Afterpay has captured a large number of headlines in recent weeks, first with a strong business update, followed by a capital raising to support the global expansion, then with an audit notice received from AUSTRAC, news of a Visa initiative in the buy now pay later space and most recently with a board and management restructure. Below we outline Clime’s analysis of each of these events.
6 June – Afterpay Business Update

  • On 16 May, we reviewed our Afterpay forecasts and valuation based on data from web analytics. We looked in particular at the number of US app ratings per day and the number of US merchants being added to the platform. This suggested that the US business was adding customers materially ahead of our previous expectations. The company subsequently confirmed this with a business update on the 6thof June, stating that US active customer numbers had increased by 50% from 1.0 million to 1.5 million over the last three months.

11 June – Capital raising

  • Shortly thereafter, the company came to market to raise $317m via an institutional placement, with a retail share purchase plan to follow to raise approximately $30m.
  • Together with the capital raising, the CEO, Chairman and Group Head each sold approximately 10% of their holdings to new and existing US based investors.
  • In terms of the rationale for the raising, Afterpay needs to maintain at least 15-20% equity funding in their US receivables warehouse facility. The equity they have raised would support this facility to meet the FY2022 business target of processing over $20bn in underlying sales.
  • The other part of the equation is that profits in the Australian business are currently being offset by early stage investment in the US and the UK. It is in shareholders’ interests for Afterpay to grow their market presence in the US as fast as possible to build their economic moat against other market participants. With a stronger balance sheet, they are best placed to do this.

13 June – AUSTRAC notice announcement

  • On 13 June, APT advised the market that they had received a notice from AUSTRAC the previous evening requiring APT to appoint an external auditor to review its AML/CTF compliance. This essentially formalised the process that was already underway, adding specific requirements for the content of the audit and requiring reporting to AUSTRAC on a set timeframe (120 days for the final report from the date of appointment).

Details of the notice

  • AUSTRAC stated that it has “reasonable grounds to suspect that Afterpay is a reporting entity that has contravened and/or is contravening sections 32 and 81” of the AML/CTF Act 2006.
  • These two sections deal with having an applicable AML framework in place and with conducting ID checks for customers before providing a designated service.
  • Designated services include providing a loan and factoring receivables. The AML rules do not specifically address buy now pay later services, given the emerging nature of the industry, but the services are reasonably captured by the existing designations.
  • The AUSTRAC notice refers to updates to APT’s AUSTRAC enrolment details “whereby changes were made to the designated services it provides”.
  • The audit is required to cover the internal processes at APT leading to the changes to its AUSTRAC enrolment, the ID procedures and suspicious matter reporting, among other general matters regarding AML compliance.

Afterpay’s AML framework

  • In terms of s.81, Afterpay had an AML program in place and was registered with AUSTRAC when they started operations in Australia.
  • The company took legal advice on the structure of this program at that time.
  • This advice included that APT is a low risk entity, which determines the intensity of AML processes required.
  • Most relevant to the forthcoming review, the advice was that the “designated service” which APT is providing under the AML Act is receivables factoring. This is a service provided to the merchant, requiring ID checks of the merchant but not end customers. Consequently, APT has always undertaken appropriate ID checks in onboarding merchants.
  • Prior to July 2018, APT’s end customer ID checks were not based on AML requirements given the aforementioned designation. APT’s process relied on the KYC processes of customers’ banks.
  • It is worth noting that AUSTRAC has granted PayPal an exemption from customer ID checks for account balances less than $1,000. This would cover the vast majority of APT’s customers if they were granted a similar exemption.
  • In July 2018, APT made a business decision to strengthen its ID checks for end customers with external ID verification, using the databases of Illion and greenID. This required registering with AUSTRAC as providing a designated service to the end customer in order to access electoral roll details.
  • Any customer transacting after July 2018 has had ID checks conducted which would comply with AML requirements if APT is in fact required to make these checks.
  • It is no surprise that the change in registration raised AUSTRAC’s interest, as it implies that APT was not complying with its s.32 ID checking obligations prior to this time.
  • A counterargument to this would be that it is not clear what APT’s obligations are, given AML rules do not specifically address the buy now pay later industry. Moreover, APT took legal advice on an appropriate framework.
  • In regard to suspicious activity reporting, APT has always had systems in place to meet these obligations and does from time to time report suspicious activity. At the same time, the company is yet to identify any instance of money laundering or terrorism financing.

