We have profiled Afterpay a number of times in the past year, following the company’s meteoric rise. Afterpay at its core is an incredibly simple concept, flipping the economics of credit-cards on their head.
Not long ago it was accepted that consumers would, through charges and interest, pay for access to credit. This made sense as the consumer benefits from instant gratification. However, the real benefactor of consumer credit is the merchant. Whilst the consumer needs to eventually pay back their loan, the merchant receives the full benefit upfront. What’s more, credit card users typically have larger basket sizes and conversion rates compared with others using alternative payment methods.
So why should the consumer pay for something that in turn benefits the merchant more than it benefits them?
By flipping the cost of credit from the consumer to retailer (through a fee of between 4-6%), Afterpay can offer consumers interest-free finance (paid back over 8 weeks in 4 instalments). This, in turn, leads to consumers again having larger basket sizes and conversion rates than other payment types, even credit cards.
Afterpay has proved attractive to millennials, who turned away from credit cards in droves after the GFC, presumably attracted to the no interest offer combined with capped fees that meaning it cannot create a runaway debt situation.
What initially attracted us to Afterpay in 2016 was fact that the company established a customer base of 1 million customers and almost 9,000 integrated merchants whilst spending less than $1m on marketing. This is highly unusual, and suggests network effects at play.
Further, we saw early evidence that Afterpay was building a moat around its business through its substantial retail and consumer dataset, its rapidly growing loyal customer base and its ability to be the largest or second largest (after Google AdWords) referrer of traffic to retailer’s websites. Not even PayPal receives the brand exposure Afterpay receives from its merchants, who advertise its service on every single page, even before their users reach the online checkout.

Figure 1. Afterpay being advertised on Urbanoutfitters.com
Source: Company website
If the business’ operational trajectory continues, it could find itself in a similar position to PayPal as an instrumental payments provider globally. The question for retailers could eventually evolve from ‘Is Afterpay worth the extra cost per transaction?’ to ‘Can we afford to not offer Afterpay?’

Figure 2. Afterpay customer growth and marketing spend
Source: Goldman Sachs Research/Company Data
The company is now a major payments player in the Australian market, transacting 25% of all online fashion retail and over 8% of total online retail purchases in the country. 15% of Australian millennials and over 7% of the general population over 18 years old have an Afterpay account.
Given its runaway success in Australia, the company recently turned its sights to the U.S.  To help with execution in the US Afterpay partnered with with technology specialist Matrix Partners to try and replicate the viral growth they saw here…
Australian company trying to grow into foreign markets, I’ve seen this story before!
There is no shortage of horror stories when Australian corporates eyed a bigger pie overseas, only to blow up shareholders’ capital and director’s careers in the process. In recent times we saw Rio Tinto’s ill-fated foray into Mozambique, Slater and Gordon’s almighty blow-up in the U.K., Wesfarmer’s hubris in the U.K and BHPs regretful plunge into U.S. shale assets.
Given these high-profile blow-ups, Australian investors are understandably wary of flashy presentations showing a blue sky offshore opportunity.
But every so often a home-grown success nails it offshore. Some Aussie companies that have seen success with their global ambitions include fast-fashion jewellery retailer Lovisa, plumbing part specialist Reliance Worldwide, women’s skincare player BWX and education placements and English tuition player IDP Education. From an Australian context, it has been the smaller, nimbler players that have been able to achieve success in international markets as opposed to the more rigid, slow moving corporate giants (barring some names like CSL and Cochlear).
The good news for Afterpay investors is that Nick Molnar, the co-founder and previous CEO, will be heading up the U.S. expansion and basing himself out of the country. Given his experience in building the company from the ground up and being instrumental to its successful growth strategy in Australia, we could think of no one better to lead the company into the world’s biggest consumer market.
Size of the Pie
The U.S. presents a massive opportunity for Afterpay. One only needs a cursory look at their population and economy to see this – an addressable population almost 13 times the size, online fashion sales 14x larger and an in-store sales opportunity 15 times bigger than Australia.

Figure 3. Addressable markets in Australia and the U.S.
Source: ABS/US Census Bureau/Goldman Sachs Research/Euromonitor
The real momentum in Afterpay’s Australian operations started to be seen in FY17 as the company onboarded bluechip retailers such as Myer, Officeworks and Target. These wins validated the platform to other retailers and exposed new demographics and customers to the Afterpay concept.
In the U.S., Afterpay’s first customer was Urban Outfitters, the 14th largest fashion retailer in the country. For context, if they could take 25% of its last reported total online sales, it would equate to almost AUD $450m in underlying sales through the platform, or roughly 20-25% of Afterpay’s last combined Australia/New Zealand reported sales numbers. If the trends in US customer and merchant onboarding are somewhat similar after its Australian bluechip wins, the U.S. business could potentially reach the same size as the Australian business within 12-18 months.
Since launching in the U.S. just over 2 weeks ago, the company has grown from 50 pre-announced retailers to over 250. Also supporting our view on its viral uptake in the States are its strong growth in social media mentions (particularly Twitter) and Google search volumes. Whilst it is hard to quantify the exact number of customers that will be added as a result of this, it is interesting to note that its search volumes are roughly 8 times larger than Sezzle, a copycat competitor that started a couple years earlier with mostly smaller online retailers.

Figure 4. Search trends of Afterpay and Sezzle (U.S. competitor) in the United States
Source: Google Trends
It is certainly easy to get caught up in the hype surrounding this company, but given the flawless execution of management so far, we believe there is genuine potential for this Sydney born company to become a global payments player.
Risks are ever present in the business world, and the main three we see for Afterpay are competition from an already established player (e.g. Paypal), a serious economic downturn or regulatory action regarding its onboarding process. We are keeping our eyes open for any potential signs that these issues could affect the business, but so far Afterpay’s trajectory appears to continue unaffected.
There are not many company’s we can think of like Afterpay available on the ASX, with genuine potential and a business model that has already been proven and validated in the Australian market. To get some idea on the potential valuation of the global business, we can consider that many of the covering brokers (which we broadly agree with on our own analysis) value the Australian business at between $6 – $7.50 on a standalone basis. With the U.S. opportunity being upwards of 15x the size and a potential global market at least 50x the size of Australia, and Afterpay being the current leader in the buy-now-pay-later space, we will be content holders as long as management continues with its extremely impressive execution of its growth strategy.
Clime Asset Management owns shares in Afterpay Touch Group (APT.AX)