APT - Afterpay Limited

[tinhat]

An interesting business and interesting analysis being provided here. I see afterpay being offered on so many e-commerce websites now. A few thoughts:

1. Reading the company's last presentation it is easy to see that this consumer finance product appeals to compulsive instant gratification consumption (hairdressers) as well as bigger ticket spending on things that consumers might try and put off but which are not discretionary in the long run (such as dentistry). For merchants it's a no-brainer.

From the 18 Jan presentation:

Afterpay is progressing to formal documentation with two major US investment banks for a total facility size of up to US$300 million. It is anticipated that the facility will be completed in H2 FY19. A US$300 million facility is able to fund well in excess of US$4 billion in annual underlying US sales. While subject to final documentation and relevant final approvals, the term sheets received to date reflect efficient and flexible funding proposals similar in form, term and pricing to the existing $500 million Australian and NZD$20 million New Zealand facilities provided by National Australia Bank, Citigroup and ASB.

A couple of things here:

Firstly, the business model is relying on a very high velocity of turn-over of finance, as luutzuu identified, which is key to afterpay achieving their desired return on lending out the money it has borrowed. It's aiming to generate merchant fees from turning over the money it borrows 13.33 times per annum.

There is the obvious risk with the business model that its cost of borrowing (interest rates) go up. The next credit crunch may be a way off yet, but it will come.

Then there is the risk of bad and doubtful debts, defaults by customers. This is heightened by business model that is requiring such a high velocity of turnover of the credit. As soon as a borrower is late or defaults in paying their debt that money can't be lent out again but afterpay have to pay interest on the borrowings. So any credit crunch during an economic downturn could have significant impacts on the business model.

On the positive side, I would imagine that there is a lot of value to be captured and monetized from their customer data as a market intelligence and promotional asset alone.

 

[luutzu]

An interesting business and interesting analysis being provided here. I see afterpay being offered on so many e-commerce websites now. A few thoughts:

1. Reading the company's last presentation it is easy to see that this consumer finance product appeals to compulsive instant gratification consumption (hairdressers) as well as bigger ticket spending on things that consumers might try and put off but which are not discretionary in the long run (such as dentistry). For merchants it's a no-brainer.

From the 18 Jan presentation:



A couple of things here:

Firstly, the business model is relying on a very high velocity of turn-over of finance, as luutzuu identified, which is key to afterpay achieving their desired return on lending out the money it has borrowed. It's aiming to generate merchant fees from turning over the money it borrows 13.33 times per annum.

There is the obvious risk with the business model that its cost of borrowing (interest rates) go up. The next credit crunch may be a way off yet, but it will come.

Then there is the risk of bad and doubtful debts, defaults by customers. This is heightened by business model that is requiring such a high velocity of turnover of the credit. As soon as a borrower is late or defaults in paying their debt that money can't be lent out again but afterpay have to pay interest on the borrowings. So any credit crunch during an economic downturn could have significant impacts on the business model.

On the positive side, I would imagine that there is a lot of value to be captured and monetized from their customer data as a market intelligence and promotional asset alone.

Most of the metrics they're pushing in their presentations and ads aren't metrics investors should use to measure the APT's business performance.

It's pretty easy to pay for people's purchases, not that hard for them to accept your offer when the offer doesn't require any probes or collateral.

Likewise, not hard to get a retailer to adopt if all they need to do is give you about 4% discount. I mean, if I want an item enough but could live without it, I just negotiate with the shop and most often could easily get 5 to 10% off.

APT's management make it out like their Australian "partners" wanting them to move overseas is a great thing. Come on man, any idiot would invite you to move your operations to where you'll help move their stocks for a mere 4% discount. Most stocks would be discount by that, or more, if they aren't moved quickly anyway.


Please check my maths, 'cause if it's correct, about one quarter of APT's revenue is defaulted. That's very high for any business right?

 

[Knobby22]

Most of the metrics they're pushing in their presentations and ads aren't metrics investors should use to measure the APT's business performance.

It's pretty easy to pay for people's purchases, not that hard for them to accept your offer when the offer doesn't require any probes or collateral.

Likewise, not hard to get a retailer to adopt if all they need to do is give you about 4% discount. I mean, if I want an item enough but could live without it, I just negotiate with the shop and most often could easily get 5 to 10% off.

