Is Affirm a Growth Stock to Buy Now?

Another week, another big IPO. This time it's former PayPal (PYPL 0.34%) founder Max Levchin's latest act, Affirm (AFRM -0.45%). In this episode of Industry Focus: Tech, host Dylan Lewis and Motley Fool contributor Brian Feroldi talk through this layaway 2.0 company and how it plans to disrupt the existing consumer financial model.

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This video was recorded on Jan. 15, 2021.

Dylan Lewis: It's Friday, January 15th, and we're talking about another big IPO. I'm your host, Dylan Lewis, and I'm joined by fool.com's acute accelerator of articulating awesome asset.[laughs] Oh, you got me, Brian, you finally got me. Awesome asset allowance arguments, Brian Feroldi. As if you needed an introduction.

Brian Feroldi: Was it the allowance tipped you up, were you expecting allocation? Is that the trick? [laughs]

Lewis: I was.

Feroldi: Yes.

Lewis: The brain works in mysterious ways.

Feroldi: All right, now I know.

Lewis: Yeah. I had a great run as it turns out.

Feroldi: You did. [laughs] Dylan, great job. It took me like 30 tries to get you. Success.

Lewis: Well, if listeners can't figure it out, we're talking about a company that starts with an A, given the alliteration that Brian dropped in his title. Specifically, we're talking about Affirm today and this is a show that our colleagues, Matt Frankel and Jason Moser, did a little while ago back in November when their prospectus came available, shares hit the market this week. So, we're going to be talking about it. But Brian, I think before we even really get too far deep into the show, I want to ask you, is this a business that you have seen on the consumer side, just browsing around on the Internet?

Feroldi: I have not. This is a company that specializes in the "buy now, pay later" or pay installments over time. I'm not their target consumer, so I haven't interacted with it, but they seem to have a whole lot of raving fans, Dylan.

Lewis: I will say, I have noticed that little button, buy with Affirm, pay with Affirm, starting to crop up on more and more websites. I think I first noticed it when I was doing some research for a show on Peloton (PTON -0.98%) back when that S-1 came available, and we're going to talk about their relationship in a little bit. But this is one where I think even just on the consumer side, you can start to see this showing up in more and more checkout interfaces. You start seeing it on more and more product listing sites online.

Feroldi: Their primary competitor is a company called Afterpay and I know that the "buy now, pay later" installment is really picking up steam and there are a lot of consumers that are asking for and demanding this technology.

Lewis: We're going to get into a variety of reasons why this is appealing both on the consumer side and the merchant side. I think maybe the easiest way to put all this together into a nice bow for folks that aren't familiar, is this is basically layaway for the 21st century. Then that might be the easiest way to think about it.

Feroldi: I think that's a pretty fair description. This company is basically out to make credit cards for millennials, if you could. It's eliminating all of the bad things about credit cards while enabling all the good things about credit cards.

Lewis: The mission really hammers that home, "Deliver honest financial products that improve lives." That's pretty straightforward and it really speaks to what they are trying to do, and what they're trying to correct when it comes to the financial system.

Feroldi: I love mission-driven companies and I love it when a company has put it right in their S-1 upfront. First thing you see, our mission. So, check for Affirm there.

Lewis: Just some quick details on the IPO. It came public earlier this week, up over 100% on the first day of trading. Hard to believe, I feel like we've been saying that a lot, Brian. They raised a pretty decent amount of cash. But they did wind up obviously leaving a lot of money on the table.

Feroldi: They raised over $1.2 billion at $49 per share. As we're taping this, it's around $113. They could have raised basically twice as much money for the same amount of dilution.

Lewis: We'll talk about the IPO process and really why we keep seeing this in 2020 and 2021. But I do wonder if this is something that will be fixed at some point, because we have seen so many mispriced IPOs over the last 12, 13 months.

Feroldi: Could be a big reason why this SPAC boom is taking off and why direct listings could get more popular. Dylan, I'm glad you pointed this out because when we were doing show notes, I just quickly used and glanced at Yahoo Finance to get some information on this company. It says their market cap is $13 billion. That's incorrect. The actual market cap of this company is about twice as high. So just be warned, if you're looking at Yahoo Finance data.

