Australia How Afterpay went from zero to $39 billion thanks to loyal millennials, powerful lobbyists and the COVID-19 pandemic

23:24  03 august  2021
23:24  03 august  2021 Source:   abc.net.au

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For most global businesses, the COVID-19 pandemic has been nothing short of a train wreck.

For Afterpay, it's been a blessing in disguise.

The $39 billion takeover of buy now, pay later darling Afterpay by US payments giant Square may have seemed unfathomable more than a year ago, when the company's share price tanked at around $8.90.

Now it's making media headlines around the world as the subject of the biggest corporate takeover in Australia's history.

"It turned out, COVID-19 meant e-commerce was about to get a jab in the arm," write Australian Financial Review journalists Jonathan Shapiro and James Eyers in their book released this week about the incredible Australian success story of Afterpay's co-founders Anthony Eisen and Nick Molnar.

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"Afterpay would not be asphyxiated by the crisis; on the contrary, it had been pumped full of oxygen".

In just six years (the company listed on the Australian Stock Exchange in 2016) the two neighbours who created Afterpay in their home in the affluent suburb of Rose Bay, Sydney, have managed a spectacular triumph over the naysayers.

With more than 16 million customers and 100,000 merchants around the world, and a market capitalisation of under $40 billion, Mr Eisen and Mr Molnar will take stakes in Square worth about $2.7 billion from the deal (to be paid out in stocks).

The duo will join the US-listed company as employees once the deal is completed in the first quarter of 2022.

It still needs the Treasurer's sign-off, with Foreign Investment Review Board approval pending. But if the takeover proceeds without hurdles, the deal will further boost the fortunes of Afterpay's two co-founders.

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Mr Molnar, 31, and Mr Eisen, 49, are already billionaires, ranking in the AFR's list of richest bosses as well as richest individuals.

To pull off what they have – against constant regulatory pressure — is extraordinary, according to even the harshest critics.

Those who think Afterpay is overvalued — note that the $39 billion price represents 42 times Afterpay's 2021 revenue – still give praise to the founders.

"You've got to say, they've played their hand as best as they could and so you have to give them an A+ for execution," says one analyst.

The analyst did not wish to be named but contends there's long been much hype surrounding Afterpay – a company that still hasn't turned a profit nor paid out any dividends.

The pandemic cemented Afterpay's success

The pandemic could have been the factor that caused Afterpay to implode. Instead, coronavirus lockdowns spurred online shoppers onto their platforms.

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Shapiro and Eyers write how on March 23, when Afterpay shares dropped to under $9.00, "Eisen, speaking to global investors, felt their widespread panic".

"For some of Afterpay's early investors, the plunge was too much to bear," they write.

But it was not long before Afterpay shares surged again.

In May that year, Chinese technology giant Tencent paid $300 million for a 5 per cent equity stake in Afterpay and by June that year, the company was riding high again.

By February this year, the share price hit a record $160 and its founders were touting new products that would challenge the big banks.

While the majority of Afterpay's revenue comes from the 4 to 6 per cent fee it charges retailers for each transaction, it's the company's ability to be the payment platform of choice for millennials that's helped it gain new merchants.

Millennials had already come to love the brand since 2018, when Afterpay became a payment option available for hip retailers from fashion stores like Urban Outfitters and Forever 21 to Kim Kardashian's KKW Beauty empire.

The lockdowns throughout much of early 2020 meant Australian millennials were stuck at home with extra cash (thanks to the $1,500 JobKeeper subsidy at the time) and became repeat users, spending an average of about $150 for every purchase.

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As Nick Molnar said when Square announced its second-quarter 2021 earnings on Monday, "Afterpay has become a leader in the global buy-now, pay-later space".

"We have flipped the traditional credit model on its head to drive significant value to both merchants and consumers," Mr Molnar said.

"Our model is based on trust."

Gaining the trust of politicians and regulators

Gaining trust hasn't been an easy feat for Afterpay's co-founders.

And it's not just the trust of consumers and shareholders that's been critical.

Afterpay is one of several buy now, pay later players that have had to contend with constant fire from consumer groups who warn that using their services can be risky for vulnerable consumers.

The alarm bell was raised as recently as last week following an Afterpay ad featuring Hollywood star Rebel Wilson, who in one scene tells a young girl that, "if credit cards and cash had a baby, you could pay it over time without ever paying interest".

Financial Counselling Australia chief executive Fiona Guthrie said the campaign went a step too far and complained to regulator Ad Standards to have it pulled.

The Afterpay duo have also spent much of the past few years fronting parliamentary inquiries, explaining how their products have in-built protections that stop consumers being able to spend money on the platform once they hit a certain limit.

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They argue that far from being a risky offering, their product is far safer than credit cards (consumer groups argue the risk is just as high as people often use buy now, pay later debt in addition to other forms of debt and because the products are aimed at a far younger audience).

From Canberra to Washington, Afterpay hired top-notch advisers to help gain the support of regulators and politicians who still needed convincing.

In 2019, former World Bank chief economist Larry Summers joined Afterpay to advise it on its US expansion.

