Affirm Holdings (AFRM -0.45%) was one of the hottest initial public offerings of 2021. The buy now, pay later (BNPL) services provider went public at $49 per share last January, started trading at $90.90, and closed at an all-time high of $168.52 last November. But today, its stock trades at about $20.
The stock tumbled as investors fretted over its widening losses, rising leverage, and the long-term sustainability of the BNPL business model. Rising interest rates, which sparked an exodus from the market's pricier and unprofitable growth stocks, exacerbated that sell-off.
Contrarian investors will point out that analysts still expect Affirm's revenue to increase 54% in fiscal 2022 (which ends this month) and grow another 42% to $1.9 billion in fiscal 2023. Based on those estimates, the stock still looks pretty cheap at just three times next year's sales. Unfortunately, three bright red flags could prevent it from recovering anytime soon.
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1. Inflation will throttle consumer spending
Affirm generates most of its revenue in the U.S., where inflation recently hit a 40-year high. BNPL services generally target younger and lower-income consumers who can't get approved for traditional credit cards, and that core market could get hit hard by inflation.
The bulls will point out that BNPL services can provide those shoppers more-flexible payment options as prices rise. A recent survey from Credit Karma found that 60% of consumers said inflation was driving them to use more BNPL services.
However, their overall spending could still decelerate as they limit their discretionary purchases. Before inflation soared, many Gen Z shoppers had been introduced to BNPL services through social media influencers on TikTok and other platforms, which persuaded their followers to take on more BNPL debt to buy clothing, accessories, and other discretionary products.
Some of those consumers are now struggling to pay off that debt, and Credit Karma found that 40% of BNPL users have an outstanding balance of $665 on average, and 20% were actually using credit cards to cover their BNPL payments. Affirm's delinquent loans (over the past 30 days) only accounted for 2% of its active balances in its latest quarter, but that percentage could climb quickly in an inflationary (or potentially recessionary) environment.
2. Rising interest rates will generate major headwinds
To tame inflation, the Federal Reserve needs to raise interest rates. Higher rates will generate headwinds for Affirm and other stand-alone BNPL firms because they consistently borrow the money that they lend to their users.
To offset that pressure, Affirm needs to charge its users higher interest rates and raise its merchant fees. But in its latest 10-Q filing, the company warns that "in order to continue to expand our consumer base, we may originate certain loans" with "zero or below market interest rates under certain merchant arrangements that we do not expect to achieve positive revenue." In other words, the company is still willing to operate at a loss to fend off its growing list of challengers in the BNPL market.
Rising interest rates will also make it difficult for Affirm to raise fresh funds. It was still sitting on $2.26 billion in cash and equivalents in the third quarter of fiscal 2022, but its high debt-to-equity ratio of 1.7 (compared to 0.9 a year earlier) doesn't leave it much room for new debt offerings.
3. Apple's entry into the BNPL market
Affirm already faced formidable competitors like PayPal and Block's Afterpay in the BNPL market, but Apple's (AAPL -1.92%) planned entry into the arena could be a game changer.
During its latest Worldwide Developers Conference on June 6, Apple introduced Apple Pay Later, a BNPL extension of its payments ecosystem that lets consumers split their purchases into four equal interest-free monthly payments. Apple will handle its lending and credit checks through an internal subsidiary, then fund the platform from its own balance sheet instead of taking out additional loans like Affirm and its BNPL peers.
That key difference should terrify Affirm, since Apple ended its latest quarter with a whopping $193 billion in cash and marketable securities. It also suggests that BNPL platforms might function much better as subsidiaries of larger, cash-rich companies instead of stand-alone businesses.
Are Affirm's days numbered?
Affirm found a fresh way to challenge traditional credit card companies, but there's no evidence its approach is actually sustainable. The company is practically giving its services away to gain new merchants and customers, but it will face daunting challenges this year as consumer spending slows down, interest rates rise, and Apple expands its BNPL services.
It won't go bankrupt anytime soon, but it simply doesn't have a bright future as a stand-alone company. The best outcome might be a takeover by Alphabet's Google or its current retail partner Amazon, but I don't see either tech giant rushing to buy its unprofitable business in this volatile market. So for now, investors should stay away from Affirm and stick with better-run tech companies.
