Many great businesses are founded on, at their core, simple ideas that provide intuitive solutions or improvements on how we interact within the economy. This is even truer in the internet and smartphone era, with applications that allow us to socialise, share photos, pay bills, stream music and watch videos being utilised by millions of consumers worldwide and gaining multi-billion dollar valuations. Whilst there have been considerable advancements in the payments space pushed by various fintech players over the last decade, there have been few material changes to the consumer finance industry since the advent of credit cards and in-store credit lines decades ago.
You may or may not have heard of two Australian companies, Afterpay and Zipmoney. If you have not, it is likely that you will in the not too distant future.
Business Overviews:
These two relatively new entrants to the fintech space both have a similar offering, essentially a modern layby or deferred payments system. They allow users to receive their goods and/or services immediately, whilst paying off their purchases over an extended period, interest-free (in most circumstances).

Afterpay was founded in 2015 by Nick Molnar and Anthony Eisen. The back-end IT system was built by Touchcorp, an experienced Australian technology company who serve large corporations such as 7-Eleven, Optus, Transurban and CBA. After testing was completed through a select number of retailers in 2015, the company raised $8m in equity and was floated on the ASX later that year. In an interesting turn of fate, Afterpay essentially acquired Touchcorp through a scrip merger. After accounting for Touchcorp’s existing 28% equity stake in Afterpay, Afterpay acquired the company at a very sharp price, which had been depressed after the unexpected passing of Touchcorp’s founder and CEO. Afterpay locked down its technological backbone, a profitable business and removed the liability of fast growing transaction payments which Afterpay paid Touchcorp on every order.
Afterpay is a deferred payments product that allows its customers to buy a good or service now whilst paying off their purchase in four fortnightly payments over eight weeks, interest free. There are no account setup fees or ongoing charges and the setup process takes only a few minutes. A flat $10 fee for the first missed payment and $8 for a second missed payment acts as an incentive for customers to pay on time. Afterpay’s payment option is imbedded in partnered retailers’ websites and when a purchase is made with the company, Touchcorp’s anti-fraud system decides almost instantaneously whether to approve the transaction (>80% requested during 2016).
Currently Afterpay has over 800,000 customers and its service is available at over 6,000 online retailers and is rolling out its in-store offering. The company is also looking to expand into new verticals as well as eyeing an international expansion, with New Zealand already underway.

Figure 1. List of some of the top retailers at Afterpay
Source: Company website

Zipmoney was founded in 2013 by Larry Diamond and and Peter Gray. It listed on the ASX in 2015 after a $5m equity placement. Unlike Afterpay, Zipmoney had its IT systems developed in-house, which include its proprietary anti-fraud software. The company also runs Pocketbook, a budgeting and personal finance management app with over 350,000 users.
Zipmoney currently has two primary products; Zipmoney and Zippay. Zipmoney is a virtual line of credit, which is interest free periods of between 3 and 36 months. A small origination fee may be payable as well as a $4.95 for each month a balance is owing, which can be as high as $10,000. Zippay is a $1000 limit credit line for smaller purchases and offers 1 month interest free. Alternatively, users can pay off their balance at a minimum of $40 per month, incurring a $4.95 fee each month money is owing. Zipmoney is targeted at bigger ticket items such as elective surgeries and holidays whereas Zippay is geared more towards smaller retail orders, such as fashion and groceries, with an average order size of under $200.
Zipmoney currently has over 300,000 customers with its service available at more than 3,000 merchants. The service is currently available at a wider variety of retailers than Afterpay, including grocers, travel agents and elective surgeries.

