Take-aways From CFPB’s Report On Buy Now Pay Later

CFPB just released a report on Buy Now Pay Later (BNPL) which I think is pretty comprehensive. The report covers a lot of ground using data between 2019 and 2021 from five surveyed lenders. If you are interested in consumer financial products or BNPL in particular, you should have a read. Below are some of my takeways

BNPL grew furiously in 2020 and 2021

According to the report, the number of loan originations from BNPL lenders in the US grew by 227% per year, from almost 17 million in 2019 to 180 million in 2021. The amount of BNPL loans grew even faster, by 245% per year, from $2 billion in 2019 to $24.2 billion in 2021. In the same period, the average loan size increased from $121 to $135. I suspect that this is due to the popularity of Peloton in 2020 and early 2021 at the height of Covid and the urge to go back to travel late 2021. The growth in average loan size is exactly what the lenders will sell to merchants: come to us, pay us the merchant fees and we will bring you more business.

BNPL Loan Origination Volume
BNPL Loan Volume By Merchant Vertical

BNPL usage rate and the number of BNPL super fans continuously rose

Per CFPB:

The quarterly usage rate has steadily increased over the past three years, reaching a high of 2.8 loans per unique borrower in Q4 ’21. In Q4 ’21, four of the five lenders surveyed had a usage rate between 2.9 and 3.2 per quarter, while the fifth had a usage rate below 2

In short, the last three years saw an increase in quarterly usage to about one loan per month per average user. This increase was slower than that seen in the upper ends of the spectrum. Specifically, the share of users with at least 5 or 10 loans per quarter reached 15.5% and 4% at the end of 2021 respectively. It’s quite surprising yet interesting to me that 4% of BNPL users used the product more than 3 times a month. I am suspecting that these high-usage users concentrate more in the young generations. With BNPL, users must be underwritten on a transaction basis. The fact that some ignore the inconvenience of filling an application 3 times a month instead of getting a credit card indicates that they cannot get a credit card. On the other hand, a debit card is always available, even to these thin-file consumers. Hence, it is a little worrying to see this kind of behavior, when there is a debt-free alternative out there.

Share of Unique Quarterly BNPL Borrowers With 5+ and 10+ Loans

Young consumers like BNPL and they tend to default

The surveyed lenders’ demographics data backs up my suspicion above over the credit-trapped young consumers. BNPL skews heavily towards younger generations. Even though we see more older and presumably wealthier consumers over 40 years of age, almost 50% of BNPL users are 33 years old or younger. Compared to the 2020 Census Bureau data, these young consumers are over-indexed.

Worryingly, it is consumers aged 33 or younger where we found default or charge-off most frequently. According to the surveyed lenders, 5.7% of BNPL users aged 18-24 had at least one default or charge-off in 2021 while 4.8% of users aged 25-33 had a derogatory BNPL trade. No other age group had higher than 4%. These data points show that any credit issuer wanting to underwrite thin-file consumers need to do their homework carefully in order to manage risks. This population is too big and valuable to ignore, but they are very risky!

Share Of Unique Borrowers By Age Cohort With 1+ Default Or Charge-Off

One in ten borrowers was charged a late fee in 2021

We can deduce the amount of overextension from borrowers by looking at late fees. According to the report, the borrower-level late fee rate in 2021 was 10.5%. That’s surprisingly high to me given that all BNPL lenders enforce autopay and Affirm doesn’t charge late fees. Because autopay is virtually required on every loan and 89% of all payments in 2021 came from debit cards or checking accounts, the fact that one in ten borrowers got penalized shows that many users didn’t have sufficient funds for their purchases in the first place.

BNPL Late Fees

Apple Pay Later

WWDC is where Apple shows off its new software updates and sets the expectation for what is to come in the next year. It kicked off on Monday with a flurry of announcements on iOS16, MacOS Ventury, watchOS 9 and iPadOS 16. Among these announcements, I want to focus on one that is really interesting from a financial product standpoint and, to me, the next step forward towards making Apple not just a consumer brand. Per Apple on Monday:

Apple Pay Later provides users in the US with a seamless and secure way to split the cost of an Apple Pay purchase into four equal payments spread over six weeks, with zero interest and no fees of any kind.3 Built into Apple Wallet and designed with users’ financial health in mind, Apple Pay Later makes it easy to view, track, and repay Apple Pay Later payments within Wallet. Users can apply for Apple Pay Later when they are checking out with Apple Pay, or in Wallet. Apple Pay Later is available everywhere Apple Pay is accepted online or in-app, using the Mastercard network.4 Additionally, with Apple Pay Order Tracking, users can receive detailed receipts and order tracking information in Wallet for Apple Pay purchases with participating merchants.

When the news on the service broke on Monday, it triggered a lot of questions due to the lack of details. Until yesterday when Apple agreed to disclose more information. Per CNBC:

A wholly owned subsidiary of Apple will check user credit and extend short-term loans to users for Apple Pay Later, the tech giant said. Apple has partnered with Mastercard, which interacts with the vendors and offers a white label BNPL product called Installments, which Apple is using. Apple Card issuer Goldman Sachs also is involved as the technical issuer of the loans and is the official BIN sponsor, the company said. But Apple is not using Goldman’s credit decisions or its balance sheet for issuing the loans.

Apple will run a soft credit check to ensure that borrowers are capable of paying back the loans, which will likely be capped at around $1,000, the company said. If Apple Pay Later loans aren’t repaid, then Apple will no longer extend those users credit. But the company said it won’t report the missed payments to credit bureaus. Apple will initially launch Pay Later in the United States

Per Bloomberg:

A wholly owned subsidiary will oversee credit checks and make decisions on loans for the service, which is called Apple Pay Later. The business — Apple Financing LLC — has necessary state lending licenses to offer the feature, though it operates separately from the main Apple corporation, the company said in response to Bloomberg questions. 

Apple has been working to move many elements of its financial services in-house as part of a secret initiative dubbed “Breakout.” In addition to taking on lending, credit checks and decision-making, Apple is working on its own payment processing engine that may eventually replace CoreCard Corp., Bloomberg reported in March. It’s also working on new customer-service functions, fraud analysis, tools for calculating interest and rewards for other services.

The company is also working on a longer-term “buy now, pay later” program called Apple Pay Monthly Installments, Bloomberg has reported. While the shorter-term Apple Pay Later offering doesn’t use Goldman Sachs or other major partners, the longer-term plan is likely to rely on an array of other companies — including Goldman Sachs — that could offer different plans and interest rates. 

The new revelations shattered some of my original assumptions. At first, I thought users could turn on the payment plan after the fact, just like what Affirm Debit+, American Express or Chase offers. Now, it seems shoppers have to choose upfront whether to use an installment plan. Second, I didn’t expect Apple to go as far as securing state licenses in order to offer loans. The report from Bloomberg suggested that the company had a long-term and ambitious plan regarding financial services, a plan that is big enough for them to take on more compliance work, the underwriting itself and possibly the loan balance on its balance sheet. Nonetheless, because this is Apple, a company known for being a control freak over user experience and key capabilities, its desire to underwrite loans, process payments and battle fraud are totally on brand.

