Digital payments company Square (SQ -1.92%) announced on Aug. 1 that it intends to acquire the Australian financial-technology company Afterpay (AFTP.F) in an all-stock transaction worth about $29 billion. The deal was announced at the same time Square reported its second-quarter earnings, and Square stock jumped as much as 14% on the combined news.
However, while the market reacted positively, many investors seem to have concerns about the acquisition price. Let's see what may lie in store for these fintech darlings.
How much did Square pay?
Before diving into the reasoning behind the acquisition, it's worth taking a quick look at the specifics of the deal.
Square will be financing the acquisition entirely through stock, though it does have the option to pay for 1% of it in cash. Assuming the deal closes on its current terms, Afterpay shareholders will receive 0.375 shares of Square stock for each share of Afterpay they own.
Based on Square stock's closing price on July 30, the deal is valued at about $29 billion -- or 42 times Afterpay's trailing 12-month revenue. This valuation represents a roughly 31% premium to Afterpay's closing price prior to the deal announcement.
Afterpay is one of the category leaders in the buy now, pay later (BNPL) industry. The company's core offering enables retail customers to break up purchases into four separate, interest-free payments. Afterpay collects its fee from merchants based on a small percentage of each transaction. Merchants are willing to sacrifice this cut of sales since Afterpay's solution often results in increased sales conversions and larger purchases.
Although the company first got its start in Australia, Afterpay now serves more than 16 million customers and nearly 100,000 merchants around the world. But it's not just the core BNPL technology that attracts merchants and consumers. The company also serves as a central e-commerce hub, or a sort of digital mall, for shoppers and sellers alike.
Within the Afterpay website or mobile app, users can shop around for stores they like knowing those stores will offer BNPL even before the checkout process. While this sort of all-in-one shopping dashboard is certainly convenient for customers, it also helps merchants boost sales since Afterpay's digital real estate can aid in generating leads.
In fact, even amid a crowded market with dozens of global competitors, Afterpay grew its merchant base 78% in fiscal 2021. This boost in sellers helped the company generate $693 million in revenue -- up 100% from the year prior.
How does this help Square?
Although the roughly 42 times price-to-sales multiple understandably raises eyebrows at first glance, the combination of Square and Afterpay could unlock tons of value for both businesses.
For starters, over 85% of the gross payment volume generated by Square's seller ecosystem comes from the U.S. However, with Afterpay's international merchant base (over 50% non-U.S. gross merchandise volume), Square should be able to cross-sell a number of its more than 30 different business solutions to these new partners. Additionally, Square can integrate Afterpay into its various merchant checkout solutions, granting the latter access to new potential customers as well.
As for Cash App, the synergies are pretty clear. Cash App strives to be a one-stop shop for all things consumer finance, and the Afterpay deal should be yet another milestone in that process. Once Cash App integrates with Afterpay, the former's installed base of more than 70 million active customers will be able to pay their installments, shop across a range of stores, send money to friends, unlock exclusive discounts, invest in stocks, and plenty more, all from a single destination.
While Cash App has already seen remarkable growth in recent years, including 94% gross profit growth in its most recent quarter, this new combination should help fuel that momentum. Cash App's current customer demographic skews quite young, and that syncs up well with Afterpay's business model. According to a survey conducted by Bankrate, only one in three adults between the ages 18 to 29 has a credit card. Since BNPL is an alternative to traditional credit, the increased awareness from the Cash App integration should quickly bolster adoption for Afterpay's solution.
So while Square will have to pay a pretty penny to make this deal happen, the combination results in attractive new opportunities for both parties. Investors won't be able to truly determine whether Square underpaid or overpaid until long after the acquisition closes. Until then, the company continues to hammer away at its mission of serving the underbanked and easing access to financial services.