Investors in the buy now, pay later (BNPL) sector have continued to be pummelled since the announcement of the Afterpay-Square merger with share prices across the sector on average down ~65%1.
I was recently asked how I think things might play out.
It has become clear to me that the trend towards BNPL and away from revolving credit has stuck. Consumers, some of whom might not traditionally have received credit so frictionlessly, have enjoyed the last couple of years of intense competition between the many dozens of players. The sector is here to stay, at least for the foreseeable future.
But investor sentiment for BNPL has clearly turned and the path forward will be bumpy. Stand-alone capital raises to support working capital and to pursue the ‘Afterpay version 2.0’ dream will be near impossible to achieve in current market conditions.
What do I expect to see?
As with most start-ups where things haven’t gone perfectly to plan, companies and their Boards are turning attention to risk, cash burn and operating runway.
Take for example the recent Zip acquisition of Sezzle. That deal was announced at a modest premium of 22%, particularly when compared to Afterpay-Square which priced at a 30% premium and the Latitude- Humm deal that implied a premium of 50%.
Sezzle’s willingness to accept a relatively modest premium is in part explained by the voracious consumption of capital. Read the January 2022 financials and Sezzle consumed around US$40m in the prior quarter, with ~US$80m cash left on the balance sheet. Without a change in direction or strategy, my eight-year-old can confidently predict out how that story ends.
I’ve run similar analysis across the sector and think listed BNPLs currently have a median cash runway of between two to three quarters. But the spread is wide. For example, one company has approx. one quarter of runway while at the other end there are some well-funded players with over 30 quarters.
With the near constant debate about the sector over the last couple of years, the default view has emerged that consolidation must one day occur. While I broadly agree with that view, I doubt Zip, Latitude or Block are planning a classic roll-up strategy with the multitude of smaller players left in space.
Three strategic options
Rather, I expect the smaller players to deploy the following strategies in coming months:
1. Shrink to greatness strategy
This means amputating the most capital intense businesses and consolidating operations around a tight, and hopefully sustainable core operation.
We are already starting to see this happen.
Take for example Openpay’s announcement in their first half FY22 results presentation: “Openpay has decided to materially reduce its origination and physical presence in the UK market.”
This strategy works to extend the operating runway and gives the company more negotiating leverage if they become a target.
2. Friend a friend strategy
This is the classic textbook move to get scale, unlock synergies, and find a wider shareholder base to support the ongoing burn.
The preference will likely be for all-script deals with an accompanying cash call. I expect to see combinations between companies in adjacent verticals like BNPL mergers with consumer lending or payment companies.
3. Deeply Discounted Rights Issue strategy
When timing goes right to the wire then expect a deeply discounted rights issue to “encourage” the existing shareholders to support the business or face being heavily diluted.
In the game of chess, the ‘end game’ is defined as the stage when few players are left on the board. But the line between the middlegame and endgame is often not clear. Having observed the BNPL sector over recent years, my feeling is we are now quickly approaching that line.
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