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If the crunch of cabbage in their KFC burgers was not enough to alert consumers to the tough times ahead, the Reserve Bank shocking the market with its biggest rate rise in 22 years probably did the trick.
And no sector will be watching the consumer crunch more closely than the buy now, pay later (BNPL) operators. The BNPL outfits have little room to manoeuvre as they try to convince the market that they have a future as a viable stand-alone business and won’t be killed off by a feature on your Apple or Commonwealth Bank app.
Shares in buy now, pay later operators have collapsed this year.Credit:Louie Douvis
Andrew Brown, a fund manager at East72 and outspoken BNPL critic, thinks the industry’s future is plain to see in its recent results.
The sector’s rising bad debts and losses became more apparent after pandemic stimulus payments from the government ended last year. “The bad debt experience is horrendous,” he says. “The simple fact of life is this: BNPL business as a stand-alone means that you are going to attract a large number of people who are incapable of paying their money back, particularly if you don’t have robust credit checks.”
More challenges hit the industry last week. Apple’s threatened to upend the sector by turning BNPL into an update on its billion-plus devices with no fees for retailers or its users. Another is the Albanese government’s announcement that it plans to regulate BNPL as a credit product, potentially ending its days as an unsecured instalment loan for consumers with zero regulation.
Bad debts, red ink
To give some idea of the current challenge, Sezzle said revenue from its operations for the March quarter was just over $US24 million ($33 million), but bad debt expenses alone amounted to almost $US10.5 million. The company reported a loss for the March quarter of just over $US26 million, which means it lost a more than a dollar for every dollar of BNPL revenue it generated.
BNPL pioneer, Afterpay, dodged this day of reckoning with its $39 billion merger with Jack Dorsey’s Block Inc, effectively embedding its services into a diverse consumer financial ecosystem which includes Bitcoin sales.
Its local clones have opted for safety in scale by proposing mergers: Zip with Sezzle, and Humm with Latitude Financial Group.
Both Latitude and Humm are incarnations of conventional finance businesses. Latitude was GE Money, which still arranges Harvey Norman’s consumer finance deals. Humm emerged out of Flexigroup.
Brown is not a fan of the Zip/Sezzle deal, but some of the biggest critics are no longer external sceptics like him. The most damning voices are coming from within.
Latitude’s push to swallow Humm has drawn particular heat from the latter’s largest investor and company founder, Andrew Abercrombie. He says there is more value in the traditional consumer finance being sold than with the modest BNPL operations, which are being used to justify the merger.
“This is the Humm board telling the world that [BNPL] competition is getting worse, when in fact the entire market is collapsing.”
Abercrombie says that, until a couple of years ago, Humm would not do a BNPL service for under $500 because they believed it would attract people who would be poor credit risks.
Bad debts have finally caught up with buy now pay later operators and their growth-at-all-costs model. Credit:Bloomberg
However, the likes of Afterpay and Zip targeted transactions around the $100 mark. “And that is what is killing every single one of these guys. (It) is losses,” Abercrombie says.
Instant gratification, delayed pain
Afterpay planted the seeds of BNPL as a global consumer phenomenon in 2018 with its launch into the US market, freeing millennials from traditional credit products with four-instalment payments. By March 2019, the company was worth more than Harvey Norman, despite the retailer offering interest-free products on much more generous terms.
The key to Afterpay was that retailers grew to love it. Behavioural scientists have described the service, and the viral impact it has on users, as a perfect storm of instant gratification and delayed pain of payment. It essentially tricks users into buying more than they otherwise would.
It is a boon to retailers as BNPL customers upgrade their purchase, or don’t bother waiting for sales discounts, and while it sent share prices soaring it was a boon to BNPL investors as well. But that has changed last year when investors started to look at the massive bad debts and a growing reality that many users are also spending more than they can afford.
In a recent column, Scott Galloway, Professor of Marketing at NYU Stern School of Business and BNPL critic, points to US consumer debt jumping to record highs with BNPL playing a dominant role, but at the expense of soaring losses as bad debts and marketing expenses boomed.