APT's management make it out like their Australian "partners" wanting them to move overseas is a great thing. Come on man, any idiot would invite you to move your operations to where you'll help move their stocks for a mere 4% discount. Most stocks would be discount by that, or more, if they aren't moved quickly anyway.


Please check my maths, 'cause if it's correct, about one quarter of APT's revenue is defaulted. That's very high for any business right?

View attachment 91537

They said this loss is reducing as a total percentage. When the next half results get released we shall see. If you are late paying they never lend to you again so in the Australian market the bad debts would be expected to reduce. The cost of doing business per transaction should also reduce as the business solidifies in the US and UK.

The fact that the banks are lining up to lend should give comfort as I am sure they are doing due diligence.

The worries I have are, systemic fraud, failure to gain market share in the U.S. and UK as they have done in Australia due to new competition. Basically they have first mover advantage, with developed software and a great name.

Definitely speculative but an exciting prospect.

 

[galumay]

The fact that the banks are lining up to lend should give comfort as I am sure they are doing due diligence.

Comedy gold!

 

[HelloU]

Most of the metrics they're pushing in their presentations and ads aren't metrics investors should use to measure the APT's business performance.

It's pretty easy to pay for people's purchases, not that hard for them to accept your offer when the offer doesn't require any probes or collateral.

Likewise, not hard to get a retailer to adopt if all they need to do is give you about 4% discount. I mean, if I want an item enough but could live without it, I just negotiate with the shop and most often could easily get 5 to 10% off.

APT's management make it out like their Australian "partners" wanting them to move overseas is a great thing. Come on man, any idiot would invite you to move your operations to where you'll help move their stocks for a mere 4% discount. Most stocks would be discount by that, or more, if they aren't moved quickly anyway.


Please check my maths, 'cause if it's correct, about one quarter of APT's revenue is defaulted. That's very high for any business right?

View attachment 91537

per the discount ...... odds are the non-user customers will also help subsidise the users ....
"reverse search" is happening. Users are beginning to search for products only via afterpay sellers. Sites are being designed for this outcome.

young peeps do not like credit. they like debit. and like to have their money in their debit account longer.

 

[luutzu]

per the discount ...... odds are the non-user customers will also help subsidise the users ....
"reverse search" is happening. Users are beginning to search for products only via afterpay sellers. Sites are being designed for this outcome.

young peeps do not like credit. they like debit. and like to have their money in their debit account longer.

I think people of all ages like money in their pocket more than out of it

The figures, receivables, bad debt etc., are all heading the wrong way.

THe only thing that's growing is the "underlying sales" i.e. more members joining, using more.

But when you have increased users with a model where, so far anyway, the default rises with increased "sales"... that's just asking for bigger losses.

Noticed bad debt to receivables was 3.15%. It's 12.83% in FY18

Sales gained 3.89x while bad debt gained 4x over same period. i.e. default slightly worst, not better with scale.

Note too the gain in late fees... 4.65x as underlying sales gained 3.89x.

Note write down also 6.97x vs revenue or sales gain.

So more of its members are defaulting; more are paying late fees.

 

[luutzu]

Comedy gold!

Anyone ever told you you're a bit of a prick?

 

[luutzu]

They said this loss is reducing as a total percentage. When the next half results get released we shall see. If you are late paying they never lend to you again so in the Australian market the bad debts would be expected to reduce. The cost of doing business per transaction should also reduce as the business solidifies in the US and UK.

The fact that the banks are lining up to lend should give comfort as I am sure they are doing due diligence.

The worries I have are, systemic fraud, failure to gain market share in the U.S. and UK as they have done in Australia due to new competition. Basically they have first mover advantage, with developed software and a great name.

Definitely speculative but an exciting prospect.

Speculations are always exciting though

I hear lots of people are very happy with AfterPay... while that might sound like it's a good thing, not really when your business is lending them money.

I mean, you'd want your customers to be cursing at you when you lent them money right? Not bragging about how it's so awesome.

 

[tinhat]

Please check my maths, 'cause if it's correct, about one quarter of APT's revenue is defaulted. That's very high for any business right?

View attachment 91537

Page 11 of their annual results presentation also gives a good summary:

From how they present their figures I agree with your calculations that the impairment expense of $32.6m represents about:

• 28.6% of gross revenue of $113.9m,
• 22.9% of gross earnings including other income of $142.3m or
• 38% of gross profit after costs of sales of $85.7m.

