Square’s Acquisition of Afterpay Accelerates the Race for Alternative Credit

Yesterday, Square announced an all-stock acquisition of AfterPay for $29 billion — worth more than a quarter of its current market capitalization. This marks not just the biggest FinTech acquisition but one of the largest acquisitions in financial services to date.

Should the deal pass regulatory approval, AfterPay shareholders will own nearly 20% of Square. This is clearly a bet-the-company move by Square that the future of payments and banking lies in alternative approaches to consumer credit. So far, investors seem to like the deal — with Square’s shares up more than 10%.

What’s the deal?

• Price: Deal value is $29B, which represents a 31% premium to its closing price on Friday.
• Terms: The transaction is an all-stock deal, where AfterPay shareholders will receive 0.375 shares of Square Class A common stock. Once closed, AfterPay shareholders will own 18.5% of Square.
• Valuation: Square is acquiring AfterPay at a valuation that is ~5x greater than its own multiple (on a trailing twelve-month revenue basis).
• Our Take: While the price and terms are wildly dilutive, this signals high motivation to participate in increasingly competitive space and could represent a game-changer for Square.

Cash App Flow With Afterpay Integration

Why buy it?

• Counter increasing competition: Shopify has aggressively entered the market through a partnership (and partial ownership) in Affirm. At the same time, PayPal has coupled BNPL with existing functionality for merchants as well as consumers, and Apple is rumored to enter the market with Apple Pay Later.
• Address growing merchant demand for financing: Merchants are looking to BNPL to drive increased conversion in the shopping journey. Without this capability Square’s merchants were going to other providers, creating risk that they would migrate entirely to alternative platforms (e.g., Shopify).
• Meet consumer preference for alternative credit: Consumers are clearly gravitating to BNPL across a range of products and price points. Square can expand usage of Cash App and unlock new credit-based revenue streams by integrating BNPL. Similar to Apple Pay Later, this can reinforce existing user behavior and drive broader appeal of its consumer financial services experience.
• Boost global expansion: The acquisition enables Square to cross-sell its existing products to AfterPay’s merchant and consumer base — doubling down efforts to expand in global markets with both CashApp and its Seller solutions.
• Curb network competition: BNPL providers that control significant scale across merchants and consumers could create network effects and disincentivize (or penalize) use of alternative providers (through higher price, lower convenience, etc.). In the long run, this could lead consumers and merchants to move towards (or away) from Square based on the benefit of transacting within its network.

Afterpay digital pay powered by Cash App and POS offering

What does it mean for the market?

• Bundling of BNPL: Square will integrate BNPL as part of Cash App as well as Seller solutions. Similar to Shopify and PayPal coupling BNPL as part of their broader offerings, this suggests the true value of BNPL for consumers and merchants lies in embedded financing and leveraging transaction data for more aggressive underwriting and pricing.
• Push to offline: So far, the power of BNPL has been largely contained to e-commerce because it has been hard to create a compelling experience for the physical retail environment. Square could leverage its direct connectivity to consumers and merchants to provide financing offers that are presented within its POS or even provided after the purchase through a digital receipt generated in the POS.
• Traditional credit disruption: An increasing number of consumers will have access to alternative credit with BNPL in Cash App and the rumored Apple Pay Later launch. This will place greater pressure on traditional credit issuers as credit volume will get arbitraged by platforms that can steer and control credit volume.
• Battle for the SMB: Square is betting that integrating BNPL with its existing payment and commerce capabilities will enable it to compete effectively with Shopify. The bundling strategy taken by PayPal, Shopify, and Square point to a competitive focus on providing SMBs with a range of integrated products in a single platform.
• Industry consolidation: Square’s acquisition of AfterPay is the first move in a broader wave of consolidation in BNPL. It will be very difficult for pure play providers to compete in a market that has 3 companies with greater than $100B in enterprise value doubling down on their own efforts. These larger players have significant advantage, including the ability to:

integrate BNPL as part of a broader value proposition.

subsidize cost of acceptance and make money through other value drivers.

deploy significant capital advantage to outcompete on marketing and customer acquisition.

What will be the industry response?

Square has thrown down the gauntlet. Competitors will have to follow suit and look to acquire (or be acquired) in order to stay relevant. Our bets are:

• Shopify will acquire Affirm, which they already have a partnership with and partial ownership in.
• Paypal will acquire Quadpay or Sezzle in order to reinforce their existing position.
• FIS and Fiserv will have to acquire an asset (Quadpay, Sezzle, Divido, etc.) if they intend to compete — and do so within the next 12 months.
• Traditional credit issuers (incl. Private label) will have to develop alternative products to avoid major volume loss.
• The next battlefield for BNPL will be in offline transactions and verticalized solutions such as pet, B2B, healthcare, travel, and auto.

Bottom Line

Square’s acquisition of AfterPay should be a wake-up call not only for banks, but also consumer FinTech and SMB financial services players.

Pure play BNPL providers will get acquired as the market consolidates in the next 12 months. The lines between providing credit, processing payment, and managing financial lives (as consumers or businesses) will become increasingly blurred.

Software may be eating the world but credit is fueling the hunger.