One of the more interesting things to flow out of the just completed profit reporting season in Australia were the results of two of the hottest companies in the market.
The other one, Zip (ASX: Z1P), is a smaller competitor to Afterpay that is nevertheless growing revenue and customer numbers very quickly.
What the two company results show us is that they are playing a very different game from virtually all of the other companies on the ASX.
Unprofitable but growing fast
Rather than churning out profits from their existing businesses, Afterpay and Zip are in a race for scale which trumps all other concerns.
Once the buy now pay later (BNPL) companies are big enough, that will be the time to concentrate on making money but until then growth is the only thing that matters.
It is a race for the quick or the dead, which is well understood in the US tech sector which has witnessed this pattern with companies such as Amazon and many others but is more novel here in Australia where investors still largely invest for profits and dividends.
Taken together, Afterpay and Zip boasted total losses of $808.3 million, which is far from pocket change.
Revenue rising but so are losses
Showing how important growth is, Afterpay’s revenue was up 78% to $924.7 million, even as its losses jumped to $159.4 million after hitting $22.9 million in the previous year.
Zip was even more impressive, with revenue up 150% to $403.2 million at the same time as its losses also jumped sharply from $19.9 million to a gobsmacking $653 million.
The reason no investors seem to be tearing their hair out about these very large losses is that the underlying economics of both businesses are still relatively sound – even if that doesn’t show up in their current results.
Buying up competition is part of the game
One of the consequences of following the “growth first” business model is that you need to buy up competitors in some countries and spend up big in others to begin from scratch.
For Afterpay that meant buying ClearPay in the UK because a Dutch group had was already trading there under the Afterpay name.
That was expensive because options issued to the former owners of ClearPay increased, adding $97 million to Afterpay’s costs.
A failure to grow globally though could be even more expensive with the predator becoming prey – something that actually happened anyway with the Square acquisition.
Underlying those acquisition costs Afterpay was still making money with its net transaction margin – the money it makes from charging retailers minus what those sales cost – declining a little bit but remaining fairly sound at 2.06%.
It was a similar picture for Zip, which had to recognise the cost of buying the rest of US-based BNPL player Quadpay.
That acquisition cost a solid $306 million while writing off the value of the Quadpay brand cost $42.6 million.
Again, the alternative is to get swallowed by someone else, something that could yet happen to Zip although having bulked up it will be more costly for any acquirer.
Shareholders comfortable with losses but competition on the way
Most growth shareholders are fairly comfortable with the position of Afterpay and Zip, with customers using their services more often and growth continuing, even though it comes at a cost of higher bad debts.
Perhaps the biggest worry for shareholders in the BNPL space will be if growth in customer acquisition starts to level off – something that was happening for Afterpay in the US.
Greater competition in the BNPL space is also inevitable with banks and well-heeled players such as PayPal and Apple muscling in and potentially causing some margin compression over time.
It is a fascinating space and with more Australians getting used to the growth first and profits down the track model, perhaps we are becoming a much more fertile field for more fast-growing technology companies.