Objective analysis - Z1P's Margins

I want to start by saying this post is meant to be educational and objective in nature to discuss how margins function for Z1P and other BNPL companies. This post is not designed to provide a positive/negative view of Z1P's margins but instead I hope posters get some benefit/understanding from it.

To start of with I want to highlight that margins are important because if you have negative or zero margins, then it doesn't matter if you grow 1000% each day, you wouldn't be adding value. As with any credit business, margins make up most, if not all of revenue/profits, especially for BNPL products which are high volume, low margin so from valuing a BNPL perspective, this is probably the most important metric.

What impacts margins negatively and positively:

Negative
(1) Default rates - There is an inverse relationship between default rates and margins. The higher the default rate the lower margins. For Z1P and other BNPL companies these are likely to improve over time, as their books are self cleansing which is actually one of the best aspects about the BNPL industry. Self-cleansing means poor performers are removed from the service while high quality customers are retained, and these is done extremely quickly and efficiently by BNPL companies. Over time poor performers make up a smaller and smaller percentage of total customers, hence default rates should drop over time, a positive impact on margins.

No all products have the same risk profile and me having had experience working in a quantitative credit risk environment can provide some insights into why. The main reason why customers default on any product is due to uncertainty, typically caused by unemployment, divorce or illness/death. The longer the timeframe of a loan, the higher the likelihood one of these events will unfold. I've sorted some products by the likelihood of a consumer suffering divorce/unemployment/illness/death:

1. 30 year home loan (higher probability)
2. 2 year ZipMoney loan (medium probability)
3. 6 week ZipPay loan (very low probability)

Not only is there less probability of default due to lower uncertainty for ZipPay than for ZipMoney, but even in the event of default ZipPay's loan size is a fraction of that of ZipMoney. This comparison provides some insight into why 6 week BNPL has far better credit performance than the likes of ZipMoney (and also why Humm is rotating away from ZipMoney type products to 6 week BNPL). Z1P is putting far greater focus on growing ZipPay/Quadpay, hence over time this will also improve Zip's default rate performance and have positive impacts on margins.

So to summarize, default rates will improve more and more over time having positive impacts on margins.

Positive/Negative
Nature of the products. Prior to Tap&Zip and Quadpay's Chrome extension, Z1P would receive between 4-7% per transaction which has resulted in NTM of around 2%. Recently management have made strategic decisions to offer products such as Tap&Zip and Quadpay's recent chrome extension. Since these products can be used anywhere, it's not merchants that are paying a fee, instead it's the likes of Visa that would pay a cut from the margins that they make.
Visa charges 1.5% fees per transaction. Since they don't take on credit risk the 1.5% doesn't have to cover credit loss provisions, nor do they cover credit losses and since Visa is a channel and not a credit provider, the 1.5% doesn't have to cover the costs of funding any purchases. 1.5% simply covers operational expenses and the rest is profit.

Zip receives a portion of that fee, we don't know how much but lets say 0.7% because any less and Visa wouldn't make any profit on these transactions. With Z1P being a credit provider (maybe not by name) the 0.7% fee and any other revenue (e.g. $1 for Quadpay purchases) has to cover the  funding costs (e.g. warehouse funding facility from banks), credit loss provisions and credit losses as well as operational costs.

So with the previously reported margins (Cash gross profit margins at 0.5%) mostly containing the 4-7% product, the margins will be negatively impacted by the newer, ~0.7% margins. Going forward, the more % of loans are being written by the new products, the lower Z1P's margins will be. Another uncertainty with this mix of products is whether customers who would ordinarily have shopped through the 4-7% product, are now paying through the newer 0.7% products. There is risk of cannibalizations, and the more this is the case the faster margins drop as it would accelerate the impact from my earlier point in italic.

Positives
Funding costs
To fund Z1P's receivables, the company uses funding warehouse facilities from banks which charge an annual interest rate. The interest rate tends to be higher for riskier, unproven companies and as Zip matures, funding costs will decrease. Zip also uses securitization of it's receivables as a funding source, which is also a cheaper alternative. So over time funding costs should have a positive impact on margins.


Other revenue streams
Margins can be positively impacted by other products that can be a result of Zip's integration into society. Examples of that could include a marketplace generating an insane amount of lead referrals to merchants. Advertising revenue on that platform. Partnerships. Usage of the data that Z1P's collecting. There's likely a lot more here.

Uncertainty
From an uncertainty perspective, there really is only 1, and that's in relation to the impact from the newer products as explained earlier. In regards to the other points (e.g. default rates, funding costs) in my opinion it's very clear that they will continue to improve over time, with a positive impact on margins.

I hope posters can take something away from this, whether positive or negative, and to all the haters please note that this whole post is written in a neutral, objective manner. There should be nothing here that's new to any informed Z1P investor. I'm a holder of Z1P and have provided evidence of that yesterday. Cheers.