Summers, who had been an economic adviser to president Barack Obama, had been convinced by the former economic adviser to prime minister Kevin Rudd, Andrew Charlton, to be part of Afterpay's advisory board.

The 'secret fairy dust' that swept over Canberra

While a number of factors have led to Afterpay's rise, as Shapiro and Eyers detail in their book, political connections and financial perks that came with being part of the Afterpay empire were a big factor.

"Afterpay's management had come to appreciate the incredible power of incentives that could be harnessed through stock options," they write.

"In some respects, it was the secret fairy dust that motivated those with little interest in Afterpay's cause to publicly fight hard for its future, or to privately tug strings."

Employee stock options were also extended to external consultants.

"At no upfront cost, lobbyists would embrace the Afterpay cause and get stinking rich doing so, if they helped it succeed," they write.

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"The payout would come in the form of new shares being issued but, if the share price was materially higher in the future, everyone would win."

"With Afterpay's shares having the demonstrated potential to double, triple or better, the stock option was a powerful currency.

"The same could not be said of the stock of Australia's lumbering big four banks, which paid a healthy dividend but lacked the allure of rapid, life-altering wealth creation."

The book says among those granted share options was a former Rudd and Shorten staffer, Sharon McCrohan, who was brought in to assist Afterpay with its external affairs.

Afterpay also recruited and gave stock options to top-end public relations firm Cato & Clegg—a partnership between former newspaper journalist Sue Cato and investment banker and media executive Brett Clegg.

It also brought in and gave stock options to David Gazard, who previously was an adviser to former treasurer Peter Costello and remains a close confidant of Prime Minister Scott Morrison.

Afterpay also hired Damian Kassabgi, a former adviser to Labor prime ministers Julia Gillard and Kevin Rudd, as its director of public policy after he held a similar role with Uber.

Mr Kassabgi, who had been in Rudd's office the day the National Consumer Credit Protection Act had been passed by the federal parliament in 2009, "brought that regulatory arbitrage mentality to Afterpay, which needed to remain out of reach of the credit act", according to the book.

Avoiding new regulation despite 'risks' to consumers

But Liberal senator Andrew Bragg, who chaired the recent Senate inquiry into fintech that was considering regulating buy now, pay later platforms like Afterpay, rejects the notion the company has won any favours with Canberra.

He says Afterpay has succeeded because of its "innovative" business model that boosts competition in the financial sector.

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Consumer groups had wanted Afterpay to be regulated under the same laws as credit card companies, but in the end both the Senate inquiry and regulators rejected that.

"The committee felt that it was important to value innovation and that the big four [banks] were not able to quash consumer choice," Senator Bragg says.

The regulators carried out their own reviews but none went as far as imposing new regulation on Afterpay and its rivals.

In November, Australia's corporate watchdog ASIC released a review into six buy now, pay later players including Afterpay, finding that some players were causing consumers harm but stopped short of recommending that they be regulated in the same way as credit card companies.

And in December, Reserve Bank governor Philip Lowe said buy now, pay later providers can continue to prevent retailers imposing a surcharge when shoppers use the services (in contrast, debit and credit card providers cannot prevent merchants from adding a surcharge to cover payment costs.)

Will Australian shareholders sell Afterpay stock?

Square CEO Jack Dorsey has been clear that the payments company plans to integrate Afterpay into Square's two business units – Seller and Cash App.

Afterpay's 16 million consumers will be able to manage their instalments and repayments directly in Cash App.

He told investors on Monday the deal would help Square "reach sellers that we have not been able to serve in the past, and that includes larger, more enterprise, global retail sellers".

They will be able to use Cash App's financial tools, including money transfer, stock and bitcoin purchases and Cash Boost.

Square's Amrita Ahuja says there are "tremendous" growth opportunities, with online payments likely to grow to $US10 trillion by 2024.

"We're excited by our compelling cross-sell opportunities," she said on the investor call on Monday.

"By integrating Afterpay directly into our cash app and seller ecosystems, we can expand each brand's customer base, strengthen each other's products and build connections."

CEO and managing director of payments consultancy McLean Roche Grant Halverson believes Afterpay's financial fundamentals are still dubious, but he applauds them for pulling off the deal with Square.

Mr Halverson says Afterpay isn't a new idea since the idea of lay-by has long been in existence, and its customer base is still low when compared with bigger global players like Klarna Group, which has about 90 million consumers and 250,000 merchants using its platforms across 17 countries.

He also criticises Afterpay for the way it presents its year-on-year financial comparisons – which he claims makes them appear like they are growing more rapidly.

"If you look at the numbers, quarter to quarter, their sales are only up 14 per cent. And in Australia, they are minus 3.3 per cent for the last quarter," he says, adding that that is why the timing of Afterpay's founders to sell is "exquisite".

"Now the competition's heated up, they [Afterpay's founders] are getting out," he says.

Mr Halverson thinks Australian shareholders will most likely sell their Afterpay stock rather than retain shares in US-based company Square as that opens them to currency fluctuation risks.

"The problem you've got now is if you're if you're a mom and pop in Australia, you're now going to have a US dollar risk," he says.

"You're going to have a company that's operating in the US which, you know, how do you keep track of all that if you're just a normal investor? That's pretty hard."

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