Affirm Holdings' Moat: Why The World's Largest Retailers Want Affirm
Summary
- The story and thesis behind Affirm have drastically changed with the announcement of two new deals with the world's largest companies.
- Amazon and Apple could easily have built an in-house BNPL; instead, they chose to partner with Affirm.
- What is Affirm's Secret Sauce and Moat? This article will discuss their competitive advantage over Klarna and Afterpay.
- This article surmises to answer the question behind why these Mega-Tech companies want Affirm as well as the key risks to monitor.
- The math has completely changed for Affirm's future trajectory.
Investment Summary
Last week, Affirm (NASDAQ:AFRM) announced it was partnering with Amazon to Deliver Pay-Over-Time Option at Checkout for Amazon (AMZN) customers. According to the release on Affirm's website, "Select Amazon customers now have the option to split the total cost of purchases of $50 or more into simple monthly payments by using Affirm."
Earlier into August, News broke from Bloomberg that Apple Inc. and Affirm Holdings Inc.’s PayBright were planning to launch a “buy now, pay later” program for Apple (AAPL) device purchases in Canada, stepping up the iPhone maker’s ambitions to offer more financial services according to the release. We also know that Shopify (SHOP) expanded Affirm's BNPL solution amongst all their US Merchants.
Amazon is known for generally managing costs and they typically build solutions in-house. Why did they choose Affirm?
This article will discuss some of the hypotheses from existing information available to understand why Amazon chose to work with Affirm. The second aspect will discuss the competitive advantage that Affirm has within the BNPL space over its competitors. We’ll finalize by discussing the risks and catalysts for future growth.
[Source: Author Online Logo Search ]
Brief Introduction
The Buy-Now-Pay-Later (BNPL) was one of the major beneficiaries from Covid. The sudden interest amongst the leading Fintech players who want to enter into the BNPL space begets the question that there is external evidence pointing towards the rise of this BNPL industry. I wrote an article the weekend after Square (SQ) released its financial results and announced the acquisition of Afterpay.
It is important to begin with some context on BNPL. This context is important for understanding how the industry works and how a moat or competitive advantage emanates for a fintech player. I begin this article by discussing the 6 key performance indicators that determine success within the Buy Now Pay Later Industry, especially for the dominant players.
Key Determinants/KPIs:
1.) The ability of the provider to increase Average Order Value (AoV), Sales conversion, reduce cart abandon rate at checkout & increase Average Cart Order, Upsells, and increase repeat consumers for merchants. These are the prime metrics that every merchant looks for before selecting a BNPL Provider.
2.) Secondly is a frictionless POS payment solution and the checkout experience for the consumer.
3.) The existing merchant’s network and reach. The more merchants a BNPL provider reaches, the better the appeal to another merchant.
4.) The History, experience, and knowledge with Underwriting/Credit for consumers.
5.) The Brand and Trust element - do consumers know and trust the Brand, especially at the checkout.
6.) The access to capital and funding structure since it's a high-velocity business.
The more a BNPL provider is able to meet and achieve most of the metrics above, the higher the likelihood to achieve more customers and merchants. It’s a flywheel effect where more merchants allow for more customers which leads to higher transaction frequency for data, smaller merchants want to join, and more revenue and GMV for Affirm. It’s a flywheel with tremendous network effects as seen below.
[Source: Flywheel Effect - Affirm Investor Relations]
History of Amazon Pay and Fintech:
It is important to briefly discuss the history of Amazon Pay. This is one of many salient businesses run by Amazon.
Amazon Pay is their online payments processing service. It was started back in 2007, Amazon Pay focuses on Amazon’s consumer base allowing them to pay with their Amazon accounts on external merchant websites. They also support business-to-business lenders and support the 3rd party PSP. They have a consumer payments and money team that manages the financial aspect of Amazon's website, Alexa, Gift cards, and their core payment acceptance infrastructure.
