Square Acquires Afterpay for $29 Billion: A BNPL Deep Dive

Square Acquires Afterpay: A Deep Dive into the $29 Billion Deal

This morning saw a rise in Square’s stock price following the announcement of its second-quarter earnings and a significant acquisition. The company is set to purchase Afterpay, a leading Australian buy now, pay later (BNPL) service, in a deal valued at $29 billion.

According to reports from TechCrunch, Afterpay shareholders will be compensated with 0.375 shares of Square for each share they currently hold.

The announcement spurred a considerable increase in Afterpay’s share value, driven by the premium offered in the deal. Square’s shares also experienced a 7% jump during early trading hours.

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The BNPL Market Landscape

We have consistently covered the BNPL market over the last year, primarily focusing on the financial performance of companies operating within this sector. Afterpay has been a crucial source of data, alongside companies like Klarna (currently private) and Affirm (a U.S. publicly traded BNPL provider).

Recent reports indicate substantial growth for each of these companies, with the United States emerging as a key battleground for market share.

Notably, Apple is reportedly preparing to enter the BNPL arena. Our assessment suggested that Apple’s entry would likely have a greater impact on broad-market BNPL providers than on those specializing in niche segments.

Apple’s existing fintech infrastructure and widespread real-world payment acceptance position it as a formidable competitor for consumer-focused BNPL services. BNPL offerings tailored to specific industries or niches are anticipated to face less direct competition.

Analyzing the Square-Afterpay Deal

Let's now examine the Square-Afterpay deal in detail. We will assess the revenue, growth potential, and market reach that Afterpay brings to Square.

Furthermore, we will analyze the valuation Square is willing to pay and what this indicates about the broader value of BNPL and fintech revenues.

Ultimately, we aim to determine whether Square is paying a fair price for Afterpay.

The Integration of Afterpay into Square’s Operations

Similar to many significant acquisitions today, Square and Afterpay jointly released an investor presentation outlining the rationale behind their proposed merger. A detailed examination of this presentation is warranted.

Square operates as a dual-faceted entity. It maintains a substantial consumer-facing operation through Cash App, alongside a robust business segment providing payment technologies and various fintech solutions to corporate clients. It’s important to remember that Square is actively developing banking services tailored for its business clientele, while Cash App also incorporates banking and investment features for individual users.

Afterpay, conversely, is a prominent Buy Now, Pay Later (BNPL) provider, possessing its own network of merchants and a dedicated customer base. The company has demonstrated considerable growth in recent years, as illustrated in the provided data:

This represents an appealing business acquisition, as Afterpay is steadily capturing a larger share of the global e-commerce payments landscape (as shown on the left chart) and translating this expansion into rapidly increasing revenues (depicted on the right chart).

How do these two companies complement each other? Afterpay’s merchant customers will transition into Square customers, thereby expanding Square’s merchant base and diversifying its product offerings. Furthermore, the acquisition of Afterpay will enable Square to introduce a BNPL option for its merchants, allowing them to offer installment plans to their consumer user base.

In essence, recognizing the demonstrated consumer preference for fee-based installment loans for online purchases – a trend established by companies like PayPal, Klarna, Afterpay, and Affirm – Square needed to participate in this market or risk being left behind. PayPal has already achieved positive outcomes with its own BNPL service. Square could have chosen to develop its own solution or pursue an acquisition. Afterpay, with its existing technology and both business and consumer users, seamlessly integrates into Square’s dual-business model.

Moreover, Square’s recent financial performance has been exceptionally strong, generating substantial capital available for a significant acquisition. Therefore, leveraging these resources to acquire Afterpay appears strategically sound, given the aligned synergies between the two organizations.

The acquiring company articulated this synergy in its presentation, highlighting the combination of “complementary merchant ecosystems” between Square and Afterpay, and the convergence of “complementary consumer ecosystems” between Cash App and Afterpay. While corporate messaging should be viewed with some caution, these statements appear to be justified.

Additional considerations exist. Cash App’s user base is primarily located in the United States, while Afterpay boasts a more international consumer presence. Square currently processes over 85% of its transaction volume within the U.S., whereas Afterpay generates more than half of its revenue outside of the United States. Consequently, Afterpay will contribute to Square’s evolution into a more globally relevant company.

Ultimately, this deal has the potential to modestly accelerate Square’s overall growth trajectory.

