Buy Now, Pay Later TAM Misunderstood, Not Replacing Credit Cards

Dec. 14, 2021 7:04 AM ETAFRM, AFTPF, AFTPY, AXP, DFS, JPM, KLAR, MA, PYPL, SQ, V, COF, GPN43 Comments29 Likes
Michael Dolen profile picture
Michael Dolen


  • Investor sentiment for buy now, pay later is in, while credit cards are out.
  • Contrary to what some suggest, you should have zero concerns about Affirm, Klarna, or Afterpay disrupting major payment networks (Visa, Mastercard, American Express, and Discover).
  • As a retired credit card insider, I'll explain what the pundits have done wrong, and which payment stocks I've bought on this dip.

Klarna is an emerging buy now pay later service provider.

Ross Tomei/iStock Unreleased via Getty Images

Contrary to what Klarna's (KLAR) CEO recently said, buy now pay later (BNPL for short) is not “more healthy for consumers than credit cards.” Nor for investors. The greatly misunderstood TAM of BNPL has created better buying opportunities in the traditional payments space.

Although now retired, this is the fifth time I have seen such fear mongering about credit cards going the way of the dodo bird. This time is no different than the others – it’s noise and a buying opportunity for credit card related stocks, such as Visa (V) and Global Payments (GPN).

My background

If there’s one thing I’m qualified to opine on, it’s this topic. Having sold my credit card business some years ago, I won’t go into great detail on it given that it was to a public company. I’ll just give a high-level overview so you can understand my experience.

With less than $2k, I founded CreditCardForum at what may appear to be the absolute worst timing ever. It was the same month Bear Stearns collapsed, in March of 2008. Despite what followed in the economy, I maintained profitability every quarter. Within 36 months of launch, EBITDA run rate was in the 7-figures and eventually, 8-figures. It grew to become one of the nation's largest online advertisers of credit cards, working closely with all major banks. This was done with zero loans, zero investors, and zero ads. 100% of the traffic was organic. Between that and the fact that there was only one employee (me) the margins were insane. I have yet to encounter a private or public business that had margins anywhere near mine.

About that organic traffic, let me give you an example so you understand the large data sets (and related conversations) I had access to.

Back then, if you Googled “chase freedom” or “american express platinum,” the organic results would be my site first, before the official pages on Chase or AmEx’s websites. It was like this for dozens of popular credit cards. When I wasn’t number one, I was often 2nd or 3rd.

As a side note, for any SEOers out there wondering, this was accomplished using only white hat (approved) methods. I would dissect Google’s algorithms and study their patents ad nauseam, then create perfectly optimized content and link building.

Anyway, with that type of traffic from Google, you can imagine how many new US card applicants were coming through CreditCardForum.

For example I remember Citibank – who I hardly even advertised because both their cardholder benefits and commissions were subpar – gave me a NCAA Final Four VIP trip worth nearly $30k – because more approved card applicants came through CreditCardForum than anywhere else the prior month. I didn’t have time for so much as a weekend trip for over 6 years, so I gave it away. The point of the story is that even for my least targeted banking partners, I was handling a massive share of US applicants. My largest advertisers were Chase (JPM), American Express (AXP), Discover (DFS), Capital One (COF), and Bank of America (BAC).

Now that you have a taste of my background in this space, let me briefly walk you through the 5 times I’ve heard that credit cards are going bye-bye. I’ll then conclude with why the Buy Now, Pay Later model is so greatly misunderstood by investors and does not pose a major threat to the traditional payment incumbents.

1. The Great Recession

The days of credit are over, or so that was what everyone seemed to be saying in 2008 and 2009.

It is true that virtually every major bank ceased the advertising of credit cards back then, with the exception of Discover. Oh but Discover wasn't being reckless, far from it in fact.

Despite their last place in market share, which garners snubs and SNL skits, they have historically – across their entire card portfolio – usually had more stringent underwriting than the esteemed Chase and AmEx. From my side, it appeared to always be easier to get approved for an AmEx Delta SkyMiles Gold or Blue Cash than a Discover It card (at times my website ranked #1 for all those). I bring this up to emphasize that perception sometimes differs from reality in the world of credit. Both with the public and investors.

After the Great Recession, not only did credit cards not go away after, they came back stronger than ever.

