Affirm Holdings, Inc. (AFRM) Presents at Morgan Stanley Technology, Media, and Telecom Broker Conference Call - (Transcript)

Mar. 10, 2022 2:40 AM ETAffirm Holdings, Inc. (AFRM)
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Affirm Holdings, Inc. (NASDAQ:AFRM) Morgan Stanley Technology, Media, and Telecom Conference March 9, 2022 7:45 PM ET

Company Participants

Michael Linford - CFO

Max Levchin - Founder, CEO & Chairman

Conference Call Participants

James Faucette - Morgan Stanley

James Faucette

We'll go ahead and get started here this afternoon. Thank you very much to all of you for joining us here at the Morgan Stanley TMT Conference. Very excited to have the senior management from Affirm to chat today. Before we get started, I'm James Faucette, senior research analyst for Morgan Stanley covering fintech. I do have an important disclosure to read for important disclosures, please see the Morgan Stanley website at morganstanley.com/researchdisclosures. If you have any questions, call your representative.

So this afternoon, excuse me, I'm very pleased to have Max Levchin, CEO, thank you very much, and Michael Linford, CFO here to chat. We've only got about 27 minutes, and I have -- I was looking at -- this is about 2.5 hours' worth of questions, so we'll see how we edit a little bit. But maybe to start Max, just articulate -- because this is -- it's fine, because this is the question I probably get most often, is like what's the market opportunity for Affirm that you're going after, and really what's the long-term vision, particularly in a space where it's crowded with a lot of BNPL players and a lot of them growing quickly?

Question-and-Answer Session

A - Max Levchin

I tend to give these really long-winded, extremely elaborate answers, and given the time I'm going to go into my staccato mode. So we're building a payment network. That's the most important thing to remember. Every payment network is a credit network. If you don't believe me, that's less of an exercise for the reader, but I assure you it's true. Credit consumption has changed. If you look at Gen Z, if you look at millennial, they will not have the bullshit of late fees and deferred interest and all the other yuck that lives underneath your fine print for a credit card statement. Good news is, they are very excited about using credits. It just has to be in a form of paying over time, simple term loans, where you know exactly when you are out of debt. That's the new way to do credit. That's how the next credit network is going to be built. That's what we're building.

Last I checked, payment volume lives in the -- somewhere north of $10 trillion. In the U.S., we represent on the order of 2% of e-commerce, plus or minus sort of on a Black Friday type moment. There's 90% of the E version of commerce to take over, and then there's the 82% that's offline. So that's what we're going after.

James Faucette

So Max, look, I think the statistic I tend to supplement with what you just described is that, if you look at millennials and Gen Zs, even I was surprised, that's 40% of the U.S. population. It's massive that they don't have that full complement of credit capabilities and banking services or financial services, but they will in 20 years. But clearly, like as I said, there's a lot of BNPL players in the space. What differentiates Affirm today, and what do you think is important to do -- to continue to differentiate.

Max Levchin

So I said it before, but I will say it again, the way the young consumer thinks of credit has really changed. This idea of -- I don't want to be bogged down with things I don't understand, is really fundamental to product design. And the mission of the company from day zero, like we never had to invent ourselves as the honest actor, because we literally describe this idea of honest financial products at the foundation of the company. And so the North Star of our mission that literally has improved lives for honest financial products, allows us to be in the bullseye of what this young consumer wants. That drives a lot of our product design, drives a lot of our decisions, drives a lot of where we see revenue, where we don't try to look for revenue. And that's really important. It may seem a little superficial, but that actually really creates very important product guardrails that really matter.

To build something that actively leaves money on the table that is traditionally claimed by bank actors, deferred interest late fees, activation fees, reactivation fees, all of that is exactly what drives conversion down, and that's what merchants want for us to be able to build a business without all those things, you really have to be very good at engineering, which is a foundational advantage. My background, my cofounders background, was all building systems -- building payment systems in particular.

Within that advantage, is the risk management, which is a form of engineering, at least the way we interpret it, and that is all about taking the appropriate amount of risk, both on the approval side, on the credit spectrum, systems risk, information security, antifraud effort, all those things are very fundamental to who we are, and this will sound a little weird, but might funnel out a question or two, I'm moderately excited about the likelihood of oncoming recession, because if I hear one more, when will -- what will it look like when you get tested, you'll see. We'll get tested and be okay. I cannot say the same thing about our competitors, but we're very comfortable with our ability to manage risk, and that's fundamentally what payments and credit business is all about.