Amazon also partnered with World Pay in 2019 to further extend its payments capabilities here. They also have Amazon Pay Express that helps merchants with selling their products on e-commerce websites. They work primarily with Chase — a leader in CNP payments acquiring (Chase also happens to be very active within Fintech). The reason I provide this explanation is that Amazon has a strong Fintech presence and team, but yet decided to partner with Affirm without utilizing all their resources to do it in-house. To learn more about Everything About What Amazon Is Doing In Financial Services, this is a great resource to read more: What Amazon is Doing in Financial Services as Well as Fintech | CB Insights Research.
Why now for Amazon to go into BNPL?
Amazon is known for prioritizing customer experience and driving more eCommerce sales. Amazon is constantly working to increase their eCommerce market share and driving the cart size.
One of the best ways to achieve this goal was to add an extra BNPL feature. With a BNPL solution, the goal is to improve the payment selection for customers, improve the customer experience, attract more customers, and increase cart sizes for consumers which ultimately will drive sales.
For context, Amazon has been offering a form of BNPL for years. They have native “pay in 5” offered by Amazon for certain expensive goods like their branded-label products on their merchant goods. Below is an example, which I give Credit to Bluetooth doc for finding this item on Amazon's website.
[Source: Amazon Website]
The key here is that Amazon only offers it to the best members. Customers with good credit and standards such as Amazon Prime members with good credit standing.
The main goal that Amazon is striving towards is looking to offer this solution at a larger scale for millions of consumers (Perhaps Prime and Non-Prime members). For Amazon to scale this solution exponentially and drive incremental purchases amongst large set of consumers, they need data. They need to have a BNPL fintech provider with underwriting history to assist them and this is where Affirm plays a key role.
Data, Underwriting, and Credit Decisioning is Affirm's moat:
As one of the first movers into the BNPL market within North America, Affirm has underwritten many consumers. As a result, they have many years of experience underwriting millions of consumers both during economic slowdowns and economic booms. They have built a core competency as to understanding consumer credit and customer purchase patterns. As a result of their data advantage since they were one of the first movers, their underwriting and risk models are one of the best. They have underwritten and managed the under-banked consumers including those without credit bureau records or those without a full credit history, consumers using non-traditional or FICO metrics, etc.
Time-value: Amazon could easily have built a strong financial team within Amazon Pay to build this solution, but the challenge they would have had is having to underwrite consumers from scratch. It would take time before they have risk models that are good enough to perform such large-scale underwriting (even though they have a vast number of consumers or use Chase bank to assist them).
Although all their information is not disclosed due to competitors, but they have proven to have better default rates than competitors. As at early 2021, Affirm’s provision for loan losses dropped by more than 40%. Also, notice the decline in credit defaults and charge-offs as a result of their algorithms (including during the Covid shock). Affirm’s algorithms utilize over 1 billion unique data points and 200+ consumer data points based and include inputs for fraud detection based on over 7 million total loans. All of this spans over a 10-year period since they moved into this industry early.
[Source: Affirm Investor Relations]
Affirm’s models have proven to have lower loss ratios while allowing higher rates of credit acceptance than many other lenders. Affirm also has customer clients that are of higher quality with better repayment capability because generally, most of Affirm’s clients have higher Average Order Volumes consumers.
Apple Canada and Affirm: The logic behind Affirm’s underwriting model is a similar reason why Apple chose to partner with Affirm to access the Canadian market. Apple could have built their solution together Goldman Sachs - especially since Goldman Sachs has access to vast amount of capital. However, when Affirm acquired PayBright, Affirm got huge access to over 5000+ merchants in Canada and lots of new data, hence it was easier for Apple to do a partnership.
For Amazon, the benefit here is that they can reduce the cost of having to build an in-house solution and they would have some bargaining power over Affirm through a partnership. Amazon must have done their analysis and decided the easiest way to tap into that vast underwriting consumer data was to partner with Affirm. All in all, Investors need to understand that the underlying moat that Affirm holds is their underwriting data history with consumers.
The Bull Case: Affirm’s Competitive Advantage:
1. Depth of understanding the Consumer
Affirm has a good understanding of the consumer's behavior at cart check-out. This is important because one of the benefits of BNPL is the ability to increase sales for merchants which requires a good knowledge of the consumer.