2. Apple Pay

Apple Pay

Image credit: Apple iPhone User Guide

Who needs credit cards when you can pay with your phone? That was the fear when Apple Pay (AAPL) launched. Rather than use, say a Visa or AmEx, the worry was that Apple was essentially creating a 5th major payment network.

Not that it can’t happen eventually but here we are 7 years later and guess what? Only 6% of iPhone users in the US even use Apple pay at stores!

They’re not using it as a 5th payment network, either. Rather, they’re primarily using it as a mobile wallet – an intermediary – to pay using their old school Visa, Mastercard (MA), AmEx, and Discover. The difference is that since the transaction goes through Apple, they don’t need to have the physical card present.

3. Venmo, Cash App, etc.

Cash App

Image credit: Cash App

Square’s (SQ) most notable bull, Cathie Wood, loves to tout that mobile wallets will replace traditional banking. This tweet from last year sums up her 2 cents:

“To acquire a new customer, $SQ Cash App and $PYPL Venmo pay a fraction - as low as 1% - of bank costs. Banks do not have the right DNA to compete against digital wallets.”

I do agree with mobile replacing the vast majority of brick and mortar banking. I think everyone does. However, Cathie is wrong in that Venmo and Cash App, even with their low transaction costs, can seriously compete against bank issued credit cards.

Why? Bribes.

The savvy consumer is incentivized to pay with a credit card, thanks to rewards worth 1-2%. Contrary to popular belief, that kickback has little to do with the interest paid by indebted cardholders. Rather, it’s the interchange fees paid by the merchant which largely pay for your cash back and miles.

Interchange fees average about 1.8% for credit cards. They can go a bit lower and a lot higher depending on the exact card and circumstances. For example, a Visa Signature or Mastercard World Elite will cost more to process than Traditional/Standard. Swiped (card present) is cheaper than keyed (card not present). There's also a flat fee per transaction, typically 10 to 22 cents. This makes small transactions quite lucrative, in terms of fees as a percentage of purchase.

While these fees are collected by the payment networks (Visa, MasterCard, AmEx, Discover), they pass along the vast majority of that revenue back to the issuing bank of the card. In the case of AmEx and Discover, they are both the payment network and the issuing bank, usually. Visa and Mastercard are only networks, never banks.

So yes, it is theoretically possible that in the not too distant future, we will see Venmo and Cash App be accepted payment methods at everyday stores and merchants. The store is incentivized to do that. The consumer not so much.

To incentivize consumers, they would need to start charging fees comparable to the payment networks, in order to offer rewards. If/when they do that, the store then has little incentive to offer or prefer Venmo/Cash App over say, a Mastercard. It's a catch-22.

4. Regulatory crackdowns on credit cards

This is the only uh-oh moment that I was actually afraid of.

In 2005, there was a class-action anti-trust lawsuit brought by merchants against Visa, Mastercard, and most of their issuing banks in the US. Merchants wanted substantially lower interchange fees which were more on par with debit cards. Why that scared me was because if it happened, it would mean a slashing of rewards. Then, other modes of payments could become competitive.

I can tell you there was a lot of talk behind the scenes of a potentially devastating outcome. What came to fruition was less than a slap on the wrist; a $7.25 billion settlement at the end of 2013. That settlement consisted of a 0.1% reduction in swipe fees, but only for 8 months! Merchants would now be allowed to charge different prices for card vs. cash payments. Previously they couldn’t.

For merchants who opted-out, there is still a lingering $6.24 billion anti-trust class action but that amount too is a drop in the bucket.

5. Buy now, pay later

Last on the list is this current perceived threat. Mainstream financial media seems to be perpetuating this narrative but when I hear their commentary, rarely does it make sense to me.

Josh BrownImage credit: CNBC

For example, take Josh Brown on CNBC. I can’t count the number of times I’ve seen him on there talking about the days of credit cards being numbered, because the days of 20% interest are over thanks to BNPL.

If he only knew what I knew… that card issuers actually love customers who never carry a balance. Seriously.

Contrary to public perception, banks make lots of money whether you pay your bill in full or not. It’s all about those interchange fees, paid by the merchants. This is why, in fact, some of the most lucratively profitable cards don’t even allow a balance to be carried.

The most coveted cardholders are those who spend a lot, but pay off their balance in full each month.

