Summary
Basil Leaf Capital Rates Affirm is a HOLD. There are many positives to like about the company such as the growth rate that is possible at its current valuation. The growth is contingent on too many factors that could go against them and stifle the growth. The competition they are facing in the credit cards are entrenched and difficult to compete with.
Understanding AFRM as a Business
Affirm is a buy now pay later model. This is essentially a layaway for ecommerce. Affirm’s core business model revolves around making retail more accessible and affordable for consumers while also driving increased sales and customer loyalty for retailers. This innovative financial technology company accomplishes these objectives through the following key features:
Affirm offers consumers a range of flexible payment options, allowing them to spread the cost of their purchases over a period of time, typically ranging from a few weeks to several months. These payment plans come with clear terms, including the total cost of the purchase, the interest (if any), and the number of installments. Affirm does not charge consumers hidden fees or compound interest, in contrast to traditional credit cards.
Seamless Integration for Retailers: Retailers and e-commerce platforms partner with Affirm to offer BNPL services as a payment option at the point of sale. This integration is often simple, as it requires no additional hardware or complex systems. By doing so, retailers can potentially increase their average order value, conversion rates, and customer loyalty.
Quick and Easy Approval: Affirm leverages technology and data analytics to make credit approval quick and accessible. Many consumers can receive approval for financing in real-time while making their purchase. This is important because it goes past the standard ways of providing credit either through credit cards or loans. This could create a competitive advantage if they give credit to people that wouldn’t normally get it and they pay it back. This also opens themselves to a risk of not being paid back if they approve too many credit unworthy people.
No Prepayment Penalties: Affirm allows consumers to pay off their balances early without incurring prepayment penalties. This flexibility is attractive to consumers who want to settle their debts sooner and avoid interest charges. This is attractive to people who don’t want to pay the interest on the financing similar to when people pay their credit cards off each month without paying any interest.
Affirm generates its revenue from several sources:
Merchant Fees: One of Affirm’s primary revenue streams is the fees it charges retailers and e-commerce platforms. These partners pay Affirm a fee to integrate and offer its BNPL services to customers. The fee is typically a percentage of the transaction value, similar to the processing fees associated with traditional credit card transactions.
Interest and Finance Charges: For consumers who choose to pay for their purchases over time, Affirm charges interest on the financed amount. The interest rates are typically lower than those of traditional credit cards, making Affirm an attractive option for many consumers.
Service Fees: In addition to interest, Affirm may charge consumers service fees for certain transactions. These fees can vary based on the terms of the financing agreement and the specifics of the purchase.
Late Fees: To encourage on-time payments, Affirm charges late fees to consumers who miss payments or fail to make payments on time.
Custom Financing Solutions: Affirm forms strategic partnerships with specific retailers or manufacturers to offer customized financing solutions. Revenue may come from these collaborations.
Affirm has positioned itself as a transparent and consumer-friendly alternative to traditional credit cards, emphasizing fair terms and no hidden fees. This commitment to transparency and simplicity has resonated with consumers who appreciate knowing exactly what they’re paying upfront and prefer avoiding the compounding interest that often accompanies credit card debt.
The company’s success depends on its ability to attract consumers, build partnerships with online retailers, manage credit risk effectively, and provide a seamless and user-friendly experience for both consumers and merchants.
Valuation Metrics
The finviz stock screener is a great tool to see performance metrics that are important to assess a company’s valuation.
Affirm is valued at $5.5 Billion by market cap. Affirm does not have any earnings yet so earnings ratios and earnings growth rates are not valuable metrics. The metrics to look at this company would be revenue growth combined with cost of operations and cost of gaining sales. The current price to sales is 3.5. That means you are paying $3.50 dollars for every $1 of revenue they generate.
FAST Graphs Analysis
Since Affirm does not have earnings, we will use the operating free cash flow function on FAST Graphs instead of earnings. FAST Graphs is a powerful software that will plot the share price of the company compared to the free cash flow of the company over time. The black line is share price and the orange line is free cash flow multiplied by 15.
We can see that Affirm has only just started generating free cash flow from operations in the most recent fiscal year. What we can see is that analysts are projecting an increase in free cash flow and that the share price is close to the orange line of that free cash flow multiple. The conclusion we can find from looking at this chart is that Affirm is close to the fair value of the free cash flow growth based on analysts estimates.
Bull Thesis
Affirm is a growth opportunity for the portfolio. The buy now pay later business model is an attractive service to customers. This will drive increased sales at retailers and ecommerce. Affirm is growing revenue at a rate of 20% yoy. This is a solid growth rate especially for a tough macro environment of high interest rates. The other positive sign to look at with this growth rate is that the percent of their revenue going to sales and marketing is decreasing over that same time from 15% to 5%. This means they are gaining customers and revenue without needing to increase their advertisements and marketing.
As Affirm grows and gains more customers they could achieve the network effect. As more companies integrate Affirm, the more Affirm becomes the standard buy now pay later system and companies have to adopt them. This could cause a chain reaction event to lead to exponential growth similar to the mass adoption of the credit card companies. Investing in Affirm now could be similar to investing in the major credit card companies before mass adoption.
Even tough economic headwinds could be used to the advantage of Affirm. As the common consumer becomes worse off, the need to break payments down from one large payment into multiple smaller payments could be their only option to afford to buy things, even necessities.
Bear Thesis
Affirm is based on the buy now pay later scheme. This scheme is not a new invention and has been around in the form of layaway and credit cards already. The buy now pay later space is becoming increasingly crowded. Affirm faces stiff competition from established players like Afterpay, Klarna, and PayPal’s Pay in 4, as well as other emerging startups. Competition can put pressure on market share and lead to margin compression as companies vie for retail partnerships and consumer attention. The biggest competition that no one talks about is that if credit cards offer payment plans laid out similar to Affirm does it. This is becoming more obvious that Affirm is competing with the credit card companies because they are launching their own card. When betting on the success of a start up versus the entrenched credit card companies its hard to bet on the start up.
The current headwinds for the company are the high interest rates, economic slow downs, and taking on bad credit. Affirm generates a significant portion of its revenue from interest and finance charges. If interest rates rise, it could increase the company’s borrowing costs, potentially reducing profitability. Additionally, higher rates could make buy now pay later financing less attractive to consumers. Economic downturns can lead to higher unemployment rates and reduced consumer spending. This, in turn, could lead to an increase in delinquencies and defaults on buy now pay later loans. Affirm’s business is sensitive to the overall economic environment, and a recession could have a negative impact on its financials. Affirm’s business model involve extending credit to consumers. This exposes the company to credit risk. If consumers default on their payments, it can lead to increased bad debt expenses, potentially impacting Affirm’s financial performance and profitability.
Rating
Basil Leaf Capital is rating Affirm a HOLD. Opening a new position at these prices are not attractive however the bad news and uncertainty is priced in. If you believe the bull case for the growth of the company and think they can challenge the credit card companies for market share then these could be reasonable prices to enter a position. We don’t lean that way because we want to see it before we believe it. If you believe the bear case for the company and that the growth can’t continue, then you would want to exit your position. The current valuation is reasonable for the potential growth however there are too many questions surrounding the growth for us to invest in our portfolio.