Zip Co will pay a big break fee to eliminate debt using proceeds...

Zip Co will pay a big break fee to eliminate debt using proceeds from a new equity raising, and has indicated it will push the accelerator on growth in the United States despite regulators investigating whether it has violated consumer protection laws.
With its buy now, pay later payments growing by 43 per cent in the US last quarter, Zip said it would introduce a “Pay in 8” product to allow its almost 4 million American customers to pay for more expensive items such as travel and whitegoods

Zip chief executive Cynthia Scott. “This is the last step in simplifyingour capital structure.” Kate Geraghty

Zip is set to return to the S&P ASX 200index next Monday – the same day its equity placement, which will raise $217million, is due to settle. Shares are being priced at $1.52, a 5.3 per centdiscount to its close on Tuesday, and is underwritten by joint lead managersGoldman Sachs and Unified Capital Partners.

Today’s equity raise will further strengthenour balance sheet, by removing the corporate debt facility to enable greateroperational flexibility [and] is the last step in simplifying our capitalstructure,” Zip chief executive Cynthia Scott said on a call.

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But she cautioned investors to be aware of the “evolving regulatoryenvironment”. The company’s investor presentation slides said in a footnotethat the powerful Consumer Financial Protection Bureau had this month flagged apotential enforcement action against Zip for alleged breaches of US consumerprotection laws.

The CFPB is concerned that “convenience fees”charged by Zip are finance charges that should have been disclosed tocustomers. It is also investigating whether Zip products are actually “creditcards”, which would require additional consumer protections, and has flaggedpotential disclosure issues for credit requests that were denied.

Zip said it “intends to provide a thoroughresponse to the letter and is cooperating with the CFPB”, but could not“provide any assurance regarding its ultimate outcome”. If changes arerequired, “they would be unlikely to have a material adverse effect on itsoperations”, the company added.

The potential for legal action comes after theCFPB in May found buy now, pay later lenders satisfied definitions of “cardissuers” and “credit cards”.

Despite the renewed regulatory attention, agrowing number of analysts covering Zip – Citi, UBS, CLSA, Ord Minnett andE&P Capital were on the call – focused on the prospect for top-line growthin the US market, as institutional investors who benchmark to the ASX 200considered whether to buy.

E&P’s Julian Mulcahy, who initiatedcoverage of Zip earlier this month with a positive rating, probed management onthe large $89 million exit fee, given the $150 million debt facility will bepaid down early.

Back in the black

Zip chief financial officer Gordon Bell saidthat the fee had been set at 4.9 per cent of its market capitalisation, at atime the company was trading at around one-fifth of its current market cap of$1.8 billion. Retiring the debt will save Zip $22.5 million in annual interest,given the facility had a fixed annual interest rate of 15 per cent.

Zip is expected to report core earnings ofbetween $67 million and $70 million for the year on August 27. This will turnaround a $48 million loss in the last financial year.

Its performance in Australia remains soft:active customers of 2.2 million were 5.4 per cent lower compared to the fourthquarter a year ago, and the value of transactions is 11.4 per cent lower – butsales grew by 43 per cent in the US.

Net bad debts were lower, at 1.4 per cent oftransactions in the fourth quarter, down from 1.9 per cent a year earlier. Ziphas appetite for bad debts to rise in the US to between 1.5 per cent and 1.7per cent. “We are not planning on relaxing our risk settings, but we areundertaking activities in the US to stimulate customer growth,” Ms Scott said.

Citi analyst Siraj Ahmed asked about the“levers for further growth”. Ms Scott pointed to penetration of buy now, paylater products being less than 2 per cent of US payments, and an estimated 100million customers “underserved” by traditional financial services.

Zip shares remained in a trading halt onWednesday, after last trading at $1.60, up 160 per cent this year. The stockhit $12 each in February 2021, before it collapsed asinvestors questioned whether the company would survive.