Looking back at the statement from their presentation which I quoted above, the whole business model appears to be based on a very high velocity of turn-over of the credit they extend to their customers.

They state:

A US$300 million facility is able to fund well in excess of US$4 billion in annual underlying US sales.

They are seeking to turn over the amount they give out as credit at 13.33 times per annum; which at a fee of 4% per transaction equates to a target return on funds deployed as credit of 53% per annum. In other words, for every $100m of capital allocated to credit finance they are seeking to finance $1.33b of transactions @ 4% return (merchant fee), which on $100m of capital would yield $53.3m in merchant fees per annum.

Now let's model the business from the point of view of someone looking to provide the debt financing they are seeking to raise. Let's look at the business model, based on the reported earnings and expenses and using the assumption they provide that $100m of capital deployed will finance $1.33b of transactions generating a gross revenue of $53.32m p.a. For ease of analysis of the figures I am pro-rata scaling all the reported expenses to fit into a modelling a deployment of $100m as finance capital.

Like Luuzuu, I'm not sure whether the revenue figure they give comprises just the 4% merchant fee and whether late fees are therefore included in the other income figure, which is not included in the calculations above. Can anyone clarify this? Because it might be that the late fees collected balance out a substantial amount of the impairment cost.

Obviously, you can't pro-rata scale fixed overheads in the real world as I have done in the model above, but it is just easy to scale the figures to something that is easier to analyse. Furthermore, you would need to remodel the indirect expenses (overheads) into any forecast as you would expect them to reduce substantially as a percentage of sales revenue as the business scales.

The point I am making, as stated earlier, is that the business model relies on a very fast velocity of turnover of the credit (forecast to churn over 13.33 times per annum). At a 4% merchant fee per transaction this is central to the business model. It is important to keep this in mind because any increase in bad debts can be expected to drag down that velocity of credit churn and thus will impact the revenue stream. Any shortfall between late fees collected and outstanding payments reduces the amount of finance available to churn over as credit for the next transaction and the business model is for that money to churn over every four weeks! In other words, the business model appears to be very sensitive to any change in bad debts. Probably much, much more than a traditional consumer finance model.

On the plus side, I can imagine this business not needing to generate any return on the funds deployed as credit as I expect there to be potentially more value in using customer data as market intelligence and opportunities of working with merchants on sophisticated direct marketing through the platform.

PS: *I'm having such a hard time writing this post. I don't understand how the image attachment system works or how to insert a table into the text!

 

[tinhat]

Just to add to the above, I don't know much (anything!) about the finance industry but when they say:

A US$300 million facility is able to fund well in excess of US$4 billion in annual underlying US sales.

We can assume that in practise that cash is not going to actually flow through their books at a velocity of 13.33 times per annum. They are, no doubt, going to rely on a fractional system whereby the actual cash flow is probably going to be much less than the amount of credit that is circulating on paper. For example, how long do they delay settling with the merchant?

This is a business I would imagine you would really need to keep a close eye on the cash flow against credit on the books, especially if any problems get papered over through raising of additional funds to finance growth, because if things are going wrong it could be all too late by the time the investors find out. In a credit crunch and this business could well be burnt toast.

 

[So_Cynical]

Nice work Hat - good reading.

 

[galumay]

Nice work Hat - good reading.

+1, some great 2nd level thinking there!

 

[tinhat]

So, I've just found out that afterpay require 25% upfront payment from new customers but repeat customers don't have to make their first repayment for two weeks. So, assuming that for new customers afterpay collect the 4% merchant fee on 100% of the sale but only finance 75% of it, then, depending on the mix of new to repeat customers, that will adjust down that velocity multiplier of 13.33 I calculated above, potentially reducing it to a potential velocity of 10x annualised if all transactions are by new customers. Also, the higher the proportion of transactions completed by repeat customers, then in theory the lower the risk of default and bad debt.

 

[Toyota Lexcen]

is there any info regarding debit card or credit card usage?

so many people live pay week to pay week

 

[Knobby22]

is there any info regarding debit card or credit card usage?

so many people live pay week to pay week

According to Afterpay over 90% of users make repayments through a debit card. Source Mozo advice site).
I agree paying down the payments through a credit card is a recipe for disaster.

 

[luutzu]

is there any info regarding debit card or credit card usage?

so many people live pay week to pay week

I think in the FY18 presentation they were saying that 85% of members uses Debit. So 15% using credit.

