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The rise of Afterpay and emergence of a new business model

Afterpay has been the absolute standout global growth story on the Australian markets over the past few years. This article explores the attributes that have allowed the company to become such a rip-roaring success.

Afterpay commenced operations in early 2015 and listed on the ASX via an IPO raising $25 million in mid-2016 at a share price of $1. Today the company's shares trade at over $70, an astonishing 190% per annum return over the past four years for participants in the IPO who have held on through thick and thin.

We were relatively late to the party, first purchasing Afterpay shares around the $7 mark in mid-2018. At that time, we shared what was then a controversial view that the company could be worth between $25 to $50 within 12 months. Then the company only took 10 months to reach the $25 mark. We recall being so excited by the company's potential that we sent hard copies of our research and letters to a number of prominent US investors such as Berkshire Hathaway.

Product features

Afterpay’s features are by now well known. They provide a tweak to the traditional lay-by model by allowing consumers to pay for products in four instalments while being able to use the product straight away. Afterpay removes the need for retailer to track and hold stock and payments in return for a small percentage-based fee. Afterpay then 'owns' the customer who pays the instalments to Afterpay rather than the retailer.

Effectively, Afterpay then becomes the 'destination' for the consumer who can efficiently compare product offerings at the Afterpay website. It 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 bring to the table is nothing short of brilliant. By being a 'no-cost' payment method to the consumer, it circumvents any claims of usury and reduces consumer costs via a no-interest model, driving incremental demand for retailers.

The datasets of consumers and their behaviours are also extremely valuable intellectual properties that are not reflected on Afterpay’s balance sheet. We view the platform as an equalising tool that independent retailers can use to differentiate themselves against the might of Amazon and other large online aggregators. In a nutshell, Afterpay is the antithesis of the traditional finance business model predicated on 'screwing the customer' to a business model that empowers customers to responsibly spend and budget without incurring a cost.

Business model

The core driver of the Afterpay model is its extreme capital efficiency and the uniqueness of its model to capture value. Conventional lenders turn over their loan books one to three times a year, depending on the nature of their lending activities. They typically charge an interest charge solely based on the time duration that a loan is drawn down.

Conversely, Afterpay has historically turned over its loan book approximately eight times a year whilst collecting a fixed return per cycle. This allows the company to squeeze a much higher return out of a much smaller capital base.

The company enjoys strong and scalable unit economics driven by a high level of automation. Its initial core target markets were skewed towards discretionary consumer markets, which typically have high gross margins thereby making Afterpay's merchant fees supportable. It also makes incremental demand from the Afterpay system especially valuable. Interestingly, we have seen significant extension into other industry verticals (with similar dynamics) such as health services over time, as the service has become more mainstream.

The viral nature of the product is a strong attraction with demand from both customers and merchants alike. Customers are attracted by the cost-free nature without the stigma of conventional lay-by. Merchants are attracted by increased customer spending via larger basket sizes as well as higher repeat purchase rates. In addition, the use of Afterpay draws new customers to merchants as well as reducing the financial risk of charge-backs and fraudulent payments as Afterpay bears the financial risk post transaction.

A dynamic we have observed in real time has been the 'peer pressure' in terms of merchants’ deployment of the service. For example, we noticed that early merchant adopters of the service quickly obtained a competitive advantage versus competitors who did not offer Afterpay. This forced merchants to adopt the service or risk losing business to competitors. It has resulted in a huge, long-tail of merchants who have adopted the service over time and leading to near ubiquitous offering in its target markets and sectors.

Management team

The story goes that Afterpay's two founders, Nick Molnar and Anthony Eisen, met fortuitously when Eisen noticed another night owl across the road from his residence working late into the night and introduced himself to Molnar one morning.

