The markets shellacking of the buy now pay later sector has been...

The markets shellacking of the buy now pay later sector has been violent and Zip co-founder Larry Diamond says he feels the pain of retail investors and staff holding Zip stock that has nosedived by 80 per cent over the past year.

The rout – which has included a 30 per cent slidesince a merger with Sezzle was announced in late February –was triggered by a savage change in global sentiment towards technology sector growth stocks as interest rates start to rise.

For Zip, there have also been concerns that Mr Diamond – who owns just less than 10 per cent of the company – and Sezzle boss Charlie Youakim will not achieve promised synergies or hit their target for the combined businesses to become profitable in 2024.

The evisceration of technology and payment stocks has triggered a fall in Zip’s ASX market cap from more than $6 billion a year ago to $1 billion this week. It has responded by tightening lending criteria in a bid to ease market fears that higher interest rates will not only lift funding costs but credit losses as well.

“Markets are signalling they don’t like BNPL risk – very high bad debts with increasing interest rates and inflation are all no-go zones for investors,” independent payment analyst Grant Halverson said.

Mr Diamond said Zip started reducing credit limits for existing customers and raising the bar for first-time users of the platform late last year. In its half-year results posted three weeks ago, Zip reported bad debts plus expected credit losses had increased fivefold to $148.3 million, 3.3 per cent of sales or almost half its revenue of $302 million.

“We have tempered growth expectations, so we can improve our bad debt figures,” Mr Diamond toldThe Australian Financial Review.

“We did that at the onset of COVID in 2020, adjusting the portfolio to respond to changing conditions in real time to restrict first-time customer volume. As a result of what we are seeing in the US and Australia, we have adjusted approval levels and limits for existing customers - we have taken the decision action.”

Moving through credit cycles

Mr Diamond said buy now, pay later was a new sector that had not proven itself through a full economic cycle.

“We have to be able to demonstrate to the market an ability to move up and down within tolerance levels through the credit cycles.”

Analysts and investors have questioned the logic of the deal, after Zip raised equity at a discount to buy Sezzle at a premium. One banker said this smacked of desperation, whileMacquarie described the deal as “merger out of necessity rather than one to create long-term shareholder value”.

Sezzle’s Mr Youakim said the deal was all about getting more scale, to allow it to sign up more retailers. He said the two companies had been in discussions since last July, well before markets started panicking. Mr Diamond said he was confident of hitting the promised synergies.

With many Zip staff paid in shares and with scrip used to finance its global expansion, Mr Diamond said it had been tough on morale.

“It looks violent and vicious but as leaders of the business we do have to look around us, to what is happening the with the stock and change course accordingly,” he said.

“We are long-term owners and long-term operators of the business, but certainly, we feel the pain with our shareholders, particularly retail shareholders, and staff who are also shareholders. We are all aligned. We have had to pause, to reflect and change course accordingly.”

He remained confident that Zip could hold its ’“net transaction margin”, the key earnings driver (revenue from retailers and customer fees minus the cost of debt funding and bad debts).

Revenue is holding firm despite intense competition, and he said Zip was not as sensitive to rising rates as some in the market might have thought because of the short-term duration of its instalment loans.

Zip shares had a rare day in the black on Wednesday, closing up nearly 10 per cent to $1.56. The price was briefly above $10 in February last year and capital markets remain on edge. USBNPL player Affirm pulled a bond offer last week– the fifth securitised-credit transaction delayed or pulled from US markets in recent weeks because of market volatility – and had to reassure investors about its funding sources.

Zip will talk to some of the investors in its asset-backed securitisation (ABS) deals later this week, but the company thinks the market will continue to reduce its credit margin as it proves an ability to get bad debts under control. Its previous $500 million ABS was AAA-rated, and Zip has no short-term plans to issue more debt.