Australia | Oct 17 2019
Is the market pricing in excessive growth for Afterpay Touch or does there remain a significant opportunity for US expansion? Two brokers initiate coverage and differ in their outlook.
-Opportunity to build a niche amongst credit-starved millennials in the US
-But Afterpay Touch lacks a protective barrier outside Australasia
-Will Afterpay Touch eventually be considered a credit provider?
By Eva Brocklehurst
Two brokers recently initiated on payments provider Afterpay Touch ((APT)) with widely differing viewpoints. Is the market pricing in excessive growth without factoring in the risks? Or is there a significant opportunity for the company to expand in the US?
Afterpay Touch has achieved mass adoption in Australia and has acquired 2m users in the US in its first year of operations. The stock price has increased to 35x times its April 2016 IPO price and the company has delivered on substantial growth promises so far.
Morgan Stanley envisages an opportunity to build a niche amongst millennials (Gen Y & Z, aged up to 40) in the US who have had their supply of credit from traditional lenders curtailed since 2009. These generations are in, or will enter, their key debt accumulation phase over the next decade and are likely to drive the bulk of US loan growth, which Morgan Stanley estimates at around US$850bn over the next 10 or more years.
Capturing this cohort today means Afterpay Touch can participate in this credit creation. These generations are also comfortable banking with financial technology. Morgan Stanley initiates coverage on the stock with an Overweight rating, believing gross merchandise value is the key driver of the business, targeting $27-37bn in FY22-23 versus the company's $20bn-plus target.
The broker's price target is $44.00. In contrast, UBS has initiated with a Sell rating and $17.25 target, assessing that, paradoxically, if runaway success continues, the company will likely attract the attention of competitors and new entrants, as it lacks a strong protective moat outside of Australasia.
The product is easy to replicate and barriers to entry are low, although the company does have a first-mover advantage and a strong brand. Regulatory scrutiny may also be heightened and execution risks are significant.
UBS believes the share price currently implies none of these risks play out, and considers this is unlikely. Key is the company's model, which relies on prohibiting merchants from passing on the surcharges to customers.
Regulatory Risk
In the case of credit or debit cards in Australia, merchants cannot legally be prevented from passing on costs. Yet the company's model relies on consumers not bearing any additional cost, transferring, instead, these costs to merchants. For a $150 transaction, Afterpay Touch's merchant fees represent a 19-49% return and if customers were to be presented with the true cost of Buy Now Pay Later (BNPL) UBS envisages risks to growth.
There is also a risk that the company is eventually considered a credit provider. Afterpay Touch is currently outside the definition of being a credit provider and is therefore not regulated by Australia's credit code.
However, UBS points to surveys which reveal that 64% of customers think BNPL is credit while 30% have used a credit card to pay down their balance. Those that use BNPL are more likely to be indebted, in the broker's assessment, and more likely to have had applications for credit cards rejected.
Morgan Stanley acknowledges Afterpay Touch could be drafted into the credit act and the obligations to conduct inquiries and verify customer income and expenses could then become a significant burden on the business.
US Market
Therefore, UBS poses the question of whether Afterpay Touch can succeed over the long term in the US, which has a market more than 10x times the size of Australasia. The US is home territory for VISA, MasterCard and PayPal and there are substantial budgets to defend against disruptors.
The broker considers it unlikely the company will achieve the same penetration it enjoys in Australasia, amid greater competition and more challenging economics, such as higher interchange fees. Higher credit card rewards incentivise credit card users in the US as well.
The broker estimates the share price infers a long-term US customer base of around 12% of the population and that appears optimistic. Consensus estimates may also not be factoring in margin dilution from US growth.
Yet Morgan Stanley emphasises the upcoming youth boom in the US. The US Gen Y and Z population is already 10x times Australia's and will become the largest borrower cohort within the next decade.? Beyond capturing the millennials base, achieving mass user adoption will be tough in the US, the broker agrees.
Afterpay Touch is entering a highly leveraged market late in the cycle and there is little room for error. A study of transaction margins for PayPal in the US, where interchange and charge-off rates are higher, highlights the risk, but the broker deduces investors will probably tolerate lower profitability for the near term.
Morgan Stanley emphasises the demographic tailwinds and considers the risks low for the near term. These include a spike in bad debts, which is the biggest risk and a catalyst for potentially changing its Overweight rating. In that case the bear case valuation would drop to $5/share. However, the broker is comforted by the fact employment trends remain robust and falling interest rates are alleviating pressure on budgets.
The company's payments business comprises two services, BNPL, which offers an interest and fee-free repayment schedule over four equal fortnightly instalments and the "Touch" component, which is software that enables products to be purchased via a number of methods both online and in-store.
FNArena's database has three Buy ratings, one Hold (Citi) and one Sell (UBS). The consensus target is $32.36, signalling -4.6% downside to the last share price.
See also, Material Catalysts Ahead For Afterpay Touch on September 30, 2019.
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