Lewis: Always good when you're looking at the data aggregator [laughs] to make sure that they've got it right. Maybe check your sources in a couple of places. This is not in any way to throw Yahoo Finance under the bus here. Because you catch it anywhere. The reality is a lot of these places are just making sense of a lot of data and a lot of different spots. Always go check it. Worst case Brian, do the math on a napkin or an envelope. Figure out how many shares they have, figured out the share prices and you can work your way to that number pretty quickly.

Feroldi: Yeah, just don't do what I do, and assume that whatever Yahoo said was correct there. Thank you for correcting that. I'm sure it will be corrected in time. This is clearly a popular company and that data fills in over time as the company gets public for a little while longer.

Lewis: Brian, just to walk through exactly what people do when they're interacting with Affirm. I teased it a little bit earlier. But basically, you are shopping online, you see something that you want to purchase, it's probably a more expensive item if you're interacting with Affirm. You have the option to buy it currently or rather than paying that cash all upfront, you can purchase it now and wind up making installment payments over the course of the next 12 months, maybe three years, depending on how you end up structuring it. This feels a lot like the way that credit and debt works with a credit card, but it's different with how Affirm is trying to position it.

Feroldi: There's a couple of key differentiators here that are huge benefits for the consumer. No. 1 is transparency and No. 2 is flexibility. To your point, let's say you are about to shop online and something was going to cost you, say, $1,000 in spending. You could, of course, put that directly on your credit card, but then you risk all kinds of potential bad things happening down the road such as interest compounding. If you miss a payment, there are penalties and there are fees, a lot of which are unknown to the consumer at the time of the purchase. Affirm flips that on its head and lets consumers pick the terms that they want for repayment. All that information is put right upfront and there's a little sliding scale that consumers can use to determine how quickly they want to pay back the loan. If it's longer than a certain time period, I think the minimum is six weeks. They do charge interest on the loan, but the interest is simple interest, it is not compounding interest. Again, it offers consumers flexible payment terms and transparency with what they're going to pay.

Lewis: I want to pull a couple of lines here from the S-1, because I think it really drives home how the company is looking at their relationship with customers. They write, "We believe that consumers lead absolute immutable clarity in what they will pay and when it's due. We believe that the morality of each financial product offered to our consumers is a key consideration and an essential part of the Affirm brand. We put what is good for our consumers first and we'll never benefit from their mistakes or their misfortunes." I think that, if you were to pull our listeners or our Fool members, there are probably a lot of people that have had to pay a credit card company or a bank because they've made a mistake at some point, whether it's an overdraft fee, a late charge, something like that. I think one of the core things that this company is really trying to do is build trust and build a long standing relationships with their consumers by not nickel-and-diming them.

Feroldi: I think that that speaks to this company's mission and they actually mean it when they say that. That's the reason why they've built up so much momentum so quickly. I actually was happy to see when they were risking out there risks, one of the things they said is, we put our consumers first, sometimes at the expense of shareholders. So this company seems deadly serious about delivering for consumers.

Lewis: I have to say, I was surprised at how many customers they have. It's always hard to get a sense of the scale for a business like this. Because if you see it here and there, you might think, OK look, there's enough of a critical mass for all of these merchants to be on board. But what does it actually look like? We have those details in the S-1, 6.2 million customers and 3.9 million active customers, so folks that have used it in the last year. That's actually quite a bit bigger than I thought it would be, Brian.

Feroldi: This company is only eight years old, Dylan. So to go from essentially a standing start to, as you said, 6.2 million total customers and four million of them have used the product in the last year, totally agree, that is an impressive scale.

Lewis: Now, the one thing that I did think was interesting is, pretty decent scaled, customer size, the usage was lower than I thought it would be. We have 2.2 transactions per active customer, and I believe that's an annual statistic. Maybe when you think a little bit more about the kinds of purchases that tend to be used with Affirm, it starts to compute a little bit more. If you're thinking about what would make sense for products like this, it's probably a four digit purchase. Something in the thousands or maybe something in the high hundreds. Maybe there aren't that many of those per year, but 2.2 did seem a little low to me.

Feroldi: That number was up over time, and they have plenty of used cases in there. Their longer serving cohorts are using the product as much as ten times per year, but I totally agree with you. The fact that there are six million in total customers and already essentially 2.3 million of them are inactive, meaning that they haven't used the product in that year is a potential risk. But nonetheless, the company scale is very exciting here.

