But more attention is focusing on the bottom line. Investors hone in on the net transaction margin. Essentially, this examines how much the company is making after bad debts, processing costs and funding costs are subtracted from the merchant and late fees revenue. It reflects that, like banks, buy now, pay later profits need to be offset by the customers who don’t repay.
For now, generous government stimulus packages have been back-stopping bad debts and encouraging spending – so bad-debt levels at Afterpay, Zip and the other players have remained low. Short repayment cycles and capped spending amounts for new customers help (users can get access to more credit over time after proving themselves).
"In future results, investors should watch Afterpay’s consumer adoption, gross merchant volume and revenue margins and form a view around where these metrics can grow to over the long term," says Callaghan. ECP is not invested in any other players in the sector.
"We favour Afterpay's simple and free instalment solution, which has a proven track record of rapid consumer adoption upon launch in new geographies."
This land grab for global scale is forcing the main players into losses, which for now investors are willing to tolerate. They understand there are likely to be only be a few winners globally, and getting to scale requires serious investment in marketing, R&D and staff.
'It's about who is winning the land grab phase'
Afterpay is planning a move into Canada, and potentially China after Tencent took a substantial stake in May. Zip is also forging into the US after the acquisitionof QuadPay in June, which triggered a stock re-rating.
"Right now, it's about who is winning the land grab phase and doing it in the most efficient way possible," Mitchell says. "Now is not the time to be slowing down to show profitability, it's about establishing and cementing a market lead so you are more likely to be there at the end."
Bulls are encouraged by structural themes playing out during the pandemic. These include a shift towards more electronic payments and online commerce, where buy now, pay later players have their foundations given integrations with merchant websites.
Further, more customers (especially younger Millennial and Gen-Z cohorts) are using debit cards rather than credit cards. So they are attracted to Afterpay which provides short-term credit without traditional credit card checks, given it operates outside the credit laws (by not charging customers interest). Its instalment payment plans allow users to make a purchase and then smooth payments out when money is tight.
Retailers get access to the power of the platform. For many retailers, it is the next biggest referral of customers after Google. Customers are coming to Afterpay first then deciding where to go to shop. Bell Potter's Lafitani Sotiriou says many investors underestimate the power of the network effect that Afterpay has created. "Many of its peers do not have a directory, or have one without the scale and traffic of Afterpay," he says.
Bears cite growing competition, the spectre of bad debts rising in the recession and the prospect of rising regulations as reasons to be very cautious investing in the sector, especially at these high valuations.
Pressure on merchant fees
Afterpay is not only facing down local rival Zip in Australia, the US and the UK, but also Klarna, a private, European companybacked by Commonwealth Bank, which this week laid out plans to help it expand.
Other offshore players have also been drawn to Australia to list their shares given the investor interest in the sector.Sezzlehas been reporting rising US user and merchant numbers;Splititsurged after a deal with Mastercard allowing its users to split payments, something it also offers for Visa. Then there are other local, private players such as LatitudePay andLimepay, which has created a white-label offering.
All this competition could put pressure on the merchant fees Afterpay charges retailers, which is also being closely watched by the Reserve Bank of Australia. It is examining whether buy now, pay later providersshould be able to continue to prevent merchants imposing a surchargeon customers who use the service. A decision is expected next year.
There is also the possibility ofrenewed regulatory attention from the Australian Securities and Investments Commission, which is preparing a report on the sector expected to be released in September or October, which could slow down the on-boarding of new customers by calling for more stringent credit checking.
Investors also need to bear in mind the potential for slower discretionary retail spending as the economy struggles out of the crisis. Many analysts have flagged the potential for rising bad debts across the sector as coronavirus stimulus is withdrawn from September. Buy now, pay later players have been "material beneficiaries of current fiscal stimulus given key customer demographics", UBS analyst Tom Beadle has warned. "We therefore see risks to the growth outlook and credit risk as policy support unwinds."
Determining whether Afterpay and the other stocks are properly valued is difficult given they are growing at such a rapid rate. Analysts have keen eyes on metrics including the number of downloads of various apps and traffic to merchant websites as indicators of potential growth.
While enterprise value/sales is a common metric, others use more traditional measures, including sum-of-the-parts models based around estimates of customers' lifetime value. Bell Potter says this delivers a valuation of $83 per share.
ECP Asset Management says short-term valuation heuristics can, however, be a misleading indicator of value. It says its valuations are built on "a long-term view of Afterpay’s earnings potential as its scale increases materially offshore".
This is similar at Ophir. As Mitchell says: "It all comes back to the story and the numbers. You need to check the likelihood of your story for Afterpay coming true and what numbers are attached to that story.
"Practically, this sees us assume what the business's profitability looks like at a more mature stage, rather than the current early land grab stage that it's currently in. We then work out what an appropriate multiple is to pay for those mature future earnings and ultimately what that works out to be in today's dollars."
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