Below are some of the ways, they use their understanding of the customer to drive value.
[Source: Consumer Insights – Affirm Investor Relations]
Building on the earlier point, due to their data and underwriting experience, they understand the consumer and their transactions. From their 10-K Investor reports, they claim to have lots of consumer insights as well as key information around product types for consumers. They have built the data, analytics, and information around knowing how consumers react or might manage certain products.
Convenience and Flexibility are key: Most consumers would prefer to have only 1 or perhaps 2 max for their BNPL provider when they go shopping. Nobody wants multiple BNPL solutions at checkout, so this could have been one of the reasons why Amazon chose to do a partnership since Affirm already has a large number of consumer and merchant reach.
2. The efficiency of Affirm’s Cart Checkout and Conversions
One of Affirm’s competitive advantages has been their ability to increase AoVs and drive improved sales conversion for merchant businesses. Affirm has a lot of data and analytics on the consumers and their purchase patterns especially at checkout. Below are some of the key features that have been released in recent years to further improve checkout as well improve their breadth for merchants and consumers when they reach that cart checkout point:
[Source: Products – Investor Relations]
An example of their efficiency is the result of Affirm powering Shopify’s Shop Pay. The observation from Shopify (SHOP) was that Affirm had the highest-converting checkout amongst major BNPL Fintech. 1 in 4 merchants using Shop Pay during its early access saw 50% higher average order volume compared to other providers. Merchants saw 28% fewer abandoned carts through Shop Pay Installments after switching from a third-party buy now, pay later solution to Affirm. Lastly, Merchants had 85% higher merchant AoVs compared to other payment methods when analyzing BNPL Solution according to Affirm’s Investor Relation. Industry experts have confirmed Affirm's checkout success rates.
For Amazon, Affirm’s feature and payments tech is an added feature that will help them improve their sales. Some metrics shown below:
[Source: Product Discovery – Investor Relations]
Hence, one of the key competitive advantages of Affirm is the design and vast data of the checkout experience, managing customer problems during or post-purchase especially with their acquisition of Returnly, and the ease of convenience which helps to drive sales for consumers.
3. The Brand and Consumer Cognitive Referent of Affirm:
The cognitive referent can be referred to as a brand power that a company has over its consumers or within its industry. This is what Airbnb owns in travel, UBER in transportation, DocuSign owns in eSignature, etc.
Within the BNPL Space within North America, Affirm is currently the leading first cognitive referent that emerges for consumers when you mention BNPL. This is a brand that is popular amongst millennials and Gen-Z.
This is an underrated moat and a bargaining power for Affirm when it creates deals and contracts with Merchants or companies like Amazon or Apple. Brand power and trust is a huge aspect of the BNPL sector because when consumers arrive at the checkout, it is important that they trust a company with their credit information as well as trust that the company will not charge hidden fees on their payments.
The millennial connection: Affirm has a strong audience primarily amongst millennials. Affirm charges almost 0% on almost all their products, not everything, but they are one of the most cost-effective BNPL products for consumers than their Klarna and Afterpay competitors. They have a massive opportunity within this audience. This is an area that Amazon lacks any strong connection.
[Source: Affirm Investor Relations]
Affirm's brand is further solidified by an NPS of over 78. Amazon still does not have the appeal to millennials and Gen-Z consumers as they would want, a deal with Affirm allows Amazon to better tap into this new customer group.
[Source: NPS – Affirm Investor Relations]
4. Existing Merchant Networks and Partnerships with Walmart and Shopify
Affirm has a vast number of merchant partnerships on their network especially in North America. Although, Afterpay has made some significant strides in taking market share in recent years in the US. Affirm still owns some of the high-end and most expensive brands in North America.
[Source: Affirm Investor Relations]
Affirm is also the key BNPL partner for Walmart (WMT), Shopify and Peloton (PTON). Walmart is one of the largest grocers and retailers in the world.
