Fintech Finance: A success story with a weakness

The team at Projects RH works with a number of tech and Fintech companies as they head on their journey. It is critical that each of these companies has a sound business model and wise people involved to ensure that they head in a sensible direction.

Afterpay has been an incredible success story and a market leader with many companies who have emulated its business model. What has happened is that its business model has been found to be flawed. It is not that the whole buy now / pay later is wrong but rather it needs, not only controls to protect consumers, but also shareholders.  

The story of Afterpay suggests a failure of the business model when applied at scale and when sales targets became the key goal. What has been seen is that its credit process has been found wanting. Other buy now / pay later models have a different performance and may not have had the same rate of growth of sales but they are not seeing the same level of under performing loans.

Introduction

Afterpay was the darling of the stock market and the company we all wished we had invested in when it was chasing money from the early-stage venture capital funds and from individuals. Last year it was acquired by Square from the United States for $39 billion this was front-page news. Square subsequently became renamed as Block. [1]

Afterpay’s business model is based on the consumer paying same price for the good cash credit card or with its product. Clearly the retailer must pay the cost of its product. Retailers must consider that cost which I considered to be exorbitant to be fair, as from dentist to dress shops after pay is widely accepted.

The kicker for after pay has always been in late fees. These by most standards are high but the problem lies in those who do not pay.  The level of bad debt Is expected from all credit providers, the question is, managing this and effectively credit selection needs to occur at the time of sale.

Why Now

Afterpay has recently reported a total income of $645m and a loss of $345million after being dragged into writing down late fees and writing off loans. Its income from late fees was only $79 million.

The level of this write off is far more than expected with this cost of business having increased by 65% and that’s levels of bad debts up by 70%.

The problem is its level of bad debts, not underperforming loans, was 13.1% of revenue. It is far greater than expectation but as a function of the business model. The consumer market concern is Afterpay budgets to make most of its profits underperforming loans but expects that they would be the source of profit as people struggle to repay their loans.

The Moral

It is not my place to be judgmental on the business model, but to express concern that management clearly were not monitoring the underperformance of debt and actually managing it. At Projects RH we work with a number of Fintechs and it is refreshing to see that a key part of what they do is have highly complex algorithms that would actually tell them how the business is performing well before the accountants do.

There is concern and allegations that the level of bad debts is understated and under provision for. This is for others to opine upon.

What is clear however is that cash strapped consumers with little credit checking could buy shop “gift cards” which enabled them to purchase the necessities of life now with no or little likelihood that they would be able to repay in a timely manner.

Conclusion

In the classics they say all that glitters is not gold. What we are seeing in Fintech finance is that rapid growth alone will not compensate for a product which relies on consumer failure to achieve its profit goals.

Investors may be correct when they suggest the Block paid too much for Afterpay and that mass rollout in the United States where it already has 44 million monthly consumers may have issues yet to come.

For investors it also may be an important lesson that they should apply portfolio theory to their selection of assets.

See you next time.

Paul Raftery – CEO, Projects RH, based in Sydney. 21^th April, 2022

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[1]  De Krester,  A and Shapiro, J.; Costs, bad debts push Afterpay loss to $345m – Financial Review, 4/13/2022