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One of the key reasons for KFC’s massive success has been its ’11 secret herbs and spices’. As the founder of Wendy’s explained, “everybody wants in on a secret.” The closely guarded secret recipe is securely held in a safe at the KFC headquarters to ensure it’s never leaked. Thankfully for us, the secrets to the success of stockmarket runaway, Afterpay, are not so closely guarded. But unlike the Colonel’s secret recipe, they’re difficult to reproduce.

In the second part of our series on Afterpay, I asked our three expert contributors to share their view on what’s been behind Afterpay’s incredible success over the last 3 years. Responses come from Dean Fergie, Cyan Investment Management; Michael Frazis, Frazis Capital Partners; and Emanuel Datt, Datt Capital.

Staggering performance supported by financial success

Dean Fergie, Cyan Investment Management

It’s important to reiterate that Afterpay (APT) is not simply a speculative stockmarket tearaway, its price performance since listing (a rare 30x bagger) is also supported by extraordinary financial success.

In FY17 APT earned a gross income of A$22m; two years later that figure was $250m. By comparison, it took JB HiFi - arguably one of Australia’s most successful bricks and mortar retailers - 13 years (from FY04 to FY17) to improve their gross income from $20m to $260m.

Three reasons for Afterpay's success:

  1. It’s highly scalable (and global) - there’s no coincidence that the cohort of “overvalued” WAAAX are all tech based - and global. In-demand technology can be deployed quickly, cheaply and cost-effectively such that rapid adoption and demand can be fulfilled.
  2. It’s has a product that offers obvious value: Afterpay has resonated with both consumers and retail merchants. Their payments platform has been a true win-win outcome where consumers enjoy interest free payment plans and retailers see an immediate uplift in sales. I’ve said this previously; a company has clearly made it when their name becomes a verb.
  3. The platform roll-out and execution has been impeccable. Barriers to entry are not high (behold the number of new competitors launching look alike products) but APT’s management have managed to absolutely brain their first mover advantage by signing up 4.6m customers and 32k merchants in 3 years. That is not luck.

Lots of talent and a little bit of luck

Michael Frazis, Frazis Capital Partners

There are a lot of little things that go into creating a hit, whether it’s a movie, a restaurant, or payment product, and it takes an extraordinary amount of talent and a little luck to get it all right.

Right from the start, users consistently said they loved it, which is quite an achievement for a method of payment. This is the most important attribute, in my opinion. Instead of going in all kinds of different lending directions, management had the discipline to stick to a single product and refine the message to perfection.

Secondly, it’s a fundamentally excellent lending business, perhaps one of the best. Afterpay lends small amounts, for very short periods of time, during which the credit is steadily repaid and de-risked. If you annualize the amount Afterpay charges merchants, they earn a higher lending rate than credit cards, for a fraction of the credit risk, in a way that doesn’t cost consumers a penny.

This is the fairest form of lending I’ve seen: almost everyone can borrow at first, and those that don’t pay are locked out forever (and the loan is not enforced). This is far more democratic than asking people to fill out silly forms with expense guestimates. It’s also the friendliest, coming with zero cost to consumers, and no way the loan can compound into a serious debt.

There’s one final key attribute – the merchant proposition. Merchants are willing to pay for Afterpay as Afterpay brings incremental sales, and they can easily track their contribution. To be honest, we didn’t predict this, but the data quickly spoke for itself. US and UK retailers can see the data from their Australian divisions, which no doubt helped make those country launches a success. As long as Afterpay drives incremental sales, and though their app, incremental web traffic, merchants will find the fees well worth paying.

Success has come on two fronts

Emanuel Datt, Datt Capital

The attributes that have made Afterpay so successful are numerous and can be viewed from both the customer and merchant perspective.

For customers, the ability to pay at their favourite merchants via four interest free instalments rather than in a single lump sum was and continues to be a big hit. The service is entirely free to customers so long as they comply with their repayment obligations.

For merchants, Afterpay has several benefits. Most immediate is that the choice of Afterpay as a payment option leads to material increases in customer basket size and conversion rate. Afterpay's online mall is also a proven demand driver for merchants and so a free source of incremental business.

In addition, Afterpay is available for a small extra cost to merchants relative to conventional electronic payment networks. Generally, merchants would pay merchant fees of anywhere between 1-3% of transaction value to process electronic payments such as credit and debit cards. Afterpay charges on average a 4% fee to the merchant which transfers the credit and chargeback risk to Afterpay.

A major factor for Afterpay's popularity is the fact that the service is entirely free for customers complying with the services terms and conditions. This means there is a very real switching cost to Afterpay customers who wish to try other competing services, none whom offer a service that is entirely cost free. This extends to bad players who are banned from the Afterpay system due to non-compliance.

In conclusion

Whether you're a consumer or a merchant, it's clear that Afterpay offers a strong value proposition. This provides incentives for merchants to use their system, despite the higher costs, and for consumers to ensure they pay their accounts on time. And as the great Charlie Munger once said,

“Show me the incentive and I will show you the outcome.”

Afterpay provides value to merchants and consumers, but is it good value for investors? Our three contributors share their view in the first part of this series.

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Comments

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Pete Poland

Save a share split I believe Afterpay will be a $100 per share within the next 3 to 5 years-wait, wait its coming!

Kim Jordan

From the git-go, it was a fabulous concept, executed brilliantly by the implementation team, and even with the copiers, it seems the enormous momentum, first-mover advantage, and the network effect are all working in concert.

Peter Ralph

“I think that, every time you see the word EBITDA, you should substitute the word ‘bullshit’ earnings.” Charlie Munger. If Charlie thinks that about EBITDA I think I can hazard at a fair guess about what he thinks about gross income. The figure I like to look at is profit before tax ... in 2018 Afterpay lost $8 million and the loss increased to $43 million in 2019. The question I ask myself is, "Would Buffet and Munger buy this stock?" I think not!

Duncan Owen

Tip - Buffet and Munger's style isn't the only way to invest. They never would have bought Amazon at a few hundred per share either. It's been a 10 bagger since.

Emanuel Datt

Thank you for your comments, which largely speak of the lack of accounting profits at Afterpay. We would like to point out that Amazon, the world's 3rd largest company by market capitalisation, only started to make consistent accounting profits in 2016; 18 years after it's founding. By any measure, Amazon has been an incredible success and has improved the quality of life for a huge segment of society. We believe Afterpay has the potential to achieve the same.