Why All the Interest in Buy Now, Pay Later?

PayPal (PYPL 0.63%) has agreed to buy Paidy (a Japanese buy now, pay later company) for $2.7 billion. In this episode of MarketFoolery, Motley Fool analyst Asit Sharma analyzes the growing interest in the buy now, pay later industry, as well as the latest results from Coupa Software (COUP). As the Industry Focus podcast gets ready to record its 2,000th episode, Chris Hill answers a question he's been asked several times over the years.

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This video was recorded on Sept. 8, 2021.

Chris Hill: It's Wednesday, Sept. 8. Welcome to MarketFoolery. I'm Chris Hill. With me today, Asit Sharma. Good to see you.

Asit Sharma: Good to see you, Chris. And of course, you and I can see each other because we're recording this via Zoom, as well as our high-tech audio equipment, but it literally is good to see you this morning.

Hill: Yes, absolutely. We have a Motley Fool podcast milestone that will be later in the show. But first we have an acquisition and some earnings. We're going to start with the earnings. Coupa Software's second-quarter profits and revenue, better than expected. Wall Street analysts were actually expecting a loss in the quarter for Coupa. Help me understand this because the stock is down about 2%, which is not a lot. But the context is that they reported after the closing bell yesterday, and the stock was up somewhere to the turn of 12% after hours. Did something happen on the call? What is going on with Coupa Software?

Sharma: Chris, I think sometimes it can be hard to parse out why investors get enthusiastic about a stock after the earnings release, then they listen to a call and suss out some type of hesitancy on management's part about a company's future outlook. I think this has a little bit to do with it. The numbers, as you said, were pretty decent. There was an operating loss. But if you look at the adjusted basis, they actually had a profitable quarter. The big story here is that revenues and billings looked great. Revenues were up 42% year over year. I liked that their subscription revenues, which is a high-margin contribution to the top line, increased 40%. They had positive operating cash flows which were in excess of the prior period, if you look at the six months ended July 31, they had just reported on the quarter ended July 31. But if you telescope out the first six months, cash flows were still positive,about $21 million. That's versus a use or a cash burn of $32 million in the comparable six-month period from last year.

So on a lot of fronts, I think Coupa did very well. Now, why investors may be having a second look as the dust settles here, one of the things that Coupa is up against is a little bit of a need to spend on sales and marketing expenses to push that top line. That expense really jumps in the quarter versus the prior year, and it's jumped in the six months versus the prior year -- that is up more than 50%. While we had a really nice jump in that top line -- the company had total revenue of $346 million -- they generated a net loss of $187 million versus a loss of $58 million in the comparable six-month period. When you start putting this year together, you see that they're really trying hard to push that lever. Research and development up nicely. You want to see an increase year over year. They've increased that spend to $86 million versus $57 million. Again, I'm giving you a six-month view. But all in all, the loss from this particular quarter more than doubled from $43 million in the year-ago quarter to $87 million.

Now, what's the upshot of this? There's so many companies that we follow, Chris, that are software and software-as-a-service companies. We give them a pass for operating losses as long as revenue is scaling. I think one of the things that Coupa is really trying hard to do is to convince investors that they've got a unified platform. What they do is to provide business spend management to companies. They help companies save money in many different areas of spend like the supply chain, procurement. They also help with payments, treasury management services. Each of these fields that Coupa specializes in is a target for companies that specialize only in that: only in saving money on the supply chain, only in procurement, only in treasury services. Their unified platform is something that the company has been moving to for quite a while to convince both its customers and investors that it can be this one-stop shop for back-end office accounting. It's not a business that gets a lot of love or attention from retail investors. If you've been paying attention for the last couple of minutes, you can see why. It's maybe not the most exciting business to explain. But I think what we're looking at is maybe investors are sobering up to the amount of the losses and the fact that there wasn't more of a lever in that sales and marketing spend for the quarter.

Hill: It's going to be interesting to see what the next couple of years holds for Coupa, because it's been public for nearly five years. It was October of 2016 when the company went public. Since then, if you've owned it since the early days of it being a public company, good for you. Because it's up more than 700% from the IPO. But over the past year, it's at about $255 right now. That's down from the high. Earlier this year it was close to $380 a share and it's a $19 billion company. This is the universe of companies that can look at Coupa Software and say, "We think we can do better than they can with what they have, therefore, we're going to buy them." That's a much smaller universe when you're a $19 billion company than if you were, say, a $3 billion or $4 billion company. You used the phrase, "They're trying to convince investors." They're going to need to keep doing that because I don't think -- and I'm not saying that management necessarily wants to sell the company -- but even if they wanted to, you just have fewer opportunities when you are a company of that size.

