Why I bought AfterPay Touch shares in December 2018

Will the AfterPay Touch Group Ltd (ASX:APT) share price rise in 2019?

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I must admit to starting virtually no new positions on the ASX in 2018 because while some quality businesses such as Reliance Worldwide (ASX: RWC), Dulux Group (ASX: DLX), or Nanosonics Ltd (ASX: NAN) have interested me to some extent, I've preferred to look to the U.S. market over the past year due to the better growth, company quality, and valuations on offer.

In the U.S. tech companies such as Alteryx, Twilio, or MongoDB have doubled or tripled in value in 2018 on the back of some exceptional growth and nice competitive positions, and you won't find that on the local market.

Or will you?

One exception to the rule might be buy-now-pay-later start-up AfterPay Touch Group Ltd (ASX: APT) that is posting strong growth with a potentially long runway ahead of it.

I blundered in ignoring Afterpay in 2017 even after speaking to its engaging CEO Nick Molnar a couple of times about the group's growth, strengths and an (admittedly) embarrassing editorial error made by The Motley Fool.

Faith in management is one essential ingredient of an investment thesis and I used a decent pullback in the stock over December 2018 to buy what is admittedly a small position.

However, I may add to it as the main attraction to the business for me is its impressive start to life in the giant U.S. retail market.

At first I was sceptical that a small start-up from Sydney could find the staff, resources and roadmap to make serious inroads into the US market, but perhaps the product offering of lifting retailers' sales in exchange for a small fee is so compelling it pretty much sells itself.

The rise of AfterPay in Australia has also been fuelled by a prisoners'-dilemma-style-network-effect whereby retailers feel they have no choice but to use it as otherwise competitors may get ahead in terms of market share.

In the U.S at the end of October 2018 AfterPay reported it has signed up more than 900 retailers, with 1,300 more in the "pipeline".

It had 300,000 consumers using the platform and had processed A$115 million worth of sales. It's also gaining traction on popular millennial social media channels such as Instagram (think Kim Kardashian) and Facebook, which all suggests it could win in the U.S. market too.

However, AfterPay remains a high-risk investment as it has reported that net transaction losses are higher so far in the U.S., with an FY 2019 A$20 million EBITDA (operating income) loss in the region also expected.

Adding to the risk is AfterPay's push into the UK market. Again, this will stretch its human resources, although it reports the launch is going to plan with expectations for an EBITDA loss in the region of 50%-70% of the $20 million clocked in the U.S.

AfterPay is entering the UK market via the acquisition of ClearPay Finance (in exchange for 100 million AfterPay shares) from FTSE AIM-listed ThinkSmart. When the deal was announced on August 23 AfterPay shares were changing hands for more than $18, compared to $12.35 today.

Unfortunately, it appears AfterPay's UK push may be ill-timed (high share price aside) given the diabolical retail environment in the Brexit-hit country, with sales described as the worst in 9 years since the GFC.

Recently, the CEO of leading UK retailer Sports Direct even described conditions in a November trading update as the "worst on record, unbelievably bad", which suggests AfterPay may face an uphill battle for now at least in the UK.

Should you buy?

In compensation for investors the stock has fallen from above $18 in August to $12.20 today, although I'd caution it remains vulnerable to greater regulation and a spending downturn in Australia in 2019 due to falling house prices or weaker macro-conditions.

Many millennial consumers also have personal finance strategies along the lines of paying off the student loan with the credit card while 'After-paying' new jeans, which adds to the business model's vulnerability if weaker economic conditions do emerge in Australia.

AfterPay also reported a $9.6 million loss in FY 2018 and has a lot of investment ahead of it given the international expansion plans, therefore I wouldn't allocate more than 1%-2% of investment funds to shares.

However, it looks one of the few good tech bets on the local market given its opportunity in the U.S. alone.

Motley Fool contributor Tom Richardson owns shares of AFTERPAY, TWILIO, ALTERYX, MONGODB and FACEBOOK. The Motley Fool Australia owns shares of and has recommended Nanosonics Limited. The Motley Fool Australia owns shares of AFTERPAY T FPO. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. This article contains general investment advice only (under AFSL 400691). Authorised by Scott Phillips.

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