Read somewhere that AfterPay does charge interests on credit users. After some 56 days or so.

 

[luutzu]

So, I've just found out that afterpay require 25% upfront payment from new customers but repeat customers don't have to make their first repayment for two weeks. So, assuming that for new customers afterpay collect the 4% merchant fee on 100% of the sale but only finance 75% of it, then, depending on the mix of new to repeat customers, that will adjust down that velocity multiplier of 13.33 I calculated above, potentially reducing it to a potential velocity of 10x annualised if all transactions are by new customers. Also, the higher the proportion of transactions completed by repeat customers, then in theory the lower the risk of default and bad debt.

Maybe more risk of default, not less.

If users want to play AfterPay, they might go ahead and repay all the dues on time. Doing so give them more credit from APT right? The better the repayment, the more afterPay gives... then you take that couple grand or whatever.

For honest and law abiding citizens, lower outstanding debt are easier to repay. The higher it is, the more difficult it gets. So if a lost job or didn't plan proper. Could risk high fees and default.

 

[Smurf1976]

In a credit crunch and this business could well be burnt toast.

I certainly agree with your assessment that there are vulnerabilities in this business.

What the customers do is one thing. What happens with broader credit markets is another. What governments may choose to regulate is another.

That said, short term at least there's plausibly value in the concept, the tech, data analysis and so on.

 

[tinhat]

I certainly agree with your assessment that there are vulnerabilities in this business.

What the customers do is one thing. What happens with broader credit markets is another. What governments may choose to regulate is another.

That said, short term at least there's plausibly value in the concept, the tech, data analysis and so on.

Despite my concern over the long term viability of the business model, I do agree that with you that this could fly in the short to medium term. I notice there is a gap in the chart between $14.45 and $15.10. I'll add this one to the watch list.

 

[bigdog]

News article about yesterdays Senate credit and financial services hearing

The next meeting is tomorrow
24/01/2019 9:00AM - 12:30PM AEDT
House of Representatives, Standing Committee, Economics (Credit and financial services targeted at Australians at risk of financial hardship)


https://www.news.com.au/finance/mon...g/news-story/5aaf3c804cc62b1ca2e47257429e5e73

Afterpay, Zip Co execs defend companies at Senate hearing
An ad encouraging “broke” Aussies to use Afterpay to “treat themselves” has been savaged by the buy-now, pay-later provider.

Stuart Condie
AAP January 22, 20193:34pm

Afterpay executives say they were “absolutely distressed” by a retailer’s advertising campaign that encouraged “broke” consumers to use their service.

The ASX-listed buy-now, pay-later provider says it threatened to withdraw service from the retailer when it became aware of the advert last year, and would have severed ties had there been any repeat.

The ad in question encouraged “Broke AF” consumers to use Afterpay to “treat themselves”.

Appearing before MPs as part of an inquiry into credit and financial services targeted at those at risk of financial hardship, Afterpay executive chairman Anthony Eisen said the company had beefed up monitoring to ensure retailers complied with its efforts to ensure struggling consumers do not take on more debt.

Mr Eisen said the ad was unacceptable and contrary to the values of a company that derives 80 per cent of its income from retailers rather than consumers.

“We were absolutely distressed when we (were) first made aware of that campaign,” Mr Eisen said on Tuesday.

“There is nothing whatsoever associated with that campaign that was supported, endorsed or acquiesced (to) by Afterpay in any way.”

The cost to consumers in late fees for Afterpay — a modern form of lay-by — is capped at $68 or 25 per cent of the cost of the goods or service, whichever is smaller.

Afterpay says late fees are not designed to generate profit and are a genuine estimate of losses incurred as a result of late payments.

The company’s submission to the inquiry said it “promotes responsible spending and seeks to offer a credible alternative to credit products.”

It has largely been used for consumer goods, but Afterpay acknowledges it is now being used for other services such as dentistry.

“We know that Millennials have one of the lowest participation rates in private health and general dental is not covered by Medicare,” Afterpay’s submission said.

“Our first partnership is with Primary Dental and it has proven extremely popular, with thousands of patients opting to pay via the new method since launch.”

Rival Zip Co, which also appeared before MPs, said it was created due to consumers’ unhappiness over the high cost of credit cards and endeavoured to act responsibly.

The company does not allow customers to use the service to pay off other debt.

“From day one, we have tried to be one of the most ethical players in our segment,” chief executive Larry Diamond said.