17 Jul 2019

Afterpay

While no share price ever goes up in a straight line some can definitely be more volatile than others.  Often this can just be from swings in general market sentiment but sometimes news flow can whipsaw the share price around.  That is just what happened to Afterpay in the last quarter.

The quarter started relatively quietly regarding news.  Afterpay’s share price had been quite volatile, moving from $21 to $28 then back down to around $24.  Then the news flow started.

6 June – Afterpay released a business update that was generally solid but noted “dialogue” with AUSTRAC (Australian Transaction Reports and Analysis Centre) regarding its Anti-Money Laundering / Counter-Terrorism Financing (AML/CTF).

11 June – A few days later Afterpay announced a capital raise to accelerate growth in offshore markets and an equity sell-down by some of the founders to Tiger Management (the private hedge fund run by Julian Robertson).  We viewed the acceleration of the US opportunity as positive and were not overly concerned by the sell-down as a) the founders still owned a material amount of equity and b) the arrival of a very well respected US based investor would seem to be an endorsement of the offshore opportunity.  We used the capital raise to top up our position.

12 June – The raise was completed and very well supported, going at $23, which was at the top of the price range.  However, at the end of the day AUSTRAC sent Afterpay notice requiring them to audit their AML/CFT program.  Timing, as is often the way, could not have been worse, particularly when executives had just sold down shares.  The market did not like this news and sold.  We spent some time reading AUSTRAC’s prior cases and overall, while the news was not great, we were not unduly concerned.  Our take was that AUSTRAC could see how quickly the buy-now-pay-later sector was emerging and wanted to ensure all was in order, not that blatant AML/CFT issues were necessarily present.  Historically, AUSTRAC has only fined companies for pretty material issues, often involving dodgy cash handling, which we just don’t think is present at Afterpay. That said, we do expect the audit to highlight deficiencies in processes, especially from earlier years, and note areas of improvement.

28 June – Visa announced that they were launching instalment payments. This kicked off some late selling on the Friday and again on the Monday (1 July).  Again, the headline sounded bad, but as always it is not as simple as that.  Firstly, Visa is the mechanism for enabling payments, the issuing banks provide the credit, and they will need to decide whether to use this extra instalment function.  Their relationship is with the card holder, not the thousands of merchants that Afterpay has, so unless each of them wants to go out and commence agreements with all these merchants the only option is to charge the cardholder additional fees or interest for this service.  So, it is more an extension of the credit they already offer, not a direct competitor to Afterpay’s interest free model that charges the merchant for the service.  Interestingly, Mastercard did something similar a few years ago and it does not appear to have gained much traction to date.  It also misses the important and growing aspect of Afterpays relationship with its consumers (Millennials in particular) that is providing important referrals to merchants.  In our opinion, this will increase in importance as Afterpay’s network grows.  Merchants are focused on communicating with current and future consumers and, in our opinion, this places Afterpay in a good position.  We took advantage of the short term selling to top up further on the Monday at under $23.

2 July – The final bit of news was a board re-jig to increase board independence with a move to an independent chair (previously Anthony Eisen was executive chair).  This is arguably a sign of growing up as a company (Afterpay is now in the ASX100).  In our opinion, alignment is still more important than independence.  Anthony, whilst not independent owns a lot of stock, which gives us confidence that he wants to steer the company in the same direction we wish to see as investors.

These periods are great examples of why investing with a long-term horizon helps to give you the clarity needed to successfully navigate news that gets shorter term investors panicking. For each bit of news, you are asking yourself “does this change the long-term fundamental opportunity for this company?” If the answer is no, then these become great opportunities to top-up when many investors are selling.