We recently discussed PayPal, and the natural progression was to take a look at Affirm and whether it represents an attractive buy. Unfortunately, valuing Affirm is not as easy... and it's a much more speculative play in the Buy Now Pay Later (BNPL) space. But, we'll do our best today.
I did not buy the Affirm IPO, because I felt like there was just too much risk (primarily of competition). PayPal had then just announced its BNPL efforts, and I felt like it it could crush all competition. I still feel like PayPal has that potential – part of my investment thesis in it, at these price (if you haven't checked out that post... make sure you do!). But, PayPal has honestly been pretty slow at implementing BNPL, and Affirm is now proving to be the clear leader. So, I'm revisiting my original thoughts to see if anything's changed.
In the interest of transparency and authenticity, I wanted to repost my original TiktTok on IPO. Yes, I do TikToks... so you can follow me there for more frequent updates and videos. They're short, and fun (I'd like to think so at least).
Since we're no limited to a 60sec TikTok, let's dive a bit deeper into the business model and some qualitative news driving the stock's price in recent months. The model, pictured below, allows Affirm to profit from both Merchant and Consumer.
Here's how it looks for the consumer on Amazon: https://www.amazon.com/b?node=23376591011
Affirm did start their business with the core "buy now pay later" model, but does have other product offerings, and innovated over the years – which you can see below.
Checkout: Consumers can choose Affirm as a payment method at checkout online. Consumers receive either 0% APR, where they pay no interest, or simple interest loans, where they pay fixed amounts of interest that never compound. Each loan has configurable repayment options.
Virtual Card: Consumer can apply at Affirm's website or Affirm app and if approved receive a virtual card they can use online or offline. This enables consumers to use Affirm's pay-over-time features even if the merchant is not integrated with Affirm in their own checkout flow.
Split Pay: At select merchants and for purchases <$250, consumers can pay with a multi-part payment plan with 0% APR.
Affirm App + marketplace: Mobile app that provides offers from merchants based on the consumers' spending habits and enables users to customize repayment terms. Over the last quarter, 32% of Affirm's total transactions occurred on the marketplace and the app has been downloaded 4.8M+ times in the U.S.
High-yield savings account: Through the Affirm app, offers interest-bearing savings accounts. No minimum deposit requirements or fees. Current APY is 1.00%.
You're probably aware of Max Levchin... who's the very well-marketed founder/CEO of Affirm. He was part of the founding team, or PayPal mafia. After PayPal, Levchin built out social media Slide – which was acquired and failed under Google. After that, Levchin's next move was Affirm.
What's the hype all about?
In order to understand the hype around BNPL, it's best to just look at a few key statistics which should make things clear to you. The question we're trying to answer for, "does BNPL have the potential to completely disrupt the current consumer payment and debt structure?"
The first thing to look at is it's market share of e-commerce payments, which is clearly on an uptrend... from less than 1% in 2016 to more than 2% in 2020. This is forecasted to be 3% by 2023. You can also see this is as high as 20% in some European regions, with much higher adoption.
In terms of e-commerce, we already know it's a monster and still growing – around 15% CAGR until 2027. It's the Millennial's and Gen-Z's preferred method of shopping, who are also the first adopters of BNPL.
Although the spending power of Millennial's and Gen-Z's are increasing, we're also seeing very high consumer debt levels – which is a bit concerning to me, which I'll address later. According to the Federal Reserve, Americans are now over $4tn in debt – which a significant portion is credit card debt. This shows the need for alternative, more flexible payment options such as BNPL – that ideally don't contribute to overspending.
Before we dive into valuation, let's better understand some of the competitors in this space. You have competition not only from other BNPL platforms, but also digital wallets such as PayPal, traditional credit services such as Visa and Mastercard, as well as big banks and debit cards.
I've already mentioned the way I see PayPal being a threat (which so far, they don't seem to be doing a very "threatening" job); but, for now, lets focus on other BNPL competitors.
It's important to note the data above is an year old since the Affirm IPO. However, it's clear there is serious competition in this arena. With Square's acquisition of Afterpay, Affirm is the only investable pure play in the markets. A Klarna IPO would change a lot for Affirm. So, this is why I didn't invest in the Affirm IPO... but now we have the Shopify and Amazon deals, which are game changers in this race. This can allow Affirm to take a significant lead.
Shopify & Amazon Deals
It's important to understand the structure of the Shopify and Amazon deals, as I wouldn't say either of them what due to Affirm providing any material benefit over the competition. To-date, we don't have evidence that one is superior over the other in its risk modelling or underwriting... in fact, we don't even have evidence that this model can be profitable and sustainable. It's way too early.