Even though the newly reported details are helpful, I still have some lingering questions that I’d love to understand more:

  • The transaction amount is currently capped at $1,000. Is there a minimum limit? Can I still go to a restaurant and put my dinner expense of $20 on a payment plan?
  • Apple Pay Later is slated to go live in the US later this year; which is not a surprise. If there is a plan to expand internationally, how long will that take? Apple Card went live almost three years ago and it’s still exclusively available in the US
  • Costco doesn’t accept Mastercard at its stores. Can I still use Apple Pay Later there? That seems like a significant use case for shoppers in the US
  • What does the application process look like? I can’t imagine that any cashier or customer would wait comfortably for a two-minute in-store Apple Pay Later transaction
  • iPhone is very popular among young folks who don’t have a lot of credit history. This type of financial product definitely resonates with them. How much risks would Apple tolerate from this population?
  • What is the unit economics of a transaction? How much would Apple charge merchants?

BNPL providers usually charge 2-6% of a transaction amount. These providers argue that they earn this cut because they raise the average order volume (AOV) as well as bring more leads to a business. While Apple Pay Later will also help merchants increase the AOV, what would Apple do to generate more leads at the top of the funnel? We already see promotional emails like this from Apple, but will Apple add a Deals tab somewhere in the Wallet?

Implication for Apple’s future

For the argument sake, let’s assume Apple will earn in revenue 3% of all Apple Pay Later transaction amount, including the 0.15% cut it already has on every Apple Pay transaction. Affirm did $13 billion in loan volume in the US in the last 12 months. If Apple Pay Later had the same volume, a 3% cut means that the company would earn almost $400 million in revenue, before expenses. It’s not nothing, but it’s still essentially a rounding error for a machine that generated $365 billion in revenue last year.

The bulk of the value that Apple Pay Later brings is to increase the stickiness of the Apple ecosystem. Existing users have one more reason to stay locked in. Those on the fence have one more reason to lean towards Apple. Merchants will be more motivated to add Apple Pay to their checkout pages. Regarding merchants, I do think Apple has a big plan in place to become more than just a consumer brand.

Going back to the first announcement, buried inside the text and overshadowed by the installment product is the fact that consumers will soon be able to track orders from Wallet on Apple Pay purchases. For this to happen, Wallet will effectively become an ordering system where merchants can process orders and have the delivery status updated. Instead of having an iphone as a payment reader and another software as an ordering system, Wallet can function as both. All a merchant needs is an iPhone. Here is how I see it:

First, Apple launched Apple Business Essentials, a subscription program that helps small companies manage their Apple devices. Then, the company introduced Tap To Pay with iPhone, which allows merchants to use their iPhone as a payment terminal without any extra hardware. A few days ago, Block (Square) said that they would bring Tap To Pay with iPhone to Square sellers who can use their Square POS app on an iPhone to receive payments in stores. Next, Apple Pay Later offers another payment option to shoppers and all the benefits that BNPL can bring to sellers, including higher average ticket value and conversion rates. Last but not least, merchants can use Wallet as an ordering system. Can you see the picture now? Payment is an integral part of doing business nowadays. If Apple devices and services can become integral to companies’ payments, Apple will have a stronger case for Apple Business Essentials. Far-fetched? Perhaps, but I am curious to see if my prediction comes true.

Implications for other BNPL providers

CEOs of Klarna and Affirm already got on TV to appear defiant and confident in the outlook of their business. But I suspect that the last few days already triggered some serious discussions in the boardrooms. How could they not take this seriously? Apple has some advantages that none of these BNPL firms have. First, Apple is one of, if not the most, recognizable and talked about brands in the world. It doesn’t have the brand awareness debt that a newcomer in this space would have. Second, Wallet is a native app that lives on Apple devices by default and requires no further download. If shoppers don’t have BNPL apps downloaded beforehand, the only way these firms can process loans is through merchants’ checkout pages. Unfortunately for them, Apple Pay is at least as popular a checkout button as any. Plus, if Apple can manage to push Apple Pay Later to Apple Watch, I don’t see how Affirm or Klarna or PayPal can get there to compete. Third, some BNPL firms are required to pay interests and expenses on the loans they generate. Apple, on the other hand, has an otherworldly balance sheet and generates cash as well as any company in the world. That should give Apple advantage in terms of unit economics. For now, Apple only offers one flavor of BNPL, but as Bloomberg reported, there are more to come. Hence, whatever advantage on product offerings that the likes of Affirm or Klarna have over Apple may soon evaporate.

Do I believe that this is a winner-takes-all space? No. BNPL firms will still have their space with their loyal followers and non-iOS users. However, their growth will likely be capped with the introduction of Apple Pay Later. I expect that we’ll see moves from these providers in the near future as they will try to bolster their positions while Apple Pay Later gets its feet wet.

In short, as someone who is interested in payments and invested in the future health of Apple as a company, I am excited about Apple Pay Later. Not only the service, but also what Apple does to launch it the way they do, I believe, will have an impact on the business. Personally, I am curious to see if my prediction on Apple Business Essentials will ring true. I also want to see how the BNPL space will change with the arrival of Apple Pay Later. Some already cast demise on BNPL providers as they are now just a feature that Apple offers. But I am skeptical of that view. The space is big and just because you compete with Apple, it doesn’t mean you can’t survive or grow.

Weekly reading – 30th April 2022

What I wrote last week

Thoughts on Buy With Prime

Business

Starbucks Is Having an Identity Crisis. Can Howard Schultz Fix It? 70% of Starbuck’s orders are to-go. The popularity of their mobile app is magnificent, yet it goes against the identity that Howard Schultz envisioned when he bought the brand. He wanted Starbucks to be the 3rd place that people frequent in addition to work and home. Starbucks needs to decide on its future identity and positioning. Because if most orders are picked up at drive-through, what the hell are the stores for?

Will Ford’s new truck finally make Americans buy electric? “Surveys, both by the company and independent analysts, have found that customers for the F-150 are typically younger, richer, more urban than the truck’s traditional mainstream buyer – and in many cases have never owned a truck before. Like the rest of the industry, the company is contending with shortages of key computer processing chips, batteries and other materials that have held back production – and challenged the company’s effort to keep the starting price at about $40,000 (£31,500)”. It doesn’t sound very easy, does it?

Netflix’s Battle for Asian Subscribers Pits It Against Rich Rivals, Hundreds of Local Upstarts. The challenge for Netflix in Asia is multiple-fold. First, it has to keep the subscription prices low while needing to spend millions of dollars on local original content. Second, its competition is nothing but fierce and they are willing to keep the prices low to retain customers. Some such as Disney or Amazon are willing to splash a big sum on sports such as IPL to woo local viewers in India. Netflix hasn’t shown interest in following suit so far. The company once thought invincible at least in the streaming world doesn’t look invincible, does it?

Kard, a fintech that helps credit card issuers build custom reward programs by brands. “The company works with roughly 30 issuers today, representing 10 million consumers, Mackinnon said. It helps process about 60 million transactions per month, and has seen revenue grow 10x over the past year, according to Mackinnon, though he declined to share a specific revenue figure. He describes the business as a two-sided marketplace for rewards, with merchant partnerships on the supply side and card issuers on the demand side. For issuers, the API is powerful because it “connects them to merchants, brands, retailers that essentially are the funding vehicle for any of their rewards,”

Netflix’s Big Wake-Up Call: The Power Clash Behind the Crash. Cindy Holland seems to be the one person who wants to steer Netflix to adopt Apple TV+’s strategy. Nobody can guarantee that if Cindy hadn’t left, Netflix wouldn’t be in where they are today. She could have stayed and Netflix could have been just as bad or worse. But it’s baffling to let go the relationship-building wizard that forged a bond with the studios and not find a replacement. I have to say, though, that when Netflix was dominating the streaming market and a darling of Wall Street, you didn’t get to read these pieces. You were served with articles on how great Netflix and its culture were. As soon as the company’s fortune plummeted, critical reporting show up like mushrooms after rain.