Lewis: Yeah, I think one of the things that we'll have to answer over time with this business is, is this something that people use when it's incredibly convenient for them, and have it shown to them, or is this something that they build a relationship with over time and are they actively seeking out the ability to pay this way? Because if you can be taking something that would be a $1,500 purchase and paying it out in installments without any additional cost to you, that makes sense. You're willing to jump through a hoop or two to make that happen even if you're not trying to build a relationship with that company. What they really want though is to become the source of purchases of a certain amount for those consumers. That's going to be key to them, really growing and sustaining the network effect that they seem to start to have.

Feroldi: Yeah, that network effect is going to be critical to get probably in this company in the long term. It's your plan, let's knock out the rest of the scale. While they have 3.9 million consumers, they've already signed up 6,500 merchants. This includes some big name companies. They have Peloton onboard, they have Walmart, they have Shopify (SHOP 0.23%), they have Eddie Bauer, Purple, Kate Spade, Priceline, Expedia etc. 6,500 merchants are already onboard. Importantly, Affirm actually allows consumers to pay with the Affirm even if their merchants are not on the platform as of yet. You can go to Affirm, get a one-time code and use that to make a payment, and then that brings it back to the Affirm platform. That's a small but growing part of the business. As they build that out, that will definitely convince more merchants to join.

Lewis: Yeah, I think that's a key for customer retention and really building a relationship with folks, is being able to add that access to capital, that ease-of-use and the simple payment structure. Two things that then maybe create demand for merchants to offer them. If you're a merchant and you see a lot of people using this one payment method, all of a sudden, Affirm looks pretty good to you as a partner and certainly it's going to make the customers that are using it very happy.

Feroldi: Yeah, the data that we've seen shows that there's a lot of benefits from merchants to offer this. First off, Affirm has a net promoter score among its consumers of 78. That's unbelievably high, and that blows other financial institutions out of the water. But if you partner with Affirm, you get all kinds of benefits. You increase your customer conversion rates, you get all kinds of data, it helps you to do dynamic pricing, to offer different discounts and promotions, to push consumers over the edge. Their data says, if you use Affirm, the average order value increases by 85%. Almost doubling the average ticket value from your consumers and it increases your repeat purchase rate by 20%. Holy cow, Dylan.

Lewis: Yeah. I guess we shouldn't be as surprised as we are. If you make it easier for people to pay for things, they are probably going to be willing to pay for more things. Personal finance, like being safe with your money, part of my brain, Brian, does panic a little bit when I see numbers like that. Because you always want to make sure that people are spending in ways that they are able to pay for, and they are not signing themselves up for too much. We know that this is a company that is mission-driven and is trying not to take advantage of folks. It's a big part of what they're doing. But it does give me a little bit of a heart attack [laughs] sometimes when I see that.

Feroldi: Dylan, I am right there with you. On one hand, I love that they are eliminating fees and going on the consumer side. On the other hand, I really don't want people to be stretching themselves and buying things that they shouldn't in the first place. I'm right there with you when it comes to the conflict.

Lewis: Yeah. I'm sure folks are wondering, if we're not focusing on the fees, the overdraft fees or the late fees and work with a simple interest model rather than compound interest model, where's the money coming from? In fact with this business, a big part of it is on the merchant side. I think that's another big thing for them in attracting consumers and really building that strong network, is they are basically saying, "Merchants are going to be footing the bill for a good chunk of what we're doing and for all the convenience that comes with being able to pay this way. We're not going to push that onto the consumers." That's probably another thing that works in their favor.

Feroldi: Again, there are so many advantages for signing up as a merchant. You can understand why they're willing to pay that. It's a good deal if you pay a few percent back to Affirm, but you grow your average order volume by 85%, so understandable why retailers are warming up to this. But this company has numerous sources of revenue, five at my count, and there's lots of room for that to grow over time. Currently, more than half of their sales, as you say, come from the merchants. The number that they use as an example is roughly 5%. If they sell $1,000 worth of goods on the Affirm platform, the merchant will kick back about 5% back to Affirm as an origination fee.