Sharma: Chris, I'm going to translate what you just said into some very high-level investment terminology. Coupa Software isn't a spring chicken anymore.

Hill: That's much better than what I said.

Sharma: No. But it's true. What you're saying is absolutely true. At that market capitalization, the company now is hitting that spot where investors really want to see a little bit of operating leverage. Some future path to better cash flows than they've been able to generate. At the end of the day, everything, as you well know, depends on cash flow. Valuation depends on it. The ability of a company to spend on its own objectives, invest in itself that depends on cash flows. I think it's maybe a longer-term existential question for the stock chart at this point in time in, and certainly they can maybe flatline from here. But I'm looking at the chart as we speak, and what you're saying really resonates with me. The company is down from its all-time highs substantially. It's been a volatile stock over the last two years, not just 2021, but going all the way back to 2020. Part of that is COVID-related, but the visual on this is that investors are really trying to figure out what that future holds for Coupa and whether it's going to be able to fend off smaller attacks and be able to capitalize on new initiatives. They announced an app marketplace, they've got new efficiencies for supply chain management. There's a lot of good stuff going on here, but investors, so far, I think they want to see more.

Hill: Let's move on to the war on cash. PayPal is buying Paidy, a 'buy now, pay later' company based in Japan. This is a $2.7 billion deal. PayPal is mostly going to use cash for this, and I saw a decent amount on FinTwit and in the financial media making the obvious comparison to Square buying Afterpay. This deal is about one tenth the size of Square's acquisition of Afterpay from last month. But maybe not surprising to see more activity in this space because we were talking right before we started recording. Buy now, pay later really is heating up.

Sharma: Absolutely. We'll get to this still in just a second. But Chris, I wanted to second you there. It seems that if you're investing in the payments space, you can't avoid this acronym BNPL: buy now, pay later. This is a market that's estimated variously at $20 billion by 2028, up to $100 billion in the next few years, depending on which research firm you're looking at. Everyone agrees, though, that the growth rate of this market is phenomenal. I've seen compounded annual growth rates pegged at above 20%. That is a fast-growing market. Just to back up a bit here, if you're not familiar with this phenomenon in the payments industry, it's simply a method by which payments companies will team up with retailers and offer customers the ability to pay on installments. For those of you of a certain age, you'll remember terminology like layaway. It's very similar to this. If you pay as a consumer for a product using buy now, pay later and you hit your payments installments as agreed -- be they three or four, five, six payments -- then you won't owe any interest or fees. How it works for merchants is that they share a little bit of revenue with the middleman that provides the BNPL service, of which there are several.

You mentioned Afterpay. There's also Klarna, which is a really huge player in this space just getting more into the U.S. and their market. In fact, they may be looking at an IPO later this year. Klarna processes 2 million transactions daily, Chris, they've got 90 million active customers. Just to give you an idea of how this space is exploding. Of course, we heard recently that Apple is now enabling buy now, pay later. Affirm, which is another huge player in this space just inked a deal with Amazon. If you spend $50 or more when you're shopping on Amazon, you'll be able to use Afffirm to do buy now, pay later with your purchase. This is a market that everyone is trying to get a piece of. Having said that, I do want to circle back to whether this is a fad or not.

But let's talk about PayPal. They've got this deal to acquire, and we think it's Paidy, this is a Japanese company. We're going to go with the pronunciation Paidy. As you mentioned, it is a $2.7 billion deal, mostly in cash. I like this, Chris, because it gives PayPal a footprint in Japan where it can pull more customers onto its platform. It's really a smallish deal for PayPal's balance sheet. The deal that we were just mentioning, this is the Afterpay deal with Square, a $29 billion deal, that was an all-stock deal. PayPal has this very solid balance sheet. It's not a huge matter for them to fork over close to $3 billion in cash. What I like about PayPal's approach to this space is that they basically have turned on buy now, pay later like a light switch in their own business. They are already entrenched with so many merchants and millions of customers around the globe. They started their own buy now, pay later service just a few quarters ago. And Chris, it's on track for $6 billion in total payment volume, if you extrapolate from their most recent quarter within a year of starting. Without having to buy another company or to advertise a service or to spend a lot of their own coin, they simply enable this service for their millions and millions of customers, and that business itself is exploding. Now they've added on this piece in Japan, which is one of the largest e-commerce markets in the world, I think it's the third largest e-commerce market. This is a good logical entry for them, but they are not trying to bet the firm on this phenomenon. I'm going to pause here and get your thoughts. I'm curious, Chris, do you think this is here to stay, buy now, pay later as a financing method? Or is it maybe a fad that's gotten some jet fuel from stimulus payments that came around last year and earlier this year?