Vietnam’s VinFast takes the EV battle to Tesla with U.S. push. The pace of development at Vinfast fits the culture of quick results and brand ambition at Vingroup. That’s how they always do things. That approach doesn’t necessarily come with the best quality of products or services. Hence, the question becomes: do they think up a thorough plan to penetrate and dominate the EV market in the US? Every car maker in the world wants to succeed in the US. It’s home to Tesla, which has an enormous scale advantage. It’s home to Ford, which is always a familiar brand in the mind of Americans. There are always Volswagen, Hyundai, Kia, Subaru, Toyota, Mazda etc…Such a list of world-famous brands indicate nothing but fierce competition. The first movers also have great scale advantage. List cars at too high a price and Vinfast won’t make enough sale. List them too low and the company wont have any profit. Whether Vinfast can weather the initial storm to reach critical mass remains a giant question mark.

Inside the first suburban Amazon Go store. I have a nagging feeling that Amazon is playing a really long game here and soon enough in the future they will become a major grocery chain

Other stuff I find interesting

Why didn’t our ancient ancestors get cavities? It is a very interesting theory that our transition to agriculture is the likely cause of our cavities

Women and girls have to pay for water with their body and dignity. The struggle people in poor countries around the world has to face makes it even more incredulous whenever folks in the US complain about trivial problems. I don’t know like having to wear a mask during Covid or taking life-saving vaccines.

Stats

According to the founder of TSMC, it costs 50% more to produce the same chips in the US than in Taiwan

80% of US consumers use BNPL to avoid credit cards, according to Experian

According to Mastercard, global first-party fraud which refers to a legitimate online purchase being disputed after the fact amounts to $50 billion

Online retail sales in India is estimated to reach $85.5 billion in 2025

Banks and credit unions pulled in more than $15 billion in overdraft and related fees in 2019 and $12 billion in late credit card fees in 2020

Google Pay has 150 million users across 40 countries, as of April 2022

Thoughts on PayPal’s latest earnings

What happened?

Last week, PayPal reported its Q4 FY2021 results, causing the stock to reach by almost 25% and reach its 52-week low. Once a $360+ billion company at its peak valuation, PayPal is now worth $148 billion. There are a few contributing factors to this implosion.

The first is the disappointing guidance. A few months ago, the company set the revenue growth for 2022 at 18% which is now replaced by the 15-17% range. The guided Earnings Per Share is $4.67, well below the consensus of $5.21. For Q1 2022, revenue is expected to grow by 6%, significantly lower than the two-digit growth rate usually seen in every quarter since 2019. High inflation, the supply chain issues that have been felt across markets, increased tax rates and tough comparisons to last year’s results are to blame.

Net new active accounts are also a let-down. Total net adds in 2021 stood at 49 million, far lower than the 55 million target reaffirmed in November 2021. This year, PayPal expects to add 15-20 million new accounts. This conservative goal is lower than what PayPal managed in 2018 or 2019 before Covid-19 boosted their business and pulled forward a lot of net new accounts. The management gave two reasons for this muted outlook. First, 4.5 million accounts are found to be illegitimate. Even though the number is immaterial to the overall account base of more than 400 million, it affects the company’s estimate and thinking in terms of net new adds. The second and bigger reason is a new pivot in customer acquisition. Used to plow a lot of money in incentive-led marketing tactics, PayPal is going to abandon low-ROI efforts on low-value customers and instead prioritize high-ROI engagement campaigns which they say have better yields.

Because of the new pivot in customer acquisition, PayPal determined that the target of 750 million active accounts by 2025, which was only set last year on Investor Day, is no longer appropriate. The rumored acquisition of Pinterest a few months ago already called into question the growth outlook. This unexpectedly disappointing development aggravated investor doubt that the management team bit more than they could chew last year and sold investors on unrealistic targets. For me, it is the biggest shock from the earnings call. After Q3 FY2021, I was already concerned about PayPal’s ability to hit its long-term goal, but I, in no way, could expect that they gave up one year into the 5-year plan! Talk about disappointment!

Are the business’ fundamentals still healthy?

Investors are right to be downbeat on PayPal. The announcements on the earnings call gave nothing, but cause for doubt on the health of the business. Nonetheless, I don’t really think that all is lost. The outlook from here isn’t as rosy as we were told before, but one of the most iconic brands in the world can’t just crumble over night. Here are a few reasons why.

The divorce from eBay is strategically essential as it liberates PayPal from the exclusive partnership. EBay is now responsible for only 3% of PayPal’s total payment volume (TPV) and revenue, down from 8% of total TPV and 14% of revenue in the same quarter two years ago. Ex-eBay TPV growth has outpaced total TPV’s every quarter since Q1 2019. This, coupled with the fact that average transactions per active account continues to rise, signals that PayPal’s non-eBay services grew on merit and appeal to consumers.

PayPal's TPV and ex-eBay TPV growth
PayPal’s TPV and ex-eBay TPV growth

Venmo continues to impress with $60.5 billion in TPV and $250 million in revenue in Q4 FY2021. There are 83 million active users in the U.S alone, meaning that almost 1 out of 4 people in the country uses Venmo. The TPV and the popularity are likely to rise with new major partnerships such as the one with Amazon or DoorDash. However, since these partners may command a low take-rate, whether they will help with the monetization remains to be seen. That’s the overall concern with Venmo. Despite the apparent popularity and making up 17% of PayPal’s active account base, Venmo is only responsible for 3.6% of the company’s revenue. The likelihood of merging the two apps any time soon is low. The risk of damaging the Venmo “cult” and taking away its appeal by folding it into the parent app is too big, but at the same time, how would the company entice Venmo users to try out other services? Currently, Venmo is available only in the U.S. What about an international expansion? Investors definitely can use some more disclosures on both issues from the management team.

BNPL is another bright spot. Launched only in August 2020, Pay in 4 already reached $8 billion in total TPV, 12.2 million unique customers and 1.2 million participating merchants. Considering that the parent company has 383 million consumer accounts, 33 million active merchants and 200 markets, there is a lot of growth ahead. As customers who used BNPL delivered 2x average revenue per account, this service will be an important acquisition and engagement tool. Would that translate into money for PayPal? The jury is still out on this question. As there is no fee charged to consumers and no additional service fee to merchants, PayPal is hoping to generate revenue through additional services. This is one of the areas on which I wish to gain additional insights in the near future.

Ironically, I find the new pivot in customer acquisition positive to some extent. While I was disappointed by the abandonment of the 5-year target, I think or at least hope that this is the right move for the business. Let me explain why. I used to receive a lot of incentive-led marketing campaigns from PayPal such as a reward for downloading an app, a discount at a partner store or a chance to win a money pot. As a consumer, I liked these efforts. The investor in me, though, thought that these outreach efforts seemed like a desperate attempt to inflate active account numbers and keep the Street happy with the progress towards the magic 750 million number. But as the active consumer account base grows, you can’t buy cheap engagement forever. Soon, the cost of low ROI campaigns would catch up and it did for PayPal. Therefore, now that the target doesn’t float over their heads any more, the company can be smart about allocating valuable marketing dollars. The next few quarters and the new disclosures on ARPU will be critical in regaining investor trust.