And then to build a real scalable network that is full stack, fully integrated, you have to be good at capital markets. Like ultimately, if you're a nonbank lender and inevitably anyone who is building the credit system has to have capital to drive the growth, you have to be able to execute it at scale, and we scaled our capital markets program literally from, let's borrow some money from our founders, and see if we can balance sheet loans that way, all the way out to doing securitizations every other quarter or more. And that skill set and the kind of team that we've been able to assemble, has allowed us to take out some really, really complex challenges. And we serve Amazon, Walmart, Target, Shopify, all of these merchants drive enormous amount of volume and require both scalability, which means engineering, exceptional risk management, which is another flavor of engineering and a capital program that can actually take on the sort of scale they have to offer. And so those are the -- that's the list of things, but I think fundamentally, it all comes back to the way we do business, which is sort of the demand.

James Faucette

And so do you think your approach to that, or where have you seen your approach to that be different than some of the other BNPL players that are in the market? I am trying to isolate the nuance, if you will?

Max Levchin

Look for one, we don't like to set large piles of cash on fire to -- when we try to win deals. We tend to win deals on the strength of our ability to deliver a product that tightly integrates with the merchant, where we can actually show incremental lift through really tight EB testing, where we can show -- we deliver incremental volume that is distinct and different from credit card volume. A lot of that has to be properly instrumented. There's quite a lot of engineering work and you can pave your inadequacies on the engineering side over with cash, but it doesn't really work for large enterprise customers, because they ultimately don't want companies that will ultimately go out of business, because they do, in fact, like to set large modifiers of cash up.

And so that string is really important, when we deal with our very large partners and the risk management side of things, it's not just enough to have the risk management strength that's kind of an internal pacing thing. You actually has to be able to articulate it to the partners, when you come and say, look, here are the approvals and here's how you price, how you think about the incremental volume we can deliver to you, based on the risk we're willing to take, and be able to turn it around and take that conversation to our regulators, which, by the way, is the other really important action in the space, where you say, look, we're willing to be entirely transparent.

One of my favorite recent things to do was, to fill out the CFPB questionnaire, where it was the giant spreadsheet of zeroes, how to say, oh reactivation fees, nope! Deferred interest, nope! Late fees, nope! And we built a very nice extremely profitable business, without any of those things. And when you come to a -- especially millennial and Gen-Z focused merchant, one of the question is, well, are you going to tarnish my brand when the consumers come in and they say, 'oh, I've been slapped with a reactivation fee,' our answer is like, no, there's a big page of zeroes. So I think a lot of that adds up to being very different.

James Faucette

So Michael, Max talked about like improved conversion for the merchants, et cetera. What are the updated metrics that your merchants see from -- and the benefit they have from Affirm to -- for them, and what -- in particular, we get lots of questions about what types of sales uplift, repeat usage, marketing cost reduction, efficiency, et cetera. So like what are the key things that you guys are focused on delivering to the merchants?

Michael Linford

Yes. I mean, firstly, we have a pretty long track record of driving much bigger baskets, and that's measured in the average order value, and Max has shared this ad nauseam, the history of our company, you can see that impact when you turn on Affirm very quickly, and it's pretty obvious if you offer a way to pay for things over time, you can sell bigger baskets that's upselling for higher quality, but also more quantity at the merchant. And there we see average order values, lifting on the order of 85%, and there are very few things that merchants can do, that can drive a change in average order value anywhere near that quantum.

We also drive higher levels of repeats, sometimes as much as 20% or 30%. We also can really stem the number of abandoned baskets, abandoned carts, which has become a real thing. Think about all the advertising costs going up and everything going on and much discussed with the pressures in the advertising ecosystem. Once the consumer has got the cart, it becomes an extremely valuable transaction to close. There's a real focus on, can you avoid abandoned carts, and again, we can see numbers as high as 20% or 30% of abandoned cart rate reduction, which just means that those advertising dollars to the merchant go much further, which in this environment, with Apple having done what they've done, really is an important thing for merchants to be able to get the most out of the dollars they've spent.

James Faucette

So as much as you can and recognizing the obvious potential sensitivity, but talk to us a little bit about those engagements with Amazon and Shopify and kind of what you talked about. I mean was it just the basic metrics that Michael reeled off, in terms of like, 'oh, this is the uplift we see,' in terms of cart size and these kinds of things? Or what -- like I think for a lot of people, they were surprised that either company, let alone both companies, would choose to go with Affirm, at least out of the gate for their initial BNPL partners.

Max Levchin

I'll skip the...

James Faucette

Yeah, you're pretty awesome, right?