Hill: I definitely think it's here to stay. In the same way that we've seen over the past six months, some people, for whatever reason, get surprised that in the retail industry, the year-over-year digital sales growth starts to flatten because it skyrocketed in 2020 for all of the obvious reasons. I hope no one is looking at the growth rates that we've seen recently in buy now, pay later and assuming, well, this is just going to continue in a straight line. I do think that this is going to backfire for some consumers. The other thing I'll add is that you hear the phrase "bolt-on acquisition" now and then. This to me is the quintessential bolt-on acquisition. This fits right in the PayPal ecosystem. It is not a ton of money, as you said. They are keeping the brand, they are keeping the existing management at Paidy. This is a perfect example of a bolt-on acquisition.

Sharma: I agree. I think the management team at PayPal are very shrewd allocators of capital. They tend to shy away from huge acquisitions, but they make a lot of investments, I should say, in small companies, especially in the fintech space. They basically have their own venture capital arm. This is a little bit bigger than that, but it's within character for them: Yes, absolutely, a great definition, if you hear that phraseology used, this is what it means. You bolt on a business that's complementary to your core revenue stream, which with some attention, can maybe help grow revenue and your bottom line in the coming years without you having to take too much of your capital as risk capital. The thing that PayPal, I think, does better than anyone else is to make it easy to open up ancillary services on their platform. They're coming up with a super app, which is basically an upgrade to their app. But this is probably going to be one of the pieces that's front and center in the future when you log on to your new and improved PayPal app later this year: the buy now, pay later space.

I want to go back to something that you alluded to, Chris. You were talking about. I think this is a really huge digital spend that we've seen in the past few months. Expectations, I think, are actually sky-high in the investment community. I think they may be unrealistic for the potential of buy now, pay later. One of the things that gives me pause, is that the primary demographic group that's driving buy now, pay later are millennial consumers and younger consumers who are wary of credit cards. They don't like debt. The issue that we might see with buy now, pay later in the future, is a realization among some of these consumers who are averse to debt, that this actually is a form of credit if you don't make those purchases on time. I'll add to that, there was a really interesting survey earlier this year by LendingTree. They surveyed about 1,000 Americans. Almost half of them said they wouldn't have made their purchase if they didn't have the option to finance. So, it's a big bright compulsion when you're checking out and you see a buy now, pay later option. A purchase you might have passed on, you decide to go ahead and make it because you can pay installments. As time goes on, some of us might have experienced that this isn't really what we want to do and pull back. Maybe the market isn't destined to grow at this 20% clip in the coming years. But one thing we can say for sure with all these heavy hitters investing their billions in this space: As you said, it's here to stay, so we'll have fun watching it over the next several years.

Hill: Asit Sharma, great talking to you. Thanks for being here.

Sharma: Thanks for having me, Chris.

Hill: Before wrapping up, I just wanted to take a couple of minutes, to share a couple of things about Industry Focus, because tomorrow, Industry Focus is going to have its 2,000th episode, and the fact that Industry Focus got that far is a testament to the people who have done that show week in and week out, their dedication to doing the best possible show and helping listeners around the world. What's great to me about Industry Focus is that it is a show that on paper should not work. You would not set out to design a show like Industry Focus. That's why there are no other shows like Industry Focus. Think about that for a second: There are no other shows like that one. There are plenty of other shows like this one. There are other shows that at their core are business news shows. There are a lot of business news shows out there. If you're looking for one, good news, you've got options, a lot of shows like MarketFoolery, a lot of shows like Motley Fool Answers. Personal finance is a big space in podcasting. There are even shows like Rule Breaker Investing. There's no one like David Gardner, and God knows, there are few people with his 25+ year track record of investing. But the format of a single person sharing his or her insights and observations about the stock market? Yes, there are other shows like that.