Figure 2. List of some of the top retailers at Zipmoney
Source: Company website
What is the value proposition to users/retailers and how do they make money?
For users of these services, both companies offer attractive ways to manage their week to week cash-flows. Assuming customers keep on top of their payment schedules, both Afterpay and Zippay offer customers a free way to manage payments for mid-size purchases over multiple paycheques. Zipmoney extends both the repayment period and the amount of credit offered, whilst having more fees attached. Whilst not ‘free’ in the sense of the other two offerings, it is notably cheaper for the consumer than traditional consumer lenders or payday loans. Both companies have easy signup process and user-friendly websites and the ability to payback any amount owing early.
Picking which product resonates with the end customer more, it seems fair to say at this stage of the journey, Afterpay has hit the sweet spot. The offering at its core is simpler to understand and has less conditions and fees attached to it, whilst offering an interest and fee free repayment schedule almost twice as long as Zippay (56 days vs 30 days). Zippay may be more attractive to certain demographics, as it does have more flexibility in how long users can stretch out their repayment periods. This comes at a price to their customers, which removes some of the potential allure that advertising the product as ‘free’ can bring.
Ultimately, there seems to be a difference in philosophy between the two companies in regards to where and how they generate their revenues. Zippay earns a larger slice of its revenues from user generated fees, whereas Afterpay earns more from its merchants through a higher fee. Zippay’s model relies on generating fees on a more even basis between the customer and the merchant whereas Afterpay gives has a better offer for the customer whilst charging higher rates to the merchant.
For merchants of these services, the primary question of whether to utilize them is a similar one when considering the fees they pay for credit cards and premium providers like American Express: Is the cost of using the service and thus lower margins on sales compensated via a revenue uplift and other benefits of using the service, such as the removal of fraud and credit risk? Zipmoney/Zippay charge a 3% flat fee to merchants using its services while Afterpay charges a larger rate of between 3.5-5%. Both of these services remove the risk of chargebacks, fraud and credit risk, with the companies assuming all costs associated with these. In the U.S., where more data is available on the issue, studies estimate that online retailers spend an average of 7% of their revenues on combatting and paying for fraudulent transactions. Making various assumptions in terms of the total percentages of orders that these services will capture for a merchant, the increased fee over standard credit cards can potentially be justified on this metric alone.
Fraud and credit reduction, however, is not the primary benefit to merchants. When integrating these payment options into their websites, merchants see meaningful uplifts in conversion rates (visitors to site who make a purchase) and average order sizes, both combining to add a significant increase to overall sales. As both companies have pointed out in various presentations and results releases, checkout rates have increased by up to 30% and total order sizes (of users of the services vs. other methods) increased by up to 60%. If these metrics can be maintained, the question retailers will be asking themselves will change from ‘should we be paying for this service?’ to ‘can we afford not to have this service?’

Figure 3. Left, overall effect of Zippay integration to online retailers. Right, select retailers changes in key metrics post integration of Afterpay
Source: Company presentations
Further to the points on order sizes and conversion rates, as both of these players continue to grow their user bases, their network effects will become further entrenched. Management of Afterpay have commented that when they onboard a new retailer to their service, they often see a short term surge in sales above and beyond the eventual sustainable increase. These can be put down to the promotion of the recently enlisted retailer through their internal channels (email alerts, social media and app [for Afterpay]), which notifies hundreds of thousands of their customers that they can use their ‘buy now, pay later’ service at a new destination.
How have the businesses grown, how big is the addressable market and which is the better business?
Both Afterpay and Zipmoney have experienced incredible growth in their user bases, integrated merchants and transaction volumes since listing in the last couple of years. As of their latest updates, Afterpay currently has over 800,000 customers, 6,000 retailers and annualised underlying sales of over $1b. Zipmoney has over 300,000 customers, almost 4,500 retailers and roughly $350m in annualised underlying sales.

Figure 4. Key operating metrics for Afterpay
Source: Latest Business Update

Figure 5. Key operating metrics for Zipmoney
Source: Latest Quarterly
Between them, these two companies have moved from being a fraction of a percent of market share in the online fashion retail and broader Australian retail market to almost 20% in fashion retail and over 5% of total Australian online retail in a couple of years. Both are well funded: Afterpay having undertook a second equity raising after listing, acquired Touchcorp’s cash balance through its merger and a $200m funding facility from NAB. Zipmoney has over $20m in cash on its balance sheet as well as $400m in debt financing from a combination of U.S. investor Victory Park Capital and NAB. Funding for both companies remains comfortable for the near to mid-term with significant headroom in both of their facilities.

