Shaw and Partners $10.45 target
Z1P – Equity Report current as at –14/10/2020–Pg. 1
Zip Co (Z1P)
Rating: Buy | Risk: High | Price Target: $10.45
Quad is the Fastest Growing US BNPL
Jonathon Higgins | Analyst
+61 3 9268 1182
[email protected]Event
Z1P 1Q21 results to market.
Highlights
• USA Flying – Our thesis regarding Quad being the fastest growing US BNPL company in
the USA is playing out in 1Q21 and was indicated by our prior analysis of data.
1) Customer numbers for Quad are at 2.2m+, + 400k in one quarter alone, +340% YoY
and +4,450 a day in the largest consumer market in the world. To put this into context
this net add rate is +35% on 4Q20 and double what APT was experiencing at a similar
stage to its existence. Quad essentially didn’t exist 2 years ago;
2) TV was a record A$322.5m in 1Q21 in a seasonally slower period and beat Shaw
estimate by 38%. This is A$1.3Bn of annualised TV and is the fastest listed BNPL to hit
this milestone, with APT +10 quarters and Z1P +15 quarters. TV grew 42% on Q420 and
+388% YoY. TV is ahead of key peer SZL (US$228m) which grew 21% QoQ; and
3) Revenues were a strong $23.4m +50% on Q4-20, +409% YoY and ahead of Shaw by
+50%. In October QuadPay is likely to deliver $100m in annualised revenues which has
taken 10 quarters versus APT at 12 quarters. Importantly revenue yields have held up
strongly (surprise) even as larger merchants have been added. 1Q21 yields were 7.3%
as a percentage of volume. This implies materially higher NTM’s above 2%, room to
move with large merchants and an innovative and differentiated revenue model with
various levers (customer, interchange, affiliate and merchant).
• Into strongest period of the year – Q1-21 was a strong period for QuadPay that sees all
key metrics such as add rates, average spend, transactions, TV and revenues all
accelerating QoQ. This bodes well for the real show in BNPL which is Q2-21 however,
which sees Christmas, cyber sales, Prime Day, elevated online sales penetration (40%)
and +30% YoY for the entirety of the online sector. The entire sector is a buy out to
January, and this will be the best time to own the sector with Quad the best leverage.
• ANZ Strong – Whilst the focus and delta in share price is all focussed upon QuadPay the
ANZ businesses continues to track nicely. This saw $621m in TV for 1Q21 (in line), + 9%
on Q4-20 a strong result in the context of various lockdowns and high-volume merchants
in Victoria. TV’s are + 50% YoY and transactions rose 74% demonstrating continued
adoption. Whilst the ANZ business isn’t growing as fast as the USA, in a seasonally weaker
period net customer adds in 1Q21 were +155k which is 80% of the 4Q20 adds versus
1Q20 being 56% of 4Q19. Revenues were $45.7m ($183m annualised) in line with Shaw.
• 4.5m customers – Zip is now a big business and global. In 3 markets with 5 products
expect UK launch in the near term to provide further growth support. The trend is your
friend and Zip now has 4.5m+ customers and is adding 6,200 a day (record). Annualised
volumes are $3.8Bn and we conservatively forecast this reaching $5.3Bn in 2Q21.
• Zip trading at 60% discount – Zip is currently trading at a discount of 60% to APT. We
expect as Quad volumes take greater share that the multiple will re-rate with Quad
having 3x the effective ROE of the Zip core business.
• 80m+ active Americans– Shaw estimates that with a similar adoption curve to Australia
(currently faster) that BNPL could have 80m active customers within 3 years and account
for 14% of all online retail. This equates to an annualised TV volume opportunity of
US$110Bn out of the US alone. Shaw currently forecasts $5Bn in TV by December 2022
for Quad which compares with earn-out’s that imply $7Bn+.
• Changes – Upgrade to revenue of 3% in FY21-23e. TP upgraded by 4.5% to $10 per share.
Recommendation
The trend is your friend and that which is getting bigger faster is becoming more valuable.
Re-iterate Buy into the strongest quarter of the year with the most fertile conditions.
Shaw and Partners Z1P – Equity Report current as at –14/10/2020–Pg. 2
Zip Co. Ltd. provides integrated solutions to small, medium
and enterprise merchants across numerous industries, both
online and in-store. It offers point-of-sale credit and digital
payment services to consumers and merchants. The
company was founded on June 24, 2013 and is
headquartered in Sydney, Australia. ****Note please refer
to Shaw and Partners key assumptions page within
document for figures based on a portfolio, gross margin and
cash EBTDA basis. Figures Shaw sees as most applicable to
current operating envelope.
