The once highly publicized fintech concept BNPL (Buy Now, Pay Later) has suddenly lost investor interest. Affirm Assets (NASDAQ: AFRM) was the poster child for the over hyped concept and now the stock has crashed due to concerns about higher costs and limited profits. My investment thesis is more neutral on the stock as competitive pressures are likely to fade here, but the stock has already rallied strongly off the lows.
No lack of growth
Although the BNPL concept is not actually new, Affirm went public in early 2021 and was quickly assessed as a fintech opening up a new financial concept. Surprisingly, the stock’s IPO was $49 and eventually soared above $170 late last year as e-commerce demand soared and the company recruited a whole host of new online retailers. The stock is now below the IPO price after a year of very strong growth.
Affirm operates the type of business out of favor with the market right now. The fintech produced an acceleration in loan volumes during the third quarter of 2022, represented by a 73% growth in GMV, followed by a slower revenue growth at only 54% during the quarter, followed by net income even slower (revenue less transaction costs) growing only 37% to just $182.4 million. .
At the top, Affirm was valued at a market capitalization of nearly $50 billion, but the company doesn’t even generate $200 million in quarterly net revenue after signing deals with the top 2 online retail platforms. While Affirm likes to focus primarily on revenue metrics growth, the company has a problem with very high expenses, which highlights the main concern about the Amazon (AMZN) agreement originally.
As shown below, transaction costs include provisions for credit losses, funding costs, and loan processing and servicing fees. Affirm spends approximately 50% of its revenue on transaction costs on a quarterly basis. In Q3’22, revenue was $354.8 million and transaction costs were $172.3 million, or 49% of revenue.
Investors should understand that either Affirm is a relatively low gross margin business or the company has low adjusted net earnings. Fintech doesn’t spend a lot of time discussing the actual operating expenses of the business.
For the March quarter, operating expenses were $409.0 million. Sales and marketing spend soared nearly $100 million from a year ago to $156.2 million, an indication of the costs of attracting customers to platforms like Amazon and Shopify (STORE). While most of these costs are attributed to stock-based compensation expense and warrant costs, the numbers reflect the impact on the diluted share count. Non-GAAP operating expenses drop from nearly $220m to just ~$180xm excluding these costs, but these expenses are still very important to the valuation of a fintech company offering online lending .
Affirm achieved a massive increase in the number of active merchants, from 12,000 last FQ3 to 207,000 last quarter, but the earnings picture did not improve in the process. The stock slumped in a bid to only reach adjusted operating profit by July 1, 2023.
Dead cat bounce
Many battered stocks like Affirm have risen significantly from the lows, which has reduced the appeal of continuing the stock here. The stock has a listed market capitalization of $7.5 billion based on a listed stock count of 290 million shares.
In reality, Affirm has substantial dilution ahead due in part to Amazon’s tenure as well as other stock options and restricted stock units. The company has the potential for more than 50 million additional diluted shares, adding another $1.3 billion to the eventual valuation, although a large number of potential shares like the 15 million warrants of Amazon are not exercisable until stock prices are significantly higher.
Since Affirm doesn’t forecast much profit for years, the stock remains a P/S story. The stock is much better value here at 4x forward sales, although it should be remembered that actual net earnings are about half of current FY23 earnings estimates of $1.9 billion.
The stock has likely already rebounded for this cycle given the big uptick in Amazon and Shopify deals that are priced into FY23 guidance. Affirm is not even expected to reach annualized adjusted operating profit levels until the end of the next fiscal year.
The key takeaway from investors is that Affirm has already rebounded nearly 100% off recent lows. The BNPL product has a questionable business model due to Affirm’s high cost structure to offer the solution online.
Investors shouldn’t chase the stock here despite the fact that Affirm is still trading well below the IPO price.