They also earn money from interest. Sometimes they go out and they buy the loans that are being made from one of their bank partners, so that it allows them to earn simple interest on their consumers purchases, that's about 30% of revenue. Sometimes they sell the loans out on the marketplace and they earn fees for doing, so that's about 9% of revenue. Whenever somebody uses their virtual Affirm number, so not with a merchant, they bring it over to a party that does not accept it, they do earn interchange fees for that. That's about 3% of revenue. They also manage loans for third-parties, that's only 2% of revenue. The lion's share of revenue here is from merchants and interest income, but they definitely have shown optionality with willingness to open up new revenue opportunities.

Lewis: Yeah. I think if you're just trying to get the high-level takeaway here, about 85% of the business is going to be them collecting fees from merchants or collecting interest. That's where almost all it is right now. They have these other options and I think this is a business with optionality and we can talk a little bit more about that. But for the foreseeable future, I think the next couple of years, that's going to be where the money comes from. One thing that I think I probably need a little bit of clarity on, I need to do some more digging on Brian is, where that 5% winds up clocking in in the grand scheme of how payments get processed. I have a more primitive understanding of this than probably our Financials host, Jason, Matt and John Maxfield. But I believe that's higher than typically what you would pay on the credit card processing side. I think that those are typically somewhere in the 1.5% or 3.5% maybe 4% range. On the merchant side, it is something where you're probably going to be working over a little bit more than you normally would to facilitate transactions.

Feroldi: Yeah. It might not be a one-to-one comparison and that was just used as an example. They do say that that number does vary from partner to partner, but the example that they use in their own S-1 is using a 5%, so I agree with you, it does seem high. But hey, if consumers are demanding and merchants are making out from the transaction, it makes sense to offer it.

Lewis: Yeah, it certainly does. Brian, you mentioned the gross merchandise volume growth earlier. Let's talk a little bit about what all of that translates into when we look at their financials. Because this is not a particularly old business, not necessarily a young business either, it's been around for a little while. But we're seeing some pretty high top-line growth rates.

Feroldi: Tremendous, and it would make sense why they're coming public now. They know, "Hey, we're growing fast and we're going to get a higher valuation." Boy, oh boy, have they done that. Their fiscal year ends in June, so we have data looking back a year, and also from the most recent quarter, which ended in September. For the fiscal year ending in June, revenue was up 93% to $510 million. Last quarter, their revenue was up 98%. That is some slight sequential acceleration. Tricky thing here is, how do you calculate gross margin? Because there are a lot of puts and takes. One of their biggest expenses, a loss on loan purchase commitments, and they also have provision for credit losses. We wouldn't value this company the same way that we'd value in other high-growth tech stocks. Hard to come up with a gross margin or even look at the margin profile overall. However, we do know that they are purposefully losing money, they spend a huge amount on sales and marketing over the last couple of months to really turbocharge business growth. But last quarter, their net loss was about $15 million, so $15 million net loss on $174 million in revenue, that is not a huge number, especially since post IPO, they have $1.8 billion in cash.

Lewis: This isn't a company that is just lighting money on fire without any foresight into what might become a profitable business down the road. I think there's a path there. It drives me crazy when we don't have a sense of gross margin, just because that makes it a lot easier to kind of wrap your head around what a consistently profitable business, maybe five years from now looks like. I would always rather get that number from management than have to figure it out myself. But if we're anchoring to somewhere in the mid-20s, that at least gives you some feel for what [inaudible] .

Feroldi: Yeah. It totally depends on how you calculate it, and again, because such a big chunk of the business is earning interest, they have to set aside money for loan loss provisions. You have to value this like a financial stock and there are different ratios and stuff that we're just not used to looking at on the tech side, Dylan.

Lewis: Yeah. One thing I will note in what we do understand when it comes to the financial space, Brian, is, if you're talking about those loan provisions, the loss provisions, we're seeing less and less as a% of overall revenue being allocated there, which to me, signals there is strength in the loans that they're writing. They feel better and better about the performance of those loans, and we're also seeing crucially that the loan performance is getting better overtime. The charge-offs are declining as you get further and further out and you see more and more customers coming in. That's good, because a huge part of the pitch here is we have better data collection. We can make better sense of that data, and all of that leads to us steadily improving writing what we think to be better loans and possibly also being able to write loans to folks who normally would fall through the cracks in the financial system.

