Big brokers split over Afterpay’s future moves

Two dramatically contrasting views on the same company from two global brokers has puzzled investors.

Two leading global brokers recently initiated on payments provider Afterpay Touch with widely differing viewpoints.

Is the market pricing in excessive growth without factoring in the risks? Or is there a significant opportunity for the company to expand in the US?

Afterpay Touch has achieved mass adoption in Australia and has acquired 2 million users in the US in its first year of operations. The stock price has increased to more than 30 times its April 2016 IPO price and the company has delivered on substantial growth promises so far.

Morgan Stanley envisages an opportunity to build a niche among millennials (Gen Y and Z, aged up to 40) in the US who have had their supply of credit from traditional lenders curtailed since 2009. These generations are in, or will enter, their key debt accumulation phase over the next decade and are likely to drive the bulk of US loan growth, which Morgan Stanley estimates at about $US850bn ($1.25 trillion) over the next 10 or more years.

Capturing this cohort today means Afterpay Touch can participate in this credit creation. These generations are also comfortable banking with financial technology. Morgan Stanley initiates coverage on the stock with an overweight rating, believing gross merchandise value is the key driver of the business, targeting $27bn-$37bn in the 2022-23 ­financial year versus the company’s $20bn-plus target. The broker’s price target is $44.

In contrast, UBS has initiated with a sell rating and a target of $17.25, roughly half the price the stock is trading at today.

UBS says the product is easy to replicate and barriers to entry are low, although the company does have a first-mover advantage and a strong brand. Regulatory scrutiny may also be heightened and execution risks are significant.

In the case of credit or debit cards in Australia, merchants cannot legally be prevented from passing on costs. Yet the company’s model relies on consumers not bearing any additional cost, transferring, instead, these costs to merchants. For a $150 transaction, Afterpay Touch’s merchant fees represent a 19-49 per cent return and if customers were to be presented with the true cost of buy now, pay later (BNPL), UBS envisages risks to growth.

There is also a risk that the company is eventually considered a credit provider.

Afterpay Touch is outside the definition of being a credit provider and is therefore not regulated by Australia’s credit code.

However, UBS points to surveys that reveal that 64 per cent of customers think BNPL is credit while 30 per cent have used a credit card to pay down their balance. Those that use BNPL are more likely to be indebted, in the broker’s assessment, and more likely to have had applications for credit cards rejected.

Therefore, UBS poses the question of whether Afterpay Touch can succeed over the long term in the US, which has a market that is more than 10 times the size of Australasia.

A study of transaction margins for PayPal in the US, where interchange and charge-off rates are higher, highlights the risk, but the broker deduces investors will probably tolerate lower profitability for the near term.

Clearly, Afterpay Touch is entering a highly leveraged market late in the cycle and there is little room for error:

Eva Brocklehurst is a writer at the share research service www.fnarena.com