PayPal's marketing tactics
PayPal’s marketing tactics

Competition

Adding fuel to investor doubt is the fact that PayPal has fierce competition in the payment market. The silent killer Apple Pay provides a seamless checkout experience on millions of Apple devices and thousands of online stores. Block/Square is investing and pushing aggressively (such as the acquisition of Afterpay) to gain an upper hand over PayPal to become THE Super App for financial needs. Affirm is evolving from being a pure BNPL player, and adding new capabilities such as eCommerce button, savings and rewards. Additionally, there are Shop Pay and Facebook Pay, native checkout experiences on hugely popular platforms with thousands of merchants and consumers. Last but not least, the rise of real-time payments around the world and in the U.S will also be a threat. Given this elevated level of competition and the sudden change in long-term targets, it’s obvious that PayPal underestimates competitors and overplays their hands. From now on, it’s back to the basics which include constant innovation, addition of value-added services and a firm grip on its engaged and loyal customers.

In summary

The latest quarter is undoubtedly a disaster. There is no other way to describe it. Management overestimated their competitive advantages and consequently set unrealistic goals which led to misguided actions (the rumored acquisition of Pinterest). When such mistakes came into light, the punishment followed, in the form of billions of dollars in market capitalization. But the iconic and trusted brand is still there. PayPal still has incredible assets and millions of active accounts on its platform. The ingredients for redemption are ready. Now it’s up to management to bring about results and restore investor trust.

Venmo’s TPV
Transactions Per Active Account

Get to know Affirm

Want to understand Affirm, what it does and how it makes money? Read on as I am discussing one of the most popular BNPL names below. My goal is 1/ to give you a better understanding of the company than a normal article on the news and 2/ not to overwhelm you with a 20-page essay with a lot of details. Ready? Let’s do it.

What is Affirm? What does it do?

Affirm was founded by Max Levchin, a co-founder of PayPal, in 2012 with the purpose of reinventing the payment experience for consumers and merchants. With Affirm, consumers can spread out a purchase over multiple payments over time without deferred interest, penalties or late fees. There are generally two types of transactions processed on Affirm platform: with or without interest. 0% APR transactions guarantee consumers a payment plan with no interest, fee or additional costs. Interest-bearing transactions carry an interest rate that never compounds. For instance, if a $100 purchase comes with an APR of 10%, $110 is the absolute maximum amount that a shopper will ever pay. The unpaid balance will not compound. All of the benefits give shoppers more purchase flexibility, especially those who are tight financially.

For merchants, Affirm helps increase sales through a bigger ticket size, more leads and more options at the checkout for consumers. When consumers can pay off a big purchase in installments, they are more incentivized to take on more expensive items. What merchants don’t want to sell their pricier products or services? In addition, as one of the most popular technology names out there, Affirm can bring hundreds of new leads – new businesses, to merchants. In exchange for all of these value propositions, Affirm charges participating merchants a fee on every transaction.

How does it originate loans?

When Affirm authorizes a transaction on its platform to a shopper, it is essentially giving out an unsecured loan. Even though Affirm itself doesn’t have a banking license to do that, it works with Cross River Bank and Celtic Bank, which help the fintech firm originate loans and comply with regulations at state and federal levels. Affirm is obligated to purchase the loans processed on its platform and originated by the partner banks. Such an obligation is backed by a cash deposit that Affirm has at these banks. The purchase price of a loan is the combination of its outstanding principal balance, a small fee for the banks’ trouble and any incurred interest. As a result, Affirm incurs an expense for every 0% APR transaction because they have to purchase the loan at a value higher than the fair market value of the loan. This expense is called “Loss on loan purchase commitment”.

Because the banks originate the loans themselves, they have the ultimate power to either approve or decline such loans and Affirm needs to underwrite within the risk parameters that the banks set. You may ask why banks need Affirm in this whole process after all. The answer is that Affirm brings in the ability to sign up merchants, the marketing expertise to appeal to shoppers and the capability to use machine learning to process data that can help better underwrite loans.

How Affirm originates loans
Figure 1 – How Affirm originates loans. Source: Affirm

How does Affirm make money?

Affirm has multiple revenue streams. The first is Merchant Network Revenue, which consists of transaction-based fees. Every time Affirm processes a transaction on its platform, it takes a percentage cut from the purchase amount, coming out of the merchant’s pocket. The amount varies depending on a specific arrangement between Affirm and the merchant in question. Typically, Affirm earns larger Merchant Network fees on 0% APR transactions. Similarly, the firm earns a higher commission rate on higher value purchases. In some cases, in order to grow its user base by working with a giant partner, Affirm may not generate positive revenue and the loss is recorded as Sales and Marketing expense.

The second revenue stream is Virtual Card Network. This revenue stream essentially is comprised of interchange fees earned by Affirm for transactions on its platform. Apart from paying the Merchant Network above, merchants also have to pay another on every sale smaller fee called interchange. A portion of that fee, or I would say, the lion share of that fee will go to Affirm. Based on the aforementioned descriptions, it’s obvious that how much money Affirm can make in Network Revenue (Merchant Network + Virtual Card Network) in general hinges on how much transaction volume (GMV) it processes. Barring some caveats that I will explain later, GMV is a good indicator of Affirm’s health.

In addition to Network Revenue, Affirm also makes money from the interest on non-0% APR loans to consumers (Interest Income). These interest-bearing loans typically result in lower Merchant Network fees than 0% APR loans, but fill in the gap with interest. In Q1 FY2022 ending September 30, 2021, 57% of Affirm loans were bearing interest and the rest were interest-free. During the fiscal years 2019, 2020 and 2021, 45%, 37% and 37% of Affirm’s revenue came from this revenue stream.

The company can also leverage its outstanding loans for more income. It can sell part of its outstanding balance to any interested party and record Gain/loss on Sale. While keeping a balance on balance sheet can lead to more interest income, it comes with a charge-off (consumers don’t pay off) risk and additional expenses (cost of funds). By selling some of the balance, Affirm can recognize, usually, gain on sale and reduce its risk exposure. Moreover, loan owners can solicit Affirm’s expertise to manage the loans in exchange for a monthly fee or what the company calls: Service Inc

Affirm's revenue breakdown in FY2021
Figure 2 – Affirm’s revenue breakdown in FY2021

What are Affirm’s competitive advantages?

Affirm’s competitive advantages come down to two things: its two-sided network and underwriting capability. Let me expand on that.

While difficult to build at first, a two-sided network provides a real strong competitive advantage. More shoppers entice more merchants that make the whole ecosystem more appeal to new shoppers. To maintain and grow its two-sided network, Affirm needs not only consumers, but also merchants. So far, the company has done a good job at this by partnering with some of the biggest names in the U.S such as Target, Peloton, Shopify, Walmart and Amazon. By locking in popular retailers, Affirm becomes more popular among shoppers which, in turn, help it acquire more merchants and negotiate more favorable terms. By working with Shopify, Affirm can onboard a lot of merchants right away and appeal back to shoppers. I suspect that some of these partnerships (Walmart, Shopify and Amazon) come at a cost for Affirm as the company must make major concessions, but in the long run, it’s a smart move by its management. Who else can make the same claim that they are the BNPL provider for these brands?

