In the U.S., the $12.2 billion ($17 billion) Nasdaq-listed buy now, pay later shares of giant Affirm have cratered 45% from top to bottom in the past three trading sessions. scholarship only. On Feb. 10, it raised its revenue forecast for fiscal year 2022 to between $1.29 billion and $1.31 billion. He also said second-quarter revenue rose 77%, with active consumers up 150% to 11.2 million.
So why does a group reporting huge growth have investors running for the hills? Perhaps because its margins are shrinking due to rising fixed costs. In the second quarter, the gross margin reached 50.8% of sales. In the third quarter, at the midpoint of the forecast, gross profit is expected to fall to 42.8% of revenue.
For similarly trained Wall Street analysts and investors, plummeting margins are a traditional sell signal, a sign of competitive pressure or structural problems.
Affirm’s chief financial officer, Michael Linford, said on last week’s earnings call that its financial outlook already reflected the roughly 180 basis point rise priced into the 3-month LIBOR curve.
Mr Linford also said that beyond fiscal 2023, for every 100 basis points of rate moves beyond the current forward curve, his gross profit margin could fall by 40 basis points as measurement of revenue, less transaction costs, as a percentage of gross market value.
These forecasts assume that Affirm’s current funding mix remains the same at a time when credit or bond markets are expected to tighten for corporate borrowers.
The underlying credit quality of a portfolio of loans revolving over a typical three-year period may change if bad debts on loans increase.
If buy now, pay later, lenders need to issue more bonds in the future to fund expanding loan portfolios, this may need to be done with wider fixed margins above a rate floating benchmark loan such as LIBOR.
In all fairness, it is possible that some of the lenders will convince the rating agencies to give their securitization issues higher credit ratings and therefore obtain lower fixed margins. But only if they show that their business models are moving towards sustainable cash flow profitability.
On the other hand, the subprime mortgage crisis of 2008-2009, where credit and loan markets froze dramatically as counterparties worried about each other’s creditworthiness, shows that lending on pooled debt portfolios is a risky business.
The GFC also showed that credit scores tend to go up the escalator and down the elevator.
Recently, the near-zero interest rate environment has artificially limited bad debt and eroded risk aversion. This means that the price of risk has fallen, but its level has remained and is expected to rise.
Do rating agencies, still tarnished by the GFC, expect bad debts to worsen in frequency and severity? It’s up for debate, but as interest rates rise on student loans, cars, mortgages, and credit cards, pressure on cash flow will increase for buy now, pay later users. The most responsible may use it less often, so less creditworthy users make up a higher proportion of the total.
It may sound neurotic, but the collapse in valuations reflects the risks. Shares of subprime lenders Zebit and Laybuy are down 95% and 91% since their respective IPOs.
Zip Co and Sezzle are down 77% and 83% over the past year and fell 5.3% and 7.3% respectively on Monday to new 52-week lows.
On a currency-adjusted basis, Block’s current value means its takeover bid on Afterpay would be worth just $56.74 per share today, compared to the $160 per share that investors sent to Afterpay on top of buy now, pay later bubble this time last year.