Affirm rides the BNPL waves

What happened

Affirm Holdings Inc announced strong earnings results on 29 August 2024, significantly exceeding its own guidance. The leading "buy now, pay later" (BNPL) company reported quarterly revenues of $659mn, largely surpassing its guidance range of $585-605mn. Additionally, Affirm's adjusted operating margin came in at 23%, well above its guidance of 15-17%. The company also offered a positive outlook for the next fiscal year, forecasting top-line growth of over 25% and achieving GAAP profitability towards the end of the period.

Analyzing Affirm's results provides insights into the broader BNPL industry – let’s review them!

Impact on our Investment Case

Credit quality remains stable

Credit quality has been a concern for investors in the BNPL sector, especially given the surge in subprime-rated borrowers. As credit card interest rates have climbed above 20% in the United States, BNPL has gained market share, raising fears of increased delinquency rates in the sector.

However, Affirm’s delinquency rates have remained stable at around 2.5%, which is manageable in terms of write-offs. This stability suggests that credit risk remains contained, alleviating one of the sector's key concerns. On the other hand, over the last three years, credit card delinquency rates have surged from ~1.5% to 3.25% and are on an upward trend. This data also tends to confirm that it is not necessarily the people who have run out of credit limits on their cards that switch to BNPL. BNPL is a distinct financing solution that attracts many people for its ease of use, starting with younger generations (e.g., about half of Millennials and Gen Z have used it over the past 12 months).

Strong demand for asset-backed securities (“ABS”)

Affirm has effectively managed credit risk by securitizing and selling most of its loans to the market, rather than holding them on its balance sheet. After its debut as a listed company (and in an environment with interest rates expected to increase and credit to tighten), Affirm struggled to attract investor interest in its securitized offerings. However, as Affirm grew and built a solid track record of borrower credit history, market confidence improved significantly.

In the last fiscal year, Affirm executed $3.4 billion in the ABS market, with recent issuances being oversubscribed, upsized, and offered at lower spreads than previous issues. Over 120 institutional investors now participate in Affirm’s note offerings, reflecting strong market demand and confidence in Affirm's securitized assets.

First mover advantage

The competitive landscape in the BNPL space has also been a key consideration. Historically, BNPL take rates (revenue divided by volume processed) have been >200bps higher than those of credit cards, but the increased competition was expected to drive down the take rate. Nevertheless and contrary to expectations, in its outlook for the next fiscal year Affirm actually expects an increase in its take rate. This indicates that Affirm is successfully leveraging its first-mover advantage and superior products.

Furthermore, Affirm’s established network of merchants and partners provides a competitive edge that is difficult to replicate quickly. Attracted by the growth rate of the credit card killer app, several Big Tech companies have entered the BNPL market but faced a rather challenging reality. For example, Apple attempted to launch an in-house BNPL feature in March 2023. However, by June 2024, Apple withdrew this feature in favor of partnerships with Affirm and other BNPL providers. Building scale and trust in the BNPL ecosystem is not easy.

Our Takeaway

Affirm is well-positioned on its path to profitability. With a market share <2% of North American e-commerce, there is substantial room for growth. The company eyes expansion into the European market, where it will compete, like in the United States, directly with the global leader, Klarna.

The potential decrease in interest rates in the United States could further support Affirm’s positive business momentum. Lower interest rates would benefit both borrowers and ABS investors. The former will have less credit risk, while the latter will be in a quest for returns, which should provide additional liquidity to the ABS market. This favorable rate environment could drive higher transaction volumes and support Affirm’s top-line growth and margin expansion.

Finally, we can also mention that the recently announced rules for BNPL players by the Consumer Financial Protection Bureau (CFPB) seem totally manageable. As we expected, BNPL companies will have to comply with similar rules and reporting as credit card companies.

Affirm has been a core holding in our Fintech portfolio for several years, reflecting our confidence in its business model and strategic direction. We remain optimistic about Affirm's future developments and its ability to capitalize on growth opportunities in both existing and new markets.