Affirm may have to subsidize some partnerships
Figure 3 – Affirm may have to subsidize some partnerships. Source: Affirm

The second advantage is its ability to use data analytics for underwriting. Underwriting unsecured loans is a tricky business. Quite often, the riskier customers are the more profitable as they pay interest income yet they can also default on the loans. The art of underwriting is to find a sweet spot between profitability and risk. If Affirm only had reliable borrowers, they could still make money with their business model. However, they would leave out folks who need POS-lending the most, you know, the folks with FICO less than 700 or bad credit history. This population is significant, but it can result in losses. This is a challenge for not only Affirm, but all the companies that are offering unsecured loans. With a lot of transaction data, Affirm can fine-tune their underwriting model to limit losses while expanding the customer universe.

It is an interesting and fairly complex business

It’s not straightforward to understand Affirm’s performance from one quarter to another. The first issue is the nature of the company’s partnership with strategic brands. The partnership with Peloton, while fruitful and successful in the beginning, gave the POS lending tech firm some headaches, such as its recall of products (it reduced the merchant network revenue by more than $5 million in FY2021), 0% APR loans that are more expensive to originate and the delay in loan recognition as well as revenue booking. In FY2021, Affirm facilitated $66.3 million more transaction volume than what was captured and reported by Peloton.

Even though GMV, at first glance, can be a good indicator of Affirm’s business health, how the company generates GMV affects its revenue streams heavily. A high concentration of low-value or interest-free transactions negatively affects the company’s top and bottom lines, as explained earlier, despite an excellent growth in merchant and shopper counts. Case in point, the number of active merchants increased from 29,000 in Q4 FY2021 (ending June 30) to 102,000 in Q1 FY2022 (ending September 30). while the number of active customers rose from 7.1 million to 8.7 million in the same period. However, revenue only increased by 3%, from $262 to $269 million. One of the main reasons is that the average order value decreased from $495 to $402 and the concentration of 0% APR loans went up from 38% to 43%. As the partnerships with Amazon, Walmart and Shopify ramp up, I expect the trend of a bigger ecosystem, lower AOV and modest increase in revenue will persist. But who knows? If Peloton roars back and brings more high-value loans or if Affirm signs a similar partner, the situation will certainly change. This makes it a bit tricky to analyze this business as it has more than meets the eyes.

Another factor is how much the company estimates its provision for credit losses. The fancy term essentially means how much of the loan is expected to be lost. This estimate depends on not only the concentration of 0% APR loans or new product lines with higher expected losses but also macro economics factors. At the beginning of the pandemic, Affirm expected higher losses, but the expectation subsided over time before it was normalized to the pre-pandemic level. Because we are not out of the woods yet with Covid-19 (thanks Omicron!), it’s not practical to have a consistent estimated provision for credit losses.

Lastly, and this one is more for the future: the regulatory risks. As of now, the BNPL field is largely unregulated, yet there are signs that it’s about to change. The Consumer Financial Protection Bureau already opened an inquiry into BNPL products and ordered information from the main players, including Affirm. Whether there would be new regulations in place, what such regulations and what the ramifications would be remain to be seen. Personally, I think that the worst that could happen is Affirm will have to deal with the same regulations as banks do. But the same would also go for other BNPL firms. As long as the fundamentals of the company are strong and not prone to collapsing under more scrutiny, Affirm should be fine.

Credit losses increased at a much higher clip than revenue in Q1 FY2022
Figure 4 – Credit losses increased at a much higher clip than revenue in Q1 FY2022. Source: Affirm

In short, even though what Affirm does sounds simple on the surface, the inner workings behind the scenes and the numbers are not. I hope if you make it this far, you already have a better understanding of the company. Not too deep, but not too shallow either.

Disclaimer: I have Affirm stocks in my personal portfolio.

PayPal Q3 FY2021 Results

The last quarter featured some great developments, acceptable numbers and a couple of concerns for PayPal, from my point of view.

The earning call started with the news that Amazon would let U.S customers check out on their website with Venmo. It’s a great win for the payment company as Amazon is the biggest eCommerce in the U.S, which is PayPal’s main market. The management team didn’t reveal much about the terms of the partnership, but given that Amazon has more bargaining power here, my guess is that PayPal has to offer some sweet economic incentives like a lower rate. In the 9 months ending September 2021, Amazon’s U.S sale was $197 billion, including hardware, physical stores, subscriptions etc. The company doesn’t break down the sale volume for its eCommerce, but for the sake of simplicity, let’s assume that Amazon.com generates around $200 billion in sales ever year. Even if Pay with Venmo processes 1% of that, it will still give PayPal a boost of $2 billion in Total Payment Volume (TPV). Not bad. You may ask given that Venmo TPV for this quarter is $60 billion alone, why is $2 billion lift a year not bad? Well, that’s because Venmo would actually generates money on this $2 billion lift in TPV while the reported $60 billion includes person-to-person (P2P) payments that earn Venmo almost absolutely nothing.

This kind of partnership is possible in the first place because PayPal is no longer constrained by legal obligations with eBay. Hence, we should see the company strike more similar deals in the future. Speaking of deals, PayPal also announced collaboration with Walmart, Booking.com, Fanatic, Phillips 66, GoFundMe and Everlane. At first glance, some of these deals make a lot of sense to me. Walmart is the biggest grocer in the country and a major retailer. Adding PayPal as a checkout option is huge and can help elevate PayPal’s TPV in the same way as Amazon would. 2/3 of Booking.com reservations are online. Since PayPal is already a checkout option, adding Venmo is a logical step to capture more of that payment share. Meanwhile, Everlane, as a fashion retailer, serves as a good case study for Happy Returns, which will be important to PayPal in acquiring and retaining merchants. Last but not least, offering QR codes at gas stations such as Phillips 66 and Valero facilitates seamless payments in a very familiar use case for all consumers.

PayPal Q3 2021 wins
Source: PayPal

BNPL has been an astounding success for PayPal. Launched in August 2020, the service already amassed $5.4 billion in transaction volume, $2 billion of which came in the last quarter alone, 9.5+ million users and 950,000 participating merchants. That’s about 2.5% of PayPal’s consumer base and 3% of its merchant base in only 6 markets so far. The potential growth is enormous. The company is introducing PayPal in 4 in Spain and Italy in Q4 2021 and planning new different flavors of its BNPL in the first half of 2022. I won’t be surprised if PayPal has $8-$10 billion in BNPL volume in the next 12 months (60% or 100% growth).

One of the biggest initiatives for PayPal is the launch of its new mobile app. It’s a major milestone towards being THE Super App for consumer financial needs. The early results, as reported by the company, were great. I don’t take much stock in them, though, because 1/ it’s still early and 2/ I don’t fully understand what all of the reported lifts mean. I’d rather wait for a couple of more quarters to see how the new app fares and hopefully the management team can give more color.

Early results of the new revamped PayPal app

On to the numbers. The last quarter’s TPV stood at $310 billion, a 26% YoY growth. Excluding $10 billion in eBay TPV, which is 3% of the total figure and trending down, the YoY growth is 31%. While eBay is gradually becoming the past for PayPal, Venmo is increasingly looking like the future. Its TPV last quarter was $60 billion, up 35% YoY, faster than the main app itself. Even though it’s only available in the U.S so far, Venmo managed to grow its TPV by more than three folds since 2018. In terms of active accounts, as of Q3 FY2021, PayPal had 413 million active accounts, including 80 million Venmo accounts and 33 million active merchants. Transactions per active account came in at 44.2. Transaction and total take-rates continued to trend down, standing at 1.88.% and 1.99% respectively in Q3 FY2021. As the reliance on eBay tapers off and the product mix is unfavorable (more bill volume or more volume from partners like Amazon that have lower rates), I expect this trend to continue for the foreseeable future.

