Credit cards have for a long time been the traditional form of consumer borrowing since their inception in the 1950s. But the business model they work off has led to many customers being laden with high levels of debt, with interest rates and other charges keeping users locked up in a never-ending cycle of arrears.
However, a new kid is on the block offering borrowers an alternative method to fund short-term financing. Buy now, pay later is a growing trend in the e-commerce space, providing a transparent pricing structure with no interest payments so long as users keep up their payments on time.
Affirm Holdings, Inc. (AFRM), a major player in the BNPL industry, is currently riding a set of secular tailwinds that are shifting customer focus towards simplicity and flexibility in financial products.
Since going public in January 2021, the company’s now surpassed Afterpay as the largest BNPL enterprise on the market, and its price action has also been stellar, with over 83% in Q3 2021 alone. Will the firm continue in the same vein, or is the buy now, pay later hype set to go on hold?
Affirm: Making Partnerships Where It Matters Most
One of the key growth drivers behind AFRM’s recent success has been its ability to craft out profitable partnership deals with some of most important retail outlets on the planet.
Affirm markets itself to online vendors as a customer acquisition tool, promising to funnel its 7.1 million members onto their websites, where, Affirm claims, those customers will spend 85% more on the average overall order than the typical consumer would spend.
Affirm generates its money by charging a commission fee to vendors on the transactions its members make, and in return merchants enjoy a 176% higher conversion rate when they offer Affirm’s BNPL payment option.
An early deal with Peloton (PTON) demonstrated Affirm’s worth with merchant partners, and the company continued adding high-end brands to its roster. It wasn’t long, however, before some of the most dominant names in the retail space including Shopify and Walmart (WMT).
Affirm’s partnership with Shopify (SHOP) proved especially beneficial for the Canadian e-commerce company, which saw 50% higher conversion rates, 27% faster checkout times, and almost 30% fewer cart abandonments.
But by far Affirm’s most significant collaboration is the deal it recently signed with the world’s largest online retailer, Amazon. The online e-commerce platform agreed to integrate AFRM’s pay-over-time option into its native shopping cart, heralding Affirm as its first ever BNPL offering. The agreement is still in its embryonic form, and pilot testing the scheme is still yet to be completed.
Amazon Prime boasts around 200 million customers, and has generated approximately $221 billion in sales in the first half of 2021 alone. For Affirm, exposure to this market should lead to a great many more members joining its own network, and the growth opportunity it provides will be enormous.
Affirm Stock Is Not Risk Free
While there’s plenty of interest in the buy now, pay later idea, the space does come with some hefty risks accounted for in its business plan. The fintech world is especially enamored by the concept, especially in the post-Covid era.
PayPal (PYPL) recently bought out the Japanese deferred online payment service Paidy, and Goldman Sachs acquired BNPL specialist GreenDay for $2.24 billion. But is the enthusiasm for this new type of credit provision misplaced?
The first problem for lenders issuing credit in this manner is that the core user base for BNPL-related products is comprised of customers who are already likely to have bad credit scores to their name.
A report by Credit Karma found that a third of U.S. consumers using BNPL services had missed one or more payments, and 72% of them surveyed had seen their credit score actually worsen.
Younger customers were found to be the ones most likely to miss payments, with more than 50% of millennial and Gen Z respondents saying that they’d missed at least one payment.
Furthermore, Affirm and other BNPL providers have been operating in an environment conducive to consumer spending of late, and this is not guaranteed to last.
In the US, government stimulus initiatives over the last year-and-a-half have seen customers take a windfall of cash from various sources, making them freer to spend more through credit-related payments.
Low interest rates have also helped lending platforms offer attractive credit terms. However, when the stimulus programs stop, and/or interest rates inevitably rise, the spending will slow down, and credit companies may be forced to increase their fees.
Finally, buy now, pay later credit payment schemes are in their infancy, and as they mature it’s not unlikely that users will naturally accrue BNPL debt to the same tune that traditional credit card holders have done too. And since BNPL customers are typically those unable to secure credit through the usual channels, the risk to lenders will be that much higher.
AFRM Had A Very Good Fourth Quarter
Affirm ended its financial year 2021 on a strong note. The company missed its EPS target by $0.15 at -$0.48, but revenues of $261.78 million beat Wall Street predictions by $37.39 million.
Its top line was up 71% year-on-year, and its Gross Merchandise Volume (GMV) also grew 106%.
The company continued to expand its network over the quarter, increasing its active merchant count by more than 400% and nearly doubling its number of active consumers.
Founder and Chief Executive Officer of Affirm, Max Levchin, also praised the firm’s “unrivaled technology”, adding that its superior core products cemented its position as the pre-eminent leader in the field.
Affirm up-guided its revenue estimates for the coming year from the consensus expectation of $1.16 billion to a range of $1.16-1.19 billion.
Its revenue and GMV guidance also doesn’t take into account its deal with Amazon (AMZN), nor the cash flows expected from the ramping of its Affirm Debit+ card, and it has underestimated the returns from its work with Peloton.
In other words, AFRM is factoring in the downside effects of lower customer concentration from Peloton, but not countering this with the positive upsides of the Amazon partnership. The market seemed to like this over-cautious approach and rewarded the stock with a 20% gain in after-market trading.
AFRM Price to Sales Is…
From a pessimistic point of view, Affirm will probably have to weather some headwinds due to the fact that the long-term viability of the space faces some serious challenges.
Alternatively, the company sits at the apex of a high-growth market, with a business that’s partnered with the biggest names in online retail, and a realizable roadmap for the future.
While not profitable yet, Affirm’s strong revenue growth should translate into bottom line gains, eventually. The stock is relatively expensive at 21 times trailing sales – but compared to a similarly sized peer, Afterpay, whose Price-to-Sales ratio is around the 40 mark, AFRM is currently cheap, and a definite buy for now.
The author has no position in any of the stocks mentioned. Financhill has a disclosure policy. This post may contain affiliate links or links from our sponsors.