News From the Buy-Now, Pay-Later Industry

On the heels of its recently announced partnership with Amazon (AMZN -2.56%), buy-now, pay-later (BNPL) company Affirm (AFRM -0.45%) just released some pretty impressive results. And elsewhere in the BNPL space, PayPal (PYPL 0.34%) just announced its planned acquisition of a leader in the Japanese market that could have global implications for the business. Plus, host Jason Moser and Fool.com contributor Matt Frankel, CFP, each discuss a stock they have on their watchlists right now.

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This video was recorded on Sept. 13, 2021.

Jason Moser: It's Monday, Sept. 13. I'm your host, Jason Moser. On this week's Financials show, we'll dig into Affirm's most recent earnings report. PayPal is making an acquisition in the buy-now, pay-later space, and we've got a couple of stocks we're watching that we'll talk about, too. Joining me, it's Certified Financial Planner -- and he's a happy football fan today, because his Gamecocks and his Eagles both won over the weekend. It's Matt "Touchdown" Frankel. Matt, how's it going?

Matt Frankel: Good. I can broadcast the Gamecock alliance. I usually can't keep the fact that I'm an Eagles fan to myself. [laughs] People hear that and just assume certain things about it.

Moser: Man, I tell you, the NFL, I can ruffle some feathers. Man, no pun intended, in all honesty, we need some serious loyal fan bases out there. We need a little bit of the day when we can just agree to disagree and still move forward. Whatever happened to those days?

Frankel: The Eagles are a little polarizing, but they did look dominant.

Moser: They are. That's funny. Real quickly, I grew up at Dallas Cowboys fan, In South Carolina, there was never a home team, so to speak, and the Cowboys were always on TV, so that was just the team I always watched. My wife, several years back, got me a ticket to go see the Cowboys play the Eagles. The Cowboys were out of the season, it was over for them, but it was just a chance to go see an NFL game. So I drove up to Philly to go see the game, and I swear to you, there was no way in the world I was letting anyone know that I was actually pulling for the Cowboys, because I was afraid I might not make it out of there alive. That's a rough place to go see a game, man.

Frankel: Yes, it is. I miss it up there, I tell you.

Jason Moser: It was a lot of fun. It's an electric environment for sure.

Matt, last week, Affirm reported earnings for the quarter, and that was on top of a very positive headline of a relationship they just developed with Amazon. But all in all, Affirm shareholders are going to be feeling really good about where the company is going right now. A lot of positive news out there, and the results from the most recent quarter certainly support that. Wondering, when you look through that most recent report there, and we talk about Affirm a lot here, the buy-now pay-later space, it seems like they are starting to do what you and I think we were a little bit concerned with this business, and we were concerned about that customer concentration. It seems like that customer concentration risk is starting to dissipate a little bit.

Frankel: I love that you and I read the earnings report and come up with the exact same takeaway. [laughs] It's pretty great. And you're right, the biggest negative I mentioned when we talked about Affirm back in its IPO day was that it's very levered to Peloton (PTON -0.98%), its No. 1 customer. Peloton, if you're not familiar, was using Affirm to let people finance those $3,000 workout bikes over, I think, three years interest-free, or something to that effect. So their sales, their gross merchandise volume, their GMV, was up 106% year over year, excluding Peloton, the non-Peloton portion of their business. It was up 178% year over year.

That part of the business is growing faster, which is really welcome news, and that's not including any impact from the Amazon relationship that we talked about. It's really welcome news, because it just couldn't have come at a better time. Peloton's dropping the prices on its bikes. It's seeing sales start to slow down from the pandemic boost. If you remember, there were times last year when you couldn't get a Peloton bike.

Moser: Yeah.

Frankel: I don't know if they're still on a backlog, but for a while, it was months from the time you ordered till the time the bike arrived, just because they were so backed up, and that's not the case anymore.

It looks like they're growing the business in the right way. They brought Shopify (SHOP 0.23%) merchants onto their platform. That was a big deal. The active merchants on Affirm's platform are now at 29,000; that's 5X from a year ago. The big reason is because in June, they opened their platform up to all Shopify merchants who qualify. That's a big plus that they're getting away from just Peloton, and Amazon will help them diversify even more.