The decrease in take rates will continue to heap pressure on revenue. Q3 FY2021 revenue growth already slowed down to 13%, much lower than what was reported in the previous four quarters. If we isolate the revenue from value added services which have little to do with the core business of PayPal, revenue growth is clocked at 10%. International revenue only grew by 2% YoY. This is particularly concerning if the management team wants to meet the goal set on Investor Day. To reach $50 billion in annual revenue at the end of 2025 starting with $25 billion in revenue this year, PayPal would have to grow the top line by at least 25%. Growth at the current clip is not going to cut it. On the Q3 Investor Update presentation, PayPal mentioned that the acquisition of Paidy would add 3 million new net accounts in 2021, but said nothing about revenue lift. I suspect that the company will continue to use M&A to aid with the growth numbers in the future. Is it a good approach? It could be, though every M&A carries a certain level of risks and you can’t fault people for doubting your own organic growth if you rely on M&A.

PayPal revenue and growth

Back in Q2 FY2021, PayPal made a major change to their pricing that went into effect on the 2nd of August 2021. Essentially, merchants will have to pay PayPal more in commission when consumers use the company’s branded mobile wallets such as PayPal, Pay with Venmo, PayPal in 4. On the other hand, when consumers key in card information without using PayPal’s wallet options, merchants will incur slightly lower rates. The assumption behind this move is that PayPal is confident in the attractiveness of its own mobile wallets. According to the latest 10-Q, the company claimed that the pricing changes didn’t meaningfully affect revenue. While it sounds encouraging, it has been only two full months. So we’ll have to wait a bit before rendering any verdict.

In summary, I’d give the quarter around 7 out of 10. The numbers aren’t catastrophic. We may just see the effect from a tough comparison from last year and the rule of big numbers. What concerns me more is that I don’t have enough information as of now to believe that they can hit the aggressive goal set for FY2025.

PayPal Total Payment Volume (TPV)
PayPal TPV YoY Growth
PayPal Active Accounts

Weekly reading – 25th September 2021

What I wrote last week

Is BNPL replacing credit cards?

My thoughts on Visa’s new benefits for U.S Signature/Infinite cardholders

Articles on Business

When to Buy Now, Pay Later, and When to Just Pay Now. “Affirm doesn’t report payments on its four biweekly payment zero-interest loans, it said, or when consumers are offered a three-month payment option with no interest. Afterpay doesn’t work with credit bureaus at all. Sezzle Up explicitly informs users that it will report on-time payments to Equifax and TransUnion. Affirm doesn’t charge late fees, but late or partial payments can hurt your credit score, and may prevent you from using the service in the future. Sezzle Up also reports delinquencies. Klarna and Afterpay revoke access to their platform until payment is made. Both companies also charge late fees, tacked onto your next payment. Afterpay charges $8, or 25%, of the purchase, whichever is less, while Klarna charges a maximum $7, or no more than 25%, of the past due amount. Klarna said it will contact users to collect payment before charging a late fee.

This delivery app went above and beyond for its workers. Then Uber took over. Cornershop’s original operating model was more beneficial and friendly towards workers. After the acquisition, life became more challenging for drivers. It remains to be seen whether the regulation in Chile will allow workers to unionize and force Uber to recognize drivers as full-time employees. This is a classic case of conflicting interests between gig companies and drivers as well as of the important role that governments play in this conversation.

Why the University of Florida gets a ~$20m cut of Gatorade profits every year. A fascinating story on a wildly popular drink.

The Most Important iPhone Ever. “What makes the iPhone and perhaps Apple special is that it seems to deliver things that nobody asks for but then everybody wants while eschewing overshooting a performance dimension that a few demand but most won’t use. The tragedy of overservice and disruption is that if you don’t shift the definition of performance eventually you run out of demand at the top of the performance curve. That opens you up to “good enough” competition from below. Instead you need to re-define the notion of performance: compete on a new basis, reset expectations. That the iPhone can find new dimensions of performance and hence demand is effectively a solution to the innovator’s dilemma.”

PayPal Introduces Customers to the Next Digital Payments Era with the New PayPal App. “The new PayPal app will introduce new features including PayPal Savings, a new high yield savings account provided by Synchrony Bank, alongside new in-app shopping tools that will enable customers to earn rewards redeemable for cash back or PayPal shopping credit and uncover deals with hundreds of merchants. Additionally, the new app offers PayPal customers a single place to manage their bill payments, get paid up to two days earlier with the new Direct Deposit feature provided through one of our bank partners, earn rewards and manage gift cards, send and receive money to friends, family and businesses, pay with QR codes for purchases and redeem rewards in-store, access and manage credit, Buy Now, Pay Later services, buy, hold and sell crypto, as well as support causes and charities they care about.”

Other stuff

The tangled history of mRNA vaccines

Stats that may interest you

“One in five consumers made a purchase using a “buy now, pay later” service within the last 12 months.

One in six consumers who made a buy now, pay later service purchase regret doing so, commonly citing high interest rates, a lack of options to build credit, or making unnecessary or unaffordable purchases.”

There have been 47 startup venture deals in Africa in 2021 so far with the average deal size of $21 million

CPC on Amazon ads is $1.27 in August 2021, up from 86 cents from a year ago, according to a survey

31% of online grocery shoppers use PayPal, according to a new study by ACI Worldwide and PYMNTS

Fuel Wasted Due to U.S. Traffic Congestion in 2020 Cut in Half from 2019 to 2020

14% of U.S consumers said they switched to an iPhone from another operating system in the last two years, a report said

Is BNPL replacing Credit Cards?

BNPL is a red-hot phenomenon now both in the financial and retail worlds. Because most BNPL transactions are funded using debit cards or checking accounts rather than credit cards, one of the main debates is whether it is replacing or will replace credit cards.

When asked about BNPL and its impact on credit card balance, the CFO of Discover, John Greene, had this to say:

What we’ve seen to date is consumer appeal has been on the lower credit quality folks. I think there will be a natural evolution that, that will come up the credit spectrum. We’ve also seen in terms of the firm, some higher credit quality customers actually electing to do a buy now pay later transaction, whether it’s paid in for or something else.

We haven’t seen any discernible impact whatsoever. So where I would likely see that is through new customer acquisition, and that’s — that activity has been very, very robust. The balance sheet on existing customers here, so loans, that’s been impacted by stimulus and kind of how they’ve allocated their dollars within their household. Nothing from the details we’ve looked at that would indicate that buy now pay later’s impacting the portfolio.

Discover Financial Services – Barclays Virtual Global Financial Services Conference

Echoing that sentiment, Brian Wenzel, CFO of Synchrony Bank, said there was no visible impact from BNPL on their credit card portfolio:

Yes. So first, we have studied buy now, pay later impact over the last couple of years as it really has grown, and we partnered with an outside firm to kind of do a deep analysis really on the — at the customer account level to kind of understand the behavior patterns it has. So when we see it and the data we’ve seen, I think, 75% of the buy now, pay later accounts are funded out of a debit account, right? So the view is that they are — you’re using cash and taking what would be a debit transaction through the buy now, pay later. We then looked — and really the impact of our business, and we looked at it and talked a little bit about it in Q&A last week about the impact on our business.

