Description

While shorting anything with topline growth has been a fool’s errand in the post-COVID bubble we believe that Affirm (AFRM) is one of the most stark business model mischaracterizations in the market right now.  We are short and have a $30 price target, approximately 75% below the current price of $122, based on the following thesis:

• AFRM has high exposure to subprime consumer credit, per their securitization docs, almost ⅓ of their interest bearing loan book has a FICO of <650 

• Sell side initiations rolled out today, when reading through Truist (41 pages), Goldman (21 pages), and Credit Suisse (78 pages) the word “subprime” comes up exactly zero times 

• The “sweet spot” for Buy Now Pay Later (BNPL) on the prime end where the merchant funds the economics is likely much smaller than the market thinks and should shrink as the merchants realize the inefficiencies of this spend

• Peloton is a 30% customer and they accounted for about 45% of AFRM’s growth in 2020, not only that but they pay AFRM a 12.5% coupon to underwrite their bikes which is more than double what other merchants are paying, all this leaves AFRM very exposed to a vaccine/WFH unwind as PTON faces very difficult comps

• Competition in BNPL is heating up, along with Afterpay, AFRM, and Klarna, PayPal/Visa/Mastercard/Synchrony/Progressive are all coming to the market w/offerings

• AFRM claims to have a secret sauce in their form of their AI algos which has allowed them to see charge offs decline throughout 2020, but looking at any consumer credit business it is obvious that this is an industry wide phenomena as stimulus checks have allowed consumers to pay down debt or increase savings 

• AFRM trades at 33x 2022 sales, while crazy on an absolute basis its also much more expensive than the other BNPL players, AfterPay at 16x sales, Katapult at 2x sales

Consumers have finite spending power, this hasn’t changed in centuries, so finding a new platform to extend them credit on isn’t revolutionary or “a better mousetrap”, nor will it be immune from competition or credit cycles which cause most consumer lending businesses to trade a single digit P/Es.  While AFRM has a better platform to grow off of, the business model is actually most similar to GreenSky (GSKY) when you track how a dollar actually moves through the process, funding sources, interest rate risk, etc...Due to the high growth nature of the business and it’s high profile partnerships (notably SHOP)we think it can trade at 7x sales, or $30, but wouldn’t be surprised to see it trade lower than that over time as the gravity of consumer lending exerts itself.

Brief Business Overview

Affirm’s e-commerce based payment solution allows consumers to pay for purchases over time in fixed amounts. When consumers proceed to the checkout page of their online cart they will be presented with an option to pay with Affirm next to standard credit/debit/loyalty options.  Consumers are offered either true 0% APR payment options (46% of GMV), or interest-bearing loans(54% of GMV). The company has more than 6.2M consumers and  6,500 merchants on the company's platform.   Gross merchandise volume (GMV) is ~$10.7B with ~64% of loans taken on by repeat customers.  Revenues come from two main sources: Merchant Network (50% of revs), and Interest (37% of revs). Merchant Network revenue is derived from a merchant discount fee paid by the merchant, typically 5-6% of the transaction value. Interest income is generated from consumer payments on their interest bearing loans portfolio, the average rate is 25%.  Due to the low penetration of online installment financing, COVID tailwinds to e-commerce spending, and PTON’s success business at AFRM has been white hot with revenues growing over 60% in 2020.

Subprime Exposure

• The company stresses that it doesn’t like to talk about FICO scores and considers them to be a poor indicator of credit quality, but, for those that do here are the table from their most recent securitization:

• The tables are self explanatory, about ⅓ of the interest bearing loans are subprime with an avg APR of 25%+

• The only difference between using this and a generic credit card is AFRM has decided to be less aggressive in chasing bad accounts, citing “investment in customer goodwill”

Peloton Customer Risk

• PTON makes up 30% of revenue, this alone would be a material risk but in AFRM’s case it seems to be an even larger potential problem 

• Only a handful of businesses have been a bigger benefactor of COVID than PTON, you can have your own view here but ours is that it comps negatively in 2022 and AFRM doesn’t have the ongoing subscriber revenue stream to fall back on

• PTON pays AFRM a 12.5% merchant discount rate on all sales, this is 2x the average that other merchants pay (can be backed up by AfterPay’s 5% take rate) so $1 of PTON revenue lost is doubly as painful as any other customer

• PTON also announced on it’s last earnings call that to mend customer relations it would be moving payment timing from checkout to closer when the product is delivered.  If you’re a subprime customer you likely don’t care, but if you’re a prime customer and you were sitting there saying “Well, I’m not getting the bike for 2-3 months, might as well take the free financing in meantime, right?” you might reconsider if you don’t have to float the charge for more than a week or two…

• From the PTON earnings call: “In the US, we have already begun to rollout delayed payment capture to a portion of our customers, which means we are adjusting our transaction process to collect payment closer to the time of delivery rather than at the time of sale.”

“We expect to finish our global rollout of delayed payment capture in Q4 of this fiscal year.”

Competition

• Right now the main players are Klarna, AfterPay, Affirm, and Katapult but everyone in the industry will be coming to market with their own product….the nuts and bolts simply aren’t that different from any other credit decisioning process

• Paypal:

https://newsroom.paypal-corp.com/2020-08-31-PayPal-Introduces-New-Interest-Free-Buy-Now-Pay-Later-Installment-Solution

• Visa: https://www.pymnts.com/digital-payments/2020/visa-launches-visa-installments-pilots-in-the-us/ 

• Mastercard:

https://www.paymentssource.com/news/mastercard-tsys-partner-in-buy-now-pay-later-deal

• And the list goes on, I would imagine Square won’t stand still either

Industry Loss Rates

• One of AFRM’s key pitches is it’s AI algo for credit decisioning that outperforms the industry across different FICO scores, however, it doesn’t take more than a glance to see that the industry overall has experienced a credit quality windfall in 2020 due to stimulus checks allowing consumers to clean up their personal balance sheets.  However, this is likely something that turns into a headwind sometime in 2H 2021 or 1H 2022

• Below is the three year 30 day delinquencies chart:

Conclusion

AFRM has done a great job getting a foothold into the online consumer credit business, but in our eyes, it’s nothing more than a new spin on a very old business.  Traditional players will have no trouble duplicating the model, an example would be the installment lender Progressive who will roll out it’s POS solution for large retailers like BBY/LOW fully online by 2H 2021, the products will look identical.  Typically these businesses get a single digit P/E or 1-3x sales, a far cry from AFRM’s 33x sales.  As PTON momentum fades and competitive offerings roll out AFRM’s multiple should be drawn back down to levels typically assigned to consumer credit businesses.

Catalyst

-IPO lockup

-PTON slowing

-momo unwind