We respond to some recent spurious claims put out by a fund manager with a Q&A below.
Is Afterpay similar to Zippay or other providers of consumer credit/finance?
Credit can be defined as providing funds to another party in exchange for a promise to repay the principal plus an additional agreed amount (interest) generally linked to the duration the funds are drawn or advanced.
Afterpay does not provide complying consumers with credit per se being a truly cost free instalment payment solution for compliant customers.
Note my emphasis on consumers complying with Afterpay's terms of service. Non-compliant consumers occur a fine or late fee as they accept under the terms of service.
While there have been critics of these 'fines', consumers are under no obligation to use the service if it does not suit their needs or if they find the terms of service onerous.
In summary, Afterpay is free to use for compliant customers in contrast to providers of consumer credit who charge interest to the customer as their core business.
Is Afterpay just a factoring business in disguise?
Afterpay is not a factoring business, but rather an innovative blend of modified supply chain finance and lay-by tailored for the mass consumer market. The table below illustrates the key differences between Afterpay and a 'vanilla' factoring business.
Aren't merchant fees a bit thin at 4% considering the credit risk?
The rate merchants pay for the facility is set by Afterpay. The 4% rate assumption was probably valid 12-18 months ago when Afterpay was an unknown quantity in the market. We have spoken to numerous retailers who use Afterpay; the recent commission structures in the sub-$20 million revenue business category appear to be between 6-7% plus a nominal fee per transaction. Customer satisfaction is very high with over 85% of revenue being generated by repeat customers.
This to us demonstrates the pricing power of a market leader or incumbent. We have also noted that once a merchant within a particular market segment adopts Afterpay, it's competitors follow suit fairly quickly adding to the products virality.
Afterpay as the payment intermediary captures value in a number of ways:
Yes, you do not need a credit card to be eligible for Afterpay. A credit card is not necessarily evident that a consumer is credit worthy.
Credit card usage has actually been on a slight decline in terms of per capita usage in Australia. In fact less than 30% of Millennials possess a credit card in the US market. 85% of Afterpay transactions are via debit card ie. not credit card.
But what about the credit risk?
Afterpay transfers 100% of the credit risk from the merchant to itself, with genuinely no recourse for any shortfall in the case the customer does not complete their payment plan. This is attractive from a merchant perspective, and puts the onus on Afterpay to develop systems that accurately assess a consumers ability to repay the instalments.
Credit risk is mitigated by the fact that if any payments are late, new transactions are impossible; so the quality of the credit book continually improves with the number of transactions that go through the system. Afterpay relies on a mathematical principle called the Law of Large numbers. This probability theorem stipulates that as the number of occurrences (or in this case, transactions) increases, the average of the result of these transactions will be closer to the expected value. We see this principle at work commonly within the insurance industry and other industries which assess and transfer risk.
What if there is a recession, could Afterpay lose money?
We feel that in an economic downturn, it is likely thatAfterpay’s utilization may increase due to attractiveness of paying off discretionary purchases via instalment plans; it is evident that customers use the product as a budgetary tool.
Afterpay can be thought of as a microfinance tool, as the average customer use is circa $200 in value, being used 5-6 times per year. Given the regular usage, relatively small amount advanced and large utility value of the service; we think that it’s highly unlikely that customers would risk the loss of access to a service they use regularly.
In contrast, the average credit card debt in Australia is $4,200 and average personal debt is circa $8,000 per head; these payments can be deferred without any immediate consequences and have a differentiated risk profile when compared to Afterpay.
The potential for credit risk is actually highest at the time of a consumer's first purchase, with it falling rapidly with each subsequent purchase as users do not want to lose the utility gained by using the system.
OK, what about companies offering competing services; what are Afterpay's key differentiating factors?
Afterpay product offering is clear and vanilla to customer; with no variation in terms whatsoever, in contrast to competitors.
Competitors are at least 2 years behind Afterpay in terms of technological integration, merchant reach and services levels from both customer and merchant aspects. One only needs to possess a rudimentary knowledge of technology to know that the company with the most functional application, API and User Experience generally does best over time.
Afterpay's execution has been outstanding to date. It has successfully taken exploited its first mover advantage and scaled up to become the dominant player in the Australian market. We note that in developing segments of the market, it is typically who can take the most market share at the earliest stage that eventually survives and thrives. An example of this is Paypal, who fought off a number of competitors to emerge as the market incumbent due to its virality and success in customer acquisition.