Moser: Yeah, I think you're right. It feels like with Affirm, the concern at least I think for many, I know this was at least an observation on my part, was just that buy now, pay later seems a bit more like a feature than the whole business. But by the same token, we're seeing a lot of investments being made in the space from companies like Mastercard, Visa, PayPal, Square. We've got Affirm doing their own thing. It's certainly not to say that a firm can't grow into becoming more things. That, I think, is one of the strategies that management has exclusively stated, is ultimately becoming more of a financial-services company.

I wonder how you view that, because if you look at the world today with all of the options out there, with the PayPals and Squares of the world. It feels like it'd be a lot easier to go from developing a payments network and then offering additional ancillary services, like buy-now, pay-later, crypto, or whatever it may be. For a firm to start out as a buy-now, pay-later platform, and then ultimately pivot to other services or other offerings, it seems like that's probably a bit of a higher hurdle. Not to say they can't do it. It just seems like it's a tougher ask. What do you think about that?

Frankel: Well, in Affirm's case, the fact that they got Peloton early really was the differentiator.

Moser: Yeah.

Frankel: The fact that they partnered with one of the biggest buy-now, pay-later-friendly businesses in the world, the tailwinds from the pandemic didn't hurt. Let's be honest. But they're having really good success as a standalone business. Just the economics of this. The more I dig into it, the more the economics of the buy-now, pay-later business makes sense. When you think of the companies we follow -- say, Visa, Mastercard, Square, PayPal -- Visa, Mastercard get what 2%, maybe, of each transaction, if that. PayPal and Square get, what, 30 cents every time, or 12 cents, I think it is, in Square's case, every time a transaction is made. The buy-now, pay-later margin is actually really good; a firm makes a roughly 10% margin. They get 10% of the transaction volume on their platform.

In the second quarter, the transaction volume was 2.5 billion, and the revenue they generated was over $261 million. That's a pretty big revenue stream. This is not the pennies that Square and PayPal are making. This is not the swipe fees that Visa and Mastercard are making. They're actually making a good bit of money when people are using their platform, which is why, the point being, because it's such a moneymaker, if it's going well, it does work as a standalone business, because they don't need those trillion-dollar payment volumes. They just need one really great partner, which they've got in Peloton, and that really catapulted them legitimacy as a business.

Moser: Yeah, I think you're right. The one thing I wonder about with buy now, pay later, because at the end of the day, this, really, it's just another form of credit -- you're drawing out a purchase instead of paying for it all at once. You're paying for it in installments. The relationship with Amazon, I think, is really interesting, because I know we've talked about this before, but I know, I could have sworn that I saw installment options on Amazon, and certainly they do have installment options where they guide you through their credit card. The Amazon Prime Visa that you pay for your purchases via installments through their credit card. But this is a different offering now that they'll be presenting with Affirm. It's another offering.

At the end of the day, though, this is still debt. You're getting something up front and you've got to pay for it over time. I guess I wonder, and this is less about the company; this is really more about consumer behavior, and it's a question. I'm not really sure how this ends. But at the end of the day, I wonder, does this guide consumers to spend more responsibly? Or does this just become ultimately one more way to accumulate debt? Because the glass-half-empty guy in me can see a world where consumers get tapped out of their buy-now, pay-later bandwidth and then start seeking out additional forms of credit, like, say, a credit card.

Frankel: Yeah, no. I definitely agree with that. It's a question of how much credit do Americans need, first of all.

Moser: Yeah.

Frankel: Like I mentioned last time, it could be complementary to credit cards. In Amazon's case especially, I have to think everyone who wants an Amazon credit card already has one. It's got to be pretty close to full market penetration in terms of demand.

Moser: Not a bad...

Frankel: There are some benefits to buy now, pay later over credit cards. I mentioned last time, it's not reported to your credit unless you make a late payment. Let's say my Amazon card has a $5,000 limit, if I were to charge a $3,000 entertainment system for my living room on my Amazon card, it would show as almost a maxed-out credit card and hurt my credit score. If I use buy now, pay later, that wouldn't be the case. It wouldn't ding my credit for financing that purchase. Having said that, the early results are not encouraging when it comes to consumer behavior. Default rates, delinquency rates for buy now, pay later are significantly higher than credit cards.

