Buy Now, Pay Later & Payment Ramifications

There’s been a lot of ink spilled over Square’s $29.0B acquisition of Afterpay, ramifications for public / private payment companies; with numerous bulls / bears on both sides. In most of what’s been written, there’s still a fundamental misunderstanding of Buy Now, Pay Later (“BNPL”), implications for incumbents, challengers, consumers & merchants alike.

BNPL is yet another payment type, not dissimilar from an unsecured lending mechanism. While some view it as the continuation of the evolution of alternative payment methods dating back to store charge cards in the late 1800s / early 1900s, and layaway / installment plans that became prevalent during the Great Depression; others think it will be the preferred payment method for younger Millennial / Gen Z’s to pay for goods online (regardless of net worth) particularly across categories including Apparel, Beauty, Homeware, Pharma, Dental/Optical, and Travel, replacing credit card spend in a generation allegedly allergic to debt.

It’s projected to be one of the fastest growing payment methods globally over the next couple of years, reaching hundreds of billions of dollars of GMV, so merchants, FinTech investors, and consumers broadly should have an understanding of what this means (and more importantly in many cases, doesn’t mean) for them.

What Is BNPL

BNPL enables customers to purchase goods & services by paying for the full purchase price across a number of installments, typically with 0% APR and no hidden fees, making purchases more affordable / convenient for consumers, while increasing conversion rates & average order value (“AOV”) for merchants. There are two main types of BNPL offerings:

• “Pay in X”- E.g., PayPal rolled out their “Pay in 4” offering which allows consumers to choose Pay in 4 at checkout at millions of online stores, splitting their payment into one every two weeks. Consumers can use this today across online stores such as BestBuy, Bose, Coach, Sonos, and even Vineyard Vines. This is the most common type of BNPL with payment terms usually of ~6 weeks (e.g., 25% upfront and 25% every 2-weeks thereafter) but can range from 0–5 months.
• Long-Term Financing- Alternatively there are long-term financing options available for higher purchase priced goods such as Affirm’s relationship with Peloton (which was ~28% of revenue for FY ended June ’20 & 20% for 1Q21). When purchasing a Peloton, users can select monthly financing options of 12,24, or 39 months.

Affirm has leading market share in the high AOV segment of BNPL with an AOV of $609 in FY20 vs. $110 for Afterpay. There’s puts & takes of each model:

• Higher AOV- Higher take rates, and higher barriers to entry leading to less competition which should lead to less pressure on economics (e.g., underwriting a $1,895 bike for 39 months is different from a 6-week $100 “loan”). The company is exposed to greater default risk on longer-term higher value orders versus shorter duration, lower value orders. There is also greater interest rate sensitivity in a rising rate environment (although AFRM internal studies have shown no material impact until short-term rates are at ~6.0%).
• Lower AOV- tends to lead to larger customer bases & increased transaction frequency. Economics are less favorable (e.g., take rate of ~2.25% for Afterpay vs. 3.5% for Affirm), and more susceptible to margin pressure with lower barriers to entry (e.g., four equal, bi-weekly payments at 0% interest). This is less of a traditional credit decision. On the SQ acquisition call Afterpay CEO Nicholas David Molnar said, “When you sign up to Afterpay, we don’t conduct a credit check or ask you to jump through any hoops. Our model is based on trust. You start with a lower spending limit that increases over time and reflects good repayment behavior” which would make a traditional head of credit squirm.

There’s a bit of a misperception that BNPL is a financing option of last resort (a la layaway), but the data suggests otherwise with numerous studies showing that BNPL users have higher incomes than average and typically have access to multiple payment options.

Market Opportunity

From the Affirm S1- “In 2019, consumers paid approximately $121 billion in credit card interest, $11 billion in overdraft fees, and $3 billion in late fees according to studies from LendingTree, the Center for Responsible Lending, and NerdWallet, respectively.”