There's no other show like Industry Focus, because you wouldn't design a show like that, and if you've been listening to that show since 2013, when it started, you already know it didn't start out that way. It started as a daily show about banking and financial services. It was the brainchild of David Hanson and Matt Koppenheffer. It was called Where the Money Is. It was five days a week, which I did not think would work. The Motley Fool had two podcasts at the time. I was hosting both of them. David and Matt came to me and said, "We have this idea for a show," and they laid it out. And it was very clear to me: They had thought it through, they had great programming ideas. And the only thing I really pushed them on was that it would be five days a week. I was like: "Maybe start with three days because you don't want to get burnt out and then cut back, from five. Maybe start with three?" They wanted to do five, and they did, and it succeeded well beyond my expectations. That is not a knock on Matt and David. I just thought that's a single topic, banking financial services, it's daily. I don't know how big that audience is. I knew they would find an audience, I knew there would be an audience, it was just a question of, how big is that audience? It turns out that the audience was four times bigger than I thought it was going to be, which is a tribute to David and Matt, and how hard they worked.

About a year and a half after they launched the show, as happens at The Motley Fool, as our company grew, those guys got tapped to do other things, to take on bigger roles at the company. It was clear that the show could not continue as it was. There weren't two other people as passionate and interested in banking and financial services as those two guys were, so we couldn't keep doing Where the Money Is. But now we have this audience that they had built up. We didn't want to just give that up. So in 2014, we had a meeting to figure out how to program the show without David and Matt, and pretty quickly we settled on this idea that different hosts could bring their own passion for the topics that they are interested in to the studio. That's when Industry Focus was born. A couple of years after that, I was out at a bar in D.C. I had met up with my buddy Jim, and he ended up leaving the bar before me, so I was just sitting at the bar finishing my drink. A guy comes in that I know; he works for a financial media company in D.C. We ended up chatting and sitting at the bar and he said, "We were talking about you guys the other day." I was like, "Really?" And he said, "Yes, we were talking about business podcasts and different producers and The Motley Fool came up." He starts talking about our shows. At this point, Motley Fool Answers had launched, so had Rule Breaker Investing with David Gardner. This guy mentions each one and says something nice, and then he gets to Industry Focus and he says, "Hey, what's the deal with that show?" I said: "It's a different industry every day. Monday is banking and financial service." I start describing the show. He cuts me off, he says "No, I know what the show is, but what's the story?" Keep in mind, we're sitting at a bar. It's not like if you're ever sitting in a bar and you're on a date with someone and you're facing them. We're just two guys sitting at a bar mainly looking straight ahead and that thing where you look to your side, you sort of turn slightly to the person you're next to. So I wasn't really looking him right in the eye. He's like, "What's the story with that show?" I was confused so I turned to look at him. ''What's the deal with that show?'' Now I can see the look on his face, and I realized what he is really asking is: "Why does that show work? How come people listen to Industry Focus? Why is that show consistently ranked among the most listened-to business shows on Apple podcasts?" And God help me, it made me so happy, that this guy and his co-workers were in their office talking about Industry Focus and they're smart people but they couldn't figure out why the show works. I'm not trying to knock this guy because I have had a version of that conversation a bunch of times since then, usually at podcast conventions, talking with other people from other production companies. Again, on paper, it should not work. That's why there are no other shows like it. No one is out there saying: "You know what we're going to do? We're going to do our version of Industry Focus."

It shouldn't work, but it does. The reason it does is because of the smarts, and the dedication, and the flat-out work, the effort of people like Jason Moser, Emily Flippen, Nick Sciple, Dylan Lewis, Asit Sharma, Matt Frankel, Brian Feroldi. Before them, people like Shannon Jones and Sarah Priestley and Kristine Harjes and the other hosts and guests over the years, and engineers like Austin Morgan and Tim Sparks. That's why Industry Focus works. That's why tomorrow, they're going to have their 2,000th episode. And I salute them because there's only one way you get to 2,000 episodes.

As always, people on the program may have interest in the stocks they talk about and The Motley Fool may have formal recommendations for or against, so don't buy or sell stocks based solely on what you hear. That's going to do it for this edition of MarketFoolery. The show is mixed by Dan Boyd. I'm Chris Hill. Thanks for listening. We'll see you tomorrow.