Feroldi: Yeah. That's a big part of the thesis here, is as we grow, as we gain scale, we're going to get smarter and smarter with making smart loans out to people that, as you said, might have qualified for credit either. That is yet another bull case for owning this company.

Lewis: This company is also taking on what I [laughs] would just characterize as a very large, maybe several larger giants in the space. Payments are huge. It's a really fragmented market. But there are very big legacy players on the consumer credit side, there are also other players in this space. How defensible do you think this business is, Brian?

Feroldi: That's going to be a real tough question for us to answer and look at over time. But again, you can't go from 0-6.2 million consumers and $500 million in revenue in eight years without having some type of competitive advantage. They claim that they have the network effect going on, where the more consumers that sign up for their product, the more they're going to be using them at merchants, the more merchants are signed up, the more that's going to increase their data and allow them to increase their analytics, which is going in turn allow them to make more attractive loans to consumers, etc. They are saying that they benefit from the network effect and I can't see that ramping up. I'm just not going to say it's the strongest network effect that I've ever seen. But one thing that they do have going for them is those partnerships with their merchants. Again, they have partnerships with Walmart and Shopify. Those are two exciting partnerships and Shopify actually took an 8% or 9% ownership position in Affirm as part of the deal. Shopify is invested in Affirmțs success. When you combine that with the data that they have, I do think that they are building a mooch for themselves.

Lewis: I think if you want to track the consumer side of that network effect, maybe one of the best ways to do it is to look at the success of the business line they have where people can use Affirm with merchants that don't use Affirm. If they can create a pretty vibrant growth story there, then I think that proves that the people are going to continue to come back to this thing and it winds up being a preferred provider in the financial space. I do worry that there are elements of this where they are going to benefit when someone sees them on a page when they're buying something anyways, and if that's what it is, I'm not nearly as interested in the stock.

Feroldi: Fair enough, and I think the option of offering to pay with your product, even at merchants that don't offer it yet is a wonderful -- even if it's a loss leader for the company, it puts you on the merchant's radar so you can't look at that number alone and track their success because if they're having success with the merchant that's not yet on their platform, they could potentially become a partner in time. I actually love that part of the business, but I take everything that you just said seriously.

Lewis: Yeah. I think that's the right way to think about it, Brian. It doesn't need to be where they make money. But I would like to see that segment of their business continue to grow, because it's basically sales and marketing for them, and it's proving out the value to customers beyond just what they happen to find when they're checking out on some other e-commerce player. I do think we've seen so many winners come out of the fintech space, Brian, and this has a lot of the hallmarks of a strong player here. There are so many trends pushing this company forward. You don't have to imagine very hard for [laughs] it to be successful in the future.

Feroldi: This is a company that clearly speaks to millennials and Gen-Z. They have a statistic in here that blew my mind. 25% of millennials do not carry a credit card. That blew me away. But they believe that their opportunity is just massive. Obviously, there are trillions of dollars flowing through e-commerce both on and offline globally, and they want to be a player in that. One way that they do size up their opportunity is to say that "now, pay later" is less than 1% of all transactions in North America, but it is one of the fastest-growing payment segments, and some market watchers think that that's going to reach 3% of total transactions by 2023. For perspective in Europe, Middle East, and Africa, "now, pay later" or pay overtime is 6% of transactions and that is expected to grow to 10% overtime. If you buy that thesis as well as to say nothing about the growing buying power of millennials and Gen-Z, this company has plenty of room for growth.

Lewis: I think to put a cherry on top of that too, Brian, I think there's some really good optionality here with this business, and I plucked this slide from their prospectus that just tracks some of the different features and things that they've rolled out overtime. In 2013, they had integrated checkout, and this was the idea that you're paying over time 0% APR. 2016, they launched their virtual card, which is something that is universally accepted with Visa rails, basically. That's how they are processing all this. Then they have split pay in 2018. It's a fixed payment plan for purchases under a certain threshold. You create their marketplace product, which is a personalized, data-driven product discovery. They're putting products in front of customers in 2019 and then by 2020 FDIC insured interest-bearing savings accounts. They are continuing to go further and further into what we consider conventional financial products. I think they're going to be a lot of adjacent markets and a lot of cross-sell opportunities for the customers that they have.