Molnar at the time was selling and distributing jewellery from his family business on eBay, whilst Eisen was a seasoned corporate executive. The two got along well with Eisen mentoring and introducing Molnar to a variety of individuals in his business network. By 2015, Molnar had built his business into one of the largest local distributors of jewellery online. Molnar was frustrated by the low conversion rate of website visitors and ruminated on how to increase sales via larger and increasing repeat orders. After rolling out a basic instalment plan option on his website, he noticed that a large improvement in the specific metrics that were key drivers of his business. He noted that breaking down a $100 purchase into four instalments of $25 was perceived as a more attractive proposition for his customers than paying a single lump sum. This was the genesis of the Afterpay system, with the company launched in mid-2015.

The two founders had the perfect blend of skills: Molnar the young entrepreneurial talent coupled with Eisen the experienced and street savvy corporate executive. Joined by a talented supporting team consisting of Craig Baker (technical lead), David Whiteman (product), Fabio De Carvalho (Sales), Barry Odes (COO) and David Hancock (finance), the company was impeccably positioned to support hyper-growth.

Molnar and Eisen fostered an excellent culture within the company founded on humility, agility and focus. We noted uniquely that both founders have been the CEO, with Molnar initially holding the position and being replaced by Eisen once the company reached a certain scale. This demonstrates the good working relationship and lack of ego between the founders, which we consider to be the ideal dynamic. The company have been open to ideas put forth by its customers, merchants and investors; as well as being sensitive to the needs of regulatory changes in a novel industry. The focus the company has demonstrated can be exemplified by the single product status of the company. The temptation to monetise its customer base in the short-term has been overcome by focusing on the key longer-term value drivers.

Risk management

Given that Afterpay transfers the credit risk from the merchant to itself and bears the subsequent credit risk, prudent risk management is essential for long-term survival.

Afterpay rewards users who comply with the terms and conditions of the offering, by allowing continued use of the service which provides utility to the user. Non-compliant users, such as users who default on payments, are now banned in contrast to the earlier approach of charging late fees to ensure compliance.

This stricter adherence approach has been hugely beneficial to the company for a variety of reasons. By weeding out bad players continually in real-time, Afterpay increases the quality and therefore value of the existing user base. A harsher compliance regime also ensures that bad players bear a real opportunity cost, as being banned means paying for competing services versus Afterpay's free service. This opportunity cost also ensures that the user base is sticky and compliant. Over time this leads to superior outcomes in terms of risk and shareholder value.

The vanilla product offering makes mathematical risk modelling very simple. The system can be viewed as a large number of small transactions on fixed terms, providing alignment with mathematical theorems such as the Law of Large Numbers (LLN), a core element in the insurance industry.

This principle holds that the average of a large number of independent identically distributed random instances tends to fall close to the expected value. The entry of additional instances to a pool tends to reduce the variation of the average loss per instance to around the expected value. Thus, an increase in the number of instances strengthens the pool by reducing the probability that the pool will fail. This is the 'magic' of insurance, increasing predictability and reducing risk via the principle of LLN. Insurers have learned the wisdom of insuring the largest number of similar risks possible, and Afterpay investors appear to have recognised this dynamic at work within its business model.

Novel industry

Understanding that Afterpay was the first mover in a novel industry, now branded 'buy-now-pay-later', was the first building block of our investment thesis. We were familiar with the notion of novelty and how quickly it may spread throughout a society. In this case, we had a novel, technology-driven service that was convenient and without stigma. The multiple angles of utility provided by the service were self-reinforcing and was recognised by the typical early adopters in any society, young adults—branded millennials in our era.

Securing its first-mover advantage involved Afterpay capturing as much of this demographic as possible, as quickly as feasible in a straight out 'land-grab' scenario. Organically as expected, we saw later adopters in the older demographics adopt the use of the service as its use became increasingly more mainstream. Its ubiquity in Australia now is a testament to the formation and execution of the business strategy.

Considering the industry segment and the business model itself, the company's 'moat' is the size of its user base. The ability to continue to grow this user base until maturity is a core part of the bull thesis.

