Start profiting now from the surging “buy now pay later” financial subsector

“Buy now, pay later” services are expanding exponentially, driven largely by demographic and social trends. The big payments providers are already paying attention. So should you, says Stephen Connolly

Make a purchase online these days and the chances are that at the checkout you will be given the option to pay in instalments, often interest-free. The option to buy now and pay later – or “BNPL” – is proving a hit with consumers and retailers. BNPL spending quadrupled to $99bn in the US this year alone and is expected to exceed $1trn worldwide in just four years’ time, according to Bloomberg. No wonder, then, that technology start-ups such as Klarna and Clearpay have been in a frenzy to grab market share. BNPL could be another way for investors to cash in on the ever-evolving boom in e-commerce.

The way it works is relatively simple, which is why it is so popular. Retailers sign a deal to let a BNPL provider appear at their check-out offering its service. If the consumer takes this up, the purchase is made and the retailer gets its money for the full amount, minus a transaction fee, from the BNPL service. 

The retailer is now largely out of the picture and the buyer settles with the BNPL service, typically via equal instalments spread over a few months. A big attraction for the consumer compared with using a credit card is that there is typically no interest due, which perhaps makes it feel less like a debt; the BNPL provider is paid via its fee from the retailer.

Of course, no-one wants to pay interest. But this difference, which appears to be benefiting BNPL at the expense of more established routes to finance, such as credit cards and bank loans, highlights how changes in the global population, and consequently social attitudes, are disrupting so many established sectors. Consider that around two-thirds of US internet users are either millennials or members of Generation Z, according to market-research group eMarketer: everyone aged between ten and 40. At the same time, about half the global population is under 30. 

We live in an increasingly youthful world and surveys show that among the younger population there is a mistrust of the mainstream and a preference for alternatives in areas ranging from cryptocurrencies to naturally sourced products. Previous financial crises have made the under-40s wary of the shackles of debt and interest. BNPL, with its quick, interest-free repayments, ticks the box as something of a halfway house between living debt-free and turning to traditional lenders.

A burgeoning market

Forecasts from RBC Capital Markets underline the trend. It expects annual compound growth of 4% in the use of credit cards between 2019 and 2023. The use of digital wallets, which can include new payment-technology such as Google Pay and Apple Pay, is expected to rise by 18% a year. But for BNPL, the predicted annual growth rate is 28%.

These shifts in consumers’ preferences as society changes are profound. BNPL will grow, underpinned by the practical reality that retailers have no choice but to get these providers onto their shopping-platform checkouts. Surveys support this conclusion. Over nine million people in the UK alone, for example, said earlier this year that they would not use retailers without a BNPL option for buying goods, according to personal-finance specialist Finder UK. 

Investors, meanwhile, are becoming more at home with the concept. Take US-based Affirm Holdings (Nasdaq: AFRM). It only came to the market in January this year and after an initial uptick the shares languished. Shareholders were unconvinced by the overall BNPL idea and noted that the group derived more than a quarter of its sales from Peloton, the maker of home-exercise equipment that flourished during lockdowns when gyms were shut.

The turning point for the shares came this summer. First we heard that Amazon would offer its customers Affirm’s BNPL service, which spurred a strong rally in the stock. In September, the company produced highly optimistic forecasts for future sales, which propelled the shares sharply higher again. The stock is now testing $160, up from lows of $60 in spring. If Warren Buffett’s mentor Benjamin Graham was right to describe the stockmarket as a voting machine, then it’s a big thumbs-up so far from investors.

Nevertheless, questions about the BNPL sector’s business models and their sustainability remain. There are inevitable pressures from the costs of expanding while competing with others determined to win in such a fast-growing market. Potential bad debts as a consequence of the race to acquire new customers are a concern. And hand in hand with success and a higher profile comes regulatory scrutiny over protection for consumers, which could prove burdensome in future.

Share-price gains for the likes of Affirm, alongside private fundraisings such as for Klarna earlier this year, imply few difficulties raising capital. So BNPL firms can keep expanding. Their worth for now is determined more by the economic footprint they can build through their partnerships with large and well-established retailers and the take-up of their associated apps and products.

When it comes to bad debts, analysts argue that whereas some people got into financial trouble with “plastic” due to minimal monthly repayments alongside eye-popping interest rates, BNPL is different: it typically covers short periods, while the equal repayment amounts are straightforward and will clear the debt with no interest. How they determine how much a customer can afford is being examined by governments. 

We probably won’t know how successful they are at assessing creditworthiness until the completion of a full economic cycle. The past few years have been a relatively benign period for credit. Advanced algorithms and artificial intelligence are said to help lenders make better judgements but, again, time will tell. In the meantime, regulation is gradually being implemented, with a consultation in the UK under way until January next year. 

A key issue for regulators is that BNPL is “low-friction”: getting credit is too easy, with little delay to allow for consumers to reflect on whether borrowing the money is sensible. Moreover, consumers could easily overextend themselves in the confusion over a variety of loans from different BNPL providers.

The big names are showing interest 

What we can say with greater certainty is that despite concerns, the overall growth numbers for the industry make it inevitable that bigger, more-established players will be drawn into the market, leading to consolidation. BNPL still only represents about 2%-3% of e-commerce sales in the US, for example, so there is a huge, open and fast-growing market to play for. Giants such as Apple are reportedly working with Goldman Sachs, while dominant card processors Visa and Mastercard, as well as leading fintech disrupters such as PayPal, are involved. The big banks will look to use their financial clout and strong presence with consumers to force their way in.

How can investors get on board? For those who like risk, some of the newest entrants are publicly quoted and so it is possible to go right to the coal face with relatively young businesses. Affirm is a buy. It is expanding and if it can keep up the pace with the partnerships it is establishing, such as the one with Amazon, then it looks set fair for the long haul.

Another provider to consider is Square (Nasdaq: SQ), a slightly broader payments service that recently bought BNPL provider Afterpay in a $29bn deal. The purchase makes it a market leader with significant opportunities ahead. Again, more broadly, PayPal (Nasdaq: PYPL) is establishing itself in the BNPL sector with its own offering, which it has been bolstering through acquisitions and regional expansion. PayPal’s existing payments business, meanwhile, produces considerable free cash flow, giving it the firepower to keep expanding its platforms. 

PayPal’s shares have lagged the overall market this year and they recently came under pressure due to talk that it was interested in buying the social-sharing site Pinterest to expand its reach among consumers. Investors disapproved and the stock took a tumble. But there’s now no deal in hand for Pinterest and with the shares yet to recover this weakness is a good chance for long-term investors to buy in.

Finally, for those who like the theme but don’t want the risk of individual stocks, the best route is a broad-based, actively managed financial technology (fintech) fund. Not only will this capture growth in BNPL, but it will also capitalise on other developments in e-commerce and financial services, giving you a broader foothold in the e-commerce boom.

One to consider is the Robeco FinTech Fund, a £1.3bn fund with ongoing charges of just under 1% annually. With a strong tilt towards the US, it includes innovators such as PayPal as well as long-established growth stocks, including Visa. The fund returned 12.8% in the first nine months of 2021. Since it was created at the start of 2018 it has delivered a return of 16.9% a year, a substantial premium to the 11% from global equities generally.

Stephen Connolly writes on finance and business, and has worked in investment banking and asset management for nearly 30 years (sc@plainmoney.co.uk)

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