Feroldi: Totally agree with you there. That's something that management calls out explicitly, is that as a growth strategy, we want to create and roll out new products. Currently their biggest personnel expense is R&D and their data analytics. They are spending heavily on sales and marketing and overhead, but they are funding R&D aggressively to build out new products. I agree with you there, there's lots of optionality that this company has.

Lewis: We've talked a little bit about some of their customers and we've name checked a couple of names that a lot of Fools are probably familiar with. Peloton and Shopify being two. I think one of the interesting things with Shopify in the way that that partnership is structured is Shopify has a top it mentality. If they're going to go out and take on [laughs] a business like Amazon, and Amazon is going to basically say, you guys are doing this well, we're going to let you do this. They obviously have it together when it comes to e-commerce, and we've seen that story play out over and over again. Having the partnership with them is wonderful for Affirm. Because it not only gets them in front of Shopify, but within Shopify, you're diversified among tons of merchants. Everyone on the platform, and they are the exclusive provider of any of those types of financial services on there. I'm relieved to see that there is an equity partnership in place with that agreement, because were there not I think I would look at that, Brian and say, well, this could be Shopify just doing some market research [laughs] and letting someone else's solutions see if it's really worth them building it themselves.

Feroldi: That is a perfectly valid point there Dylan. But yeah, we got the data in front of us. I was a little bit off. Shopify owns almost 10% of this business. That is a number that is measured in the billions. Currently, that's $2.5 billion or so that Shopify has had from that partnership so yes, it is a good sign that you shouldn't worry too much about Shopify saying, hey, we're going to eat our lunch.

Lewis: [laughs] That's always a relief. Isn't it? Especially when you have someone who is so driven and effective in the marketplace. I think one of the interesting things to watch at this business on the customer side too, is just how their cohorts perform. We've talked a little bit about the retention rate. It's over 100%, which is great. To drill into that a little bit more of though, the numbers swing pretty wildly depending on the cohort that you're looking at, and what we saw in this most recent year is that they basically bring in terms of GMV, gross merchandise volume, more business than they had in previous years combined for the first year. They have a very large cohort that we will see the performance of as we head into this new year. But the 2018 cohort saw a 10% gross merchandise volume lift in 2019. The 2017 cohort basically doubled its GMV in two years. We're seeing varying degrees of growth within the customers that they're bringing in. But almost across the board, we're seeing growth, which is good.

Feroldi: Absolutely. It's going to be hard to say how much of this was skewed because of 2020 where these one time gains, and as we'll get into, they have a pretty sizable customer that it might be hard for them to put up a repeat purchase in the future.

Lewis: [laughs] Yeah. I think that's fair to say. Before we get there, let's talk a little bit about management and culture. I think this was actually us bearing the lead a little bit, Brian, because [laughs] the guy calling the shots here at Affirm is very well known in the tech world, and maybe that's why it's OK. This is a tech show because we're talking about someone who traces routes all the way back to PayPal and being part of the PayPal mafia.

Feroldi: Max Levchin is the founder and CEO here. He is part of the PayPal mafia. He did co-found a company that would later become PayPal. Serial entrepreneur, tons of success behind this guy. He actually cofounded another company called Slide, which was sold to Google [Alphabet] a few years after for $182 million, to say nothing of the success of PayPal. He was an early investor in a lot of successful ventures, including Yelp. But Affirm was a company that he founded on his own and he is still leading the charge today, and he also owns a significant amount of the voting. If you are investing in this company, just know that he is calling the shots. He owns about 20% of shares outstanding in total. However, he has super-voting shares, so what he says goes.

Lewis: Yeah, and we're not unfamiliar with these types of stories. It's just that if that's the case, you got to be bought into what management's saying, because management doesn't really need your sign-off to do it.