The novelty of the business model and the development of the industry sector has not been without its regulatory challenges. To its credit, Afterpay has made the necessary amendments to remain compliant with regulations as well as making contributions to the development of the regulatory environment. We will discuss these issues in future articles.


Emanuel Datt is the founder of Datt Capital and Managing Director of Datt Group, a Family Office based in Melbourne. This article contains general information only and does not consider your personal circumstances.


August 17, 2021

Looks like everyone here was wrong. A/P hit pay dirt with that buyout, even though I agree with Eugene - how do they finance their lines of "instalments"? And the rising stock price on a company that never returned a net profit (remember that basic, simple old fashioned expression). I think they call that irrational exuberance.

Eugene Dominic
June 13, 2021

Not one article on an exhaustive Google search describes how the startup, Afterpay, financed its user's purchases during its early startup period. How does a company which buys items at retail prices for its customers earning a fraction, 3%-7% of the retail price afford to purchase in large numbers the items in the first place? Did Afterpay secure a line of credit from a bank offering interest rates under that which they charge their retailers as a fee? How were they capitalized in the beginning to get the business started? Regardless of word parsing on Google, not a single return listing, in text or video, described the real secret to their success - cost of capital, perhaps the most critical component in any business model.

August 27, 2020

Could it be that investors foresee massive default payment revenue on the horizon.

August 10, 2020

"Non-compliant users, such as users who default on payments, are now banned in contrast to the earlier approach of charging late fees to ensure compliance." - I'm not sure what's meant here, but APT certainly seem to still be charging late fees:

August 10, 2020

Defaulting Afterpay customers are banned from the service, rather than being charged late payment fees or interest. Does Afterpay chase up banned customers or just write off the debt? What stops people rorting Afterpay with fake sign up identities and no intention to pay?

August 09, 2020

Another brick pulled out from the base of the wall.

Housing debt. Consumer debt. Government debt. Eventually the new generations will not be born into debt, they will inherit it generations afore birth.

Jeff Costello
August 09, 2020

I have heard of a new player “ Splitit”
Has anyone have a comment on them?

August 08, 2020

Retailers pay fees for customers using credit cards. Why is Afterpay singled out as being different? Retailers get sales leads from Afterpay, which directs customers to their store/website, where credit card companies dont do that, but they then charge their users 20% interest and it can go on for years. I dont use Afterpay, but millions of young people do, and love the service. Nothing wrong with that. There is plenty of competition in retail land for everything already, smart customers shop around, and then use Afterpay. Its going to be the new normal way to buy stuff.

August 07, 2020

utterly pointless for me to use Afterpay.
I have 55 days interest free on my credit card, and earn awards points ( enough for me to get $500 free petrol vouchers each year ).
if you can't pay it off within 55 days then you should not buy it.
I refuse to buy into this ridiculous overblown hype.

Richard Thomas
August 06, 2020

As others have noted "take home lay by" has been a feature of retailing for many years. Latitude, a competitor, makes more profit each month than Afterpay's monthly revenue.
The little story about the idea born from customers paying for their jewellery in 4 installments is homely but ignores the fact that it is actually based on Swedish BNPL behemoth Klarna, 85 million + customers.
Klarna is here with the backing of CBA. Watch the battle unfold particularly when VISA and Mastercard come to the party.

August 07, 2020

Latitude's forecast profit for 2020 was $170m.

Don't let facts get in the way of your inability to analyse business

Ruth Alvarado
August 06, 2020

Afterpay business model is not new. This business model has been used Banks in developing countries for many years. It was brought about more by necessity as people in these countries/ economies can only afford to buy items and pay bills in installments.

