Zip Co CEO Larry Diamond and co-founder Peter Gray. Picture:...

Zip Co CEO Larry Diamond and co-founder Peter Gray. Picture: Supplied

• CLIONA O'DOWD

  JOURNALIST

  @ClionaODowd

  
• 10:08AM JULY 12, 2022
• 5 COMMENTS

A horror year for buy now, pay later operators is rapidly worsening, with the abandoned Zip Co and Sezzle tie-up the latest hit to a sector struggling to find any viable path to profitability.

Zip and Sezzle on Tuesday confirmed their planned merger, announced in February, would not go ahead, with both parties agreeing to dump the deal amid challenging market conditions and a darkening outlook.

The decision to walk away – which will see Zip cough up $US11m in break fees – comes after the company just weeks ago told the market the acquisition of US-focused Sezzle was on track.

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It is the latest buy now, pay later tie-up to fall over in a matter of weeks, with Latitude and humm in June agreeing to abandon the proposed sale of humm consumer finance to Latitude.

The cracks in the troubled sector are only growing, and not just in Australia: Europe’s former buy now, pay later darling, Klarna, has just seen its value slashed by 85 per cent to $US6.7bn on the back of its latest funding round. For investor Commonwealth Bank, that means the value of its holding in the Swedish company has dived by about $2bn.

Meanwhile, the federal government is gearing up for a regulatory crackdown on the sector, with assistant treasurer and minister for financial services Stephen Jones telling a lending summit on Tuesday that buy now, pay later should be treated as credit.

READ MORE:ASX up; Zip, Sezzle merger off|Zip falls as UBS halves target price|Comm Bank set for mammoth investment hit

“If it walks like a duck and quacks like a duck, it’s a duck. So let’s have an end to the silly argument about whether BNPL is credit and get on with the next stage of growth for this emerging industry,” Mr Jones told the Responsible Lending Summit in Sydney.

The dream run for the burgeoning sector, in the boom time of free money, came to a screeching halt in 2021 as investors started to question whether profitability was even achievable.

But payments analyst Grant Halverson, of McLean Roche consultancy, warned the worst was yet to come for the under-pressure industry.

“Australia has had just an enormous bubble (in this sector). It’s absolutely bizarre that the Australian Securities Exchange has 12 listed BNPL stocks … And it is all built on this notion that you can borrow money forever and not pay for it. As long as your shareholders are prepared to burn cash.”

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At the peak, the combined market capitalisation of Australia’s buy now, pay later operators, including Afterpay, sat at $47bn. That market cap has crumpled to just $1bn today.

“I think in 12 months time, you‘ll have two or three surviving, the rest will all be gone. They’ll either go broke or they’ll be bought very cheaply.”

Zip and Sezzle’s announcement surprised the market, with analysts questioning the rationale behind the move and warning it would slow the scale of Zip’s US ambitions, increase the cost of funding and potentially crimp its ability to turn a profit.

“We are somewhat surprised at the timing and reasoning of today’s announcement,” UBS analyst Tom Beadle told clients.

“The termination of the proposed merger has the potential to slow Zip‘s near-term cash burn given Sezzle is loss-making, but it also slows the scaling of Zip’s US business, where we continue to have concerns around transaction frequency.”

Citing macroeconomic and market conditions as a reason for walking away added further uncertainty to the near term outlook, Mr Beadle warned.

Likewise, Morningstar analyst Shaun Ler warned the move to ditch the merger would have an impact on funding costs.

“The Sezzle acquisition was an important milestone for Zip to leverage scale, to increase volumes and thereby reduce funding costs to become more competitive in the US,” Mr Ler told The Australian.

“I think it will be very difficult for (Zip) in the US. It will be really, really challenging. They could continue to lose market share in that market in terms of volumes and may end up attracting customers with poor credit quality.”

Inflation, rising interest rates and spiralling bad debts have all heaped pressure on the sector this year, with share prices reflecting the horror run.

When the acquisition was announced in February, Sezzle was trading at $1.78, while Zip stock was changing hands at $2.25 a share

Since then, both companies have cratered amid a broader market rout: Zip’s shares closed Monday’s trade at 50c while Sezzle was at 42c. By Tuesday, Sezzle had plunged a further 35 per cent while Zip was up 5 per cent at 52c.

Sources told The Australian that Zip, speaking to stakeholders on Tuesday, was in part blaming complexities around bringing the two companies together for the decision to walk away from the deal.

This was in stark contrast to the February messaging by both companies, a point highlighted by RBC analysts: “Zip and Sezzle highlighted compelling strategic and financial motives for pursuing the merger, including meaningful customer benefits, complementary merchant networks, $130m of synergies supporting Zip’s path to profitability and balance sheet accretion. Were these synergies no longer achievable? Why?”

But the buy now, pay later operator sought to reassure shareholders, saying its underlying business remained strong, “with consistent customer and transaction volume growth across core markets, and a solid pipeline of enterprise merchants joining the platform”.

The US remained a core market and area of focus, and posed a significant opportunity for the business, Zip said.

“We believe that mutually terminating the merger agreement with Sezzle at this time is in the best interests of Zip and its shareholders, and will allow Zip to focus on its strategy and core business in the current environment,” Zip chair Diane Smith-Gander added.

Likewise, Sezzle co-founder and CEO Charlie Youakim said his company was also chasing profitability.

“While we were excited by the potential of this transaction, our board and management team are laser-focused on our strategy and execution.

“We remain dedicated to driving toward profitability and free cash flow and believe this is the best outcome for our shareholders.”