Afterpay (OTC:AFTP.F) is one of the world's leading providers of buy-now-pay-later (BNPL) technology, which is an increasingly popular service that allows consumers to break purchases into four separate payments free of interest.
The model is designed so that Afterpay puts up the initial cash for the purchase on the premise that the consumer will pay it back over six weeks. Afterpay then generates revenue through an average 3.8% take rate on each transaction -- which merchants are more than happy to pay, since the BNPL option helps boost order frequency and raises the customer's average order value.
Though Afterpay isn't alone in this market, there are several reasons to think this Australian financial technology specialist could be much larger in the future.
Afterpay has already seen immense success with its digital payments offering. As of its latest semiannual report, Afterpay's BNPL technology is currently accepted by roughly 75,000 merchants around the globe, with more than 13 million consumers using the product. This widespread adoption helped Afterpay generate $325 million in revenue for the first half of the current fiscal year -- 89% more than the year prior (Afterpay's fiscal 2021 will end in June).
But despite primarily being a payments option for e-commerce transactions, there's no reason to think this model of breaking up and deferring payments can't work for in-person purchases as well. Afterpay seems to have recognized this, and in 2020 rolled out a virtual in-store card in the U.S. in conjunction with Mastercard. The Afterpay Card can be stored in an Apple Wallet or Google Pay account and used for contactless transactions at retail stores.
As the reopening from the pandemic continues and some in-store shopping returns, this card should help Afterpay remain a meaningful part of the consumer's checkout process.
The digital mall
In addition to being a payment option at checkout, Afterpay also serves as a merchant directory. At Afterpay.com, consumers can explore and find various brands that they are sure will accept BNPL as a form of payment. By aggregating merchants such as lululemon athletica, Target, Under Armour, and others into a single destination, website visitors get a digital mall-like experience. Afterpay has also coupled this website with a consumer-facing app that offers the same basic browsing function so consumers can access the platform from anywhere.
This directory-style platform incentivizes more retailers to join as it grants them exposure to new customers simply by agreeing to accept Afterpay's technology. For example, in 2020 alone, Afterpay sent roughly 27 million referrals to the company's retail partners through its Afterpay channels. More merchants on the platform create a network effect, since the value proposition for customers to join becomes more enticing as well.
Young people's aversion to credit
Though Afterpay isn't the only provider of buy-now-pay-later technology, adoption of the category as a whole is driving growth for the company. In April of 2020, it was estimated that the BNPL industry is expected to grow at an annual rate of 28% over the next five years. This should serve as a sort of rising tide to lift all boats.
While the exact drivers of this trend are hard to pin down, it seems that a fear of credit card debt has evolved into a general stigma around credit for young people. In fact, according to bankrate.com, only about one-third of Americans below the age of 30 have a credit card -- far lower than the generations before them.
Despite the various cash-back incentives and loyalty programs that consumers can get with credit companies, the evidence is quite clear that consumers are seeking alternatives. This is perhaps best exemplified by how quickly Afterpay rose to success. In spring 2016, within a year and a half of its founding, Afterpay went public on the Australian Securities Exchange with about 60,000 unique customers. Eight months later, it ended the year with more than 350,000. Talk about product-market fit.
Even though Afterpay has its competitors, such as companies like Klarna or Affirm Holdings, its total addressable market is huge, and it continues to pick up steam in critical areas like North America. With the massive tailwind of dwindling credit driving growth for the company, it's probably safe to say that Afterpay should continue to grow from here.
While the business model and growth prospects are certainly enticing, the price-to-trailing 12-month revenue of roughly 40 times puts the stock at a premium valuation. Though this is definitely worth keeping an eye on, the stock remains on my watchlist for the time being.