Affirm highlights issues with both debit / credit:

• Credit- According to the Federal Reserve, as of June 2020, Americans owed nearly $1 trillion in credit card debt, evidencing the massive amount of consumer debt and the clear need for flexible payment options.
• Debit- We believe that debit cards also do not meet the buying needs of many consumers. They are an inflexible method of payment, particularly for consumers contemplating a higher value purchase. Debit cards restrict buying power to a consumer’s account balance, constrain the ability to budget over time, and do not provide the optionality or ability to responsibly access credit.

According to eMarketer, global online sales grew ~20% to $3.4T in ’19 and are expected to reach $4.8T by ‘23E, however eCommerce still only accounts for ~14% of total retail sales. One of the constant themes in a post COVID-19 world is (i) Digitization of Payments (e.g., Cash to Card Conversion) & (ii) Rise in eCommerce. From the smallest cornerstone business to the largest global enterprises, COVID-19 required all business owners to develop an omnichannel presence. In doing so, these retailers are quickly adopting a host of various payment methods including card, digital wallets, mobile payments, PoS, Financing, BNPL, and crypto. Every element of commerce is moving online, from storefronts, to order fulfillment, to payment and checkout experiences. According to Statista ~70% of millennials prefer to shop online, and ~25% don’t carry credit cards at all.

At present there are over 600+ alternative payment methods (APM) / local payment methods (LPM) globally, which grew largely out of necessity based upon payment customs per country & available technology. To ease complexity some FinTech co’s have accelerated the integration process of new APM/LPMs & BNPL is leading the way with participation across the acquirers (e.g., FIS, FISV, GPN), the networks (V/MA), digital wallets (e.g., PYPL), and pure-play companies (AFRM, APT AU, Klarna), etc…

According to Jefferies, the addressable market across consumer credit for FinTech enabled credit products is ~$840B, which is an incremental ~$18B TAM for smaller installment loans.

BNPL is still in its infancy in the US with ~1.6% (~$18B) of eCommerce transactions paid using BNPL in 2020. Total volume is expected to more than quadruple to $74B by ’24 or reach ~4.5% of total eCommerce sales according to Worldpay.

This is a global phenomenon. In the Paytm’s S1 they highlight BNPL as a growth area. “Disbursals under BNPL models is expected to grow 5x from $15-$20B in FY21 to $90-$100B in FY26.” Whether it’s PYPL, SQ, Paytm, Grab, Meituan, Rappi, Nubank, etc… expect global super apps to look to add BNPL functionality as an extension of their payment suites.

BNPL represents a more meaningful share of the market in several European countries, such as Sweden/Germany/Norway where penetration was 25%/18%/13% of e-commerce sales in 2019 (with several other European nations above 5%). Australia reached ~10% of all eCommerce volumes in ’20, so successful that interest-bearing credit card debt is down 1/3 in the last 3 years in the country.

From a demographic standpoint BNPL is in the early innings of growth. Younger generations have been slower to spend with credit cards & early adopters of BNPL as they see it as a convenient, more budget-conscious/transparent spending method. Bank of America surveyed ~500 Afterpay US users in the beginning of the years and found the top reasons for using the app were unrelated to credit provisioning:

• Financial Management: “It helps me manage my budget” (57%)
• Preference for installments at PoS: “I prefer paying in installments” (53%). When looking at the 6 week plan, that can cover 3 pay cycles for those that get paid bi-weekly or ~11.5% of total income.
• Ancillary Offers: “I like the shopping deals that come through Afterpay” (47%)
• Conducive to mobile: “It is easier to use on a mobile.” (41%)
• Interest costs, hidden fees: “I don’t want to incur interest costs” (25%)

This change in payment methodology from credit to debit was happening before the growth of BNPL. From a February 2020 Deloitte note, “Another trend that may hinder credit cards’ future prospects is the growing use of debit cards, especially among younger consumers. We found that 52 percent of Gen Z and 41 percent of Millennials in our survey would prefer to use debit cards most … In Australia, for instance, these products (pay later) are considered some of the biggest drivers in the overall credit card debt decline … nearly half of BNPL users have stopped using credit cards for their transactions altogether.”

You can also see this in the number of credit cards owned by generation. An Experian survey found that Gen Z had ~1.9 cards / person, while Millennials 3.18, compared to Gen X / Baby Boomers at 4.2 / 4.6 respectively.

