Bye now, party’s over: Afterpay’s clones are unravelling in Australia

As the top brass at buy now, pay later upstart Zip Co gathered for the group’s 2020 results in February last year, the mood was light. Larry Diamond, the chief of the group which pitches itself as a rival to dominant provider Afterpay, had just revealed a 130 per cent increase in revenue to $160 million and business was booming.

“Before we kick off, I’d also like to thank the hard efforts of the entire Zip team, our Zipsters, but also like to thank retailers and of course our customers and loyal shareholders for what has been a bumper half,” Diamond told analysts.

But the good vibes were short-lived. As investors digested the group’s $453.8 million second half loss, Zip’s share price began to tumble. After initially touching an intraday high of $12.46, the group closed the day at $10.73.

Over the next 14 months Zip would continue on its share price rout as investors grew nervous about the company’s chances of reaching profitability. By this week its shares were trading at just $1.46 and its market capitalisation had withered from as much as $7.7 billion in February 2021 to just $976 million on Thursday this week. It’s now pursuing a merger with rival Sezzle, which has an equally subdued share price to build its customer and merchant base and to move to profitability by 2024.

Zip is just one of the buy now, pay later (BNPL) groups listed on the ASX to have suffered share price plunges over the past year. Many of the other groups that joined the rush to list on our market following Afterpay’s success have been similarly impacted.

Most of these groups recorded phenomenal share price growth between 2020 and early 2021 as investors looked for stocks that could replicate the success of now Block-owned Afterpay’s early investors. At the height of this market, the ASX had 12 buy now, pay later groups while the rest of the world combined had just four listed players.

But over the past six-to-12 months the bubble has burst. There is now fear in the market that the twin trends that fuelled these businesses – the environment of near-zero interest rates and a two-year period where online sales grew at enormous rates thanks to pandemic restrictions – is now over. Other concerns include the entrance of established payment companies such as PayPal into the instalment payment market and the prospect of regulatory intervention in the US and UK amid ongoing warnings from consumer groups that firms are not lending responsibly.

At the same time bad debts – that is money unlikely to be repaid by customers –have blown out and the groups have little recourse to collect these debts from their customers. These bad debts are expected to grow at an even greater rate as the firms move from targeting customers wanting out-of-reach discretionary purchases to people who are struggling with the cost of living and need an instalment payment product to fund purchases of fuel or food.

“The instos – like all these sort of investment parties, or bubble parties – have left the room with all the mess and all the empty booze bottles and poor retail investors are wandering around saying ‘what happened to the party’.”

Grant Halverson, McLean Roche CEO

Payments veteran Grant Halverson, who runs independent analysis group McLean Roche, says the share price falls have been brutal and many stocks are more than 80 per cent below their peak. He estimates that more than $20 billion of investor value is gone (even adding back in Afterpay’s value as a share of its new owner Block’s business).

“The instos – like all these sort of investment parties, or bubble parties – have left the room with all the mess and all the empty booze bottles and poor retail investors are wandering around saying ‘what happened to the party’,” Halverson says.

“The core issue is that they are unprofitable. And now they’ve got bad debts that are actually going up and at the same time there’s an arms race around the world to get customers, so they’re actually going further and further down the desirable credit spiral and losses are therefore going up.”

A key issue for many of these groups in the most simplest sense is that they spend more money than they earn. Part of this is the huge marketing costs required to get a message out in a crowded marketplace and co-marketing contributions tied to deals with big clients.

At the same time, bad debts are blowing out because of low collection rates.

Tom Beadle at UBS is one of the few major investment bank analysts to take a bearish view of the sector even when it was at its height. Beadle has declined to be interviewed for this piece but his notes and price targets speak for themselves – for Zip he sees a fair value of just $1 (implying the stock price still has to fall another 30 per cent to be a reasonable investment).

“In our view, there is meaningful uncertainty in Zip’s outlook, and highlight a considerable slowdown in BNPL growth expectations recently,” Beadle told UBS clients in a note last month.

Beadle says in his note that Zip would need to hit ambitious targets including eking out cost savings out of its tie-up with Sezzle, greater transaction volume and a reduction in bad debts.

“If Zip achieves our forecasts, we do not believe that Zip will need to raise additional equity to fund its underlying operations.”

Beadle also draws attention to the need to refinance Zip’s $400 million convertible note. The note matures in 2028. A put option on the note means those noteholders can choose to exercise that note in 2025. The notes carry a conversion price of $12.06, far below Zip’s current share price. Zip did not respond to The Age and Sydney Morning Herald’s request for more details on whether the company would be required to pay any cash if the option was exercised in 2025.

Yet, against this background, Zip co-founder Peter Gray remains positive about the business. “We are focused on accelerating our path to profitability, sustainable growth and right-sizing our global cost base,” Gray says in response to emailed questions.