August 06, 2020

It's sad that the only contribution Australia can make to the world of Tech is a debt app for the poor.
-The directors have sold $135M worth of stock EACH.
-Simply wall street values APT at 0.64c
-Morningstar values APT at $24.00
-APT currently does not make a profit, but the consensus for FY21 is NPAT of $21.5M
-@ $21.5M with the current price @ $70.85. The forecast PE is 931
Good luck with that!
There are many people who are still in the stock trying to talk it up (pump & dump)

August 07, 2020

Spot on Scott. This 'product" will be regulated at some point as it is obviously providing credit. Share price is a "bubble".

Bev Durston
August 06, 2020

Thanks for an interesting article plus excellent comments pointing out important facts that Emmanuel has left out. The massive savings that Afterpay users make in switching to this service (huge savings on credit card interest rates) means that this new service is indeed a very attractive one for its target young, savvy audience. Switching from a 20% pa interest rate to "free" regular payments means that this service is a fantastic option for those who would otherwise use credit cards (sadly large numbers of people in Australia). It also makes this incredibly disruptive for the traditional credit card business, which offer the most popular current buy now, pay later model.
However this "free" service is paid for by non user customers, who I understand are currently NOT allowed to be offered a discount by merchants for paying up front. This is anti competitive behaviour, as Sam points out and subsidises Afterpay users which is an inequity. Both the regulatory authorities and the ACCC need to correct this asap. Even then, I don't expect that doing this will likely stem the flow of new customers to Afterpay as it disrupts credit cards significantly. But it will at least prevent everyone else from subsidising Afterpay users which the authorities clearly should not allow.

August 06, 2020

Good points, but.... if they were that savvy, why wouldn't these customers (consumers!) save up for a few weeks before buying, where they are earning interest in the meantime? (Sorry for the rhetorical question!)

August 07, 2020

The business pays a fee to Afterpay for their FREE service. In return, they make a sale.

Hugh Jarse
August 06, 2020

Not usury. Dung by any other name. No interest but all pay a higher product price for the (small) fee included in overall costs

August 06, 2020

Quote:"Understanding that Afterpay was the first mover in a novel industry, now branded 'buy-now-pay-later', " How is the 'buy-now-pay-later" a novel industry? This has been around for generations and common in the developing world. Just because it is packaged using technology for the younger generation and marketed to the investors by companies like this author does not make it a "novel" industry. This is another bubble that will burst like the dot com, remember - even then, a lot of top investment agencies were selling the dot companies like they were novel!

August 06, 2020

Emanuel - what's your take on Roger Montgomery's comments in the previous issue of Firstlinks ? "Afterpay is simply a factoring company. It buys a retailer’s receivables or debtors for a fee and then collects the amount owing directly from the debtor. Factoring businesses have always made thin margins which partly explains why this company will have to keep raising money and diluting shareholders to fund its expanding book" ....

September 04, 2020

Hi Mart,

Mr Montgomery has been dubious of Afterpay's credentials since we first started writing about the company when it was priced at $7. We publicly responded to Mr Montgomery's claims in prior written pieces which can be found online dated around 2018.

Everyone has a right to their opinion, but time has shown our judgement and investment thesis to be correct.

August 06, 2020

Is it true that merchants that sign up to PAYG schemes are prohibited from offering discounts for cash (physical or card) payments? If so, IMO the ACCC should throw the book at them. It seems to be a sign of the times that these businesses spend more time and money engaging in anti-competitive behavior (monopolies, regulations, patents etc) than anything that is actually innovative.

Alex Erskine
August 06, 2020

Afterpay and similar PAYG services are adding unnecessarily to inflation, no matter how slick they appear. The costs of use of such services should be charged to the customer using that means of payments, not the broader customer base that does not use such a high-cost mechanism. Failing that, all non-PAYG customers need to ask for a discount for not using that mechanism.

August 06, 2020

What inflation ????

Alex Erskine
August 06, 2020

davidy, I agree with you to the extent that overall price inflation is low. But the high cost of transactions using PAYG is one element boosting or at least keeping retail prices higher than they would be otherwise.


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