Shaw and Partners Z1P – Equity Report current as at –14/10/2020–Pg. 3
Core drivers and catalyst
Our positive recommendation and attraction to Z1P is driven by the following:
1. Structural tailwinds driving mainstream adoption – Shaw sees the emergence of
fin-tech companies driving credit and payment solutions as at the beginning of
the adoption curve. Traditional forms of personal credit and payment options are
being eroded by new players such as Zip Co. We expect structural tailwinds to
continue to grow adoption from both merchants and customers, driving well
above system growth and taking share from major incumbents, whilst growing
the size of the overall pie.
2. Fintech competitive advantages – Zip has a best in breed product geared towards
both payment and lending solutions. BNPL and credit products of the business
deliver real time approval and are across a complex decision engine that is better
than major banks and alternative lenders in the space. Zip has competitive
advantages across three key value chains which include: 1) customers; 2)
merchants; and 3) funders – a rare position to be in.
3. Operating leverage to continue to emerge – As a fintech Zip is only just reaching
profitability and is now sustainably profitable on an operating cash flow basis. We
expect profit to continue to emerge at an increasing scale and see medium term
group leverage aspirations as being achievable. With a predominantly fixed cost
operating base, Zip should be able to achieve higher risk based NIMs than other
traditional lenders in the market, as well as delivering material earnings growth
as the jaws of the business widen.
4. Recurring income – Although having relatively short amortisation and book turn
metrics compared with a traditional personal finance lender, Zip has a material
base of customers, repeat transactions and some duration and repeatability to its
book. A growing receivables book should underpin further revenue and earnings
growth, whilst increasing the predictability and value of earnings being built.
5. Optionality around further geographies and products – Whilst having five
products (and monetising two) we see potential for Zip to create new products,
data mine, improve algorithms and monetise Pocketbook. Currently valued on a
DCF and EV/sales basis, Zip has a material amount of optionality around driving
further customer LTV out if its current customer base as well as from merchants
through other low hanging fruit initiatives (such as advertising). We see further
substantial growth opportunities for the group across the USA in particular with
QuadPay likely to grow materially above prior market expectations.
6. Building a moat with corporate appeal – The payments and fintech space has
seen consolidation from both older companies, as well as newer businesses
(particularly in the USA and Europe). We expect as active customer and merchant
integrations rise that the appeal of Zip to both local and international acquirers
will rise. We further remain watchful of the significant shareholding that Westpac
currently holds for Zip and see further major bank deals in the space as likely.
Shaw and Partners Z1P – Equity Report current as at –14/10/2020–Pg. 4
Figure 1: Key assumptions
Source: Company presentation * EBITDA is now a true P&L account, rather than a cash EBTDA as previously modelled. See assumptions page for truer representation of cash EBTDA and operating with respect to
provisioning and BDD. We have consolidated QuadPay for 1 July 2020, although transaction likely to complete later for illustrative purposes. We have further modelled Zip on a current cash EBTDA basis and accept that
disclosure and metrics are likely to change with the faster amortization of 4 split payments product.
Key risks
Credit – One of the primary products of Zip’s business model is to advance credit (through
either its regulated credit or BNPL product) and as such the company is exposed to any
deterioration in quality of the loan book. Significant deterioration in credit quality across
the book that exceeds current retained BDD provision levels may negatively affect earnings,
as well as finance costs and availability. Although book performance has been strong to date
(against mainstream benchmarks) this may not always be the case. Further, AASB 9 changes
to provisioning to encompass ECL may dynamically affect provisioning across the business
and we note this is a new accounting standard being implemented (although Zip currently
compliant). We note that the book although demonstrating slowing rates of growth and fast
amortisation (repayment periods) is not fully seasoned and so the ability to view underlying
credit performance is limited.
Fraud risk – Although dealing in small ticket sizes and so unlikely to encounter large scale
frauds (such as other listed alternative financiers have encountered) Zip may encounter
fraud that could cause customer or merchant losses, which in turn may affect or cause an
increase in costs for the company.
Finance & funding – Zip relies on a number of sources of funding, including external
financiers that provide financing through mezzanine notes and mainly through securitised
funding vehicles through major banks. As Zip relies on outside sources of funding, the ability
of the business to continue operations and to grow relies on both this funding and the
combination of equity utilised. Funding issues have manifested across various alternative
financiers and one of the largest risks to Zip is availability as well as costs of financing.
Finance and funding risk is magnified within the current global volatile environment.
