Payments company Afterpay Holdings Ltd (ASX: AFY) is growing at a cracking rate. It's a promising growth business essentially allowing the consumer to buy an item now but pay for it later, over time.
Buy now, pay later. 4 equal-sized repayments each 2 weeks apart. Fee-free, unless you're late, then there are fees. On the face of it it's a better proposition than a credit card, and merchants also win from a rise in customer sales when they install Afterpay. This is necessary, since the merchant pays a % of each transaction to Afterpay, which is how the company makes its money.
It's a compelling product, the company is growing at a cracking rate, and if it becomes the dominant provider – it currently competes with similar businesses like zipMoney Ltd (ASX: ZML) – it could become many times larger over the next 10-15 years.
Is there a catch?
Maybe. It's a unique business model. Afterpay will lend to you, fee-free, and make the merchant pay for the privilege (say what?). Then there is the consumer credit aspect of the deal. Afterpay's average transaction size is around $150 according to its half-yearly report.
Afterpay is lending to people who cannot afford to spend $150 in one transaction.
Hey, we all run short of cash, and the credit card is practically a national fixture. Yet to my way of thinking, are Afterpay's customers the type of customer that people (shareholders) should be queuing up to lend money to?
What's also surprising is that loss levels with these customers are very low, running at less than 1%. Other types of consumer credit providers typically experience delinquencies (people behind in their repayments) of more like 8%.
Two possibilities jump to mind. One is the reciprocity principle. I imagine that receiving something for nothing and being trusted to repay it could lead to more conscientious behaviour among borrowers. With no fees for customers, it's possible that customers feel more obliged to repay. Contrast this with credit cards, where nobody thinks twice about just paying the minimum and pushing back the repayment date.
The other possibility is that the repayment time (2 months) is short enough (and aligned with fortnightly pay cycles) that people don't get into financial trouble the way they do with credit cards, which can accumulate into a big debt. Alternatively, customers could use multiple Afterpay purchases and just keep pushing the repayments out into the future, not unlike a credit card. It's interesting because consumers pay no fees for this service – they can do whatever they like. Merchants pay for the service, and Afterpay takes all the risk.
There's nothing inherently wrong with this as a business model. Australia lives on credit and consumers are a lucrative source of business for lenders of all stripes. Plus, Afterpay is an interesting business and it's not hard to see how the concept adds value to both customers and retailers. Even so, I'd want to investigate a few more things, like the likely impact of competition on fees, and explore why delinquencies are so low before considering a purchase.
