After a rapid expansion of the stock market in 2020 and into 2021, stocks have faced a steep challenge this year. Since the start of the year, the S&P 500 is down 17%. Growth stocks and stocks that have yet to turn a profit are taking the biggest hits. Financial technology, or fintech, companies have been hit hard. A popular tracker, the ARK Fintech Innovation ETF, which invests in financially innovative companies, is down 54% year to date.
Investors have had to deal with inflationary pressures, geopolitical conflict, and rising interest rates, all of which have put pressure on the economy. One private fintech feeling the pain from the current economic backdrop is Swedish "buy now, pay later" (BNPL) firm Klarna. The company recently announced layoffs and will take a big hit on its valuation in its next round of funding.
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BNPL firms have seen valuations plummet
Klarna is a Swedish bank that started in 2005 and has evolved to provide customers with flexible payment solutions. The company was flying high and valued at nearly $46 billion in an investment round led by SoftBank last June.
However, economic stresses have put pressure on the BNPL industry. Klarna recently saw its borrowing costs rise to the highest level on record. One factor weighing on the company is rising interest rates. Michael Taiano, an analyst at Fitch Ratings, told Bloomberg, "The big question around the BNPL sector has always been around the sustainability of the business models in a more normalized credit and interest rate environment."
Questions about the sustainability of the BNPL industry have hit BNPL firms' debt and equity valuations hard. In Klarna's upcoming round of funding, the company is expected to take a $16 billion hit, which would value the fintech at around $30 billion.
While this is about one-third of its previous valuation, the decline looks small compared to its publicly traded counterpart Affirm. Since seeing its market capitalization peak at $45 billion in 2021, Affirm has shed almost 86% and now has a market cap of $6 billion.
Data by YCharts.
BNPL companies face a tough backdrop and regulatory scrutiny
The uncertainty about how the BNPL sector will perform comes as these firms pile up the losses. In 2021, Klarna lost $487 million. It also announced plans to lay off 10% of its workforce. The company employs 6,500 employees globally. Meanwhile, Afterpay, which Block Inc. acquired, reported $346 million in losses in 2021, and Affirm has losses totaling $431 million.
Data by YCharts.
Another factor weighing on BNPL firms is increasing scrutiny from regulators. In January, the federal Consumer Financial Protection Bureau expressed concern about the growing consumer debt and data harvesting and opened an inquiry into BNPL firms. In May, the Swedish Authority for Privacy Protection said it had launched an investigation into Klarna's checkout service.
The backdrop has been tough for many companies, and BNPL firms face their own unique challenges in the months ahead. Given the unprofitable nature of the companies, the punishment of growth stocks, headwinds from rising interest rates, and regulatory scrutiny, I'll be avoiding investments in BNPL companies for the time being.
