If you spent much of 2020 shopping from home, you’re not alone. Affirm (NASDAQ:AFRM), a buy-now-pay-later company, has seen its business prosper as millions of shoppers have started buying everything from exercise bikes to cars online. And when AFRM stock had its initial public offering (IPO) this week, it surprised precisely zero investors when its stock immediately jumped 100%. Now, even more significant gains could be ahead.
Of course, though, buying AFRM at $100 isn’t without its risks — its high 20x price-to-book is no joke, even for a fintech startup. And unexpected loan losses can quickly make this hot company turn into the next AIG (NYSE:AIG) meltdown.
However, if the company can navigate the perils of moneylending risk management, it looks well-positioned to become yet another success story in the fintech world. Just make sure you wait until its lockup period ends before hopping in.
AFRM Stock Is a Growth Story in Banking
AFRM stock couldn’t have chosen a better time to go public. The company allows e-commerce buyers to finance purchases — buying goods today at zero or lower-APR interest. And with millions of Americans starting to make major purchases online, demand for online financing has never been higher.
That’s been a huge win for companies like Affirm, which competes with the likes of Afterpay (OTCMKTS:AFTPY) and Klarna to offer buy-now-pay-later deals on e-commerce sites. Despite spending just $25 million on sales and marketing in 2020 (only 5% of revenues), Affirm’s sales jumped about 94% for the year (Page 20). And even more gains appear to be on the horizon as the platform adds more vendors to its growing list of customers.
Regulatory Changes Opened the Floodgates
None of this would have been possible before 2008. Before the financial crisis, commercial banks dominated the finance industry. Successful fintech startups like Esurance were rare and existing players quickly snapped up most. Regular investors never had a chance to buy in.
But all that changed after the collapse. Alarmed by the failing banks, U.S. regulators did what most parents would do: they laid down new rules. Suddenly, companies from Wells Fargo (NYSE:WFC) to community banks found themselves limited to the dull business of banking.
Fintech companies, meanwhile, were free to operate with impunity. Today, Affirm writes loans without a banking license.
On the one hand, these regulations have allowed fintech firms to grow fast; Affirm reached $10 billion of loans written in just five years. But on the other hand, the “no rules” approach has also created a potential time-bomb. The regulatory guardrails, after all, are designed to stop financial firms from taking too much risk. So, is Affirm an accident-prone teenager waiting to get run over by a bus? Or is AFRM stock a promising young name that will make you rich?
Lower Risk Than Expected
So far, Affirm looks more like the latter — a success story in navigating the pitfalls of moneylending. The company has focused on higher-end sites like cycle-maker Peloton (NASDAQ:PTON) and mattress firm Purple (NASDAQ:PRPL), whose customers tend to have higher incomes (and are less likely to default). That’s kept its charge-offs at around 3%, within striking distance of established lending companies like American Express (NYSE:AXP).
Affirm has also wisely focused on 0% APR financing, where they only take a cut of revenues rather than try to profit from interest. In 2020, almost half of its loans were transaction-only. That’s helped reduce risk and make it look more like a consistent payment processor than a risky moneylender.
That said, the company will always face the temptation to profit from interest income — banks have rarely avoided the siren’s call to make more money and even fintech firms have fallen prey. Investors will also have to feel comfortable buying a company with roots in a highly predatory industry. For instance, Rent-A-Center (NASDAQ:RCII), a rent-to-own furniture and electronics company, often charges customers up to five times more through financing.
So, as this company continues to add merchants to its platform, investors will need to keep a close eye for risk-taking and negative press, the two things that could crater AFRM stock.
Engineering Talents Meet a Growing Industry
But don’t let this obscure AFRM stock’s massive room for growth.
In 2020, the company spent just $3.3 million on advertising versus $122 million on technology. And its largest customer, Peloton, made up 28% of total revenues for its fiscal year ending in June. That’s because, like many Silicon Valley startups, Affirm was a technology-first, sales-second company.
This truth hasn’t escaped founder and CEO Max Levchin, a founding member of the “PayPal Mafia” that included Peter Thiel and Elon Musk. As his company has matured, Levchin has wisely started to emphasize sales and marketing.
That gives Affirm two different channels of growth.
Secondly, existing customers will get bigger. Even before the pandemic, e-commerce sales had growth closing in on 20%. Since then, the novel coronavirus pandemic has strapped a rocket to e-commerce growth.
What’s AFRM Worth?
Since 2020, investors have shown massive pent-up demand for high-growth tech stocks. After the initial pop, however, things might get complicated. Last year, most fintech companies traded sideways or even down for several months after their IPOs. Plus, Affirm’s risk profile could keep it from rising in the near-term.
Still, don’t miss the forest for the trees. At a roughly $24 billion valuation, the company is a relative minnow compared to other successful fintech players. And, as Affirm continues to vacuum up customer credit data, other tech giants — from PayPal (NASDAQ:PYPL) to Amazon (NASDAQ:AMZN) — will find the buy-now-pay-later firm an increasingly tempting takeover target.
That gives Affirm a steady price floor of perhaps $50 per share – its no-brainer entry price. And if things go well, don’t be surprised if you’re sitting on 2 or even 5 times gains in several years.
In the meantime, watch for insider selling as the company’s lockup period expires. That could give outside investors the chance to scoop up this high-potential firm for cheap.
On the date of publication, Tom Yeung did not have (either directly or indirectly) any positions in the securities mentioned in this article.
Tom Yeung, CFA, is a registered investment advisor on a mission to bring simplicity to the world of investing.