From afr. ————- How about that Afterpay. It's still trading at...

From afr.

————-
How about that Afterpay. It's still trading at an immense price-earnings multiple of 158, and that's after edging down considerably from its all-time high of $21.13 in late August (it closed at $16.00 on Thursday).

Sure, no one buying Afterpay gives a damn how much money it's (not) making now: all eyes are on the product's overseas expansions, which could scale the business into one of Australia's few truly global tech success stories, sealing the reputations (and fortunes) of founders Nick Molnar and Anthony Eisen.

But poring over the accounts, we couldn't help noticing its earnings are even less than they appear from looking at the headline figures.

Digital payments development company (and Afterpay shareholder) Touchcorp was merged with Afterpay on July 1 2017. It was unprofitable in its final year, but it made sense for Afterpay to buy it as it provided Afterpay's tech development among other things (imagine if a rival had scooped it up). But in the most recent financial results, since being fully absorbed by Afterpay, there's been a rather miraculous turnaround. From a normalised EBITDA loss of around half a million in calendar year 2016, PayNow (what the old Touchcorp division got renamed to) was in FY18 making normalised EBITDA of $7.3 million, off considerably smaller revenues of $25.6 million. That's quite a profit margin!

Afterpay's total EBITDA was $27.7 million, of which a quarter (26.3 per cent) can be attributed to PayNow, or the old Touchcorp.

But this obscures a bit of nifty accounting. At the time of the merger when Afterpay acquired Touchcorp, it raised a liability for a $7.7 million onerous contract provision in the FY17 results. This provision, the cost of fulfilling an uneconomic contract, was fully utilised in FY18 and was larger than the entirety of PayNow's FY18 EBITDA. So, by booking the full cost of fulfilling a continuing contract in FY17, Afterpay was able to post strong profits in PayNow in FY18. Without this provision, Afterpay's EBITDA would have been only $20 million this year, a good quarter less than announced. Which makes its current valuation even more astronomical.

But like we said: when it comes to a stock like this, the laws of reasonable P/E ratios don't apply any more than the government's responsible lending rules. Though ASIC seems to be working on that ...