While BNPL started with Millennials & Gen Z the past couple of months have seen an acceleration of adoption across age groups. A December 2020 study from PayPal found that “Bridge Millennials” (ages 32–41), and Millennials (ages 24–39) saw 20%+ increases in usage of BNPL from March-September of 2020.

More recent SensorTower data shows that BNPL demand remains robust during the 1H of the year vs. 2020 levels, which saw a boom in BNPL activity per BAML.

BofA Global Research: BNPL SensorTower Data

According to Cornerstone it’s not just Gen Z & Millennials, but nearly ~⅓ of Gen X surveyed also made a BNPL purchase in ’20 or ‘21.

Notably, there is significant uptick in BNPL search activity around the holidays, which is traditionally the strongest seasonal period for eCommerce & retail transactions. This should continue to increase awareness & accessibility of the various offerings regardless of age come holiday season.

Business Model

The BNPL business model is fairly straight forward:

• Merchant Discount Rate- The rate the merchant pays the BNPL provider this can range from ~2–6% of the transaction value.
• Transaction Fee: Some providers also charge merchants a fee of ~$0.15-$0.30 per transaction.
• Late Fees: Depends upon provider but in Afterpay’s example they assess a $10 late fee + $7 after one week late, capped at ~25% of purchase value.
• Interest: For higher AOV products / longer-term financing there can be an explicit APR assessed (which BNPL purists are often offended by).

Merchant Benefits

While the consumer benefits are fairly straightforward (any 0% APR financing where someone else is footing the bill, in this case the merchant, is usually value-add) it’s less obvious at first glance the merchant benefits (particularly with higher MDR’s than traditional card payments).

From the introduction of the first store charge cards in the early 1990s (predominantly from Department stores & some oil companies), through the launch of BankAmericard & Visa, the appeal of both charge cards /debit / credit cards has been all about “sales enablement” helping merchants sell more at higher prices. BNPL is no different with benefits including:

• Higher AOV- In solving for “affordability” BNPL providers help merchants increase demand for higher net AOV items. Per Affirm’s internal data looking at studies in ’18 & ’19 merchants using Affirm reported 92% & 85% higher AOV, before refunds, when compared to other payment methods. PYPL announced their BNPL solution is increasing cart sizes by ~39%.
• More Customers / Higher Conversion Rates- Merchants have reported increased customer conversion when using a BNPL provider. In Affirm’s case their dollar-based merchant retention has been 100%+ for each cohort of merchants that have joined the platform since ’16. On the SQ/Afterpay call they highlighted that Afterpay drove over 1.0M leads on average per day and became a key marketing customer acquisition channel for their global retailers in attracting highly valuable next-generation consumers. Using Afterpay has also resulted in increased conversion rates.
• Increased Repeat Purchase Rate- According to Affirm ~22% of consumers from the Jan ’18 cohort & ~20% of consumers from the Jan ’19 cohort made repeat purchases at the same merchant within 12 months.
• Lower Return Rates- Afterpay noted their merchants see lower return rates when using Afterpay versus a traditional payment method.
• Enhanced Data- BNPL companies provide merchants with data to offer more tailored promotions (e.g., targeted offers in their app).
• Broader Target Market- The flexible financing terms enable merchants to reach a cohort of customers who may have previously been priced out.

Payment Stock Reactions

While people love to have a reason for why a stock goes up / down, the most accurate answer is more buyers than sellers or vice versa; aka supply & demand. That said, there is a constant search for a narrative around price movements and last week’s move in the payment stocks was no different.

Going into earnings the “deal stocks” of FIS, FISV, & GPN were all well owned by the hedge fund community. According to BAML research if a ~1.0x weighting was equivalent to the weighting of a name in the S&P 500 based on 6/30 filings, all were large “overweights” amongst the HF crowd:

• FIS- 6.4x
• GPN- 4.4x
• FISV- 2.2x

On 7/27 FISV reported strong numbers and the stock was +3% increasing expectations for the space (alongside V’s report the same day). Many hedge funds used SQ/PYPL as shorts against their long GPN / FIS / FISV positions and the confluence of GPN reporting on 8/2 (the same day as SQ’s announcement) & FIS on 8/3 only exacerbated these moves.