Shopify: If we look closely at the Shopify partnership, Shop Pay was installed for almost all Shopify merchants earlier this year. Obviously, as everyone knows, Shopify has been growing massively in recent quarters. As of mid-July, Shop Pay was installed for over 1 million merchants, and based on Shopify's past earnings call, over time Shop Pay will be rolled out to reach over 118M consumers.
[Source: Shopify Merchant Website BNPL]
There is also the future of the Apple Canada partnership that could grow with the iPhone. I believe that if Affirm’s system pays off rewards for Apple within the Canadian market, they could easily extend those services to other parts of the North American market to power more BNPL solutions. PayBright, the leading BNPL for Canada (Owned by Affirm) has 5,000+ merchants in the Canadian space. Their product offerings span both small purchases, which can go as low as $35 depending on the merchant, and then it can go upwards to thousands of dollars. Canada could be the beginning of what could emerge from this Apple partnership.
Amongst merchants, Affirm's product has been shown to be sticky. They have maintained a consistent dollar retention rate of over 100% over the past 3 years. All the merchant cohorts continue to stay and grow on the platform.
[Source: Cohort – Investor Day Affirm Investor Relations]
Over time, as the adoption of BNPL gains traction and validation, it is quite possible that Affirm will see its GMV grow bigger with the world's leading major partners. The quality of large-scale partnerships that Affirm has established is a major source of competitive advantage for them.
5. Credibility and Quality of the Management Team
Affirm has been in the business of BNPL for over a decade. It is easy to forget that Max Levchin was the original co-founder and CTO of PayPal (PYPL). He was the key technology architect for PayPal at around Age 23 amongst a powerful group of the PayPal Mafia. As a result of that experience of building one of the most dominant businesses in American History, Max and his team got to understand the Fintech, payments, and eCommerce sector.
He is often described as remarkably intelligent and a serial entrepreneur that knows how to build companies. The full management team and board image is below. There is a deep Fintech and lending experience across the board. Diagram crafted by the Generalist.
[Source: Investor Relations - Generalist Diagram]
Max has also proven to be a highly effective leader with an extremely high Glassdoor rating proving that the organization has a great culture. It is remarkably rare to find a leader with high approvals and deep technical expertise. All of these are further validations.
[Source: Glassdoor Ratings Link]
Valuation & Financials
Revenue Growth: Below are the most recent financial results from Q1 to Q4 2021. Affirm’s revenue growth has slowed down recently especially coming out of Covid. But this deal could drastically change things for the company.
[Source: Author's Analysis]
Before the recent price move, Affirm was trading at an EV/S of 35x.
In the meantime, these are the future Revenue estimates below before the announcement:
[Source: Seeking Alpha Earnings & Revenue Estimates]
If Affirm could capture like 3% of the 2020 GMV for Amazon and eventually 1% of Shopify's merchants as the solution fully rolls out, we could see an additional GMV of over $9-$10B added to Affirm’s current $8.0B in 2021 GMV. This could imply quite possibly a growth of over 100%, which would mean over $2.5B in growth for FY 2023 revenues. Also, if we even imply a 1% penetration for Affirm would mean a +47% upward revision in 2022 revenues, approaching almost $1.9 bn. More details on the deal will be required to flush out the metrics, but this deal changes the math for Affirm.
Next earnings and Guidance
In the meantime, there are two other catalysts below that should drive the next earnings and revenue for Affirm.
First, the re-opening of the economy and back to school is bullish for the stock. As a survey conducted by Affirm showed, “over 50% of parents are interested in using a pay-over-time solution for their back-to-school shopping this year. 39% of those interested in using a pay-over-time solution say the biggest reason is that it helps them stay within budget.”
Secondly, Affirm announced in June that they had expanded their Shop Pay Installments across the US for Shopify - could the impacts begin showing gradually now or next quarter? Lastly, the impact of new merchants and how Amazon and Apple Canada will drive future growth for the company will be interesting within the revenue guidance for the next fiscal year.
Risk Factors To Monitor
There are still some significant risks at play with Affirm.
Competition and Market share in North America.
