Affirm Holdings - Credit for the New Age
Each decade sees a different industry somewhat rise to prominence. Whether that's the dot-com boom of the mid-2000's that saw the rise of digital e-commerce, or the SaaS boom of the 2010's that saw new and old companies alike embrace the monthly subscription model, each era seems to bring with it a new business that's in vogue. Well we're only 22 months into the 2020's and we seem to have a pretty good idea of the industry that's capturing all of the attention (and money) of public and VC firms alike: FinTech.
The rise of FinTech has been an interesting one over the past two years, with a bit of a divergence happening in the marketplace. On the one hand, you have blockchain technology companies that look to take over the financial services industry by leveraging the technology behind cryptocurrency. These companies break not only into the crypto space, but also use the smart contracts to do things like speed up mortgage loan processing speeds or grant small businesses new loan options. You also have the other hand, which looks to take on traditional financial services companies by disrupting the established banking model. Companies like SoFi, Chime and Robinhood have attacked the traditional banks by offering no-branch models that reduce the overhead of the company, resulting in higher interest rates for savings accounts and more features in checking accounts. But some companies are also now taking on the credit card arm of financial services, offering lower-interest models on installment payments. This is referred to as the "Buy Now Pay Later" (BNPL) model, and is becoming increasingly popular with millennials and Gen-Z that are looking to buy $400 Jonas Brothers tickets but can only afford the cheap seats. At the apex of the BNPL revolution is Affirm Holdings, which has made waves in the public markets this year. But is this trend here to stay? Can Affirm stay on top amidst a wave of competition? Let's use this week's deep dive to go head first into Affirm Holdings (NASDAQ: AFRM).
Top-Line Numbers
2020 FY Revenue: $509.53 million (+92.74% YoY)
2020 FY Net Income: -$112.6 million (+6.52% YoY)
Q2 2021 Revenue: $261,78 million (+70.73% YoY)
Q2 2021 Net Income: -$153.21 million (-540.09% YoY)
How Did Affirm Holdings Get Started?
Normally I start these with the story of some little founder in his garage or an inventor with a good idea. While those are still true in this story, Affirm was founded by a few people in a startup factory. Essentially, startup factories are incubators for startup founders, where an established person can provide a safe environment for aspiring billionaires to spin up their ideas.
The best pop-culture example of a startup factory is in HBO's "Silicon Valley" where Erlich Bachman, who previously started and sold a company, took the proceeds and created an incubator to house other aspiring startup founders. In exchange, he took a cut of the company in equity, hoping for an exit opportunity. Well in this instance, we happen to have one of the most prolific Silicon Valley inventors you've never heard of. Max Levchin to the main stage please.
Levchin, prior to his story at Affirm, was the co-founder of a little payment solutions company called Confinity. He and now infamous venture capitalist Peter Thiel, a figure I write about almost as much as Joe Manchin at this point, developed an application for PDA's (remember those?) to be able to transfer money from one to the other. After merging with X.com and picking up another business partner in eccentric South African inventor Elon Musk, the company changed its name to PayPal. While at PayPal, Levchin developed proprietary anti-fraud technology for the company, called the "Gausebeck-Levchin Test," which is the genesis of what we now call "CAPTCHA."
PayPal went public in 2002. Shortly after, it was acquired by eBay, making Levchin's stake worth about $34 million. What did he do with this cash? He became an angel investor, putting his money into two companies called "Yelp" and "Evernote" which are both now raging successes. He also started his holding company "HVF," which served as the startup incubator that sought to use data in new and interesting ways. One such way was consumer purchasing insights, which led to the founding of a purchase installment company called Affirm. Affirm was spun out of HVF in 2013, independently raising cash with Levchin at the helm as CEO. In 2021, the company went public, making Levchin's stake a little over $2.5 billion.
What's the Business?
Affirm is the keystone company in the new industry of Buy Now, Pay Later (BNPL). Think of the space as the millennial answer to credit cards. Rather than put a large purchase on the American Express and potentially paying north of 20% in interest, Affirm is a selectable integration into your purchase and allows you to split the payment up over either four interest-free payments, or select from a variety of low-interest short-term loans. It's the younger generation's answer to mass credit card debt, an affliction most of us suffer from.