The American Express Platinum is a true charge card, which means you must pay your balance in full each month. The Chase Sapphire does allow for a balance but its users do not typically use it for that. Having ranked #1 on Google for those two cards and similar, I can tell you from my conversations with these advertisers, I understood the profiles of these cardholders. The same can be said about a plethora of popular reward cards, which is what my website specialized in.

Balance transfer and 0% offers were by far my least advertised categories. Primarily, it was Capital One and Citi (C) who seemed to want the balance carriers. The others were primarily marketing towards prime and super prime consumers who never or seldom carry balances.

If this still doesn't make sense to you, consider this example:

  • Customer A - Carries $10,000 balance on a card. Pays 16% APR. Pays minimum or close to minimum each month.
  • Customer B - Carries $0 balance, but spends $5,000 per month on card.

How much fee revenue after 1 year?

To keep this simple, I'm not factoring in minimum payments or addressing compounding frequency, which is daily.

  • Customer A maintains an average daily balance of $10,000. After one year, the interest paid will have been $1,600. If these were all new purchases made on day one, there also would be an additional $180 of interchange fees.
  • Customer B after one year will have paid $0 interest. However, the $5,000 per month in spending generated at least $1,080 of interchange fees.

Is customer A more desirable than customer B? Not necessarily.

Customer B still generates roughly two-thirds the fee income of customer A. Unlike customer A, customer B poses a minimal credit risk if the economy takes a downturn. Most likely, the bank will need higher capital reserves for customer A.

In short, balance carriers are great during boom times and terrible during busts. This is why the more conservative banks prefer customers who are large spenders, yet carry no balance or minimal balances.

What about factoring in the rewards expense?

Above I said rewards are worth 1-2%. Meaning, they are worth that to the cardholder. They may not be worth that much to the bank. They're getting airline miles, hotel points, and other perks for a small fraction of the value that consumers deem them to have.

As far as straight up 2% cash back? Well, you won't be finding that on a Traditional Visa or Standard Mastercard. Such generosity is only on the highest tiers of cards, which also have the highest fees.

BNPL vs. credit cards

Yes, there is definitely a place for BNPL and I’m not just talking for Pelotons and big ticket items. You’re seeing a lot of adaption on <$100 transactions.

The thing you may not understand though is that the merchant is also giving a kickback to Affirm (AFRM) or similar and it’s a lot more costly than processing a credit card.

Affirm typically charges the merchant 5.99% + $0.30 per transaction. The merchant can choose to offer 4 interest-free payments every 2 weeks (so an 8 week grace period), or installments up to 36 months. When going the installment route, if the merchant wants the customer to pay 0% for 12 to 43 months (like Peloton offers) then guess what Affirm is charging Peloton? Well, that’s not public data but I can guarantee you it’s way more than 6%.

Who pays for that? As always, the customer. Now it’s just baked into inflated prices. No wonder that bike with a tablet stuck on it costs so much. There’s no free lunch.

Aside from simplicity (e.g. no late fees, no variable APRs) the BNPL model is no better or cheaper for consumers than a credit card. In fact I would argue the credit card is much cheaper for financing, as anyone with half a brain and decent credit could shuffle their balance using 0% transfers.

Will BNPL become major payment networks?

It’s possible, but they will be a niche.

Let’s say in the future, you can check out at Home Depot (HD) and even Starbucks (SBUX) with your Affirm app or similar. That’s for those who are spending on debt. Why would anyone else want to pay with Affirm and forfeit their points or cash back? They wouldn’t.

Also, unless the BNPL provider offers a significantly lower interest rate than a credit card, I don’t see why consumers would want to funnel all of their borrowing through a BNPL provider.

Lastly, there’s status. Or if you don’t like that word, perception.

What would you think of me if we had lunch together and you saw me pay the tab with the Affirm app? Would you think of me as financially savvy or dumb and broke? To be clear, I’m not saying people who use Affirm are dumb. Rather, I’m saying it would carry a stigma if used for trivial and completely discretionary purchases like that.

Aside from subprime issuers and those geared towards interest carriers (e.g. Chase Slate, Citi Simplicity), with credit cards you just don’t know if that person carries a balance or not. There’s no stigma attached. With BNPL, there will be a stigma. Not that it can’t change, just like it did with credit cards, but that took decades to accomplish.

