Square's Deal for Afterpay Is a Hit. Why Affirm Could Be Next. - Barron's

Afterpay launched its services in Australia.

Courtesy Afterpay

Investors appear to love  Square ‘s deal to acquire the buy now, pay later company Afterpay, sending both stocks—and shares of rival Affirm—sharply higher.

Square (ticker: SQ) announced the deal for the Australian company on Sunday, saying it planned to pay $29 billion in an all-stock transaction. Shares of Afterpay jumped 20% on the Australian market, and the company’s American depositary receipts soared 35% to $95 in early U.S. trading.

Square stock rose 10% to $273, partly because of the deal news. The company also released second-quarter results that generally topped Wall Street forecasts.

The deal is also lifting other stocks in the buy-now-pay later or BNPL space. Notably, Affirm (AFRM) leapt 14% to $64 as investors speculated it could be the next acquisition target.

Afterpay pioneered BNPL services in Australia, where it has become a popular way to pay for individual items in travel, fashion, and other sectors. Afterpay then expanded t to Europe and the U.S.

Consumers who use it can pay for goods in customized monthly installment plans, typically at zero-percent interest for the first four months.

BNPL is gaining popularity given that interest rates are ultralow, reducing costs for consumers. Other fintech apps have entered the market, including Affirm, a pure play on the sector, and PayPal (PYPL). Apple (AAPL) is also developing a BNPL service with Goldman Sachs Group (GS), its credit-card partner, according to recent media reports.

Square aims to integrate Afterpay into its Cash and Seller apps, linking the service for consumers and merchants. The deal should make it possible for small merchants in Square’s network to offer BNPL purchases. It will also expand Square’s global presence, given that BNPL has gained popularity in Europe, along with Afterpay’s home market of Australia.

While the $29 billion price looks steep, Square says the deal will be accretive to growth in gross profits, though it will result in a small decline in adjusted operating margins in the year after the transaction closes, based on earnings before interest, taxes, depreciation, and amortization, or Ebitda.

Wall Street’s early take on the deal was positive. The combined company advances the “holy grail” for Square: becoming a scaled-up two-sided network, linking the Cash App for consumers and Seller for merchants, wrote MoffettNathanson analyst Lisa Ellis. “Overall, we view the Afterpay acquisition as strategically compelling for Square,” she said.

Ellis isn’t deterred by the $29 billion price. It gives Afterpay an enterprise value of 35 times gross profit for the next 12 months, she estimated. That is above the 27 multiple for Square and is slightly higher than Affirm’s multiple of 32, though the payment processor Adyen (ADYEY) is at 58 times, she noted.

Mizuho’s Dan Dolev also praised the deal, writing that it moves Square further into the $10 trillion global online payment market and should lift gross revenue for the company. He said it would add $32 in average revenue per user. While the price isn’t cheap, he wrote, the long term benefits “outweigh near-term valuation concerns.”

Dolev also sees the deal helping Square further its other ambitions: to develop payment systems in cryptocurrencies like Bitcoin and the broader ecosystem of decentralized finance on blockchain networks.

Bitcoin is already a huge sales driver for Square, which acts as a broker and custodian for the crypto. The company’s total revenue of $4.7 billion in the quarter was up 143% year over year. Without Bitcoin, the figure was up 87% at $2 billion.

“We believe Afterpay makes long-term fundamentals stronger, as SQ inches closer to becoming the JPM of the future,” he wrote, referring to JPMorgan Chase (JPM).

Still, BNPL stocks have been weak this year. Before the start of trading on Monday, Afterpay was down 17% and Affirm was off 42%. Square has also been a laggard, rising 7% versus a 12% gain for the Nasdaq Composit e index, not counting Monday’s moves.

Steep valuations have been a hurdle for BNPL and payment stocks. Also weighing on the sector are concerns that favorable market conditions—ultralow rates and a largely hands-off regulatory climate—may not last. Already, Afterpay has faced some regulatory pushback in Australia.

The Biden administration is likely to push for more consumer protections than the Republican administration of Donald Trump. And the Bank for International Settlements—a group of global central banks and regulators–has published a paper saying that fintechs should be regulated more like banks. According to a report in The Wall Street Journal, the paper argues that regulators need to look at the potential “spillover” of Big Tech on the financial sector, and that “specific safeguards” may be needed.

For now, the deal may kick off a wave of consolidation as other tech and financial companies aim to bulk up in BNPL. “Afterpay will help Cash App maintain and expand its role as a leading diversified digital bank/financial services “super app”, as that market consolidates,” wrote Ellis.

“This deal is a fairly strong signal to the market that what gets dismissed as a feature of existing payment systems is a category unto itself,” said a senior executive at a BNPL company.

BNPL can survive a bout of higher rates, he said, because merchants will continue to subsidize zero-percent short-term loans in order to keep driving top-line sales. And if credit-card rates go from 15% to 20%, consumers may be even more likely to opt for BNPL since zero-percent or even 5% for a few months will look more attractive.

BNPL still only accounts for 2% of the overall payments markets, the executive noted, leaving lots of room for growth.

Whether retailers and banking regulators sign off on that future remains to be seen.

Write to Daren Fonda at daren.fonda@barrons.com

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Square's Deal for Afterpay Is a Hit. Why Affirm Could Be Next. - Barron's
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