Huge news came out a month ago when fintech company Square (SQ 5.04%) announced plans to acquire buy now, pay later (BNPL) specialist Afterpay for $29 billion in an all-stock deal. This is a major purchase for Square, which has a market cap around $125 billion at recent prices, and is a big bet on the growing BNPL industry.
Is Square's big Afterpay purchase worth the cost? Let's take a look.
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What is Afterpay?
Afterpay, based in Australia, is a BNPL service focused on the Australian, U.K., and North American regions. BNPL is a form of credit that allows consumers to split purchases into four smaller payments over four two-week periods. Afterpay offers this service to consumers interest-free. Since there are no interest payments, Afterpay makes money by charging merchants 4% to 6% of every transaction. Merchants agree to let Afterpay take such a large chunk of each transaction because Afterpay is taking on the consumer default risk, and BNPL can help increase average order value by 10% to 20%.
In Afterpay's last fiscal year, which ended in June, it had $15.8 billion in gross merchandise volume across its services, growing 105% annually since 2019. Revenue came in at $693 million, growing 92% since 2019. A purchase price of $29 billion, which is subject to change depending on where Square's stock is trading when the deal closes, implies a trailing price-to-sales ratio (P/S) of 41.8 for Afterpay. This is expensive, and shareholders of the combined company need to expect Afterpay's revenue to grow substantially from here in order to make the deal worthwhile.
Square expects to do that by integrating BNPL into its existing ecosystems: seller and Cash App.
How Afterpay will merge with Square
To give a quick overview, Square has two product ecosystems, one that serves consumer finance and one that servers sellers and merchants. The seller ecosystem has dozens of financial products, but the main ones are point-of-sale solutions, back-office software, and debit and credit cards for businesses. Square has millions of sellers using its services, and it plans to integrate Afterpay's BNPL solution with all of them, giving merchants a better customer experience. For reference, Afterpay only has 100,000 merchants on its platform right now. Not every Square merchant will utilize Afterpay, but it provides a significant opportunity that the company can easily tap into.
On the consumer side, Square has its Cash App ecosystem. Cash App offers mobile payments and a digital wallet that targets younger consumers and the underbanked. The app has around 70 million users, according to Square, and the company plans to integrate Afterpay's offering directly onto the app. Similar to the seller onboarding, this could provide a step-change in user growth for Afterpay, which currently has only 16 million users. On top of this, Square will be integrating Afterpay's commerce discovery products from its own application directly onto Cash App. This will not only help Afterpay grow but will also create a better value proposition for existing Cash App users.
So does the acquisition make sense?
I think it is pretty clear that Afterpay and Square can help each other grow their respective businesses. BNPL is growing rapidly around the globe and should fit in nicely within Square's seller and consumer services. However, investors have to be concerned about the $29 billion acquisition price. At 41.8 times trailing-12-month sales, Square is purchasing Afterpay at an incredibly steep P/S.
In order to get a good return on this purchase, investors need to expect Afterpay to grow its annual revenue to multiples of where it is today, while also helping accelerate the growth of Square's existing businesses. Can the combined company do this? Probably. But don't think this merger is a guaranteed success, and any shareholders need to have high expectations for Afterpay's growth going forward.