Moser: Are they? I was going to ask you about that if you had any data on that, because that's got to be a little bit of a worry there.

Frankel: Depending on what source you're using and which study you're looking at, it's usually between 20% and 30% of users have made a late payment on one of these. An alarming amount of people are using credit cards to pay for their purchases afterwards. In other words, they're setting up a buy-now, pay-later agreement and then using a credit card to pay their installments.

Moser: Right. Well, see, that just gets to what I was talking about here. It's one for the other. There's a responsibility here on the consumer's part, I guess, is ultimately what I'm getting at. I think buy now, pay later is an outstanding idea. I think it's a wonderful idea. But it still does boil down to customers, consumers acting responsibly or at least somewhat rationally with their money. We know that's not always the case.

Frankel: Yeah, it's very early in this industry, so it's really tough to say how the long-term effects are going to be. And, plus, remember the economy is pretty strong right now, especially when it comes to consumer spending. A lot of consumers are flush with cash. Savings rates have never been higher than they've been over the past year. So we're seeing just one snapshot of how this works. What happens when a recession hits, and these obligations that are easier to get the most credit cards, what happens when consumers default on those in higher numbers? We're seeing high default rates in a good environment.

Moser: That's odd. That's odd.

Frankel: It's tough to say what it's going to do throughout the cycles.

Moser: Yeah, I guess something worth keeping an eye on there is just paying attention to those delinquency rates, and then ultimately seeing how does that translate to the ultimate cost to the consumer and to the merchant. I mean, the merchant's another part of this, because right now, these buy-now, pay-later firms are able to tout either fee-free, no late fees, zero or very minimal finance charges. But as with anything, as the risk goes up, you need to be compensated for that risk. If the consumer's a bit of a riskier proposition, then it would seem at least that costs for financing these purchases could go up as well. And maybe that's not a one-size-fits-all. You've got consumers who are very responsible and pay their bills on time, but you may have others who aren't, and that may be reflected by higher transaction costs for them, higher costs to finance the buy-now, pay-later purchase.

Frankel: Yeah. There are a lot of no-interest arrangements for these buy-now, pay-laters and someone's paying for it.

Moser: Yeah.

Frankel: When you get 0% interest financing through Peloton, Affirm's not just making no money. [laughs] Peloton's paying them for doing that.

Moser: It's like saying free healthcare. It's like, wait a minute, now. It's not free. Someone is paying for it. [laughs]

Frankel: The buy-now, pay-later service, unlike credit cards, generally guarantees payment to the merchant.

Moser: Yeah.

Frankel: Over time.

Moser: Yeah.

Frankel: They are essentially guaranteed that the merchants are going to get a steady stream of payments over time. If default rates tick up, the overall cost, whether the consumer is paying a higher interest rate or the merchant's paying a higher fee to the buy-now, pay-later company, costs are going to go up. And that could make it less appealing to merchants as well.

Moser: Yeah, absolutely. Well, speaking of buy now, pay later, and then pivoting over to the other side of the spectrum here, PayPal also last week announced an acquisition that they are making. It's a relatively small acquisition, comparatively speaking, at least. But Paidy, a Japanese buy-now, pay-later firm, PayPal is going to be acquiring Paidy and bringing that into their network. I believe $2.9 billion was the deal. They're primarily financed with cash there on PayPal's part.

Not a big acquisition for a business like PayPal, considering that they have already built their own buy-now, pay-later offering. Some may ask, well, why would they buy this as opposed to just expanding their offerings? Oftentimes, just getting into another geographical area of the world can be a lot more difficult even if you've built something that's showing the promise that PayPal's buy-now, pay-later offering is showing today here domestically. Being able to roll that out around the globe is a little bit of a different ask. And so it seems like they are buying that share into the Japanese opportunity. But looking at the numbers, it seems like a very reasonable bet on PayPal's part.

Frankel: Yeah, I like this a whole lot more than I like Square spending $29 billion on Afterpay. [laughs] Not just because it's one-tenth of the price. I like the strategy of it better.

