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“Buy now, pay later” is at a turning point

Matt Lipton, CFA, Portfolio Manager
2021-11-30
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The recently announced intended merger of two key financial technology (fintech) players will be the second-largest deal ever in the global payments sector. Here’s my latest perspective on the broader implications of this major acquisition and the related investment opportunity in the fast-growing “buy now, pay later (BNPL)” space, which I believe has now reached an inflection point in its young storyline.

A changing industry landscape

Given the size of the total addressable market (TAM) for global payments, I’d say fintech companies have been little more than a thorn in the sides of the old guard thus far, but I think that’s poised to change. Indeed, I believe the recent blockbuster transaction noted above may have transformative power for the industry.

This could mark the onset of a new era in which the modern fintech platforms scale aggressively and “take on” the incumbent banks and legacy payments processors in a way that poses a legitimate competitive threat and begins to reshape the industry landscape. Looking across both the public and private markets, I wouldn’t even be surprised if the impact of this shift starts showing up in some of the telling numbers — the trillions of dollars in global market capitalization, payment volumes, and loan receivables currently controlled by traditional financials, but for which well-placed up-and-coming BNPL companies will now be competing.

BNPL at an inflection point

The TAM for online payments is roughly US$10 trillion worldwide today, with BNPL operators currently holding less than 2% of that total. However, I think BNPL’s market share could surge to around 10% of online payments by 2025 or 2026. The five biggest BNPL players are already growing their volumes four to five times faster than much of the global e-commerce industry. In my view, these swift growth rates and likely market share gains accrue from a potent combination of trends: changing consumer appetites and habits, cheaper and easier access to credit, and better online customer “checkout” experiences.

Consumer tastes and preferences are increasingly gravitating from taking on revolving credit to making purchases via installment debt. BNPL companies allow consumers to “stretch” payables from 30 days (the typical “free revolve” period on a credit card) to 60 days up to three years with no interest charges, and under certain circumstances, no late-payment fees either. In addition, BNPL companies operate on modern technology stacks with secure, seamless, and integrated checkout processes that are mobile and app-native, making it a smoother (and safer) ride for consumers to buy products online. Of course, convenience is key as well.

Potential downsides versus traditional payment offerings? There’s often a relatively small credit limit — as low as a US$500 maximum outstanding balance in some instances. BNPL operators typically do not report to credit bureaus, so it’s not the best way for consumers to build or improve credit scores. On the merchant side, take rates1 are about twice as high as traditional credit/debit interchanges, but conversion rates also tend to be high. A/B tests I’ve seen suggest merchants can boost checkout conversion meaningfully with a BNPL service.

Bottom line: For most consumers, the positives clearly outweigh the negatives, making BNPL a rapidly expanding category with tremendous upside, in my judgment. And particularly for businesses with gross profit margins of greater than 20%, BNPL can be a very effective tool.

Regulatory risk worth watching

So why hasn’t BNPL been front and center with most payments investors (not yet anyway)? Most investors seem skeptical because many of these businesses are growing at breakneck speeds, while potentially inviting credit risk and unwanted industry regulation. At this point, I would cite regulatory risk as my chief concern. Given the duration and size of most BNPL firms’ receivables, credit risk is much less worrisome to me.

Closing remark

To me, recent developments have strengthened my thesis that BNPL cannot and should not be ignored — and that legacy payments players that fail to take it seriously do so at their own peril.


1A merchant take rate is the fee charged on a transaction performed by a third-party seller or service provider on behalf of the merchant.

Authored by
lipton-matt
Matt Lipton, CFA
Portfolio Manager
Radnor

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