• SQ- SQ rallied +10% on announcement. While SQ’s short interest screens high (~8.0%) approximately ~60% of that is convert arb related vs. ~40% fundamental shorts. Regardless due to a strong quarter / market positioning / and high retail participation (and option activity) SQ caused pain for L/S Hedge Funds who were long FIS, GPN, & FISV vs. short PYPL & SQ causing de-grossing on both sides.
• FIS / FISV / GPN- Over the last 6 trading days since deal announcement these names are now (10%) / (4%) / (10%). This is bottom ~1–5 percentile trailing 5–10D returns going back to January 2010 for FIS & GPN.

FIS Trailing Performance as of 8/9/21

GPN Trailing Performance as of 8/9/21

• AFRM- AFRM is +17% since the deal was announced on what has been a lot of short covering (shorts piled into lockup expiry, but lockup sellers never showed up and you started to get an unwind into this announcement). The bears are now concerned about potential acquisition for AFRM (although the two businesses are quite different from both a merchant / customer base).
• V/MA- Since deal announcement they are (2.4%) / (3.9%) respectively vs S&P +0.84% so notable underperformers. There are still some macro concerns around the delta variant and what could be a delay in the return of the higher margin cross border payments (specifically travel which remains well below ’19 levels).
• PYPL- PYPL is +0.95% since deal announcement, roughly in-line with the S&P. Continues to be a battleground regarding EBAY headwinds, TPV, and user projections for YE, and questions around SQ becoming a viable competitor in online checkout.
• Pure-Play Issuers- Companies like AXP, COF, DFS & SYF are +0.09% / +2.8% / +4.1% / +4% since the deal was announced & in theory have the biggest competitive risk from BNPL (which shows why stock price reaction was more positioning than fundamental read across).
• Banks- The large banks that are big card issuers (e.g., BAC / C / JPM) are more complicated businesses but SQ is aiming to compete with them directly, looking to become a financial “supermarket” (analogous to what Citigroup’s strategy was under Weil). While the read across is less apples to apples these stocks were +6% / +5.8% / 3.6% all outperforming the markets.

Payment Transaction Workflows

BNPL is a TAM expansion for card networks & acquirers. There are two legs to a BNPL transaction:

• The initial transaction with the merchant at checkout, that typically looks like a traditional card transaction to FIS. If a merchant doesn’t have a bilateral or direct integration with BNPL then a virtual card is used as tender of payment at checkout (e.g., MQ issues such cards for many BNPL providers). The merchant’s merchant acquirer would process this virtual card, no different than a traditional card, and earn similar economics. If a merchant has a bilateral or direct integration with the BNPL provider, then it would settle payments directly and sweep bank funds (via ACH) according to terms of the contract and bypass the merchant acquirer / card networks.
• The downstream collection of installment payments from the consumer, typically funded via a debit card processed by a merchant acquirer. The BNPL provider requires a merchant acquirer to process such transactions with the BNPL as the merchant of record, commanding regular card economics to the merchant acquirer.

Payment Fundamental Implications

• Card Networks- Network assessment fees are charged on a per transaction basis. The BNPL solution takes either 1 transaction (or maybe even 0 if the consumer wasn’t going to make the purchase) and turns that into 4 different transactions. The most common tender type for installment payments on BNPL is debit cards (Aftepray says that ~90% of Afterpay transaction volume is linked to debit cards). The providers also utilize virtual cards (e.g., Affirm utilizes virtual Visa cards). The risk is when users link directly to their bank account bypassing the card network (and what some bulls think Square is going to do to “close the loop.”). This would likely only happen with the largest merchants given the complexity involved as it de-consolidates reporting & complicates management of payment flows & chargebacks. This isn’t that different from today where users can fund BNPL providers with ACH, but survey work suggests ~50% prefer debit cards, 23% link bank accounts, and the balance link credit cards. Could we see the BNPL providers look to incentivize users to use ACH for subsequent transactions? Perhaps but it doesn’t seem likely with debit cards responsible for ~90% of US-based BNPL transactions.
• Merchant Acquirers- FIS, FISV & GPN all count BNPL providers as customers. FIS was the only team willing to go on record but mentioned Klarna, Afterpay, Openpay, and Laybuy are all processing clients of theirs. An effective way for BNPL providers to reach merchants is to work with acquirers like FIS, FISV, & GPN who can turn on BNPL options for millions of merchants (this is analogous to PYPL working with acquirers to turn on & manage PYPL acceptance). Similar to the Card networks the merchant acquirers are bypassed in direct bank fund sweeps across ACH (which is a trend most companies are moving away from due to the reconciliation complexity).
• Issuers / Banks- The pure-play card issuers could face material headwinds if we see BNPL take meaningful share from both credit & debit card spending. There’s a view that BNPL is viewed by younger demographics as a more appealing entry-level credit product than a traditional credit card, particularly in the eCommerce channel.