Figure 4. Afterpay various market shares and addressable markets, circa January 2017
Source: Afterpay H1 2017 Investor Presentation
Ultimately, there are a number of differing aspects between Afterpay and Zipmoney which, in our minds, show Afterpay has a superior business model. The main points are:

  • Much lower cost of acquiring customers: Zipmoney is approximately spending 25-30% more on marketing per quarter than Afterpay, yet acquiring customers at a third of the rate of its competitor.
  • Lower bad debts and superior IT backend: in its latest update, Zipmoney indicated that its bad debts had jumped significantly, on a relative basis, to 1.5%. This compares to Afterpay which updated the market that it has maintained its transaction loss ratio at approximately 0.7%, even whilst undergoing meteoric growth. The differences in these metrics are caused by two main drivers, in our opinion; the Touchcorp fraud/credit engine being superior to the in-house Zipmoney system and the streamlined repayment schedule of Afterpay’s offering.
  • Blue chip retailers: Afterpay has captured the bluechip end of the market in terms of retailers, signing names such as Myer, Big W, Rebel Sport and Officeworks. Zipmoney has won some larger retailers such as Harris Farms and Webjet, although the bulk of its transactions are at less established retailers. This fact will make it easier for Afterpay to sign other big names in future. Further to this, recent wins from MAC and Sephora (Louis Vuitton) act as a solid pathway to international growth for Afterpay.
  • Higher returns on capital: Given Afterpay has just one product with a short-term defined repayment period, it is recycling capital through its business at a much quicker rate. This compares to Zipmoney which can have individual lines of credit on its balance sheet for years at a time. Whilst the net margin on each transaction is only 2.5%, given the fact they can be highly debt funded and can recyle capital 12 times per year, it can push ROC to 30% and ROE to above 80%, assuming metrics hold.
  • Simpler model that is more attractive to the customer: Currently, Afterpay offers just the one repayment reschedule and flat fee structure on missed payments. Zippay offers multiple products with differing interest free profiles and differing fees dependant on the amount of credit being extended. Business that have been highly successful in the tech era such as PayPal and Amazon have taken very customer centric approaches, and once they have built a large and relatively satisfied user base, it is incredibly hard to disrupt or compete against them. Whilst early in its journey, we believe Afterpay is beginning to show some evidence of this.

Using a sustainable ROE model to try and value either of these high-growth businesses is a precarious task, given the large amount of assumptions that one needs to make regarding growth rates, future verticals and potential international expansions. This also extends to risks such as customer saturation points and the potential for bad debts to rise in a weaker economic environment. As such, it is likely that many of the consensus broker numbers will be measurably wrong in one way or other. However, given Afterpay has experienced 150% growth in underlying sales in 6 months and is running at over a billion dollars in annualised sales today, with forecasts having them earning $43m EBITDA on $2b of underlying sales in 2020, one can make the argument these numbers a quite conservative. In a similar fashion to other modern tech companies such as, PayPal and even Facebook, the network effect that is beginning to present itself in Afterpay will make it incredibly difficult for any competitor to disrupt them. Whilst anyone could replicate any of these companies offerings relatively cheaply, attempting to get the same level of customers and businesses on the platforms would be prohibitively expensive.
Afterpay is still in its infancy in terms of its listed life, yet it has not failed to meet any of the lofty expectations that its current market cap implies. Whilst still in the speculative basket at this stage, it is quickly derisking itself with its growing moat looking less and less likely of being disrupted.
Note: Afterpay Touch Group is currently not valued on SIV, but will be turned on after it next reports, given it has not yet released audited statements as a combined entity. A valuation note will be posted along with the stock, explaining some of the forecasted assumptions.