First, Affirm was losing market share by 2019 when Afterpay entered the US Market and competition has caught up. Klarna and Afterpay entered the US Market and have taken share from 80% in 2018 to 16% in early 2021. As a result, growth has slowed dramatically especially showing from their recent results from 100% to 65%. This deal could help manage the dent by 2022 or 2023, but Klarna and Afterpay are very strong in the US.
[Source: Apps Insights from Insider Intelligence]
Also, Square's and After-pay have built an alliance. Klarna is also a European leader in BNPL. Large banks such as Citi and Chase are gradually interested in the Fintech Space and are becoming much more active in the space.
Negative Operating Leverage
Affirm's profitability and margins are still very negative. They have had to spend significantly to attract new customers on-board and to reinvest into the business due to the intense competition. Although with the announcement of this new deal, there is a chance that Affirm can improve its margins and bring profitability closer.
Other External Industry Factors
There is still always going to be competition at play with Credit Cards and even the Big Banks. It will be interesting to see if consumers switch back to Credit Card once they feel comfortable with their finances. There are increasingly calls for regulation within this industry as it has been observed within the European market. There is always competition that the banks could always come in and take market share away from the emerging BNPL Fintech companies.
To summarize the risk thesis, Investors will need to continue monitoring competition amongst other emerging BNPL Fintech players like Square x Afterpay, Klarna, banks, credit cards market share and the improvement in margins/operating profits for Affirm to ensure the thesis is intact.
Future BNPL Growth Opportunities
Together with a large Total Addressable market that is over a trillion-dollar that comes from displacing market share from credit cards, there are massive future growth opportunities and optionality possible within the BNPL Space.
The North American BNPL market adoption is still low, especially when compared to the adoption rates in Europe and Australia.
Mobile payments and the in-store retail experience have more BNPL opportunities, the travel and ticketing industry have opportunities to continue adopting BNPL to manage big travel & vacation expenses, other industries include Hospitality, Athletics, renovation and construction projects, B2B Payments, Introduction of points/ rewards could further drive growth and many more have the future opportunity to adopt BNPL. Furthermore, there is the potential adoption of cryptocurrencies into this sector which could present exponential opportunities.
Conclusion
Here is the summary of Affirm’s Competitive Moat:
First, as one of the first movers within this space, their data around underwriting and managing risks for many consumers within the BNPL Model. This is not easily replicable for any non-financial business.
Second, Affirm’s data and analytics understanding of the consumer's pattern is key. Convenience is key since most customers have accounts with Affirm or have been underwritten by them, it is much easier for a consumer to use Affirm's BNPL rather than have to start an account with a new company.
Third, Affirm’s BNPL Technology has been proven to significantly drive merchants' cart checkouts and conversions. Almost as high as 50% as indicated by Shopify.
Fourth, Branding and trust are so essential within BNPL, especially among millennial consumers. Affirm has proven to be a go-to brand or the cognitive inherent brand when consumers think about BNPL within North America.
Fifth, Affirm has a wide merchant network especially with the leading players within the space. They already had the biggest clients like Walmart, Shopify, Expedia (EXPE), Peloton, etc., and now Amazon. Something unique that Affirm has that I didn't expand upon is their unique funding mix and partners for managing loans.
Amazon and Apple Canada are some of the world's largest companies with remarkable access to capital, talent, and resources. For them to pick Affirm shows that Affirm has something unique. I like to believe that it is primarily because of the competitive moats discussed above. Amazon must have done their due diligence before choosing Affirm and they must have realized it would increase their time-to-market.
Personally, I was fortunate to have been buying shares. I have been long Affirm shares since IPO and added throughout the dips before this price move. I had a previous Twitter thread on them. However, this deal completely changes the story of Affirm's future trajectory.
In general, it is clear that Affirm could quite possibly be the leading provider of BNPL for the world’s largest retail eCommerce companies. This could exponentially enable Affirm to be the unmatched leader within their industry in North America. The story has completely changed for Affirm if most of these thesis playouts. It will be interesting to get more details at their next earnings call.
This article was written by
Disclosure: I/we have a beneficial long position in the shares of AFRM either through stock ownership, options, or other derivatives. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.