Competitive Landscape / Opportunities

The BNPL is incredibly competitive with competition from legacy credit & debit cards issued by card issuing banks such as AXP, BAC, C, COF, JPM, SYF, etc… technology solutions provided by V/MA, as well as legacy acquirers FIS, FISV, & GPN, mobile wallets such as PYPL / SQ, and BNPL pure-plays such as Affirm, Afterpay, Klarna, Sezzle, etc….

A host of public / private companies are involved either directly or tangentially in the BNPL space.

Pure-Play BNPL Companies: FT Partners did a good job summarizing the existing landscape. One thing to keep in mind is we could see multiple BNPL options for the most sophisticated merchants (e.g., Target using Sezzle for orders <$100 & Affirm for orders >$100).

We can’t discuss BNPL without talking about Klarna. Klarna raised $639M at a $45.6B valuation in June making it not just one of the most valuable FinTech companies in the world (public or private), but one of the highest private company valuations of all time.

Klarna offers BNPL, coupled with neo-banking services & an open-banking platform which is likely the path that the standalone BNPL will have to follow. Their scale is unparalleled in the pure-play comps including:

• 87M active consumers
• 250K merchant Partners
• 2M+ transaction Per Day

Describing them as a “BNPL” player solely is unfair to them at this point, & it will be interesting to see how they describe themselves & the competitive landscape as they look to go public in the next 12–18 months.

Incumbent Efforts

Source: FT Partners

Big Tech / Big Banks

• Apple / Goldman Sachs- There were reports that AAPL & GS were working on enabling consumers to pay for Apple pay purchases in installments over time called “Apple Pay Later.” This would be separate & distinct from the Apple Card & doesn’t require users to use one, in an attempt to drive Apple pay adoption. This is likely a good move for in-store payments (where they have an existing presence) but building eCommerce merchant relationships seems challenging. There has been pushback re: merchant integration, but the acquirers would likely jump at the opportunity to work with AAPL / GS.