Will I Invest In Affirm Holdings?
Affirm is a fascinating company. The idea of a short-term loan for retail purchases isn't new, as anyone that uses a credit card will attest. It's the circumvention of the credit card company that's pretty interesting to me. Additionally, the fact that they hit you at the point of sale makes this almost an impulse addition to your purchase. However, the company does have to be integrated with Affirm in order to take advantage of the service, and they've had one hell of a year amassing partnerships.
You'd think if you were in the retail space and wanted to partner with e-commerce brands, you go after some of the big ones, right? Well that's exactly what they've done at Affirm. In 2021 alone, they've struck partnerships with Shopify, Walmart, Amazon, Apple and, most recently, Target, that rolls out this installment-based payoff model into their point of sale sites. They crushed it! Try buying something not on these websites. It's not easy, and Affirm knows it!
But then the question remains: why would these companies want to partner with a company like Affirm in the first place? Luckily, Affirm answers that question for us. The first reason is that companies that partner with Affirm see an 85% improvement in the average order value. Why? Because now customers can afford to spend more! Since they can pay it off over time, they can rack up those items in the cart and let loose, a clear win for the retailer. Second, Affirm customers show a 20% average repeat purchase rate, indicating that the consumers that use Affirm via an end-point retailer are more likely to come back to the platform to shop again.
The next aspect of this company that intrigues me is their entrance into the wider financial services arena. In September, Affirm stunned investors when they announced they were branching out beyond credit and into debit and cryptocurrency services. This followed in PayPal's footsteps earlier this year with the announcement of their own "super-app" which seems to have replaced "blockchain" in VC bingo. They both also join Square's CashApp, who themselves are now in the BNPL space after acquiring Afterpay, a chief rival of Affirm. This announcement by Affirm was met with enthusiasm by both investors and consumers, with over one million people signing up for the Affirm debit card. The crypto product is interesting because it's actually integrated into the savings account, encouraging people to buy and hold the assets, rather than day trade them. An analyst from RBC Capital Markets estimates that these new products will make meaningful impacts on the company's balance sheet sometime in 2023 as the products get ramped up.
Finally, this is still a new and small company. Their current market capitalization puts them at around $40 billion, which is considerable, but much less than its more established peers. American Express clocks in at around $135 billion, MasterCard checks in at $338 billion, and Visa is the king of the hill at $473 billion. If you think that the "super app" has the ability to rocket this company into the next level of financial services, then it has considerable room to grow relative to competitors.
Business Risks
Buy Now, Pay Later Regulatory Risks
With new companies in new spaces, usually comes new laws. Hanging over the head of pretty much every moment of innovation is the murky cloud of the federal government, releasing their resident fun-stoppers to stomp on the dreams of innovators. And, while BNPL is new in the U.S, other countries have had this concept for some time. The U.K has had a similar business model for years, as has Australia via the major regional BNPL companies of Klarna and Laybuy, respectively. In February 2021, the U.K Financial Conduct Authority found that nearly $4 billion was circulating in consumer installment payments, 10% of which were delinquent. Now, there is impending regulation around the BNPL products that would require a hard credit pull in order to obtain the loan, similar to how credit cards and mortgages work. This would dramatically decrease the effectiveness of the service, as each hard credit pull would negatively affect the user's credit score, decreasing their ability to continue using the product.
It's a similar story in Australia, where BNPL usage rates are soaring. Since their introduction in 2018, usage rates have seen an average annual increase of 75% through this year, with 30% of Australian adults now using the service. However, 21% of users have reported missing at least one payment, again having a negative credit effect. With Australia being that laid back Aussie "fuckin' right yeah mate" attitude, they're a little more relaxed around their current regulations. They passed a law in 2009 around credit protection that actually has a carve-out for BNPL-type products. The Australian Finance Industry Association released a statement in March 2021 that effectively ended regulatory worry around the space, indicating that "the BNPL Code goes above and beyond the law in Australia...while preserving customer choice to make purchases and payments in a way that suits their needs and preferences."
