Investment bank UBS predicts buy now, pay later juggernaut Afterpay’s share price will halve within a year, initiating coverage with a sell rating and flagging looming regulatory risks for the company as it scales in the United States.
Afterpay shares were trading almost 8 per cent lower after 1pm AEST on Wednesday, at $33.73, as investors digested two detailed reports circulating the market from UBS, which said current valuations assumed customer growth and spending rates that would be difficult to achieve.
The reports pointed out Afterpay’s business model prohibits merchants from passing on costs of the service to customers, which could attract new regulatory scrutiny because by shifting the cost of financing from consumers to merchants, it “arguably creates a distortion which could significantly influence consumers’ choice of payment method”.
The bank said if consumers are presented with the “true cost” of using buy now, pay later services, they might shift to alternatives and there could be “hidden costs incorporated into merchants’ prices, which imply higher fees than credit card interest rates”.
“In our view, somewhat paradoxically, the more successful Afterpay is, the more likely it will attract regulatory scrutiny,” said UBS Sydney-based analysts Tom Beadle, Jonathan Mott and Eric Choi said one of the research notes.
“We think the market is pricing in excessive growth for Afterpay without factoring the risks… The buy now, pay later sector is at risk of further regulation that is not being priced by the market for Afterpay.”
With much of Afterpay’s valuation premised on success in the United States, UBS questioned whether it would achieve the same sort of growth and market penetration that it has in Australia, where its volumes are 7 times its next rival, Zip. The US market has higher interchange fees and higher credit card rewards to incentivise credit card use, while the lack of a “moat” there may see other competitors emerge.
The view comes after prominentUS academic Scott Galloway also said last week that Afterpay shares could halve; he also pointed to the likelihood of more competition, including from large credit card schemes.
“Low barriers to entry, the relative ease of replicating Afterpay’s product offering and competition from other payment methods leave it vulnerable to competition,” UBS said.
UBS initiated coverage report with a $17.25 price target, 47 per cent lower than the $36.56 the stock was trading at on Tuesday. It also has a sell recommendation on Zip and a $4.80 price target. Zip was trading down 4.4 per cent lower at $5.19 on Wednesday.
Users think it’s credit
UBS’s view that Afterpay, which operates outside consumer credit laws in Australia because it does not charge interest, could face more regulation was also based on a survey conducted by the bank’s Evidence Lab of buy now pay later users. This revealed 64 per cent agreed it was is a form of credit, “which we see as increasing the risk of regulation”.
Buy now pay later customers also “tend to be less credit-worthy than non-users”, UBS said, including being more indebted and more likely to have been rejected for a credit card than non buy now pay later customers.
UBS said Afterpay’s high share price infers customer growth that might not be possible.
UBS said it inferred a long-term US customer base of around 12 per cent of the population, “which appears optimistic”.
The Afterpay share price infers $175 billion of merchant sales would be made over the platform by the financial year 2030, which UBS calculated would require around 47 million customers – equivalent to 18 per cent of the Australian and NZ populations, and 12.5 per cent of the US and UK adult populations – to each spend $3,800 a year on the service.
The report noted thatwhile the outcome of AUSTRAC’s investigation into anti-money laundering complianceremains uncertain, potential negative outcomes “could include civil proceedings, fines, remedial directions, and enforceable undertakings.”