Buy now, gain later: Afterpay or Zip?

Patrick Poke

Livewire Markets

Afterpay’s announcement of a capital raise of up to $1.5 billion may seem huge, but it’s unlikely to be the last big cap raise in the Buy Now Pay Later sector. When you’re in the business of lending, high growth means high capital requirements, and the growth for Afterpay and Zip has been nothing short of astronomical. Both companies recently released results, with Afterpay’s income rising by 108% while Zip’s jumped 131% compared to the prior corresponding period.

Following the results, I got in touch with Dean Fergie from Cyan Investment Management and Jun Bei Liu from Tribeca Investment Partners to get their views on the two companies. We discuss the Afterpay capital raising and its significance for shareholders, the most important points from each company’s result, and they each tell us which of the two companies they’d prefer to own.

The results

With both Afterpay and Zip beating expectations, you'd think the share price would be skyrocketing today. But, no. Today (Friday the 26th) Afterpay is down over 13% whilst Zip is down over 7% (though this was on a major down-day for the markets). Afterpay's earnings were impressive though says Dean: 

"All the metrics that you want to see going in the right direction are, and bad debts too. So I think across the board, it was a really excellent set of numbers, but again, given the significant growth expectations that are built into the valuation at the moment.

Similarly, Jun Bei sung praises for Zip, explaining that the drop in share price that we've seen over the last few days can be attributed to the market's expectations. 

"The reason the share price was down yesterday, and this is not company specific, it's more about the fact that the result was in line with expectations, or just slightly better, rather than beating them... in my view, you have to look at the last couple of months, in terms of performance. The buy now pay later sector has performed very, very well. If you look at Zip in the last month, it's done incredibly well. So I don't see that sell off as changing the trend, it's simply a bit of a profit taking after very, very strong performance."

But one consideration that defines the BNPL space is valuation. The companies within this sector, Afterpay and Zip being only two in a multi-billion industry, are not profitable. For Afterpay to meet its current valuation, Dean believes that they likely need to (eventually) earn $2 billion after tax.  Currently, their NPAT (Net profit after tax) is $-7.8 million. This means, for the valuation to be met, investors are sitting in a five to seven-year waiting room. 

"With regard to Zip, and I would say this with Afterpay to potentially a lesser extent, it's really hard to see even a medium to long-term path that is going to justify their current valuations. They're so far off that it's really hard to see them ever getting there."

Dean says this is a factor that is consistently missed by investors who continue to pour money into the juggernaut. 

How much room is there to grow? 

Investors were shocked with the news of Afterpay's capital raising, and left with their jaws dropped when the company put out their hands asking for a whopping $1.5 billion. On reporting day, UBS issued a comment: 

"Cumulatively Afterpay has now raised $2 billion in capital since last July. We believe this vindicates our view that the market continues to misprice or ignore how much capital is required to fund Afterpay's growth."

The question is then raised (excuse the pun) - how expensive is growth and are investors failing to understand the amount of capital required for the business to grow? Jun Bei says investors should not be scared of a capital raising. 

"The reason that they need to raise money is because they are growing." 

Five years ago, the buy now pay later was in its early stages of infancy. In those five years, the space has seen remarkable growth from global penetration to consumer dependency. To continue to grow at these levels, and continue to expand into markets like Europe, Asia and South America, investors need to fuel the fire and the way to do that is a capital raising. 

"We are still at the very early stage of the innovation of this product. This is a growth company so you have to capitalise on the opportunity. Should the market become mature, you will see your investment come through very quickly."

Dean similarly warned investors that a capital raising should not be viewed as a red flag. Instead, he encourages investors to think of it as a financially sensible decision for a company in their early stages to raise their capital upfront.

He also believes that investors underappreciate the efficient way in which Afterpay, in particular, is able to recycle capital. As money is paid back, it can then be lent to other users, allowing the same capital to be lent and paid back 8-12 times per year.

"The modest amounts of new capital they're acquiring in order to get massive growth in GMV signifies the attraction in terms of the velocity of capital, how quickly they're turning over their capital. I think that's a point that has been lost on a lot of bearish investors for the whole journey of Afterpay."

Too many players in the game 

Afterpay and Zip are just two of the seven Australian players in the buy now pay later space. While Afterpay is leaps and bounds ahead of the next player with a market cap of $34 billion, the sector has often been deemed as crowded. Zip, who's got the silver spot on the podium, has a market cap of $5.7 billion. For a game that doesn't make profit, surely there are too many players? 

Not according to Jun Bei who believes that the market is underestimating how large this space really is. 

"We're talking about a global payments space - this is trillions of dollars and we're very early in the market. Normally you see the top company or top two that takes the market share. However, this market is just enormous."

Whilst both companies struggle with high valuations, Jun Bei is confident that as they begin to penetrate more markets including the US, Asia, Canada and the UK, they will attain better brand recognition and investors will be met with high returns on capital. 

Afterpay vs Zip

The battle of the buy now pay later giants is far from over. With growth in the pipeline and investors lining up to cut a slice of success, both Dean Fergie and Jun Bei Liu recognise the opportunity that is just waiting to be scooped up by investors. 

We asked the experts one question that they both answered without hesitation - if you could only own shares in either Zip or Afterpay, which one would it be? Unanimously, Afterpay was deemed the winner. 

"Despite the valuation gap, I'd own Afterpay every day of the week. There's the first player, then there's daylight and then there's the second player." - Dean Fergie

Jun Bei echoed Fergie's sentiments, claiming that whilst she is a big fan of Zip, Afterpay has executed on their strategy impeccably and it therefore is deserving of the top spot. 

We would love to hear what you think. Let us know in the comment section below - will Afterpay's monster moves just keep on punching the skies, or will Zip, the pocket rocket in second spot climb higher than the market leader? 

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Throughout February, my colleagues Bella KidmanGlenn Freeman, Mia Kwok and Angus Kennedy will also publish similar Q&As on Livewire readers' most-tipped big caps and small caps. Hit FOLLOW on our profiles to be notified when these wires are published.

Thanks to Bella Kidman for assisting with this article.

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Patrick Poke
Managing Editor
Livewire Markets

Patrick was one of Livewire’s first employees, joining in 2015 after nearly a decade working in insurance, superannuation, and retail banking. He is passionate about investing, with a particular interest in Australian small-caps.

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