Affirm Holdings' (AFRM +0.96%) stock hit an all-time high after it announced a partnership with Amazon (AMZN 0.89%) on Aug. 27. Amazon is integrating Affirm's "buy now, pay later" (BNPL) network into its marketplace; the new payment option will enable its shoppers to split purchases of $50 or more into smaller monthly payments. Amazon has already tested out Affirm's service with select customers and plans to broaden its reach over the next few months.
That's good news for Affirm, which already serves big customers like Walmart and Peloton, and it's another vote of confidence for the BNPL market, which has been growing in the shadow of traditional credit card companies. Let's see why Amazon partnered with Affirm, how the deal could benefit both companies, and whether or not Affirm's recent rally is worth chasing.
Image source: Getty Images.
Cutting credit card companies out of the loop
Every time a shopper uses a credit card, the retailer pays a "swipe fee" of about 1% to 3%. The credit card company keeps most of the fee, while the issuing bank and payment processor split the rest.
To avoid that fee, some retailers refuse to accept credit card payments. Others only accept credit cards with lower swipe fees, while larger retailers often issue their own private label payment cards.
However, processing payments without credit card networks can be a difficult task. That's why most retailers that issue private label cards work with automated clearing houses, which charge much lower fees than credit card companies but take a longer time to process payments.
That's where digital payment companies and BNPL services come in. Digital payment companies like PayPal (PYPL +1.22%) and Square (SQ 0.13%) charge merchants flat fees for processing all their card-based payments, regardless of the brand or issuing bank, as a simpler solution.
PayPal and Afterpay (AFTP.F +0.00%) (which Square plans to acquire) also provide BNPL options that enable shoppers to split their payments into interest-free payments without using a credit card. That's why it makes sense for Amazon, which relies heavily on credit card payments and didn't offer any BNPL options yet, to team up with Affirm.
Is this a win-win deal for Amazon and Affirm?
Bank of America expects the market for BNPL apps to expand 10-15 times by 2025, with more retailers using the services to avoid swipe fees and more shoppers using them to avoid high interest fees.
Partnering with Affirm could help Amazon reduce the operating expenses at its retail business, which operates at much lower margins than its cloud business, and attract more shoppers. Amazon's decentralized rival Shopify also recently partnered with Affirm to roll out BNPL services.
Affirm has already grown like a weed since its founding in 2012. Its revenue rose 93% to $509.5 million in fiscal 2020, which ended last June, and is expected to grow 64% to $834.5 million in fiscal 2021 when it posts its full-year earnings report on Sept. 9.
Affirm ended the third quarter of 2021 with 5.4 million active consumers, up 60% from a year ago. Its transactions per active customer rose 10% to 2.3. In addition, the number of active merchants more than doubled to nearly 12,000.
Analysts expect Affirm's revenue to rise 38% to $1.15 billion next year, but those estimates haven't factored in its partnership with Amazon yet. Amazon serves more than 300 million active customers worldwide, so Affirm's revenue could soar as Amazon rolls out the feature for more shoppers.
However, Amazon and Affirm didn't disclose if shoppers using Affirm's BNPL service would pay any interest fees. PayPal's "Pay in 4" and Afterpay both offer four interest-free payments to all consumers, but Affirm's interest fees vary based on the retailer and the consumer's credit score.
If Affirm waived its interest fees to work with Amazon, it might be sacrificing its margins to grow its market share and boost its brand recognition.
Is it the right time to buy Affirm?
Affirm isn't profitable yet, and its stock was already richly valued at over 20 times this year's sales prior to its deal with Amazon. As of this writing, the stock trades at nearly 30 times this year's sales.
Affirm's high price-to-sales ratio might seem justified by its growth potential, but investors should remember it's not the only BNPL service in town. It's still a nascent market, and BNPL services integrated into major digital payment platforms like PayPal and Square could threaten Affirm's stand-alone business model, which relies heavily on retail partnerships.
I personally prefer sticking with diversified fintech players like PayPal and Square to gain some exposure to the expanding BNPL market. However, investors with a bigger appetite for risk might still consider buying Affirm as a "pure play" on this high-growth niche in digital payments.