Feroldi: That's exactly correct. [laughs] But we should feel good with him in charge, not only does he have a history of success behind him, but as usual, we checked the Glassdoor reviews and people seem to like working for him. Affirm gets 4.0 stars out of five, and 84% of employees would approve of the company, and about three-quarters of them recommend the company to a friend. With management here, as you said, we buried the lead by you already talking about it three-quarters of the way into the show. [laughs]

Lewis: I think with this one, Levchin is a serial entrepreneur, has started several businesses, and on the one hand you're like, wow, proven track record. There is a part of me that's like, is he going to stick around and continue to run this business? I don't really care that much, because I think in the right hands, it's probably a successful company. I'd like to see him there for several years just to make sure that it's on the right path and we don't see them go public, and then he just rides off into the sunset and does something else. But the track record of success is really helpful, and I think critically here, it's in a very similar space to where he's been before. He isn't leaving and being like, you know what? I'm going to start a car company. This is him operating in a space that he knows well and has been able to read the tailwinds and trends before. I have a high degree of confidence that they are going to be able to execute and see where the puck is going as the space continues to develop.

Feroldi: I agree with you there, but there was somebody that left PayPal mafia and started a car company, and he did OK for himself, Dylan. [laughs] But I agree with you 100% here. I liked that he's staying within the payment space that knows well. So yes, 100% approve of the management here.

Lewis: Yeah. Just investing alongside the PayPal mafia in general, [laughs] let's not get too complicated with the [...] [laughs] here, right? That has proven to be a really wonderful investing thesis in general, investing alongside Elon Musk or Peter Thiel. Yeah, I think leaders with proven success in a space that they understand well, that is generally a pretty good recipe for success. There are, of course, some risks when it comes to this business. We teased it a little bit before, but I think the big one is the customer concentration. We name check Peloton, they are a large portion of this company's sales. A big part of that is Peloton has just had such a ridiculous past 18 months, and their product is perfectly what you would use Affirm for. But you'd like to see that get spread out a bit over-time.

Feroldi: Totally, but it was still surprising to me again, they had 6,500 or so merchants, Peloton, just one, outdoes both Walmart and Shopify, and accounts for 30% of sales here, 30%. I totally agree with what you just said. Pelotons are low four-figure purchases, there's a lot of consumers that want to get a Peloton because of what was happening in 2020. It was the perfect product for having success on Affirm. But make no mistake, this company is very leveraged to Peloton's success.

Lewis: I would be shocked if Shopify was not a larger customer in aggregate with other merchants in a couple of years than Peloton. I find that so hard to believe that that wouldn't happen, just given the scale of their platform.

Feroldi: I 100% agree with you there, but hey, for right now, Peloton [laughs] is beating out Shopify. Hats off to you, Peloton. [laughs]

Lewis: Yeah, and I mean, if it's working for Peloton, I can't imagine that that relationship is going to go bad, but it is something to note. I think one of the other things to keep in mind is you have all of the traditional financial providers that are offering what we would think of as traditional credit, and those are payment options that are going to be competitive with what Affirm is doing. But Affirm is also not the only player in the new age, layaway space.

Feroldi: That's right. Afterpay would be the one that, to my mind, almost invented this market and they've just seen tremendous success. But other companies are starting to get in this game, most notably PayPal and Klarna, to say nothing of all of the credit card companies out there that offer products that do compete with this. It's an incredibly competitive space, but it's also an incredibly lucrative space if you can be successful.

Lewis: Yeah. I think that they have a lot of the elements that you'd like to see there. The big thing for me is I would like to see slightly more transactions per customer. I would like to see them deepen their relationships with the people and prove out that they really have an ecosystem that people are participating in rather than just accidentally using them when they run into a purchase that it makes sense for them to use. We do need to make a note about some of their internal controls, Brian. We're an investing show and sometimes we've got to get into the weeds. There was one thing that popped out to you rolling through to the prospectus to the point that you bolded and italicized it in our outline.

Feroldi: That's right. It was, if you read through their S-1, the words that you never want to see is material weakness and internal control over financial reporting. That basically says the auditors looked at their books and material weakness came up that could cause them to materially misstate their financial statements. Importantly, this was pre-IPO, this was back in June that auditors found this and they are actively working through there. But make no mistake, you don't want to see financial weaknesses and this company had to disclose it. I have full confidence that they will fix that problem, but it is worth noting.

Lewis: One other thing I think investors should probably keep in mind here too is the valuation is rich. We're talking about a business that's on just under $600 million in trailing 12-month sales. They're growing at an incredibly fast clip. But we talked about it before. $28 billion valuation roughly as of taping. That's just under 50 times sales. That's a rich valuation for a company that doesn't necessarily have the gross margin profile for a lot of businesses we talked about on the show.

