumption of operational profitability (taking all operating expenses into account, sans interest and tax) by next year, I still only get a per share value of about $20.5 for the buy now, pay later stock.


Source: Money Morning

Please don’t read too much into the table above. The idea is not to give you a definitive ‘this is what Afterpay is worth’.

What I wanted to show you was how hard it’s going to be for Afterpay (the business) to grow to justify their current price of $27 per share.

But hey, maybe they’ll pull it off. I just don’t believe Visa will have much bearing on the matter.

More important is that you get used to the idea that payments are changing.

Cash is dying. We’re all going digital. Delayed payments are growing in importance. And millennials are fast becoming ‘the market’ for most businesses.

Make sure you don’t turn a blind eye to the changes happening right now.

Your friend,

Harje Ronngard,
Editor, Money Morning

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Money Morning is Australia’s most outspoken financial news service. Your Money Morning editorial team are not afraid to tell it like it is. From calling out politicians to taking on the housing industry, our aim is to cut through the hype and BS to help you make sense of the stories that make a difference to your wealth. Whether you agree with us or not, you’ll find our common-sense, thought provoking arguments well worth a read. Money Morning Australia is published by Port Phillip Publishing, an independent financial publisher based in Melbourne, Australia. As an Australian financial services license holder we are subject to the regulations and laws of Corporations Act and Financial Services Act.


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