Klarna, Europe’s largest Buy Now Pay Later (BNPL) player, the latest golden child of Sweden’s tech industry, is now reportedly raising funds at a valuation of USD 6.5 billion, down from a lofty USD 45 billion valuation just a year ago. Other BNPL casualties include:
Globally, BNPL stocks are down anywhere between 70% to 98%. It is a complete collapse in an industry that just months before, was hailed by many as a revolutionary way to expand access to a non-credit card population, to increase ticket sizes for merchants, and usher a new era of growth for fintech.
As interest rates rise, masks come off. As investors become more conservative in this macroeconomic environment, many companies with frothy valuations are going to face intense scrutiny. We’ve already seen a collapse in SPAC values—most notably, Enjoy Technology which went public just a few months ago at USD 1.1 billion with former Apple exec Ron Johnson at the helm, backed by luminary firms such as Andreessen Horowitz filed for bankruptcy last week). Now, BNPL is facing its own reckoning.
What you will notice is that the kind of consumer BNPL attracts are those who are already stretched for cash. Consider the following survey results:
This is a business model whose viability is dependent on late fees and interest. In 2021, Afterpay (since acquired by Square) reported that 20% of revenue came from late fees, while Laybuy revealed that from April to September 2021, nearly half of its revenue came from such penalties.
Furthermore, many BNPL players are incredibly dependent on a few large retailers. For example, Affirm, which along with Klarna and Afterpay are the world’s largest BNPL providers, disclosed in its 2021 annual report that Peloton, the smart exercise bike company, accounted for nearly a third of its business.
BNPL’s pitch to merchants, of increasing sales, is not new. In-store, branded credit cards have been around for a long time. Since 2008, many stores have become reliant on profits from store cards, such as Macy’s where money from branded credit cards accounted for 39% of total profit in 2013, Kohl’s at 35%, and Target at 13%. This model too is dependent on late fees and interest. The key difference however, is that store cards can push customers to increase sales for the overall business, while BNPL providers don’t have that end market for their customers. They take a transaction fee comparable to credit card providers but take on significant unsecured credit risk.
If a recession hits hard, many of BNPL’s core clientele will likely stop purchases or altogether default. Already, this year Afterpay’s losses widened by 700% to AUD 156.3 million while Zip’s losses skyrocketed by 3,159% to AUD 652 million.
In Australia and many other jurisdictions, BNPL operators are currently exempt from laws designed to protect borrowers who use products such as credit cards or payday loans, because the product they offer is technically not credit. Anyone can tell you this is utter nonsense.
Herein lies an often missed part of how we value technology companies— regulatory time lags, especially when it means declining asset values. For industries such as marijuana or electric vehicle charging, analysts are always keen to spot regulatory changes that will legalize or otherwise serve as catalysts for the industry to grow. We saw this very keenly once a Biden presidency was secured in 2020, where companies like GWPH (a marijuana pharmaceutical company) or Charge Enterprises (an EV charging infrastructure provider) saw a jump in their share prices. Yet, few saw the tech crackdown in China coming, despite the increasingly strident position regulators took there.
Many of these technology “disrupters” are able to offer “new” models because they purposefully skirt regulation. Ridehailing, with its legion of workers, is able to operate with much higher margins than traditional taxi companies, not just because of its use of technology. Let’s not mince words: the lack of employee benefits such as retirement schemes, health insurance, and safety compliance is baked into the very business model of these companies.
What happens when regulators come into the picture? Payday loans saw similarly buoyant valuations and breakneck growth until regulators began instituting checks-and-balances. BNPL was a beneficiary of the clamping down of the payday loan sector. Soon, it too will have to face the music.
One particular paragraph in Affirm’s 2021 annual report stood out to us:
Our agreement with one of our originating bank partners, Cross River Bank, which has originated the substantial majority of loans facilitated through our platform to date, is non-exclusive, short-term in duration and subject to termination by Cross River Bank upon the occurrence of certain events, including our failure to comply with applicable regulatory requirements. If that agreement is terminated, and we are unable to replace the commitments of Cross River Bank, our business, results of operations, financial condition, and future prospects would be materially and adversely affected.
Besides Affirm, Cross River also originates financing for Coinbase, Best Egg, Pay.com, Rocket Loans, Stripe among 80 other customers, the vast majority of them in fintech. As of this year, it has originated more than USD 24 billion for these firms. It is the fintech banking partner, despite being regarded as a “community bank” due to its small size of having less than USD 10 billion in total assets and only a single branch in New Jersey.
Cross River is also notable for being the largest participant in the US government’s Paycheck Protection Program, distributing loans to more than 106,000 businesses, placing it behind Bank of America, JPMorgan Chase and Wells Fargo. Cross River is often touted as the little bank that could: it has been profitable since 2010, and has a 3.02% return-on-assets, double that of comparable banks of its size.
It’s done so by hitching its bandwagon to the fintech horse, and oftentimes, recklessly. In 2018, US authorities fined it more than half a million USD for “violat(ing) federal law prohibiting unfair and deceptive practices” such as requiring borrowers to sign loan documents without knowing the essential terms and conditions of the loan and misrepresenting that the consumers' creditworthiness would improve by obtaining a C+ Loan. And while only disbursing 15% of total PPP loans, fintech companies handled 75% of approved loans that were later found to be fraud by the US Department of Justice. In other words, this pillar of financing for the fintech world may have significant exposure to a downturn.
For now, we do not see a viable investment opportunity in BNPL. The goal for financial inclusion is a worthy one, but the business model still has a long way to go.
Until next month,
Ong Kar Jin
CSO at nØught labs