Moser: Move the decimal over just one, and man, I tell you, it looks a lot better than this. [laughs]

Frankel: Well, it's a bolt-on acquisition, unlike Square's, which is trying to establish buy now, pay later from scratch. PayPal has already done that. PayPal has already built a buy-now, pay-later platform. Now they're just trying to optimize that, I guess you would say. This gets them into the Japanese market. It gets them Paidy's proprietary technology. Paidy uses proprietary technology to underwrite their loans to assess creditworthiness. They have their own credit scoring method to determine consumer credit that could be ultimately applied around the world.

It's an impressive platform. They're the leader in the Japanese market, which is the No. 3 economy worldwide for e-commerce, by the way. It gets them a big head start in that market.

Square is not an international company at this point. Afterpay is in a few markets. They're primarily in Australia and the U.S., where Square already is. So it doesn't really open up the globe, and PayPal's already a global company. So I like that they could take this leader in one really strong market and apply it to the 100-plus countries they operate all over the world. It seems like a better use of capital than just spending $29 billion to buy an established buy-now, pay-later service. That's just my opinion. And this is coming from a Square shareholder.

Moser: Well, this is coming from a Square and a PayPal shareholder. I tend to agree with you. When I look at this acquisition, it's certainly a lot easier to stomach. If it doesn't work out, that's not good, but it's not something that really moves the needle for PayPal either way.

But to your point, being able to take this and even extending the proprietary technology that they get, extending the IP that they gain from this acquisition to a global scale, it could be very meaningful over time. In particular, when you look at the Japanese market, I found this pretty fascinating -- the Japanese market is still very cash heavy. Around 70% of all purchases are still paid for in cash. The Japanese people as a culture, it would seem, are much more debt averse than probably others. Not to say that's a bad thing at all, but it is probably a challenge that they'll have to overcome in convincing people that, hey, this is a way that you can purchase what you want to purchase if you want. If you have 70% of all purchases still paid for in cash, well, that means you probably have a lot of room to change people's minds and show them there's another way.

But by the same token, maybe it's a little bit easier said than done. But probably, we want to see that number come down over time for this to be an acquisition that really moves the needle, at least from a Japanese market perspective.

Frankel: Yeah, I'm curious to see what the pandemic did to that 70% rate of cash payments. I have to say it probably shifted a little bit.

Moser: I'd imagine.

Frankel: I wouldn't think Japan is necessarily a debt-averse society as much as they're an interest-averse society. I always say that I'm not afraid of debt. I'm afraid of interest.

Moser: Yeah. [laughs]

Frankel: If you want to loan me a million dollars at 0% interest, I'll put it to work and make money with it.

Moser: I'll take it. [laughs]

Frankel: Right. It's not that I'm debt averse; it's that I'm interest-averse. And buy now, pay later solves that in a lot of ways. They give qualified consumers 0% financing. Like you said, they don't take on a lot of debt in Japan because of the interest. Buy now, pay later is really interesting in a market like that, because it could get some consumers who have been historically not wanting to get credit cards. In America, we love our credit cards. Let's be honest. In some cultures, that's not the case. Those are the ones where buy now, pay later really has a lot of promise.

Moser: Well, I've had a lot of experience through the years, credit card companies building up these big robust rewards programs and convincing us that we as consumers can't live without them. [laughs] I guess, technically, $2.7 billion, it looks like this deal is, so not quite 2.9. But still, 2.7, close enough, and you get the gist of it.

Well, Matt, before we wrap up this week, not a lot going out there. Earnings season has wrapped up. But we still have two stocks to watch for our listeners here. A couple of stocks we're digging into and learning more about. What stocks are you watching this week?

Frankel: I'm watching United Wholesale Mortgage (UWMC -0.32%), ticker symbol UWM. A lot of people might remember on the show when we were talking about Better Mortgage going public through SPAC, when Rocket Mortgage went public, but I was taking all these mortgage companies with a big grain of salt. Mortgage companies look great in the current environment, when everybody refinanced their house last year. [laughs] Some people I know at the Fool refinanced twice in 2020 because rates dropped so much. United Wholesale Mortgage really is doing it different. Their CEO has made some really impressive moves, let's say, since going public. They're wholesale mortgage, which means they work through brokers. He makes his brokers choose -- do they want to work with them exclusively, or do they want to work with Rocket or things like that? He wants exclusivity, which is interesting.