Feedback from merchants suggests that revenue rises with the adoption of the service and it is a service that is in high demand with customers. Afterpay's merchant directory and promotion via its social network channels is a valuable form of 'free' promotion for merchants. In addition, in regards to merchant service issues are typically resolved the same day in contrast to the extended support timelines of competing products.
It is NOT in Afterpay's best interests to have customers spend beyond their means and be in arrears. This is because Afterpay earns more from recycling its capital quickly (ie. receiving customer payments and purchasing merchant receivables) than the late fees it charges to customers in arrears. This is in contrast to its competitors.
Why is Afterpay's revenue so low? Is this the same as gross sales?
Afterpay according to the notes in its financial statements recognises revenue as the economic capture between the gross amount and net amount paid to merchant. Gross sales they define as the total amount of receivables that they purchase off the merchants.
We consider the gross sales to be the most relevant figure in measuring growth however, both measures should be monitored.
So what makes Afterpay so compelling for you?
When analysing growth companies we look for the following key attributes:
Afterpay ticks all our boxes. We have made the analogy to Amazon previously and we compare some key metrics below.
Why are you writing this?
The main purpose of this Q&A is to correct inaccurate statements put forth by a fund manager as well as to put misconceptions around Afterpay's business model to rest.
Once again this highlights the important of selecting an investment manager who possesses the necessary skills, objectivity and intellectual humility to understand and capture profits from investing in a company with an innovative business model, experiencing viral growth.
We expect Afterpay to release additional positive news regarding further growth in the coming months. We have come across information in the public domain that demonstrates the growth path ahead for Afterpay.
Afterpay is one of our key equity investments, and we consider this a permanent holding.
Thank you to those in our network who contributed information material to this article.
This is an extract from Datt Capital's forthcoming monthly report
Disclaimer: This article does not take into account your investment objectives, particular needs or financial situation; and should not be construed as advice in any way
We got lucky. A few days after our last wire, discussing two stocks to watch, one of them, Afterpay, released a positive business update and the share price exploded, gaining in excess of 30% within a matter of days. Reading market commentary, a common perception is that Afterpay is overvalued at its current price. The real question is: how do you value a company that is growing at an almost exponential rate?
We consider the major growth avenues below:
Afterpay also possesses a number of sources of unquantified value, namely:
We consider the P/S ratio a reasonable valuation heuristic for a company experiencing rapid growth above 100% per annum like Afterpay. We would consider a P/S ratio of 1 times to be reasonable for an ASX listed company however, if a dual-listing was pursued in the US markets (for example, on the NASDAQ) we would consider a P/S ratio of 2 times to be most reasonable in that particular market.
We note the latest business update disclosed the annualised gross sales were running at circa $3 billion. We anticipate Afterpay in 12 months to be achieving minimum annualised gross sales of $5.5 billion, with the US contributing over $1 billion to this figure. Using the P/S ratios above, this equates to a share price range of between $25 and $50 assuming no further equity is raised.
We applaud the efforts and decisions of management to date and are enjoying watching the evolution and growth of another great Australian company.
Disclaimer: This article does not take into account your investment objectives, particular needs or financial situation; and should not be construed as advice in any way.
With reporting season fast approaching we highlight two companies whose results we will be watching closely: Afterpay Touch and Mineral Resources. We outline what we will be looking for in their reports to see if their incredible performance can continue.
Afterpay Touch: Will they win market share in the US?
Afterpay Touch provides a tweak to the traditional lay-by (layaway) model by allowing consumers to pay for products in 4 instalments while being able to use the product straight away, rather than the conventional method of waiting until all instalments are paid.
The customer benefits from immediate use of the product, while Afterpay removes the need for retailers to track and hold stock and payments, for a small 4% fee. Afterpay then essentially 'own' the customer who pays the instalments to Afterpay rather than the retailer.
Afterpay then becomes the 'destination' for the consumer who can efficiently compare product offerings at the Afterpay website; which leads to a virtuous cycle of lower customer acquisition costs, better credit quality over time and greater brand awareness and loyalty.
Strategically, we feel the value proposition Afterpay brings to the table is nothing short of brilliant. By being a 'no-cost' payment method to the consumer, it circumvents any claims of usury, genuinely reduces consumer costs via a no interest model, and drives incremental demand for retailers.