Feroldi: It's very highly valued, there's no doubt, and I noted here, that just reminds you of Lemonade. I think that that's a wonderful comparison. It's the Lemonade of payments, but Lemonade has proven to be a pretty successful investment here. But yeah, make no mistake, this company is priced for hyper, hyper growth, so it better come through.

Lewis: Yeah. If they can stay in the high double-digits, that's fine. [laughs] People are going to be totally OK with that valuation. It really does remind me quite a bit of Lemonade, and the reason for that is in their relationship that they have with consumers. I remember listening to something Tom Gardner was saying, talking about Lemonade, he's a huge fan of the stock, and basically saying like, how many people are excited about their insurer? How many people are bragging about their insurer to their friends and feel like they have a really great relationship that has no animosity between them? I think that Affirm starts to get at that as well, where if you give people a no-nonsense, very straightforward product in a space where they are used to getting nickel and dimed by every provider, it's going to click, at some point, it's going to make sense. They already have millions of users, and I think if they can continue to communicate that vision and that product expectation, they're going to get a lot more. In some ways, the IPO could almost be a marketing event for them. We've seen that with so many companies in the past where it really raises the profile of their business and you start to see mass adoption of the product because more and more people are aware of it.

Feroldi: 100% agree, and let's get back to that point, net promoter score was 78. It is nice to be competing against other companies that consumers do not like and do not have a positive opinion of, so yeah. The payment space is so huge, so massive. There's plenty of room for lots of winners in this space and Affirm could be one.

Lewis: Brian, we have done a ton of watch-list prospectus, pitch type shows in the last couple of months. What's your take on Affirm right now? Is this something that belongs in your portfolio, belongs on your watch list? How are you thinking about it?

Feroldi: It checks a lot of the boxes in the things that I look for. I will have to grow my comfort with the company as a public entity, as well as really dig into and see how the financials are transformed over time. But I like the brand. I like some of the things that it stands for. Clearly, I like the management team and I like the growth. This will be one that I watch, but I'm not going to race out to buy it, especially given the huge run-up that it had post-IPO. But how about you, Dylan?

Lewis: I think I'm in the same boat. I think the business is really interesting. I think it's a disruptor in a space that is probably in desperate need of disruption, and it offers something really unique to consumers. There is also, we didn't even really get into this, Brian, but there is the tech and data advantage that they claim to have, and we're seeing that bear out a little bit with their charge-offs. We'll see what that looks like over time. But really, if they are able to grab better insights into creditworthiness, who people should be willing to extend loans to, that becomes a competitive edge at some point because you can take a lot of people who maybe traditionally wouldn't qualify for things and give them access to capital and making things a lot easier, turn them into customers for life. I think there's a lot of good stuff there. I think just as someone watching the fintech space, this is the company to watch. There are other companies out there just strictly on growth and margin profile than I'm a little bit more interested in right now. But for where the industry is going, I think this is definitely a company to keep tabs on.

Feroldi: Totally. Fintech is a wonderful, wonderful place for investors to park long-term capital, so this might be a good company to check out.

Lewis: Yeah. You know what? We're going to continue to keep our eye on this one. We're going to, Brian. We've got so many prospectus shows over the last 12 months. I think we're just going to need to do a lightning round check-in at some point in the next six months, just to make sure that we're not losing track of anything we've discussed.

Feroldi: I think that's a fabulous idea, Dylan. [laughs] Just to remind people of all the companies that we've talked about.

Lewis: [laughs] Sometimes I forget myself. Brian, thank you so much for joining me on today's show.

Feroldi: Thank you, Dylan.

Lewis: Listeners, that's going to do it for this episode of Industry Focus. If you have any questions or you want to reach out and say hey, shoot us an email at [email protected], or you can Tweet us at @MFIndustryFocus. If you're looking for more of our stuff, subscribe in iTunes or wherever you get your podcasts.

As always, people on the program may own companies discussed on the show. The Motley Fool may have formal recommendations for or against stocks mentioned, so don't buy or sell anything based solely on what you hear. Thanks to Tim Sparks for all his work behind the glass today, and thank you for listening. Until next time, Fool on!