The companies’ presentation indicates that Square’s gross profit – the metric the company now prioritizes following distortions to revenue caused by bitcoin sales to consumers – increased by 71% over the four quarters ending June 30, 2021. Afterpay, in comparison, experienced a 96% growth in its gross profit. Given Afterpay’s smaller revenue scale relative to Square, a dramatic shift in Square’s growth rate isn’t anticipated. However, the acquisition could provide a beneficial boost to Square’s gross profit growth.

Thus far, the integration appears promising. The product offerings align, the global footprints are complementary, and Square may be acquiring a degree of growth in the process. With Afterpay integrated, Square is better positioned to compete against not only PayPal and dedicated BNPL companies, but also to mitigate the risk posed by Apple’s potential entry into the installment credit market for consumers.

However, a crucial question remains: did Square overpay for Afterpay?

Evaluating the Cost of the Square-Afterpay Acquisition

The acquisition of Afterpay by Square carries an implied valuation of $29 billion. While this figure requires some contextualization, it serves as a sufficient basis for assessing the all-stock transaction. Let's examine the multiples paid to determine the premium Square is offering for the smaller firm.

We will analyze annualized revenue run rates from recent reporting periods for several Buy Now, Pay Later (BNPL) companies. These run rates will then be divided by their respective market capitalizations or private valuations to compare the Square deal's expense against existing market benchmarks.

BNPL Company Valuations

• Klarna: First-quarter revenue reached 2,951,907,000 Swedish Krona, representing a 42% year-over-year increase. This translates to an annualized run rate of 11,807,628,000 Krona, or approximately $1.38 billion USD based on current exchange rates. Klarna’s most recent valuation stood at $45.6 billion, resulting in a run rate multiple of roughly 33x. It’s important to note this figure may be somewhat inflated due to the lack of Q2 data and potential growth in the subsequent quarter.
• Affirm: Analyzing Affirm’s calendar Q1 results, revenue amounted to $230.7 million, a 67% year-over-year increase. This yields an annualized run rate of $922.8 million. With a market capitalization of $14.93 billion at the time of writing, Affirm’s multiple is 16.2x. However, this number is likely conservative, as the company has experienced growth since the end of Q1.

It’s crucial to acknowledge certain caveats. Klarna, as a private entity, is subject to valuation by a distinct investor base. Recent funding rounds have provided Klarna with substantial capital for growth initiatives. Conversely, Affirm is a publicly traded company.

Furthermore, Affirm exhibits some revenue concentration risks, potentially influencing investor valuations due to its significant reliance on Peloton for a substantial portion of its revenue.

Let's now apply the same methodology to Afterpay, considering Square’s $29 billion offer:

Afterpay Valuation

• Afterpay: Afterpay recently released its full fiscal year results. However, these results are not particularly insightful for our comparison. The company’s fiscal Q3 2021 figures, corresponding to the calendar Q1 period, were initially considered. Unfortunately, these results only include Gross Merchandise Volume (GMV) data. Therefore, we must rely on Afterpay’s fiscal 2021 aggregate revenue of $693 million. This results in a valuation multiple of 42x revenue based on the $29 billion price tag.

This multiple is likely overstated due to the use of annual revenue rather than a run rate. Nevertheless, the difference between the multiples of Klarna, Affirm, and Afterpay suggests that Square is paying a premium for its BNPL acquisition.

Square is indeed paying a premium, but is it excessive? Probably not.

The acquisition represents approximately a quarter of Square’s current market capitalization of around $120 billion. While substantial, this is justifiable if Square’s strategic objectives are realized.

Considering the deal’s rationale, Afterpay brings global revenue streams, a broader user base, and a more diversified merchant network to Square. Developing these assets organically would have required significant investment and time. Square is opting to acquire them immediately.

Moreover, Afterpay’s value is unlikely to decrease; the company was exploring a U.S. listing, which would have provided access to additional capital and resources for further growth. Therefore, acquiring Afterpay now, at a higher price, is preferable to potentially paying more later.

The necessity of a BNPL solution for Square’s long-term success further justifies the price. PayPal has already invested in its own BNPL offerings. Without a comparable solution, Square risked becoming a lagging player in a rapidly expanding consumer fintech market.

Avoiding the need to catch up, particularly with Apple’s potential entry into the space, is a significant benefit. Square is leveraging its market-awarded equity value – its stock has risen from around $52 per share in March 2020 to over $264 today – to mitigate future risks, expand its global reach, accelerate profit growth, and avoid costly product development.

Is it not the inherent advantage of a public company to utilize its market value to execute strategic acquisitions? This deal is not inexpensive, but it is far from unreasonable.