One of the most recent things they've done that really could really be a game changer is they're bringing the appraisal process in-house. The appraisal process is really one of the remaining big pain points of the mortgage process. Especially right now with the labor shortage, the hot housing market, it can take weeks from the time you schedule an appraisal till it actually happens. That's a condition of your mortgage being done. By cutting out the middleman and the appraisal process, the appraiser now has a reason to work directly with UWM, because they're getting 100% of the appraisal fee, not just their cut of it. So they'll have their own appraisers on standby, ready to take their appraisal orders at a moment's notice. They're cutting it out, it cuts down on the time. It cuts down on the appraisal costs for the consumer. It lets some loans close quicker than their competitors who still use these third-party appraisal services, and it could be a really big move for this company.

Again UWM, United Wholesale Mortgage. They went public last year along with several other mortgage companies. I didn't think too much of them at first, but they are making some really big moves that could pay off.

Moser: Well, yeah, that's a good one. Speaking of companies making big moves and paying off, I'm going to be digging more into DraftKings here in the coming weeks. Ticker there is DKNG. Now Matt, correct me if I'm wrong. You and I have talked about this earlier. DraftKings is literally one of, if not the most, successful SPAC offerings out there right now. In a world where SPACs have had a little bit of a tough time here recently, DraftKings is a SPAC that really has worked out pretty well for investors.

Frankel: Yeah, it's one of the most successful SPAC mergers of all time, I believe, if not the -- I'm not sure if it's the most successful, but it's definitely made early investors a lot of money.

Moser: Yeah, it feels like it has, The stock is up around 30% year to date. It's outperforming the market. But really, football season is now fully under way, and I think we're starting to see the dominoes fall as more and more states incorporate sports betting into the fold there, which I think is a great thing. Of course, you want folks to use these platforms responsibly, but by the same token, they are ultimately in other forms of entertainment, which we know is a very big market opportunity in its biggest-picture sense. I think this is a fascinating business from a number of angles and I really want to learn more about what their ultimate goal is.

There's a lot of consolidation going on in the space right now. From a finance perspective, you see the number of different ways you can fund these accounts, whether it's your card or whether it's PayPal or e-checks from your bank, and that certainly plays into all of the different types of companies that we're following as well here on the show.

Another thing I saw which was pretty interesting, and this isn't really DraftKings-specific, but it's NFL specific. This was a tweet I saw from Dan Kaplan a couple of days back, where right before the season started, 29 of 30 NFL stadiums will be fully cashless this season. The only exception there is going to be Soldier Field in Chicago. But this is something that happened very quickly. Remember just a couple of years ago, it was a novel idea to see a stadium go cashless. Now it seems like they're all doing it. Probably the pandemic had a little bit to do with hastening that, but you and I, we've also spoken about this. I'm not so sure. If I'm a business, I feel like I still want to accept cash. I want to open my doors to the biggest customer base possible.

Frankel: Yeah. I would agree with that. I was at a football game last weekend, and the cashless thing's nice and convenient. It keeps the lines moving faster in a lot of ways. But it was inconvenient to not be able to pay for a bottle of water with the cash that's in my wallet. I have mixed feelings on it.

Moser: Yeah. I think I ultimately, personally, I tend to like to pay for things digitally, but every once in while, you got a couple of bucks in your pocket, it's nice to be able to use them. But I guess we'll see how that all shakes out. But I'll be digging more into DraftKings here in the coming weeks, learning a little bit more about that business, ultimately, what their long-term vision is, because it really does feel like with the doors opening up now toward not just sports betting, but really gaming in general, there's going to be a lot of opportunity out there for some of these big players in the space, and DraftKings is certainly one of, if not the biggest, in the space.

But Matt, I think that's going to do it for us this week. I really appreciate you taking the time, as always, to join us.

Frankel: Of course. Always fun to be here.

Moser: Remember, folks, you can always reach out to us on Twitter, @MFIndustryFocus or drop us an email at [email protected]. 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. Don't buy or sell stocks based solely on what you hear. Thanks as always to Tim Sparks for putting the show together for us. For Matt Frankel, I'm Jason Moser. Thanks for listening, and we'll see you next week.