My favorite payment players on sale

Visa, PayPal (PYPL), and Global Payments. In that order. Unfortunately when I started writing this article, Visa was down at $190 and it has since moved up, along with these other two, but they still remain historically cheap.

Visa – At 28-29x forward earnings, this wouldn’t be considered cheap for most companies, but this is not a normal company. With 65% operating margins and a net margin above 50%, they are one of the most profitable public companies. Remember it’s the banks – not the payment networks like Visa – which are exposed to credit risk. Visa just takes a cut. By my calculations, Visa is trading at the lowest premium to the S&P 500 in 5 years.

PayPal – PayPal offers you a good mix of old and new payment tech. A leader in ecommerce payments, along with multiple irons in the fire such as Venmo and yes, even BNPL. This past summer it was trading at nearly 15x sales (I sold at $302) and now it's at 9x. This still remains elevated above its pre-covid range of around 6.5 to 8.5x, as seen in the 2 years leading up to 2020 (even lower before that). But take a look at Venmo now vs. then and keep in mind, they haven’t really monetized it yet.

Venmo user growth chartImage credit: Statista

Global Payments – Perceived to be an old school payment processor. What many people don't realize is that BNPL is not new, it's been around decades, and they do it too. It's just not hyped. Some fintech actually uses Global Payments.

All three of these are excellent inflation hedges. As prices go up, so does transactions size and therefore, fee income.

Lastly, for those who are bulls on the BNPL players, I'm not saying those businesses are bad. I have a lot of respect for Max Levchin, the CEO of Affirm. For me though, the valuations on these companies are just too rich on a risk-adjusted basis.

This article was written by

Michael Dolen profile picture
I prefer to buy long term winners when they have short term problems. You may call them falling knives, I call them being on sale. Most of what I buy is with the mindset of never selling, or at the very least, holding several years. With a long to very long term horizon, volatility doesn't bother me too much. I've been investing for over 20 years now, through 3 major bubbles (dot com, GFC, and the present). I saved up $500, the minimum deposit required to open an UTMA brokerage account, in middle school. I convinced my grandpa to co-sign the account, despite the fact that he nor anyone else in my family owned stocks or any other investments (aside from CDs). Investing has been my foremost interest for as long as I can remember. While classmates may be reading Harry Potter, I was into Security Analysis and the like. Although I grew up trying to emulate the Buffett style, I morphed into more of a Munger mindset. Today, probably Mohnish Pabrai would best reflect my philosophy of favoring undervalued, while not outright ignoring generational growth opportunities. I have been self-employed my entire life and for the last several years, have been investing full time. Prior to that, for 6 years I ran an online business in the credit card space. I started it the same month Bear Stearns went under and despite my poor timing and the fact that all my customers (banks) were in trouble, I maintained profitability every quarter and never took any outside investments or loans. Eventually I sold it to a publicly traded internet company.  While running that business, the cash flow coming from it afforded me the opportunity to make high risk, high reward investments in private biotech companies. Two went public. Life sciences is a great interest/hobby of mine but because it evolves so rapidly and requires immense amounts of continuous due diligence, it is something I now only do on the peripheral of my portfolio. While the vast majority of what I buy may be considered boring, I do make investments in some highly speculative stocks.  Lastly, while I mostly agree that you generally lose more money preparing for a crash than you do in an actual crash, I like to keep a healthy cash allocation on hand for those opportunities when everyone else is panicking. For those funds I prefer munis and in fact, have been betting on long duration for nearly a decade now. Contrary to the prevailing mindset this last decade, there's far too much debt to sustain higher rates for any meaningful amount of time. I have been on Seeking Alpha for at least a decade but did not start writing on here until 2020, due to boredom during covid. Even more than parking, I despise paying for investment research. As such, I will only write about one article on here every 30 days, which is the minimum required to maintain SA Premium access. I would rather slit my wrists than charge you for my content, so you won't see a marketplace service from me. Raised in Michigan, live in Manhattan Beach, CA.

Disclosure: I/we have a beneficial long position in the shares of V, PYPL, GPN, SQ 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.

Additional disclosure: I am not a financial advisor. This article is general information and for entertainment purposes only. It should not be misconstrued as being investment advice. Please do you own due diligence regarding any stock directly or indirectly mentioned in this article. You should also seek advice from a financial advisor before making any investment decisions.

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