AUSTRAC notice analysis

  • The change in APT’s AML registration has raised questions with AUSTRAC as to whether the company was compliant prior to July 2018.
  • If the audit determines that APT is required to conduct ID checks of end customers, then there is a reasonable chance that the process prior to July 2018 did not meet the requirements.
  • However, it is worthwhile comparing the facts of this case to those of Tabcorp and Commonwealth Bank.  In particular, the small transaction sizes, lack of identified money laundering or counter terrorism financing and proactive behaviour on the part of APT in a new and emerging industry, all point towards a relatively low seriousness of offending.
  • That AUSTRAC has allowed the company to appoint an external auditor to conduct the review aligns with this view and again distinguishes this case from CBA and Tabcorp. AUSTRAC did not use the audit notice process in those cases.
  • The outcome of the impending audit remains uncertain at this point. In 2009, PayPal was found to have a deficient AML/CTF program and this was resolved with an enforceable undertaking and no fine. In more recent cases, with a greater seriousness of offending, AUSTRAC has pursued civil penalties.
  • For context, APT has a market capitalisation at the time of writing of $5.6bn and shareholders’ equity of approximately $615m.

Visa pilot program

  • On Friday 28 June, the market became aware of a Visa announcement in relation to a 2020 pilot program in the buy now pay later space.
  • The APT share price fell by 9.9% that afternoon on fears that this represented a material shift in the competitive landscape. The shares subsequently rose by 6.9% on 2 July after the market had time to more carefully consider the news and with the announced organisational update, detailed below.
  • What Visa announced was the planned “introduction of a suite of Visa’s instalment solutions APIs”. APIs, or application programming interfaces, are software tools that allow other financial organisations to use the provider’s infrastructure. In this case, Visa plans to make it easier for banks to create instalment payment offerings.
  • It is important to note here that Visa is not in the business of providing credit and is not about to become a buy now pay later provider in its own right. It will facilitate payments for banks issuing Visa cards that may wish to add instalment products.
  • It is not clear at this stage exactly what the structure and terms of these offerings will be. In order to offer a line of credit, these offerings may be built on the use of Visa credit cards (as opposed to debit cards), while the majority of buy now pay later users do not own credit cards. The service may also rely on interest and fees paid by consumers, in the absence of specific agreements with merchants, which negates a key attraction of the Afterpay service. Finally, individual bank issuers are unlikely to be able to offer retailers and consumers the platform which Afterpay has, whereby Afterpay is a significant referrer to retailer websites.
  • At this stage, Visa’s announcement represents an acknowledgement of the growing significance of the buy now pay later space, which involves a number of competitors. Afterpay has taken an early lead in this area and is building its competitive position as it continues to sign up several hundred thousand new customers each month.

Board and management changes

  • On 2 July, Afterpay announced that David Hancock, Group Head, will step down, with Executive Chairman Anthony Eisen to take the title of CEO and co-founder Nick Molnar to take the title of Global Chief Revenue Officer.
  • The company has also appointed a new Global Chief Operating Officer, Malte Feller. Malte most recently spent four years working as a Director at Facebook in the US and was previously the Managing Director of PayPal Australia. Interestingly, his period at PayPal coincided with that company’s enforceable undertaking with AUSTRAC, so he also has experience in that area.
  • Finally, Afterpay has now committed to appointing two new independent directors, moving to a majority independent Board.
  • Clime views each of these changes positively and reflective of the ongoing evolution and maturing of the business.

Clime Group owns shares in APT.