“As disclosed in our recent results, we recognise the external environment has changed, impacting our share price, and we have adjusted our strategy accordingly.”

Zip recently filled its coffers by tapping investors as part of its acquisition of smaller US-focused group Sezzle and to fuel future growth. “Our balance sheet is now secure to support our growth, realise the synergies of the Sezzle transaction and support our journey to profitability.”

Other analysts back this view. Morningstar’s Shaun Ler believes the fair value of Zip’s shares is $4.70. “We think Zip has bright growth prospects,” Ler said in a note in March. Analyst Elise Kennedy from Jarden, which was co-lead manager on the notes issue, is also upbeat about the company’s prospects with a $5.75 price target.

Zip is not the only company in this sector to disappoint investors. Other ASX listed groups like New Zealand group Laybuy, Payright, IOUPay, Openpay and Splitit have also recorded severe share price declines, some down 90 per cent from their peak.

Latitude Financial is one of the few groups in the sector to be profitable and pay dividends. The group, which is diversified, draws a chunk of its profits from crossing selling loans to its clients.

Ahmed Fahour, the boss of Latitude and former chief of National Australia Bank, has concerns about the state of some groups strongly or purely focused on the BNPL market. “They haven’t really seen a credit cycle,” he says.

“And they’ve used money as a marketing tool rather than something that needs to be done in an incredibly careful and responsible way to support the customer with what they want, but also to reflect that money isn’t free.

“A lot of these groups were using shareholder money to cover their expenses as opposed to the profit of the business to cover their investment. And so there was a huge demand on cash. We are the exact opposite.”

That’s not to say that Latitude, which listed in April 2021 at $2.60 a share and now trades at $1.82, has not disappointed many investors or has been immune from the general lack of confidence in the sector.

Analysts such as Halverson, Beadle and Macquarie’s Brendan Carrig are also worried about the jump in bad debts being recorded by these businesses.

In part this is being driven by the fact that chasing customers for debts is too costly. Halverson’s research shows that the average revenue per customer for the ASX listed BNPL sector in 2021 was just $54.75 and even for a big group like Zip revenue per customer is just $54.93.

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The industry’s code of conduct – a document prepared to show the industry’s seriousness about self-regulation – even prohibits BNPL groups from ever bankrupting a customer.

Diane Tate, the chief executive of the industry group that administers the code, the Australian Finance Industry Association, says it was designed to provide more protection for consumers.

“Decisions about credit risk and recovery practices are the remit of individual lenders and subject to various factors, including regulatory compliance, commercial operations, and the risk appetite of the organisation,” says Tate.

Instead, many of these groups rely on customers adhering to their contract and paying instalments or meeting their late fees when asked to do so. Customers who ignore the debt collectors and the reminder notices may receive a black mark on their credit rating (they also may not, depending on the provider) but there is little other recourse. Legal action for such a small debt is too costly.

Adding to this problem is that many of the ASX-listed groups are focused on growing their businesses in the deep US market, where customers are notoriously credit savvy and defaulting on debts carries far less social stigma.

Consumer advocates have been pointing out for years the inability of a large portion of customers to meet their repayments and have been calling for companies to employ more responsible lending practices or be covered by credit regulations. The corporate watchdog estimates that 20 per cent of BNPL customers experience some form of financial hardship.

Gerard Brody, the chief executive of the Consumer Action Law Centre, says it is common for his centre to deal with clients in serious financial distress who have multiple accounts.

‘I think anyone that’s borrowing to pay for essentials, like petrol, like food, like utilities, is a recipe for financial distress and disaster.’

Gerard Brody, Consumer Action Law Centre CEO

“It’s not a small proportion that are experiencing some sort of financial harm associated with buy now, pay later. That could be that they’re making late payments and incurring fees. That could be that they’re having to go into debt to make those repayments or they’re having to get extra buy now, pay later accounts to pay back their debts, and that’s quite common in what we see.

“We see people with five or six other accounts at once.”

Brody is concerned that the number of consumers unable to meet repayments will increase as groups target people struggling with the cost of living. “I think anyone that’s borrowing to pay for essentials, like petrol, like food, like utilities, is a recipe for financial distress and disaster,” he says.

But with 80 per cent of the market finding the product useful, there is still significant hope in the financial longevity of these firms and that their products will become more widely used.

That could be a sign of optimism for groups like Zip and Sezzle which combined could attract more customers and move closer to profitability.

Zip’s Gray says the business has enormous opportunities. “We have very strong traction and we truly are disrupting the credit card and traditional financial services sector. Merchants and customers in their millions are embracing what we provide and this is changing the way people pay for things.”

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