The datasets of consumers and their behaviours that they possess are also extremely valuable intellectual properties that are not reflected on their balance sheet. In addition, we view the platform as an equalising tool that independent retailers can use to differentiate themselves against the might of Amazon.
What we are looking for in their report
The key catalyst this reporting season will be an update on the company's progress in the USA, where Afterpay has managed to recruit a star-studded team.
The US retail market is over 15 times that of the Australian market; and lay-by is offered more widely relative to Australia. This has been validated by the quick uptake by US retailers; evidence suggests that Afterpay has managed to recruit more than 200 separate US retailers since launching in mid-May.
What gives us confidence is the validation in the model by consumers themselves. Starting from zero in 2015 it has managed to capture a full 25% of online fashion retail transactions in the Australian market. If Afterpay can replicate its Australian experience in terms of market share in the US, we expect the company to be worth multiples of its current price over time; and likely to be a takeover target by one of the large US based payment companies such as Visa, Mastercard or Paypal.
Mineral Resources: 3 key drivers to watch
Mineral Resources is an innovative diversified mining and mining services company. Its core business is to provide turnkey solutions covering all aspects of mining services. It also invests opportunistically in mineral projects itself and acts as a capital provider to smaller miners.
It has a large exposure to key strategic commodities in lithium, graphite and tantalum and makes use of a number of innovative technologies. Its managing director, Chris Ellinson, and its board hold circa 15% of the company providing good alignment with shareholders.
Over the past year, MIN has opportunistically bid for two other downstream companies in AWE (oil & gas) and AGO (iron ore). In both instances, they were outbid but refused to raise their offer.
This demonstrates sound capital discipline on the board's part. In the AGO instance, we believe much of the value was in the additional port access that would be available in Port Headland. Unfortunately, two heavyweights joined the fray in Fortescue and Hancock Prospecting; both likely vying for the same said port access. As a result MIN's share price has fallen by approximately 20% since the entry of the competing bidders.
The three potential catalysts in reporting season will be:
The release of the pre-feasibility study for a lithium carbonate/hydroxide plant at the company's Wodgina deposit, claimed to be the world's largest hardrock lithium resource. MIN have broadly stated that a highly refined lithium end product will have approximately 4 times the value compared to it's existing Direct Shipping Ore operation.
An update on its minority stake sale in Wodgina lithium operation, likely to a combination of global trading firms and end users. We think a premium price is achievable considering the project's scale and long life.
Further clarity around the AGO takeover and subsequent port access in Port Headland. We feel the situation is likely to end in a stalemate with both Fortescue and Hancock holding blocking stakes. Hancock has been a customer of MIN's in the past so it's likely that an arrangement can be agreed around port access.
We expect the share price to trend higher from its current level of $15.50, towards $20.
Disclaimer: This article does not take into account your investment objectives, particular needs or financial situation; and should not be construed as advice in any way.
As investors, we are all looking for an edge in earning outsized returns. Here I identify 3 simple portfolio management principles that are essential in any investor’s toolkit, and briefly outline how they can all be brought together into a simple cohesive strategy.
1) Compound (Reinvest) your returns
Would you rather be given $10,000 immediately... or wait 12 months to receive $1,000 that has been earning 1% each day, compounded (reinvested)?
If you selected the second option, congratulations, you would be given close to $38,000.
This simple exercise highlights the vast difference between compounding (reinvesting) your returns and consuming (not reinvesting) your returns.
The key drivers of compounding interest
Mathematically, the key metrics that influence compounding returns are: a) the level of returns (%) and; b) the compounding frequency.
The effect of compounding frequency are illustrated by this example: Compare 2 funds which both earn 12% per annum, where fund A distributes once a year and Fund B distributes four times a year.
If the investor in fund B is able to reinvest the quarterly distribution, this leads to an extra relative return of almost 4% over Fund A; assuming the investor is able to earn the same incremental return on the reinvestments.
A simple way for investors to benefit using this principle is to reinvest your portfolio earnings, whilst giving thought to investing in assets that provide distributions or dividends at regular points during the year.
2) Avoiding losses - let winners run but cut losses quickly
Research has shown that most individuals are risk avoiders when handling gains, and risk takers when dealing with losses. Practically speaking, this means that individuals are more willing to speculatively hold a losing investment in the hope of the loss diminishing, than to hold a winning investment with the hope of further upside.
In a nutshell, this means that a person’s strategy for managing uncertainty will often clash with the strategy needed to objectively manage the risks in an investment situation. This leads to a negative asymmetric return, in the sense that investors tend to let their losses run while limiting their gains. Investors need to fight against this primordial, behavioural urge by cutting losses short and letting profitable trades run.
