Affirm stock (NASDAQ:AFRM) is up more than 70% in the last month, with renewed enthusiasm following another deal with Amazon, this time to offer their payment services to Amazon Business users who are sole proprietors (about 23 million people in the U.S.), and most recently a report that
buy now pay later (BNPL) orders were up 72%, or $79 million, on last year the week going into Black Friday.
Investment Thesis
This is yet another opportunity to sell the stock of an unprofitable company in a competitive, fractured industry with several companies ahead of them.
According to PYMNTS’ latest Provider Rankings of Buy Now, Pay Later, Affirm is tied for 5th place with Sezzle, and actually fell three rankings. Affirm, with an overall score of 65, is behind Klarna (75 points), Quadpay (77 points), and PayPal (78 points). The score is based on channel coverage, downloads, monthly average users, average session length, and sessions per user.
Another report by Statista Consumer Insights showed that PayPal’s “Pay in 4” is the most popular BNPL provider in the U.S. right now, with 68% of surveyed users reporting using it in the past 12 months. Amazon Pay is the second most used, followed by Afterpay, Affirm, and Klarna.
What’s clear is that Affirm is competing in a highly competitive market, with no clear differentiator. In my view, owning the company at its current lofty valuation is very risky.
The New Amazon Deal
We’ll have to wait and see how this new deal is structured, but it’s likely similar to previous deals with Amazon, Shopify and other partners: warrants.
Affirm dilutes its shareholders by offering its partners warrants, many with an exercise price of $0.01, in exchange for access to their platforms. This is how they landed on Amazon.com and Amazon.ca as a payment method. So far, consumers seem to be lukewarm on the service (the average rating on Amazon.ca is 3.3/5): Reading the reviews, it’s clear that consumers enjoy using Affirm when they can get 0% APR, but not so much when rates are in the 20-30% range.
Affirm’s growth strategy involves getting access to the major ecommerce platforms, which they have succeeded in doing. However, they have paid a heavy price. For example, take a look at how their original November 10, 2021 deal with Amazon is structured. From the 2023 Annual Report:
In connection with the entry into the Commercial Agreement by Amazon Services and Amazon Payments, Affirm issued to Amazon Services:
- a warrant (the “First Warrant”) to purchase up to an aggregate of 7,000,000 shares of Class A common stock, $0.00001 par value per share (“Class A common stock”), of the Company (the “First Warrant Shares”) at an exercise price of $0.01 per share; and
- a warrant (the “Second Warrant” and, together with the First Warrant, the “Warrants”) to purchase up to an aggregate of 15,000,000 shares of Class A common stock (the “Second Warrant Shares” and, together with the First Warrant Shares, the “Warrant Shares”) at an exercise price of $100.00 per share.
So that “First Warrant”, assuming a price of $20 per share (average price target and middle of the price range over the last year), is worth $140,000,000. What is the expected return on investment of this deal?
During the year ended June 30, 2022, we granted warrants in connection with our commercial agreements with certain subsidiaries of Amazon.com, Inc. (“Amazon”). The warrants were granted in exchange for certain performance provisions and the benefit of acquiring new users. We recognized an asset of $133.5 million associated with the portion of the warrants that were fully vested upon grant. The asset was valued based on the fair value of the warrants and represents the probable future economic benefit to be realized over the approximate 3.2 year term of the commercial agreement at the grant date.
The expected benefit is equal to the value of the warrants, so they are already paying for the benefits they expect to receive for access to Amazon.
Aside from the fact that they’re shelling out hundreds of millions to partners like Amazon, there’s another big problem. Many of their agreements are non-exclusive, which means these partners can enter into agreements with Affirm’s competitors. And the agreements that are exclusive are only exclusive for 12-36 months. After the period of exclusivity, their partners can do what they please. They also have the right to terminate these agreements at any time.
A Flawed Business Model
Affirm’s business model is based on providing consumers with a secure, reliable payment option. The company targets millennial and Gen Z consumers who tend to have lower income and less access to credit cards (young people), and they market themselves as a more responsible alternative to credit cards.
In my view, Affirm has a flawed business model with limited appeal. They seem to specifically target people who are not particularly financially savvy, don’t have much money, and are in a hurry to buy something discretionary. They offer 0% APR for short term loans, like other BNPL players, and like credit card providers, for what it’s worth, except with credit cards you get points (free money), so there’s really no good reason to use Affirm for short term loans if you have a credit card. For longer term loans, they charge 10-30% APR. That’s up to three times more than the interest rate charged on a line of credit.
To investors, Affirm markets themselves as an innovative company. But the concept of BNPL has been around for over a century. The earliest form of BNPL emerged in the 19th century as a way for consumers to purchase expensive stuff like furniture and farm equipment that they couldn’t buy outright.
Conclusion
While Affirm’s competitive position puts them in the middle of the pack, their financial performance is closer to the bottom. The company’s reported returns on equity were below -20%, even during the pandemic-fueled boom in e-commerce. Now they’ve become more negative at -38%. Normalized net income margin sits at -40%. EBITDA margin is even worse at -59%. This puts Affirm very, very far behind the performance of competitors Mastercard, Visa, major banks, and fintech competitors like PayPal and Square.
Affirm offers a commoditized service, faces stiff competition, is unprofitable, continues to massively dilute shareholders via warrants and stock-based compensation, and its performance is trending in the wrong direction. For some reason, likely due to a combination of speculator enthusiasm, short covering, and call buying, the company’s stock is up more than 70% in a month.
In a competitive industry, the lowest-cost producer usually wins. It’s unlikely that will be Affirm. In my view, this company could only be a sound investment if they figured out a way to differentiate their offering, such as through a loyalty or points program, and if they were able to control costs, reduce debt, and adopt more shareholder-friendly practices.
Investors should also note that Apple is now a competitor, with their new Apple Pay Later feature. If you want to compete with them and many other excellent companies, you better have a compelling value proposition. I just don’t see it.
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