Max Levchin

Yeah we're awesome. We do say it ourselves. So the -- I mean it helps and it's important to be best-in-class, when we show up to an enterprise customer, it wouldn't be okay if we say, you know what we're like second best, but that's okay, you should work with us. And I think that -- it helps to have the kind of stats that Michael rattled off, and we're certainly at the very top of the industry. In particular, our experience in improvement of the AOV is really stand out. It's just a very different -- relative to competition. Ultimately though, the conversation flips to, will you make my brand look better or worse, and there in the original RFP from Shopify was sort of this effect of a small hand grenade in the industry, where they said, by the way, no late fees. And the only companies that's cool, was us, because everyone else was like, wait, that's like a 20% to 30% of my profit. Sorry about that. And so well, that's something that we take for granted, something we don't need and do not want. We want our brand to be pristine.

Once you sort of clear through the -- yes, we actually are not just accretive to your volume, but make your customers feel great about using the particular payment instrument. The question is, well, can you scale with us. And not just sort of can your services hold up the kind of traffic that Walmart or Amazon experienced on Black Friday. But in addition to it, can you build the kind of APIs? Can you maintain the service level agreements, can you respond in the sort of subsecond times for any sort of neutrality. And I think most companies in our space are specialists in marketing, not engineering.

And I think ultimately, when you're sitting down with someone as sophisticated as Amazon or Shopify, still very much an engineering-driven company, you end up connecting not just at the level of, hey, we'll make a lot of money together. But hey, this is going to be really cool, and we're going to build it the right way and it's going to scale, we're going to be able to come up with all sorts of long-ranging plans about, what this looks like in a year, 2 years, 5 years.

So that's ultimately how every one of those deals came together. And obviously, a huge part of -- you implied perhaps the companies are competitors. They're very much excited about eating each other's lunch, and not only do we have to be respectful of that, we have to maintain purity of separation of data and provide the same quality of care to every one of our partners, in a way that makes them very comfortable with the idea that, whatever their secrets are, are never going to leak over, and those can be direct or indirect. And so we take exceptional care around data security, even implied data security, things that we just don't think should be visible. And knock on whatever -- we've never had a single conversation around, well, hang on a second, too close and not by accident, this is by design. We've built the company around the idea, that our customers may compete, and we have to be very, very good to each of them, without compromise on the sideways.

James Faucette

So Michael, for all the congratulatory comments around like winning Shopify and Amazon and having Walmart and the stuff that you're doing, the offers that are given to customers through those different checkouts can vary. And one of the issues that investors are having, is like modeling that and forecasting that is very problematic for us, particularly as we're trying to distill like, okay, is Affirm doing what we thought they would do, et cetera. So maybe just very basically walk us through the timing and economics of some of the basic types of transactions, et cetera. I think that would be useful, at least for me.

Michael Linford

Okay. So let's start by just framing what products are available by partner today, with a really big caveat that this is going to change over time. And I do appreciate how hard it is to model. Believe me, we have a team full of brilliant business school graduates who are working on it on our own internal data, and it's really hard. But it's hard because it's growing really fast, and that's the good part of the problem.

James Faucette

It's growing really fast. So the mix of types of transactions can vary...

Michael Linford

That's right. If this business were flat and stable and boring, then none of you would want to own it. So the products are available across the 3 partners today. So at Walmart today, it's an interest-bearing product only. At Amazon today, and Amazon up until a few minutes ago, it was an interest-bearing product only. At Shopify, our integrated product with Shop Pay Installments, is a split pay product only. In all 3 of those cases, we expect to offer the wide range of products. At Walmart, and I guess I have put it myself, we do have a long-term 0% program there, too, where the brands have subsidized the loans. And at Amazon, we have aspirations of rolling out 0% programs literally right now. And on Shopify, we know in the roadmap, is the migration of interest-bearing and long-term zeroes to the broader shopping installments ecosystem, where we already have a lot of Shopify merchants, using that product directly with the firm today, and we want to integrate those experiences over time.

So what do those products look like? Interest-bearing is probably the most important one for folks to get their heads around, because we had a lot of growth in interest-bearing in our second fiscal quarter. Interest-bearing loans, when they're put on the balance sheet, take the provision upfront and earn revenue over time in the form of interest income. And what that means is, the margin profile on any given period, tends to look a little bit way down and it contributes over the life of the loan. When we sell it, we get most of the revenue and gain on sale. Occasionally, some of that gets put into servicing income, but there's no provision impact. And so the way to think about it is, for the mix that we sell, it just tends to be a little bit more short term than the mix that we hold on the balance sheet, either in one of our warehouses, or when we put it on the consolidated securitizations, those tend to be contributing over time.