Other Payment Companies

• PYPL- On 2Q21 earnings they said, “Our Buy Now, Pay Later product continues its strong growth and is proving to be extremely popular for consumers and merchants alike. Since launch, we have processed over $3.5 billion in TPV with more than $1.5 billion of that TPV in Q2 alone. Approximately 650,000 merchants have customers who use our Buy Now, Pay Later capabilities, and 40,000 have positioned Buy Now, Pay Later upstream on their product pages. Over 7 million consumers have transacted more than 20 million times with our Buy Now, Pay Later product. Australia is now fully deployed and off to a strong start with additional countries in Europe slated to roll out later this year.” PayPal’s take rate is ~3.45% vs. competitors closer to ~6.0% and they will likely look to highlight this more aggressively to merchants, coupled with more concerted efforts on integrating Venmo into the checkout process.
• V- On the 2Q21 earnings call V said, “Installments. In addition to investing in and partnering with numerous installment providers globally, we’ve also developed our own solution, which had some notable progress in the quarter. In Canada, Scotiabank is extending their post-purchase installments offering to — they’re offering to eligible Visa retail credit clients. CIBC is launching installments during purchase and Desjardin, North America’s largest financial cooperative, will be offering during purchase installments for their eligible Visa customers. In addition, Global Payments is enabling our installment solution for their merchant customers.”
• Shopify (powered by Affirm)- On the 2Q21 earnings call “In June, we made our buy now, pay later product, Shop Pay Installments, available to all eligible merchants in the U.S., with the product automatically enabled for new merchants signing up for Shopify Payments and simple self-serve onboarding available to existing merchants. While early, GMV transacting through Shop Pay Installments more than tripled in Q2 over the prior quarter as more buyers are using our product to check out. We are pretty excited about the potential here over the long term.” AFRM disclosed that ~25% of merchants who used Shop Pay Installments saw 50% higher AOV vs. other payment methods.
• GPN- On the 2Q21 earnings call “While buy now, pay later solutions may seem novel to some, we have, in fact, been providing leading technologies to that segment of the market for decades in both our issuer and merchant segments, and we continue to deliver innovative installment payments products for customers. We are currently enabling our merchant customers in Canada in partnership with Desjardins with a Visa installment solution. CIBC will also launch a combined TSYS, Visa installment solution in early 2022, and we signed a global referral agreement with Mastercard supporting installment payments in June.
• FIS- On the 2Q21 earnings call “When we think of buy now, pay later, it’s just another payment type for us. It’s another unsecured lending mechanism. Obviously, we’re enabling buy now, pay later in our largest merchants. We’re doing it through partnerships because we don’t want to take the credit exposure risk that comes with that. But frankly, we feel very comfortable not only competing in the national markets, but as we push down market into the SMB verticals, you’re starting to see we’re coming off record growth over the last 2 quarters in our merchant sales as we’ve now retooled our sales force and increased that and started pushing down market.But clearly, we’ve got the most extensive capabilities in the merchant acquiring space today, and you’re seeing that growth across our large enterprise, our large nationals, our multinationals, and that’s playing to our strength in our sales results. But at this point in time, our view on buy now, pay later is just that, another payment type that we’re going to accept. We’ll make sure that we have that available to our customers if they want to offer that, but we’re going to minimize taking the credit exposure.”
• Stripe / Adyen- Both of them can enable installments through a third-party like Klarna already (and might roll out their own solutions) but they could look to be acquisitive as a way to increase either consumer or merchant reach (we’ve written about Stripe vs. SQ’s converging roadmaps). Adyen with a public currency, has the ability to do larger M&A today, although all indications suggest Stripe should be public within 12 months.
• White Label / BNPL- While we’ve seen a handful of smaller companies look to offer white label BNPL solutions, we haven’t seen material scale without a consumer app (helping merchant discovery / close the data loop).

Conclusion

SQ’s acquisition of APT AU, PYPL’s early success, and efforts by the card networks / acquirers / issuers all suggest BNPL is here to stay. When AAPL announced the Apple Pay Later solution we said BNPL was a feature & not a standalone company (which got a lot of pushback).

Think this continues to be more true today post SQ’s announcement, and the Afterpay team, which were early pioneers, realized the benefits of being part of a larger ecosystem, while $29B probably didn’t hurt.

While the acquisition of merchants is impressive, it pales in comparison to the distribution reach that legacy acquirers (FIS, FISV, GPN), modern acquirers / aggregators (e.g., Stripe / Adyen), or digital wallets (e.g., PYPL / SQ) have in place. We’ll likely see continued consolidation & specialization as the industry evolves over the coming years.

Despite the competitive landscape there are still plenty of opportunities in & around BNPL including:

• Vertical Software + BNPL- The combination of vertical SaaS + BNPL for high AOV purchases where underwriting / merchant acquisition is more challenging.
• Automated Marketing / Personalized Offers- leverage real time transaction data to design marketing campaigns encouraging use of BNPL solutions; personalized offers based on historical transaction data. The one pushback in US penetration is the consumer addiction to credit card reward points. Is there a way to get something equivalent here in direct discounts.
• “Stripe for Debt”- Underwriting capabilities (capital / capabilities) to allow existing vertical software + non-financial service companies involved in client workflows to offer BNPL.

If you’re building in the space, would love to connect.