Unfortunately, the same type of risk is heading to American shores, and we're way less cool about it than the upside down koala huggers. A 2021 study by Credit Karma saw that 40% of BNPL users have missed at least one payment, and 72% of those users saw a negative effect on their credit score. However, the United States has a secret regulatory weapon at its disposal in favor of companies like Affirm: states' rights. According to Anda Kania of "The Paypers," laws around the use of credit are determined on a state-by-state basis, making sweeping regulatory changes more difficult than other, more cohesive nations. And then there's California. California, genesis of all things difficult and laborious, decided to pick a fight with BNPL in 2021. The California Department for Business Oversight (DBO), decided to pick a fight with Affirm competitor "Sezzle" by refusing to grant the company a license to operate in the state. They also went after Afterpay for tax collection of 640,000 residents. The investigation forced Afterpay to pay back $900,000 to consumers, as well as $90,000 in admin fees.
A final word on this: Affirm does actually assign their users an internal score prior to issuing them a loan or payment eligibility. They call this metric "ITAC," which grades users on a credit-worthiness scale from 1-100, with 100 being the lowest-risk borrowers. From 2019 to 2020, those users with an ITAC score of 96+ actually increased by 4%. From 2020 to 2021 however? That's a different story, as shown by The Motley Fool's James Brumley:
Increased Competition
As with any space, competition begins to heat up when proof-of-concept has been achieved. Affirm wasn't even the first company into the fray; you can thank Klarna and Laybuy for that. Affirm, however, made the biggest impact in the U.S and is first to the public markets, which makes it the one all others are chasing. And chase they will. Now, competitors like Sezzle, Splitit and even PayPal are chasing with their own installment plans. Some offer gimmicks like being able to re-plan payments or push payments to after the initial purchase. Some, like Klarna, have much higher credit maximums, resulting in their being better suited for larger purchases. And nothing is stopping companies like Apple or Amazon feeling the pressure in a couple of years and ending their Affirm partnerships in order to build out their own infrastructure for the space.
Valuation and Balance Sheet Risks
Affirm, for all of its merits, is aggressively unprofitable. The company's net income, net profit and earnings per share (EPS) all make for some uncomfortable reading material, what with them being in the negatives. Their operating income has dipped past -$150 million as they aggressively expand their company in headcount, advertising and partnerships. This is all fine, if it works. Early-stage companies typically have to take balance sheet risks in order to grow, especially those in the technology/finserv industries. They are expected to keep up a certain growth rate, and have to spend money to make money. Thankfully, they do still have nearly $1.5 billion in cash on hand to get them out of a sticky situation, but their debt-to-equity ratio is a little high for my liking at 72%. They're levered up to their eyeballs, so this super-app is something that needs to work for them. They really can't afford a pure write-off.
The Bottom Line
Investors are always looking for "that next big thing." The next big company, next big product or next big industry. In Affirm, you seem to have found all three. They're the biggest public player in the newest financial services sector that is developing tools to make them stickier to the average consumer. They have a very strong business model, as well as key major partnerships that will ensure the company is rapidly accelerating for years to come. However, I am concerned about consumer behavior in the space. One quarter doesn't make a trend, but Affirm's own numbers from this most recent quarter indicate increasing delinquency rates. This is the only thing holding me back from immediately taking out a second mortgage on my home and dumping it into Affirm. I'm personally going to hold for another quarter as the world seemingly comes back to normal to see if the delinquency rates shift again, or if the consumer behavior seen on the app is a microcosm of the K-shaped recovery we're seeing in the greater market as a whole. However, with a long-term perspective, Affirm could be a great investment.
Short-term: Neutral
Long-term: Long
The following article is for entertainment purposes only and does not constitute investment advice. Everyone's situation is different. Please contact a professional for individualized tax or investing advice. The author does not have a position in Affirm Holdings (NASDAQ: AFRM).
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