Small company & managing growth – Z1P is still a small business by mainstream ASX
standards and has grown exponentially as its products have been accepted across a
progressively larger Australian subset. As such, Zip has to manage a number of issues related
to being a small fast growing business including culture, employee remuneration, board
representation, listed company demands and a fast growing P&L. Failure to adequately
manage exponentially changing business conditions may result in an adverse or volatile
investor experience.
Liquidity – As a small cap business listed on the ASX, Zip has a relatively low level of liquidity;
this may affect the volatility of the share price or the efficiency of the market in pricing the
valuation of the business.
Economic environment – The overall economic environment may affect the levels of
transaction volume, user adoption, savings rates or seasonality within the business. Having
demonstrated strong quarter on quarter growth rates since inception Zip will progressively
as it becomes bigger with scale be affected by overall seasonality particularly in the retail
sector it operates within. Deterioration within the economic environment would likely
negatively affect Zip, but caution is most pertinent within the credit performance at this
stage.
Competition – Zip has a number of both mainstream (such as traditional bank credit,
Flexigroup etc..) and alternative (Afterpay, OpenPay etc..) competitors within various
products and sectors the company operates within. Higher competition is likely to manifest
itself within compression on merchant fees, tendering processes for larger merchants and
overall customer acquisition costs. We see competition increasing in the space, but also see
the two largest alternative providers (Z1P and APT) progressively becoming more dominant.
Reputational – Zip relies on origination through both organic channels (direct and via
merchant) and any adverse reputational coverage on products, experiences etc.. May affect
customer acquisition and performance.
Key management – Zip enjoys a high level of management ownership, having a number of
substantial holders that are founders of the business, in Mr Diamond and Mr Peter Gray.
Shaw and Partners Z1P – Equity Report current as at –14/10/2020–Pg. 6
Differences in management across an entrepreneurial business may manifest and Zip’s
ability to attract and retain top talent may affect the business.
Regulation and product – With numerous products that range from regulated credit
products, to BNPL, to personal financial management products, Zip comes under a wide
range of regulation that range from consumer facing, to credit and other pieces of
legislation. The BNPL sector in particular has had a number of recent inquiries including the
ASIC and Senate inquiries. We expect that the regulatory environment and focus will
continue to remain dynamic. Failure to adequately comply with regulation, particularly
around consumer engagement and relevant credit laws, may result in certain activities of
Zip being at risk.
Technology – Technology and Moore’s law are both one of the biggest benefits and risks to
a fin-tech business. Zip itself is disrupting mainstream and traditional credit and payments
companies and this may in of itself affect Zip if the company becomes complacent. Failure
to iterate, invest in product, R&D and process may result in Zip’s product being of lower
quality or having less relevance to consumers due.
COVID-19: COVID-19 is a completely unexpected and exogenous event that is affecting the
whole economy and the vast majority of consumers globally and within Australia. The scale
and potential impact of this even in our view is unprecedented. Within this note we
reference the effects of COVID-19 but note that the situation is dynamic and that the likely
end date and affects we will likely be wrong about in magnitude, timing or both. Across a
geared vehicle like Z1P with higher risk credit customers this event does raise further
financial, qualitative and potentially regulatory risks that should be noted by investors.
Acquisition, integration and growth risk: Zip’s recently announced acquisition of QuadPay
represents a significant step up in growth, ambitions of the group and risk. This in our view
is particularly the case with US operations. The overall effects of COVID, stimulus measures
and potential US growth concerns are still likely to playout in an uncertain environment over
the short to medium term. There is no guarantee that Zip will be able to integrate, deliver
synergies, grow or deliver profits from its acquisition strategy and newly acquired
subsidiaries.
Shaw and Partners Z1P – Equity Report current as at –14/10/2020–Pg. 7
Rating Classification
Buy Expected to outperform the overall market
Hold Expected to perform in line with the overall market
Sell Expected to underperform the overall market
Not Rated Shaw has issued a factual note on the company but does not have a recommendation
Risk Rating
High Higher risk than the overall market – investors should be aware this stock may be speculative
Medium Risk broadly in line with the overall market
Low Lower risk than the overall market
RISK STATEMENT: Where a company is designated as ‘High’ risk, this means that the analyst has determined that the risk profile for this company is
significantly higher than for the market as a whole, and so may not suit all investors. Clients should make an assessment as to whether this stock
and its potential price volatility is compatible with their financial objectives. Clients should discuss this stock with their Shaw adviser before making
any investment decision.
Shaw and Partners Z1P – Equity Report current as at –14/10/2020–Pg. 8
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