“Any hope of profitability depends on overextended consumers somehow making their payments and continuing to mash the buy button,” he says.
‘Any hope of profitability depends on overextended consumers somehow making their payments and continuing to mash the buy button.’NYT Professor Scott Galloway
The sudden about-face in market fortunes has provided a rough introduction for Zip chair Diane Smith-Gander who took the position in February last year. The stock peaked within weeks, valuing the Afterpay rival at just under $10 billion. This week its market valuation dropped towards the $420 million mark.
Speaking at a conference last month, Smith-Gander was open about the recent missteps which meant the sector did not adjust its growth-at-all-costs strategy as new challenges, like inflation and rising interest rates, took hold.
“The industry as a whole, which has seen bad debts spike, really missed that moment. And we are now going to have to dig our way out of that,” she says.
Like Abercrombie, she suggests that the sector was too blasé, justifying bad debts as a necessary cost of BNPL’s astonishing growth story.
“In the industry there was a bit of a feeling that well these are small amounts of money, so the payback for recovery and collection activity is not the same as if you’re collecting mortgage that’s gone bad,” she said.
Diane Smith-Gander says the buy now pay later sector is now focusing on profit margins rather than just customer growth.
Everyone now recognises that it makes no difference, which means the operators’ thinking has only just caught up with long-time critics like payments veteran Grant Halverson, who heads consultancy McLean Roche.
He has been scathing of what he describes as the BNPL providers’ high-growth-at-all-costs strategy, which has ignored basic consumer lending risk criteria. “With high losses and with very low margins, you will never make a profit, no matter how much growth is achieved,” he says. “BNPL apps also enjoyed record-low interest rates, which is now turning and makes any path to profit impossible – basically every dollar of sales goes straight to losses.”
He has the numbers to back this up.
Measuring bad debts as a percentage of outstanding consumer loans, Afterpay leads the pack at 13.9 per cent, followed by Zip with 9.7 per cent and Commonwealth Bank-backed Klarna at 8.1 per cent, according to McLean Roche.
For Australia’s largest credit card issuer, the Commonwealth Bank, its bad debt write-off estimate for accounts 180 days in arrears is 0.31 per cent, according to McLean Roche’s data.
BNPL operators have resorted to drastic measures as costs of debt funding rise, and shredded valuations mean raising further funding from investors will be tough.
‘The industry as a whole, which has seen bad debts spike, really missed that moment. And we are now going to have to dig our way out of that’Zip chair Diane Smith-Gander
“The last six to nine months has really been the perfect storm for these BNPL companies ... that is now compounded by the fact that the decline in share prices of these companies means their access to capital is non-existent,” says East72’s Brown.
Sezzle is a prime example. Its market valuation has gone from a high of $2.33 billion last year to a low of $80 million this week.
Commonwealth Bank-backed Klarna is shedding 10 per cent of its workforce to pare back the losses.
“While crucial to stay calm in stormy weather, it’s also crucial not to turn a blind eye to reality,” said Klarna chief executive Sebastian Siemiatkowski as he announced the staff cuts last month.
The same is happening at Minneapolis-based Sezzle, which updated investors last week on its plans to also slash 10 per cent of its workforce and retreat from some of its new markets to save cash ahead of its merger with Zip.
Analysts have noted that BNPL operators have pulled other levers to cut the bad debts and red ink. This includes being more judicious about what customer transactions they fund. But there are consequences.
Last month, UBS analyst Tom Beadle noted a fall in the transaction frequency of Zip customers.
“We remain concerned that there is a tail of inactive customers that could fall out of Zip’s active customer base in upcoming quarters,” Beadle says.
Analysts from Macquarie Group raised a red flag in April when BNPL web traffic declined year-on-year for the first time since it started recording the data, which suggests customers might finally be dropping off.
“We consider BNPL more of a customer acquisition tool, and in the case of declining customer numbers the value of BNPL diminishes,” Macquarie says.
All of which means that, while Afterpay is relatively safe in the bosom of Block, its stand-alone rivals will continue to face questions about their survival.
with Clancy Yeates
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