The pay-later credit services market — Buy Now, Pay Later (BNPL) — has boomed over the last couple of years. Square [SQ] is looking to capitalise on BNPL finances with the $29bn acquisition of Afterpay [APT.ASX].
Square, a financial technology firm started by Twitter founder Jack Dorsey (pictured above), announced the Afterpay offer along with second-quarter earnings on Sunday 1 August. Its share price jumped over 13% at its high of $280.88 in the very next trading session. The Square share price went on to record an all-time high of $289.23 on 5 August.
Year-to-date, the Square share price has risen 28.5% to $279.73 at the close on 9 August. It’s up 90% in the year to the same date, and is currently priced 108.7% above its 52-week low of $134, recorded on 4 September last year. In the last month, the Square share price has gained over 11%, despite the stock getting caught up in the ongoing sell-off that has seen growth stocks slide.
Valuation of Square's acquisition of Afterpay
The recent movement in the Square share price has been positive, but what will the acquisition mean for Square and will the move into BNPL pay off?
Small but significant
Australian firm Afterpay is a BNPL market leader that lets customers pay in four interest-free instalments. Square’s acquisition comes after PayPal [PYPL] entered the BNPL space, launching its Pay in 4 service on 31 August 2020.
In fiscal 2021, the year to the end of June, Afterpay brought in $693m in revenue, nearly double the $347m reported at the end of fiscal 2020. The company’s gross merchant volume, a useful metric for measuring a company’s performance over time, more than doubled, from $7.4bn last year to $15.8bn.
Afterpay's fiscal 2021 revenue
Afterpay’s strong performance in the recent fiscal year suggests it’s ripe for a bigger player such as Square to come in and swoop it up. To put its revenue into context, Square brought in $9.5bn in fiscal 2020, the year to the end of December, up from $4.7bn in 2019. If the two revenues for their respective recent fiscal years were combined, Afterpay would have been responsible for 6.8% of the total.
While Afterpay would undoubtedly give Square’s top line a boost, the potential impact of the deal lies in how Square can accelerate Afterpay’s business by making the BNPL service available through Square’s mobile payment platform Cash App.
Afterpay currently has around 16 million users and Cash App has 70 million. The 100,000 merchants that accept payment from Afterpay will get access to a wider consumer base and existing Afterpay users will be able to access other financial services available through Cash App.
A channel for organic growth
As it stands, it’s uncertain as to whether the deal will prove to be good value for Afterpay shareholders. It’s an all-stock acquisition, under which shareholders will receive 0.375 shares of Square for each Afterpay share they own, based on the 30 July closing price of $247.26. This implies a $92.72 or A$126.05 valuation, more than 30% upside from Afterpay’s 30 July closing price of A$96.66, but slightly lower than its 6 August price of A$132.15.
Following news of the acquisition, Andrew Jeffrey of Truist Securities raised his target for the Square share price from $325 to $365, a 30% upside from the latest closing price.
Jeffrey wrote in a note to clients reported by Seeking Alpha that the deal would be “a clear negative” for PayPal, as well as other BNPL competitors such as Affirm [AFRM] and non-listed Klarna. It would also help to grow Cash App’s organic revenue as it will open up BNPL financing to more people, he added.
“We built our business to make the financial system more fair, accessible, and inclusive, and Afterpay has built a trusted brand aligned with those principles” - Square CEO Jack Dorsey
Square CEO Jack Dorsey said in a statement: “We built our business to make the financial system more fair, accessible, and inclusive, and Afterpay has built a trusted brand aligned with those principles.”
Despite the BNPL boom, the market has drawn much ire, and BNPL firms are facing increased scrutiny. There are calls for tighter rules regarding BNPL lending – a number of countries, including Australia, have struggled to regulate the market. Regulation could be a future headwind for the Square share price.
The Global X Fintech ETF [FINX] has a year-to-date daily total return of 3.53% – Square is its second-biggest holding, with a 6.80% weighting as of 6 August. Ark Innovation ETF [ARKK], which has returned 5.09% year-to-date, has assigned it a weighting of 4.63%, the fund’s sixth-biggest holding as of 9 August.