Block Acquires Afterpay

In this article we’re going to take a look at Block’s $39 billion acquisition of Afterpay, potentially Australia’s best M&A exit.

TLDR

• Company Overview: The prominent Buy Now, Pay Later business model.

• Deal Strategy: Build The Moat through Block’s In-Person channel and Cash App.

• Deal Execution: Overpriced due to the BNPL bubble but a promising opportunity.

Company Overview

The Business Model

Afterpay operates under the "Buy Now, Pay Later" (BNPL) business model, providing consumers with an alternative payment option that allows them to make purchases immediately and pay for them over time.

Example: A customer buys a $200 pair of Birkenstocks using Afterpay. They pay $50 when they make the purchase, and then every two weeks, they pay another $50 until the full $200 has been repaid.

They have two core revenue streams:

1. Merchants pay Afterpay, on average, a 4.2% fee for each transaction processed through the BNPL service. This makes up ~90% of their revenue.

2. Charging late fees if consumers fail to make their scheduled payments on time.

Merchants are willing to pay these fees as they benefit from increased sales and average order values due to consumers making larger purchases when given the option to pay in installments.

On top of this, they also send over 1 million customers from the Afterpay Shop app directly to active merchants every day.

The appeal to merchants was so strong that in the early days, they didn’t do any outbound sales; they were struggling just to keep up with inbound demand.

The Competitive Landscape

While Afterpay is one of the leaders in the BNPL space, they weren’t the first to market when they launched in 2014.

Their strategy: Keep It Simple Stupid

Afterpay were relentless at doing one product and doing it well. Customers knew exactly what they were getting when they signed up. They avoided the temptation to follow their international counterparts in adding offerings like debit cards, which added confusion to what those companies actually offered.

Zip also stuck to one product offering, but even there, Afterpay made it easier for customers. Zip has a lower risk appetite than Afterpay so they perform a basic credit check on a new customer prior to their first transaction, whereas Afterpay uses the data they have available to determine the level of risk. They look at your shopping history, the history of Birkenstock sales, and even the repayment history of buyers within your postcode.

The lack of credit checks meant there were higher loss rates (where customers wouldn’t end up making the remaining payments), but it also supercharged growth as there was no friction in signing up.

Occasionally losing $150 on a pair of Birkenstocks to get access to a multitude of customers who will transact multiple times a year? That’s a pretty solid bet.

Deal Strategy: Build The Moat

The deal has two key synergies that strengthen both Block’s and Afterpay’s competitive advantage.

In Person Channel

Block’s main product is the Square Point of Sale (POS) terminals, those little white squares you tap to pay in shops, with over 1 million active sellers using the terminals. In contrast, Afterpay is largely an online service, with only 70,000 in person retailers. Block rolled out the in-person integration, so now you can use Afterpay across their over 1 million terminals and get the same Buy Now Pay Later experience.

With in-person transactions being 3x the size of online transactions, this significantly increases Afterpay’s GMV.

Cash App

Block has a product called ‘Cash App’ that allows users to transfer money to one another across the UK & USA. The plan is to integrate the Afterpay Shop into the Cash App to provide merchants immediate access to another 57 million monthly users. Providing more value to both Cash App users and Afterpay merchants.

There will be a new ‘Discover’ screen in the Cash App with products listed on Afterpay Shop. Customers can simply click on a product they want to purchase and pay through the Afterpay checkout.

Deal Execution

The acquisition took place during a “Buy Now, Pay Later” bubble, with severe cuts to both public and private valuations across the sector following the deal.

Historically, tech stocks trade between 3x to 10x revenue, depending on the level of growth expected, with early-stage companies reaching up to 20x. Block acquired Afterpay at a 47x revenue multiple, a significant premium to other BNPL players due to the expectation that BNPL is somewhat of a “winner takes all” game.

Buy Now Pay Later, as an industry, had only a 1-2% penetration of the $10 trillion online sales market and investors believed it would rapidly increase that share. However, there were, and still are, significant risks surrounding regulation, credit quality, competition, and interest rate fluctuations.

The interest rate risk has already played out. High rates impact Afterpay more than banks, as Afterpay doesn’t pass on the increase to customers. The cash flows from the 4% they charge to merchants erode as interest rates increase. The competition risk has also played out, Paypal released their own BNPL product in the middle of 2021, 7 years after Afterpay, and they now have ~70% of the U.S. BNPL market.

The sector has recently rebounded with ZIP’s share price showing over a 300% gain in the past 6 months but it is still a far cry from the all time highs of Afterpay’s exit. Using the average drop in multiples since acquisition, Block overpaid by over $30 billion. Afterpay pulled off arguably the greatest M&A exit in Australian history.

The deal has great potential to strengthen Block’s position but to summarise: Block overpaid.

The saving grace was that the deal was completed in an all-stock deal and Block’s share price was also inflated.