Limiting losses is the single largest factor in achieving sustainable returns. For example, a loss of 20% requires a gain of 25% to get back to even; whilst a 50% loss requires a 100% gain to breakeven. Conversely, by avoiding exposure to market losses, an investor can outperform the market without full exposure to the market's upside.
An allocation to non-equity asset classes should be explored to protect portfolio returns. Investors should think practically by focusing just as much on the downside just as much as the upside of an investment.
3) Reduce volatility
The ASX200 total return index (XJOA) has had a mean return of 9.7% per annum over the last 25 years, however, in just 3 of those years has the return fallen within 2% of this value.
When it comes to compounding returns, volatility has a detrimental effect due to negative compounding returns during certain periods. This impact is known as volatility drag. When comparing two investments with the same average returns but differing volatility, the higher volatility investment will exhibit a lower geometric (compounded) return, due to negative compounding over multiple periods.
If investors can utilise a strategy that can lower volatility without sacrificing too much return over time, it will likely lead to a better outcome. If investors cannot hold onto their investments through the volatility, they will never achieve the 'average' returns.
High volatility environments can often lead to poor decision making by investors. For example, selling in periods of despondency (the lows) and buying in periods of where confidence is high (the highs).
What can investors do to mitigate the effect of volatility in their portfolio? Structurally, investors are able to dampen portfolio volatility by investing across asset classes; for example in fixed interest, cash or alternatives.
Tying it all togetherTo conclude, we have demonstrated the benefits of reinvesting your returns, avoiding losses and reducing volatility in your portfolio.
We believe the ideal method of tying these 3 concepts together is utilising the power of a multi-asset portfolio to achieve consistent, sustainable returns.
We should all strive to achieve robust, sustainable returns, not ‘beat the market’. By diversifying their portfolios across asset classes or by utilising an investment manager who shares this philosophy, an investor has a far better chance of achieving a consistent, sustainable return that will build wealth year-on-year without the fear of volatility and potential losses.
As investors, we all look for opportunities where there is a clear, coherent and compelling rationale for investing. Ideally, the opportunity should possess strong growth characteristics, and limited downside should our thesis not eventuate after a period of time. We look at one such thematic, and three microcap exposures to it.
Large, disruptive changes within industries or sectors are generally driven by the confluence of technologies, political incentives, private enterprise and human nature. Certain commodities can experience huge changes in price depending on industry supply and demand dynamics.
One historic example: Iron oreA good case in point is the Iron Ore industry. This industry was typified by long-term supply contracts, no spot market, and relatively stable demand and supply dynamics. This was the case until Chinese steel production growth began to rise rapidly around 2003 from its previous incremental growth; driven by steel demand from increasing urbanisation.
To read the rest of this post, please visit the following link: https://www.livewiremarkets.com/wires/the-metal-you-can-t-live-without
The team at Datt Capital are pleased to announce the formation of it's new Fund, the Datt Capital Absolute Return Fund. We believe that this product is a unique and novel product within the funds management landscape and allows smaller, wholesale investors access to the strategies and portfolio approach commonly used by family offices and endowment funds.
The genesis of our fund was that we were unable to find a suitable investment product for our own capital. We saw the gap for a manager aligned, multi-sector and strategy, absolute return fund. Our focus on capital preservation whilst not sacrificing adequate returns is a key point of differentiation, along with being a significant co-investor within the Fund. We invest in debt, equities and derivatives.
The Datt Capital Absolute Return Fund is an extension of the successful investment strategies we have employed over the past 2 years as a Family Office, made available to wholesale investors. In this duration, we have achieved annualized returns of over 12% per annum with an average cash holding of 25% and obtained with zero leverage. Our returns have also shown little correlation with the ASX200, providing important diversifying characteristics for any discerning investor.
Some key portfolio statistics are:
Annualized standard deviation: <4%
Sortino Ratio: 4.36
Correlation co-efficient with the ASX200(XJO): 0.20
Cumulative outperformance against ASX200 over 24 months: >8%
Cumulative return over 24 months: 26.4%
Annualized compound return per annum: 12.39%
Largest Drawdown: -1.4%
Winning month ratio: 79%
Please contact us if you wish to obtain a copy of the Information Memorandum.
The Fund's inception will be circa July 2018.