Are we seeing anything that says buy now, pay later is impacting credit? And so when you look at it versus a cohort population of our Mastercard as well as our Dual Cards, we see a low penetration, and we have not seen any changes certainly with how they use credit with us. In fact, they are more engaged with us than our average customer. They generate more revenue for us, but we have not seen any change. So as we look at it — when we look at applications come through, go over some of these products are offering, we have not seen any change, discernable changes.

So when you think about the impact to us in credit, we don’t really see it yet. We think that there is a shift that’s happening probably from cash as a tender type. And I think this is where the merchants and our partners are taking a step back. They are saying, “Yes, we understand your offer, consumers like it. But is this driving incrementality for us, true conversion?

Synchrony Financial – Barclays Virtual Global Financial Services Conference

One may argue that the main business of Discover and Synchrony is credit card so they had to put on a brave face. They might have. But since they are publicly traded companies; which often require them to be truthful to investors, I’ll give them the benefit of the doubt. More importantly, what they say seems to be in line with what Marqeta sees in their 2021 State of Credit report.

Recently, Marqeta released a 2021 State of Credit Report with some interesting insights into how consumers in the U.S, the U.K and Australia use BNPL and credit cards. The report is based on a survey of 3,500 people across three countries. Here are my take-aways regarding consumer preferences in the U.S:

  • 78% of respondents in the U.S use credit cards while 25% actively use BNPL
  • 50% of U.S consumers use credit cards because of rewards, something that is still a weakness of BNPL providers but they are working on it
  • “60% of U.S. 18-25-year-olds said they made more than five purchases on their credit card online each week, compared with 19% of 50-65-year-olds”
  • “79% of consumers surveyed who use BNPL reported having three or less BNPL plans open at a given time, with 45% of people reporting their average BNPL purchase at less than $100.”
  • “Older consumers however, were decidedly against, with survey respondents 51-65 years old voting overwhelmingly (63%) in favor of the credit card-first status quo.”
  • “Americans were again slightly worse off, with 30% responding that they’d struggled to meet payments”

3 out of 4 U.S consumers use credit cards. 60% of the younger segment use their cards regularly every week while the older and wealthier crowd want to keep the status quo. That, to me, is the sign that the credit card business is still healthy and well, at least for now. By no means do I insist that BNPL doesn’t have a chance to overtake credit cards. More and more issuers such as Citi, Amex or Chase introduced the ability to put qualified transactions on installment plans (BNPL). All the major retailers in the country allow shoppers to have a payment plan. Even Apple is reportedly working on their own version of BNPL. Who knows what the future holds? But for now, all signs point to a healthy credit card industry holding their ground.

Weekly reading – 28th August 2021

What I wrote last week

My review of three books: 1/ Stray reflections; 2/ An ugly truth and 3/ Obviously awesome

Business

Facebook says post that cast doubt on covid-19 vaccine was most popular on the platform from January through March. The fact that this article was published on a Saturday means that Facebook doesn’t want too many people to see it. I honestly can see the bull case for Facebook. However, it will be remiss to not mention the monumental challenge of content moderation that the company has to face. Because when false information runs rampage on its platforms, it may affect the engagement of users; which in turn can adversely affect advertising that is Facebook’s bread and butter.

Why You Can’t Find Everything You Want at Grocery Stores. Retailers are suffering from supply shortages; which is exacerbated by higher-than-expected demand. But if these hiccups are overcome, it means that there will be a growing retail segment in the coming months and by extension, likely, a healthy economy.

Diem: A Dream Deferred? Facebook has a lot going to their advantage: almost limitless resources, four of the most popular social networks in the world, 1/3 of the global population are its users, a money printing machine that is growing at a scary clip. But there are a couple of challenges that Facebook will have a hard time to overcome. First, it’s content moderation. Should I say: content moderation without pissing off anybody. As you can see, the task sounds almost impossible. When you moderate content by people with vastly different ideologies, you are almost certain to upset somebody. Facebook doesn’t have the luxury of having upset users or lawmakers. Hence, it’s not a problem that Facebook will easily solve. Second, public trust. The company has been around for almost 20 years and it has not garnered a lot of trust. As long as it continues to rely on advertising, capturing data and more importantly be embroiled in misinformation, the public trust will likely continue to evade them. As the article from Coindesk pointed out, trust is paramount in the payments/finance world. How on Earth would Facebook succeed in it?

The Digital Payment Giant That Adds Up. Merchants are going down the omni-channel route that allows shoppers to shop in multiple ways. This will be the key to Adyen’s growth. I like the fact that they prefer building in-house and maintaining the one-ness of their platform to acquiring capabilities from other companies through M&A and bundling different tech stacks into one. Working at a company that suffers from systems not talking to each other, I know first-hand how that could become a significant problem in no time. In addition, I really look forward to Adyen coming to the U.S with a banking license. I am not sure the folks at Marqeta share my enthusiasm.

Buying a bank turned LendingClub around. Now the fintech industry is watching. It requires a lot of work and preparation to get a banking license. The benefits of owning a charter; however, include less dependency and more control over your own fate, margin and operations.

What I found interesting

Inside Afghanistan’s cryptocurrency underground as the country plunges into turmoil. One can argue that cryptocurrency can be a savior in crises like what is going on in Afghanistan. The thing is that if something requires there to be a crisis to drive adoption, I am not sure that something is as good or revolutionary as some may think.

An immense mystery older than Stonehenge. It’s profoundly impressive to me that prehistoric people could transport stones that weighed tons to the top of a hill 6000 years ago. Think about that for a second. They must not have had all the tools that we came up with up hundreds of years later. It’s just extraordinary. If I ever have enough money and time, Gobekli Tepe, Machu Picchu, Egypt and Greece are where I wish to go.

Bigger vehicles are directly resulting in more deaths of people walking. Take a trip to Europe and you’ll see how absurdly big vehicles in the U.S are compared to those in Europe. And the implications aren’t necessarily positive. I’d argue that it’s considerably better to have smaller vehicles or fewer vehicles on the roads.

European Sleeper Trains Make a Comeback. I really wish that Americans would share the same enthusiasm about travelling by train as Europeans do. Personally, I enjoyed the train ride from Chicago to Omaha. If there were a reliable Wifi, I’d take trains every single time over flights and especially driving.

Apparently, there is a 2021 Global Crypto Adoption Index and Vietnam is ranked as #1. Below are the two reasons that experts say are why Vietnam’s adoption is so high. I am not sure how I should feel about it. On one hand, this index is not negative in nature. Hence, the #1 ranking certainly feels good. On the other hand, the alleged reason that young people don’t know what to do with ETF is alarming. That implies a lack of understanding in investing and a tendency to gamble in cryptocurrencies.

“We heard from experts that people in Vietnam have a history of gambling, and the young, tech-savvy people don’t have much to do with their funds in terms of investing in a traditional ETF, both of which drive crypto adoption,”

Source: CNBC

Stats that may interest you

In 2019, 70% of music in Japan was consumed via CDs

eCommerce made up 13.3% of total retail sales in the U.S in the 2nd quarter of 2021, indicating that the Covid effect has tapered off

46% of retail BNPL shoppers didn’t use their credit cards because they wanted to avoid high interest rates

The U.S online lottery ticket market will reach $2.3 billion by the end of 2021, a 25% YoY growth

PayPal made strides towards being a Super App

PayPal amplified its efforts to become THE Super App for consumers’ financial needs with several big announcements in the past few days.

