“Buy now, pay later” pioneer Affirm (NASDAQ:AFRM) was probably right to list now, and not later. Riding the ongoing wave of red-hot tech IPOs, Affirm’s shares have doubled since trading began on Jan. 13. The brainchild of Paypal co-founder Max Levchin, Affirm seeks to challenge the dominance of traditional consumer credit players by providing “honest” financial products.
Shoppers love the idea. Affirm has over 6.2 million consumers making 17.3 million transactions on the platform so far. And judging from Affirm’s post-IPO surge, Mr. Market is also screaming “sign me up!”
But for value-orientated investors, is Affirm a buy now, or buy later? Let’s start by checking out its business model.
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How Affirm makes money
Affirm serves two groups of customers: consumers and merchants.
For consumers, Affirm is a way to split purchases into installments — something described as “buy now, pay later” or BNPL for short. With Affirm, shoppers can choose to pay a 0% APR — provided the merchant offers this option — or “simple interest” loans.
Simple interest loans are loans with fixed amounts of interest that customers can view and agree to upfront. Unlike credit card loans, the interest on this type of loan never compounds.
Affirm promises customers clear and transparent information on how much they will spend, and when exactly to pay. There are no hidden fees and penalties when paying using Affirm, which has never charged a single late fee.
This has struck a chord with customers buying big-ticket items such as a new Peloton bike, which typically costs north of $1,600. According to a Barrons article, an estimated 75% of Peloton’s connected-fitness products are sold via Affirm.
That is reflective of a key benefit Affirm delivers to merchants: By making products more affordable via BNPL, Affirm helps merchants grow their sales. One way of gauging this is by tracking the average amount spent every time a customer places an order. This is known as the average order value, or AOV. In 2019, merchants using Affirm reported an AOV that was 85% higher than those using other payment methods.
Merchants can also sell their products on Affirm’s e-commerce marketplace, which provides a new channel for customer acquisition and sales. Moreover, they can use Affirm’s data to make targeted marketing decisions, which drive better sales conversion.
In exchange for all this, merchants pay Affirm a fixed percentage of every dollar of sales. Affirm also collects fixed interest payments from consumers who’ve bought something using a simple interest loan. Merchant fees and interest income accounted for 50% and 37%, respectively, of Affirm’s revenue of $509 million in fiscal 2020.
What’s next for Affirm?
Affirm is in a sweet spot. The company is poised to ride multiple megatrends: the growth of e-commerce, the boom in BNPL payments, and the emergence of Gen Z and millennial consumers.
In the U.S., e-commerce accounted for just 16% of total retail sales in the second quarter of 2020. Low e-commerce penetration — both in the U.S. and in other countries — means global online sales could grow by 71% between 2019 and 2023.
According to a report by PYMNTS.com, 65% of BNPL provider Afterpay’s U.S. users are millennials or Gen Z. The popularity of BNPL among young users means the market could triple to 3% of all transactions by 2023. Similarly, Worldpay — a unit of payments processor FIS — says “buy now pay later” is the fastest-growing e-commerce payment method globally.
As an early mover in this industry, Affirm has benefited from these secular trends. Gross merchandise value (GMV) rose 626% over the last three years to $4.6 billion in fiscal 2020. Revenue jumped 93% year on year in fiscal 2020, and will likely grow multifold as BNPL and e-commerce penetration rises.
But that doesn’t mean the road ahead is all clear.
For one, if Affirm fails to keep up with its many competitors, growth might take a big hit. On one end, Affirm is locking horns with well-established financial services providers (such as banks) that provide credit and debit card services. And within the BNPL space, Affirm is far from the market leader. It’s the third most popular BNPL service behind Afterpay and Paypal’s Bill Me Later, and rival Klarna isn’t too far off.
Affirm also has exposure to credit risk. So far, it’s managed this effectively, with loan charge-offs falling from around 4% in 2018 to less than 1.5% in 2020. But if Affirm makes the wrong underwriting decisions, or if COVID-19 slams economic growth, the company faces the prospect of higher loan losses.
Should investors buy Affirm now?
Affirm is on the right track thanks to buy-in from consumers and merchants. Revenue for the quarter ended Sep. 30 was $174 million, almost doubled from a year ago. As long as Affirm sticks to its mission of “building honest financial products,” the company has a bright future.
Investors have jumped along for the ride, valuing Affirm at a ridiculously high 55 times fiscal 2020 revenue. Considering Snowflake trades at over 100 times projected 2021 revenue, Affirm is not the most expensive tech stock out there.
But moving forward, Affirm has to execute perfectly to justify its current valuation. As a newly listed company, Affirm’s yet to show it can sustain its operating performance over time. Should it fail to meet the market’s lofty expectations, investors might end up getting more than they bargained for.
All things considered, Affirm is not a buy now stock — at least, not until its valuation becomes more palatable.