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Afterpay: It’s Hip To Be Square

Australia | Aug 03 2021

This story features AFTERPAY LIMITED, and other companies. For more info SHARE ANALYSIS: APT

Afterpay's weak quarter was ignored following a bid from Square which brokers acknowledge is advantageous, if a bit cheap, with competing suitors unlikely

-Benefits for Afterpay from access to new merchants and increased sales
-Small chance of competing bids as others lack scale or already have this combination
-FY21 revenue slightly below broker forecasts, yet unlikely to be in focus now


By Eva Brocklehurst

Square has ruffled the fledgling BNPL (buy now pay later) marketplace with a takeover offer for Afterpay ((APT)). Will this ensure the latter's success in the US? What does it signal for the sector going forward?

The offer values Afterpay at $39bn based on the prior Square closing share price of US$247.26, Morgans notes. Square will integrate Afterpay into its seller and cash app, delivering benefits in terms of sales and new merchants. On the other side, this provides opportunities for Afterpay consumers to access Square cash apps.

Morgans believes the strategic combination makes sense, as both can leverage their client bases and the products are primarily skewed to millennial and Generation Z consumers while the merchant ecosystems appear complementary.

The broker also suggests, as part of Square, Afterpay will be better able to withstand increasing competition in the BNPL space, and the deal highlights the value Afterpay management has created since listing.

Credit Suisse agrees there are strategic merits to the merger and, while the bid is below recent highs for the Afterpay share price, it reflects Square's intention to share future benefits with Afterpay shareholders through the all-scrip offer.

There is a low risk this deal won't be completed and a small chance of competing bids, the broker suspects, as most other suitors lack scale or the culture to fit so neatly. PayPal has its own instalment offering while Klarna competes at a district level.

The combined business will be in a strong position to succeed, particularly in the US, Citi asserts, although finds the timing surprising as it is early in the history of BNPL penetration and deems the offer price is low.

The structural trends towards instalment payments is just beginning and Afterpay is a market leader. Hence, the broker would not be surprised if another bidder emerges, particularly other financial technology firms and shopping/e-commerce platforms, although acknowledges the number of potential partners with a neat fit is limited.

Bid Details

Square will acquire the business via a scheme of arrangement, all in scrip. Afterpay shareholders will receive a fixed exchange ratio of 0.375 shares of Square common stock. As part of the arrangement Square will set up a secondary ASX listing via CHESS Depositary Interests. Afterpay shareholders can elect to receive common stock on the NYSE or CDIs.

Square has two key businesses, a cash app and a large merchant acquiring business and is expanding globally. As a result, Afterpay is attractive with its BNPL product, having demonstrated an ability to connect customers with merchants.

The implied valuation of the bid is materially ahead of the UBS price target, although in line with consensus. While not covering Square, the broker highlights the consensus target is US$281.76 which, based on the fixed exchange ratio and the same FX assumptions Afterpay is using, implies a $143.82 valuation per Afterpay share.

UBS acknowledges the trading update is unlikely to be a focus for investors now, yet highlights FY21 underlying sales outcome of $21.1bn was well below its estimates. FY21 merchant revenue for Afterpay was $822m, slightly below most broker expectations. Customer acquisitions continued to surge, with North America up 88% over the year.

Merchant revenue margin was in line with the prior year at 3.9%. The main issue is whether this softer result was a function of competition and Citi concludes it may have been one factor, yet is inclined to believe softer numbers are a function of slowing e-commerce and a lack of enterprise merchant additions in the US.

Credit Suisse updates its modelling for Afterpay after the trading update and includes the recently announced e-commerce deals in the US as well as the Afterpay Money app that supports ongoing growth in Australia. The broker has a positive view on Square's US listing with an Outperform rating and US$300 target.

Zip Co

Citi derives implications for Zip Co ((Z1P)) as takeover appeal has increased for this smaller BNPL stock, which has a fast-growing US business. The main concern the broker has surrounds the medium-term risk for Zip Co, as the Afterpay/Square pairing increases the scale disadvantage of its QuadPay relative to competitors in the US.

The broker also believes the QuadPay revenue yield is unsustainable, although Zip Co could reduce the gap in scale via a partnership. Nevertheless, Zip Co's Australian business is more of a digital credit card, with strategic value in the Shop Anywhere offering, and a lack of scale internationally signals the business is likely to be valued more along the lines of a consumer credit business.

FNArena's database has four Buy ratings, two Hold and one Sell (UBS) for Afterpay. The consensus target is $121.20, signalling -5.9% downside to the last share price. Targets range from $42 (UBS) to $150 (Ord Minnett, yet to comment on the bid).

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