Everything You Need to Know About Square's $29 Billion Afterpay Acquisition

Square (SQ -1.97%) surprised investors recently by announcing it plans to dive in headfirst to the buy now, pay later, or BNPL, space with a $29 billion acquisition of Afterpay. In this Fool Live video clip, recorded on Aug. 23, Fool.com contributors Matt Frankel, CFP, and Brian Withers discuss why Square might be willing to pay such a hefty sum.

Matt Frankel: A couple of points I wanted to hit on the Afterpay acquisition. I've said before on other shows that I'm a fan of the acquisition. I'm not a fan of the price they're paying. I think they're paying a lot. Let's dig into what Afterpay is and why Square might be so interested in it. Buy now, pay later service is essentially, if you ever go to checkout on PayPal or on Amazon or any of these companies and they say, "Spread this over six interest-free payments." That's a buy now, pay later service. That's essentially what Afterpay does. If you look at this chart here, this is Afterpay's growth in customers, both consumers, and merchants. I really think the merchants are the big thing to notice here.

A couple of years ago, Square had about 2 million merchants in its ecosystem so Square's merchant count is in the millions. Afterpay's is 98,000. But this is what I was saying earlier, where I take issue with Square calling a business selling over 125,000 a year as a big client. Afterpay's merchant skew to huge merchants. This 98,000 figure includes companies like Amazon, like CVS, like Dell. Not typical Square merchants, Nike, Target, Walgreens. These are companies that are using Afterpay's service to allow their customers to pay later for products they're buying now.

That's why you're seeing such a big difference between those merchant and consumers numbers. Because their merchants have a lot of customers and this doesn't even really scratch the surface of the big merchants like Amazon or anything like that. About 16 million customers, which from Square's point of view, they could bring those into the Cash App ecosystem, which is exactly what they're planning to do. The Cash App has 40 million active users in the ecosystem so this is a pretty big bump if they can even get half of them to use other Cash App services. That's one point I wanted to mention, the other, sorry if this looks weird while I'm scrolling, Afterpay is growing fast.

Buy now, pay later is a red-hot sub-sector of the financial space. We saw Affirm go public last year, that's a big one. Affirm's big client is Peloton. Everyone's financing these $3,000 bikes over 36 months interest-free or whatever it is, that's Affirm. PayPal has built out their own buy now, pay later service so I guess Square figured they need to catch up and they're late to the party here. This also helped Square get into online retail because most of these buy now, pay later purchases, not all, but most are made through card-not-present transactions either on a mobile app, on a retailer's website, something like that. They've grown tremendously. They've more than quadrupled their merchandise volume over the past few fiscal years and this adds an instant $700 million of revenue to Square's ecosystem, which as we saw on the previous slide, is not nothing.

Square's revenue without Bitcoin is just over $2 billion. Adding $700 million of revenue is not just a drop in the bucket. Especially, this is high margin revenue. Going through this, here's how Afterpay breaks down by region. They are based in Australia, which is why that Australia and New Zealand, the green color you see in the bars is so big. Brian mentioned domestic versus international growth plans at Square. Square is mostly a domestic business, they're in a few other markets around the world, I believe Australia is one of them, Brian?

Brian Withers: Yes.

Frankel: But they are mostly a domestic business at this point, Afterpay is not. The biggest source of their revenue is North America which might be surprising being that it's an Australian-based company. But it's not the bulk of it, Australia is almost as big as North America right there when you look at the revenue make-up here. Of those 16 million consumers that use Afterpay, you'd have to assume about half of them are outside of North America. So this really gives Square's international expansion opportunity a big shot in the arm. I'm excited to see that. I think that's a big part of what Square is thinking with the strategy. If they can open their Cash App up to 16 million users, 8 or 9 million of which are not in North America, I think it's a pretty big deal. 

Withers: It's interesting to me, it looked the two things that you brought forward, these large merchants like CVS and Amazon, I think before this, Square really didn't have any reason to talk to these retailers or these enterprise-sized businesses at all. Certainly, CVS and these other companies are not going to use Square terminals for cash payments and they might take, I guess if Square had a credit card, wanted to say they did, they'd do that but that would be the only piece. So they get exposure, maybe not serving them as a customer, but really getting to understand these larger businesses and what drives them. Then on the international side, like you said, I think the last number I saw was 94% of their revenue was, I think U.S. and Canada. Six percent outside of and U.K. They just got into Ireland, Australia, and a few other countries in Europe and that's it.

Frankel: Yeah, so this is going to be really big for their international plans. They outlined their rationale for it and like their growth slide show that Brian mentioned it's not that specific. They mentioned they want to integrate it in both the seller and Cash App ecosystems. They want to allow Square sellers to facilitate buy now, pay later plans. They want to let Afterpay users access their accounts through the Cash App, which are just smart strategic move because then it shows them all the other Cash App features that they can use. A couple of more things I wanted to mention here, integrating into the seller ecosystem so any Square seller can offer buy now, pay later which helps level the playing field between smaller merchants and large ones that have traditionally been able to offer this stuff and in Cash App, you'll see you can start your Afterpay installment plan right through the Cash App, which will be much better functionality than right now. Because I got to admit if I wanted to do buy now, pay later unless the retailer had a button that said "Use Afterpay for this," I wouldn't know how to do it. That really can help Afterpay's growth story continue. The other thing I wanted to mention before I hand it back to Brian, I think we have to wrap it up in a couple of minutes.

Withers: Yeah.

Frankel: The transaction overview I mentioned, it's an all-stock transaction. That $29 billion is based on, as of the date this was announced. Afterpay shareholders, which it trades on the Australian Stock Exchange will get 0.375 shares of Square for every Afterpay share they own. The valuation can actually change. I think it has changed. I think it's in the $30 billions right now. That's the Afterpay acquisition in a nutshell. I like the acquisition, not really the price.