I think, though, the important question for investors isn't so much, what's going to hit in month 2 of Q4. The more important question is, what's the margin profile of those businesses over time. And I think one of the things that a lot of folks maybe aren't hearing the right way, is our interest-bearing product is a very strong margin product. Our APRs range between 25% and 30% on average, and that's a lot. And if you think about the margin content of the product, even with 3%, 4% or 5% of funding costs, and even with 5%, 6% or 7% of credit cost, there's still left quite a bit of margin in that product, and it's actually our strongest and most profitable segment at Affirm today. It does have some timing impact, but very, very profitable, and we feel very good about that.

In particular, our direct-to-consumer product, we call that Affirm Anywhere internally, which allows the consumer to take out an interest-bearing loan in our app, is very profitable. And that's a product that we frankly, generate a lot of lifetime value of consumers out of, as they reengage on it.

Now that's the longer-term business. You have to kind of go to the other end of the spectrum and thinking about Split Pay. Split Pay is a business where the total growth is on the order of 4% to 5%. It's higher with Shopify, although we do have to pay Shopify they're cut. And it's lower off-Shopify, but we keep all the economics. There, we've given an indication to the market, like 3% to 4% is a good number, with respect to what we call revenue less transaction costs, as a percentage of GMV, you obviously aren't going to make 4% net on a 4% gross product. So the margin structure is lower on a percentage of GMV for that product.

But if you think about the frequency, it more than makes up for it. So this is lower on a percentage of GMV, but they tend to repeat 15 times a year versus, say, a product that's interest-bearing, which maybe hits 2 to 4 times a year. And so the latter generates a little bit more per transaction. The former generates, obviously, a lot over the course of time. And in both cases, we love both, because what we're trying to do is, make sure we build products that have high levels of engagement, and over the lifetime value of that consumer, generates a lot of value for Affirm.

James Faucette

So Michael, fix a little bit my like clumsy summarization that I used, which is like, if I'm Affirm or an Affirm investor, in the fullness of time when these loans get paid back, I should be pretty indifferent, adjusted for duration and the impact of duration between what kind of loan it is, right? Is that -- I mean, is that -- is it -- and look, adjusting for duration is art, and it's hard to do when you're trying to calculate that out, but that's ultimately like what this should look like.

Michael Linford

Yes, that's exactly right. So if you think about margin that's twice as high on frequency that's half as much, what you're saying there, is the duration or frequency, another way to word duration, is higher, when you have higher frequency, you can get less margin per transaction. And the thing about us, is that we're not limited to doing one of those things. Max kind of glossed over this, but one of the reasons we won with Amazon, wasn't just because we won't screw their consumer. It's also because we can offer an interest-bearing loan, a long-term zero loan and a pay-in-4, and the complexity of doing all of that is really, really hard for other people to catch up to. A lot of folks can divide by 4. It's much more difficult to build in the risk management systems to handle 24 months of duration risk. These things are hard. And our view is, hey, look, if we can serve up and mean something to every transaction, we're going to be more viable in the end.

James Faucette

So Max, jumping to another topic. And like I said, I've got -- I probably have more like 3 hours of question here. But -- so you mentioned filling out a questionnaire. And what is your perspective on the CFPB's questionnaire motivations for asking questions and looking at the NPL and specifically focusing on their views on data harvesting and disclosure requirement. Kind of what's your view there, but more importantly, how is the firm preparing for more BNPL regulation in the future?

Max Levchin

I think it's definitely not for me to speculate sort of -- my job is to be compliant, and we certainly are and we tried very hard to be as close, and see ourselves as not the only, but one of the good guys in the space, and we're frankly delighted to provide our information and sort of show as much as we possibly can, just so the regulators can see what's really happening. There's a massive market demand for this class of products. There's plenty of people unfortunately coming out of the woodwork saying, oh, what a cool way to make an extra buck, all we need is a reactivation fee, just free margin. And sure, but that is, in fact, consumer harmful and also needs to be disclosed correctly, if that's what we're going to do. And I think there's quite a lot of work that CFPB has cut out for them, where they can start at the very least explaining, here's what disclosure set needs to look like. And by the way, a lot of usage of BNPL goes unreported, which is both bad for consumers because they're not building credit history, and bad for the industry because they're not able to see people who are abusing...

James Faucette

So specifically, unreported to credit reporting supporting agencies?

