Is Buy Now, Pay Later a Good Business to Invest In?

To put it mildly, the buy now, pay later, or BNPL, business is extremely hot right now. But is it a good business to invest in, or should investors largely avoid it? In this Fool Live video clip, recorded on Sept. 13, Fool.com contributor Matt Frankel, CFP, and Industry Focus host Jason Moser talk about the risks and potential of the BNPL space and what investors should keep in mind.

Jason Moser: It feels like with Affirm (AFRM 0.91%), 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 a 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 a firm 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 explicitly 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 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 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 say they can't do it. It just seems like it's a tougher ask what do you think about that?

Matt 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 stand-alone 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 and Mastercard get what 2% maybe of each transaction if that PayPal and Square get what, $0.30 every time or $0.12, I think it is, in Square's case every time a transaction is made.

The buy now, pay later margin is actually really good, Affirm 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 stand-alone 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 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 knew -- 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 there'll be presenting with the firm, it's another offering. At the end of the day though, this is still debt. You're getting something upfront 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 and you 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 idea.

Frankel: There are some benefits to the 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 is a $5,000 limit, if I were to charge $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.