Afterpay’s $39bn pay day

Business advisers will tell you that you need to begin a business with the end in mind; a phrase popularised by Michael Gerber in E-Myth. The announcement of the intended sale of Australian born fintech company Afterpay, pioneer of the ‘buy now, pay later’ platform, is a case in point.

Afterpay was founded in 2015 by Nick Molnar and Anthony Eisen, listing on the ASX for $1 per share in May 2016. In 2017, they hit 1 million customers and 7,200 merchants, launched into New Zealand, and merged with Touchcorp Limited. A year later in 2018, they entered the US market. In 2019, it was the UK under the brand name Clearpay. In 2020, Hong Kong listed Chinese tech giant Tecent paid $300m for a 5% equity stake. By then, Afterpay boasted 5 million active US customers, 1 million in the UK. In this same year they took the opportunity to launch into Canada. In 2021, Afterpay announced the purchase of tech group Pagantis by their UK subsidiary in preparation for their launch into Europe.

Afterpay was also exceptionally well placed for the dramatic COVID-19 shift in consumer behaviour that supercharged online retail. As at 30 June 2021, the company had 16.2 million active customers (63% growth on 2020) and over 98,000 merchants (77% growth on 2020). When COVID-19 struck, Afterpay’s share price dipped to a low of $12.44 on 20 March 202 but by 19 February 2021, hit a high of $151.92 ($96.99 at 30 June 2021). At 30 June, (unaudited) group revenue was $925m, growing 78% on the previous period (of which merchant revenue was $822m). However, growth comes at a cost with the 31 December 2020 half year results showing an after-tax loss of over $79m (joining a long list of unprofitable tech companies such as AirBnb, Pinterest, DropBox, Slack and Uber).

The rise of Afterpay has been extraordinary; a combination of a game changing concept delivering consumer flexibility and the ability for merchants to grow their customer base with the potential of increasing per transaction values, all backed by an aggressive expansion plan. They are a brand that became a verb.

On 2 August, the announcement was made that US financial services and digital payments giant Square, had agreed to acquire all of the issued shares in Afterpay for approximately US$29 billion (A$39 billion). The sale is expected to be all in stock and Nick Molnar and Anthony Eisen will join Afterpay as employees in first quarter of 2022.

For many innovative and fast growth companies, sale is the end game – generally to another company in the same or similar market with strong synergies that is willing to pay a premium for the opportunity. Afterpay has achieved that in spectacular style. And, you can see the appeal of a business model that is replicable, utilises unique systems and technology, is adaptable, and has proven its ability to grow and expand globally.

The model

For consumers, Afterpay offers a way of spreading the cost of purchases over four payments across six weeks. No fees are charged unless the payment is late. If a payment is late, an initial $10 late fee is charged, and a further $7 if the payment remains unpaid 7 days after the due date. For each order below $40, a maximum of one $10 late fee may apply per order. For each order of $40 or above, the total of the late fees that may be applied are capped at 25% of the original order value or $68, whichever is less.

While free to consumers (unless they pay late), Afterpay charges merchants a 30 cent fee, plus a commission ranging from 4% to 6% to the merchant. Payments transacted through Afterpay take 48 hours to be delivered in full to the merchant. Afterpay states that their service drives new sales and increases the average order by anything up to 40%.

The fee structure, and the fact that Afterpay makes spending easier for consumers to rationalise, has not been without controversy. A Senate committee and the Payments System Review explored whether more consumer protections, such as customer credit checks, were needed. However, neither review wanted to stifle the growth of financial competition or innovative fintechs, and believed that market forces would appropriately regulate the industry. At present, late fees represent less than 10% of the company’s revenue.

Afterpay store cards are available in the US and other markets. And, in July this year, Money by Afterpay launched in Australia and New Zealand with Afterpay staff trialling the product ahead of a full-scale launch anticipated in October 2021.

What if you have Afterpay shares?

The sale of Afterpay has a number of hurdle points including regulatory approval from the Foreign Investment Review Board and approval of the shareholders of both Afterpay and Square.

If the transaction proceeds then Afterpay shareholders will have two main options. They can either receive NYSE-listed Square shares or they could receive shares in Square that are listed on the ASX. This is because Square will establish a secondary listing on the ASX allowing Afterpay shareholders to trade Square shares via CHESS Depositary Interests (CDIs) on the ASX.

Afterpay state that the transaction is intended to be tax-free for Australian shareholders electing to receive NYSE-listed Square shares or CDIs. Among the conditions precedent is a ruling from the Australian Taxation Office (ATO) for Australian shareholders to apply scrip-for-scrip capital gains tax (CGT) rollover relief. If the rollover applies, then the cost base and acquisition date of the Square shares will basically remain the same as your Afterpay shares.