  • Giant Eagle enables PayPal and Venmo at all of its 474 stores. This is the first grocery chain in the country that accepts PayPal and Venmo at checkout. To complete an in-store order, users can simply open their PayPal or Venmo app and have the QR code shown in the app scanned by the store cashier. As an incentive to promote the adoption of this feature, PayPal will send $10 in cash back to anyone after they make the first purchase of at least $40 at Giant Eagle
  • ACI Worldwide partners with PayPal to bring mobile wallet options to ACI’s bill clients. ACI Worldwide is a leading company in real-time digital payments with numerous clients in various industries such as consumer finance, government, education, healthcare, insurance, telephone and cable, and utilities. By virtue of the new collaboration, bill payers can now make payments on ACI’s client platforms through their PayPal or Venmo wallet
  • Yesterday, Fiserv announced a new feature that enables business-to-consumer payments deposited to PayPal or Venmo accounts. PayPal or Venmo users will be able receive payments from gig economy companies, insurance firms or tax refunds from the federal governments to their PayPal or Venmo account
  • Last but definitely not least, starting October 1, 2021, the company is going to drop late fees for BNPL customers globally.

PayPal is one of a few companies that are known globally. Anyone that regularly shops online must be familiar with their iconic blue button on online merchants’ checkout page. Strong in processing online payments, PayPal; however, hasn’t been as popular with in-store checkout. Personally, I rarely see a store that accepts PayPal as a payment option. The company is well aware of that weakness and planning to address it. In the very last earnings call, the CEO mentioned that they were going to aggressively go into stores. The partnership with Giant Eagle is proof of that. Even though there are only 474 stores in the chain, this is a great first step. I imagine that PayPal will try to use data acquired from this partnership to demonstrate to prospect partners the benefits of allowing PayPal products at checkout. Plus, grocery is a staple category to consumers. If they are accustomed to checking out with PayPal/Venmo, they will be more likely to use it for other purchases as well.

PayPal has been growing its bill payment service for a while. In the previous earning call, the company cited growing bill payment volume as one of the reasons for its decreasing take-rate. The partnership with ACI Worldwide will likely grow the processing volume yet suppress that take-rate further for the foreseeable future. ACI Worldwide supports around 4,000 customers in the US and according to one study, Americans spends $2.75 trillion a year on recurring bills. Even if this move helps PayPal gain 1% of that volume, that’s another $27.5 billion a year added to the company’s U.S bill payment volume. Given that it processes $350+ billion in a quarter WORLDWIDE for ALL services, I suspect that’s the lift the management will be pleased with. I really like this partnership with ACI. Instead of going out there and going through hoops to work with numerous companies, PayPal can now be available on 4,000 checkout pages in a short amount of time. Bill payments are such a critical function in most adults’ life. Convincing consumers to use PayPal/Venmo to pay bills will create a usage habit that is difficult to break.

Here is PayPal from its 2020 annual report:

Transaction expense is primarily composed of the costs we incur to accept a customer’s funding source of payment. These costs include fees paid to payment processors and other financial institutions to draw funds from a customer’s credit or debit card, bank account, or other funding source they have stored in their digital wallet. Transaction expense also includes fees paid to disbursement partners to enable a transaction. We refer to the allocation of funding sources used by our consumers as our “funding mix.” The cost of funding a transaction with a credit or debit card is generally higher than the cost of funding a transaction from a bank or through internal sources such as a PayPal or Venmo account balance or PayPal Credit.

Hence, the more transactions are funded through bank accounts or PayPal balance, the better it is financially for PayPal. Asking consumers to transfer funds from a checking account to a PayPal/Venmo before making a purchase using that balance is futile. It’s inconvenient and cumbersome. The collaboration with Fiserv helps PayPal go around that challenge. Additionally, having a balance motivates users to be more active. If a friend of mine sends $50 to my PayPal account, I will be more willing to use it for my next purchase than I would without that $50 balance. A few months ago, Square bought the tax business of Credit Karma and integrated it into Cash App. I wrote in my thought on the acquisition

In essence, it benefits Square when customers have balance in their Cash App. The more balance there is, the more useful Cash App is to customers and the more revenue & profit Square can potentially earn. I imagine that once Credit Karma’s tax tool is integrated into Cash App, there will be a function that directs tax returns to customers’ Cash App. When the tax returns are deposited into Cash App, customers can either spend them; which either increases the ecosystem’s value (P2P), or deposit the fund back to their bank accounts. But if customers already direct the tax returns to Cash App in the first place, it’s unlikely the money will be redirected again back to a checking account. As Cash App users become more engaged and active, Square will look more attractive to prospect sellers whose business yield Square a much much higher gross margin than the company’s famous Cash App.

The integration of Credit Karma Tax into Cash App did happen. The same logic can be applied here. In addition to lowering its transaction cost, PayPal benefits in different ways from having more balance in its wallet. Instead of acquiring a tax filing business like Square did with Credit Karma, PayPal collaborates with Fiserv to enable not only tax refunds, but also paycheck deposit or insurance payments. Less capital, more applications. What’s not to like?

The BNPL market is hotter than ever. Recently, Square paid an enormous sum of $29 billion for Afterpay. Merchants are racing to enable the feature due to the fear of missing out. Banks like Citi, Chase or Amex scramble to offer their own BNPL version. Even Apple is rumored to develop its own service for Apple Pay transactions. PayPal launched its PayPal in 4 in August 2020. Since then, the service has processed more than $3.5 billion in transaction volume, $1.5 billion of which took place in the last three months alone. Yesterday, with its policy to drop late fees for consumers, PayPal took a bold step towards gaining more market share in this red hot market.

Let’s talk quickly about how BNPL providers make money. There are some providers like Afterpay or Klarna that allow consumers to break down a purchase into several interest-free payments. To generate revenue, these providers charge consumers a fee for every late payment and merchants a fee that is much higher than the usual interchange rate in exchange for new business. On the other end of the spectrum, there are other companies like Affirm that charge consumers no fees, but levy interest on the purchase. For PayPal, it originally belonged to the first group of BNPL firms that offer interest-free payment plans. As a late comer, PayPal lets merchants use this service at no additional charge, apart from the usual commission rate. Today, to attract the end consumers, PayPal decides to drop late fees, a move that will force other competitors to copy to avoid losing grounds. I expect them to follow suit soon. Late fees only make up 9% of Afterpay’s revenue. The problems for these pure BNPL players are that 1/ they don’t have multiple touchpoints to consumers like PayPal and 2/ they are already not making money. Dropping late fees will make the road to profitability even tougher. For the likes of Affirm, I mean, what can they offer consumers and merchants that PayPal can’t?

All of these developments have one common goal: to make PayPal the go-app application for all things financial for us consumers. Just take a look at the breadth of services that PayPal can offer below. There are few companies that can do the same, let alone having 32 million merchants on the network and a brand name that is widely recognized across the globe.

PayPal's Consumer Services
PayPal’s Consumer Services

I expect in the next few quarters, PayPal will have:

  • A higher TPV
  • A lower take-rate due to more bill payments, P2P, especially from Venmo, the drop of BNPL late fees and less reliance on eBay
  • Higher loss rates
  • Higher cost of transactions simply because PayPal has to compensate the likes of ACI, Fiserv and Giant Eagle
  • Higher marketing expense as % of revenue

However, as a shareholder, I can’t help but feel optimistic about the company’s outlook with these moves. I look forward to hearing the management team discuss the ramifications in the future earnings calls.