But, we do know that these deals are coming at a cost... because it is a race after all. And the hotter the race, the higher the cost. In this case, Affirm is diluting shareholders at the cost of growth.
Shopify was given the equivalent of 10% of the company for their deal, by way of warrants (for 20.2m shares).
Amazon was given the potential of acquiring 22m shares (7m exercisable at $0.01 and 15m at $100.00) at a cost of $1.5 billion while the shares had a market value of $2.94 billion entering the announcement. The agreement is only exclusive until January 31, 2023... so this can be a huge miss, should Amazon partner with someone else or build out their own native solution via Amazon Pay.
This just goes to show how fierce the competition is... why else would anyone be willing to just offer equity to their merchants. This is obviously not a sustainable strategy. It could pay off... but it might not.
As you know, the full spreadsheets of all my analyses are available to premium members of The Hawk Letter, including buy prices and targets. But, here's the summary.
It's impossible to do DCF or fair value calculation for Affirm, since it's way too early of an investment. An investment in Affirm would represent an investment in a very early stage company, whether you think it or not. Yes, there's a lot of hype... but I'll be here to remind us to think objectively (sometimes).
Much like PayPal, the key business metrics (which drive revenue) are Active Accounts and Gross Merchandise Volume (GMV). The GMV has been increasing at 80%, which we saw in our competitor comparison earlier. If we assume this grows at 50% CAGR until 2024, which is probably ignoring most of the Amazon impact (very important to note), they'll be close to $4bn in revenue by 2024.
Based on the revenue/GMV trend, I'm thinking 8% of GMV. However, I am not willing to make assumptions on profitability and/or EBITDA right now, because it's just way too early and it's quite frankly pointless. So, that leaves us with price/sales as the only way to value this.
Right now, PayPal – which I feel is the most conservative competitor to benchmark against – has a 9x P/S ratio. Visa has a P/S ratio of 18x. I think its fairly conservative and prudent to assume a 15x P/S ratio for Affirm; but, we have to understand this is purely speculative. Right now, Affirm is trading at 40x P/S, which some would call outrageous... so we are factoring in compression of that multiple.
This would give us as price target of $270 – or a 100% upside from here.
- Concentration Risk – a main risk I saw in their IPO was concentration risk with Peloton as their main customer (i.e. 30%) and most of their origination with Cross River Bank. However, I do think that they've made significant progress over the past year to reduce that. Nonetheless, I just wanted to mention it.
- Competition Risk – as I've been consistently mentioning, competition is fierce in the BNPL space, and I haven't seen any company making the claim that they have a superior underwriting (or other) model. This means the barriers to entry are as high as obtaining exclusivity with merchants (who have the most bargaining power). This could have a significant impact on the next risk...
- Profitability – because the business model and companies are so new... it isn't proven yet. There's no one that can derive a model, with conviction, for profitability. That's a key risk we have to keep in mind when allocating any amount, should we do so.
- Increasing consumer debt bubble
- Macroeconomic environment – rising rates... will it have a positive or negative income? Not clear to me.
To wrap it up, I think it's very important to understand how early we are in BNPL... and to really weed out the hype. The question we need to ask ourselves is whether the BNPL model is something that can be profitable and sustainable down the line... can this be the next wave in fintech innovation? Is this a real threat to legacy payment systems? To be completely honest, I don't know if anyone can answer that with conviction... so, neither can I.
That being said, are you willing to make a small bet if that's the case? That's the real question. I would make a small bet, if the technicals for the stock make sense. Looking at the chart now, I'm not so sure we are in the clear for a reversal in this downtrend. However, if we hit apparent support levels, it may end up being worth it to start a position... i.e. somewhere between $100-110 (let's say $105).
I like Affirm because it is the only pure play option with potentially huge upside from the Shopify and Amazon deals. Though those deals came at a high cost, I think they made strategic sense, if they can continue the partnerships in the long-term and come out profitable. There is no doubt that revenue and GMV will increase in the coming years, and that alone makes a good reason to at least enter a trade.
So, basically, I would consider starting at $105-110 if we can see some support there. I'm not in a rush with this, because I do think that there are better risk/reward plays, like PayPal right now... which I have entered. If you haven't already checked out the analysis, make sure you do!
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As always, here are the working papers for my Affirm (AFRM) Valuation & Analysis – feel free to play with it. Happy investing!