Max Levchin

Yes. Exactly. Yes. And so the good news is that we've been engaging with the CRA, the credit reporting agencies and the regulators for a very long time, well before the study came out. And so -- or when it came in, and we both had a lot of opinions and thoughts, and we're excited to get involved. And so I think ultimately, a leveling of the playing field, explanation of what isn't reportable and should be reported, et cetera, all of that I see as a positive for the industry. My general substantive regulation, it's good so long as it's thoughtful. If it's sort of a -- let's put everyone down and then see who should act afterwards, I don't think that's what's going on at all. I think what's really happening is, the regulators are saying, look, there's probably a lot of value here, let's just make sure consumers are not run over by mistake or by malice. And we don't make too many mistakes fortunately, and malice is the exact opposite of what we do. I think the industry needs a little bit more of explanation of what that is, and I'm looking forward to what they have to say.

James Faucette

So speaking of things we do in the future, you've already announced the Debit Plus product. When it -- how are we progressing in terms of general availability, I guess, there? And what are you planning on for this year?

Max Levchin

I got one -- I've been showing it off to investors in all of our meetings. I'll give you a vignette, which may be too long and potentially self-damaging, but transparency, thy is our middle name. So things we launch, do not need to be perfect. Perfection is the enemy of good enough for launch, and we're firmly aware of that. But it has to be good. It has to be the first X hundred thousand people that are going to encounter the card, have to have ways for a knockout amazing experience, so they tell their friends. So it starts gaining its own viral momentum.

We're really close. It's not quite to the level that I think I require, and I get to be the ultimate arbiter of good taste here. And it is dangerously close to us. I'm very, very excited about it. We're seeing well north of an order of magnitude increase of engagement for the consumers that are using the card. So what we really are trying to get to, is top of wallet. This is the only piece of plastic -- it's actually some weird compound materials, it's not even plastic. But we are only piece of compound material in your wallet that we want you to have. It supports every manageable transaction type, and you do not have to revolve and there's a profoundly new way of transacting, it's way better than debit. It works with your existing bank account, you can borrow money with or without interest bearing, depending on what's appropriate and there's a whole host more.

It's really simple. Just this side of -- needs another few revs of the onboarding experience. For the avoidance of doubt though, I've been working very, very hard on it, and Michael asked me yesterday, what version are we on and the current build is 156, that of the current version, which is version 119. So there's a lot of work that went into it. Therefore, we'll bring it out, give me a couple more versions, but it's definitely coming this year. And I'll bite my tongue, because Michael will yell at me and people will start modeling it, and we don't want that.

James Faucette

It's only March, first week of March or second week of March. So we're in pretty good shape.

Max Levchin

The right joke is, our fiscal year is in July.

James Faucette

Okay. Right, right. Okay. But I said calendar year, if [indiscernible].

Max Levchin

That said.

James Faucette

Just making sure. All right. So we've got a minute 10 for the metaphorical grenade for you to put the pin back in, Michael. Can you walk us through how interest rates affect Affirm's business? And rising delinquencies, how that's affecting your -- using the credit box?

Michael Linford

So let's start with the latter first. Credit outcomes are a choice for us. And the question that we ask ourselves every day and are monitoring, when we look at credit outcomes is, are the credit outcomes we're seeing, consistent with what the model predicted when we made an underwriting decision. We get that signaled 34 days after we originate a loan. So every day, we look back 34 days and say, okay, we expected this much loss, are we in line? If we are, we [indiscernible], we collect 200, we're great. We continue to operate the business. But if we ever see that deviating, we have to react. That's the nature of our product life, so valuable, as every transaction is underwritten and the duration is so short, we sit here with our hand on the [indiscernible].

The good news is, that credit outcomes today are great, and that can change very fast, which is why we have world-class monitoring. But for now, what we see, our outcome is very consistent with what we want, and when you look at the rise in delinquencies, it's consistent with what we wanted to have happen. We did this on purpose -- the credit capital markets can withstand that level of loss, we'll take it and we'll drive really great results for the merchants, and that's what we've been doing. And you'll see us behave very differently, if the outcomes start to deviate from the models, and we are in complete control of that.

With respect to the rates and the rest of the business, I think the most important thing is, we take all of the current rate expectations and run our business to this. Further rate environment -- further rate increases would impact us, and we laid out on the call exactly what to expect. But even with any substantial increase above the current rate expectations, more than 200 basis points, will still be within the range that we've given the market of 3% to 4% long-term margins. So we feel like, we have it very much in hand and that has a lot to do with the fact, that we have such a diverse set of funding partners, who all don't have direct rate exposure, and we do a really good job of executing in any environment across all our funding types.

James Faucette

Great. Fantastic. Well, we're out of time. Lots more we could talk about, but thank you very much, Max, Michael, for joining us today. Thank you to everybody.

Max Levchin

Thank you.

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