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Scary but exciting – Afterpay and Nio revisited

August 30, 2020

The Russell 1000 measures the performance of the 1,000 largest US quoted companies by market value. It accounts for over 90pc of the value of all US quoted stocks so captures the performance of USA Inc.. It is in a strong uptrend and has recently broken up to a new post Covid-19 outbreak high. There was an earlier massive breakout in 2014 from around 17 years of sideways trading. It is heavily weighted for big tech, which accounts for over 40pc of the index by value. This makes it a good proxy for the technology revolution.

If you asked me to make a wild guess I would say this index could reach 10,000 one day. Since 2010 the index has risen fivefold so another wild guess might be that this index could reach 10,000 in five years, so by some time in 2025. This would imply the value of a stock like Apple rising from around $2 trillion currently to $10 trillion. Could that happen? History suggests it is certainly possible. A decade ago, when Apple was valued at around what would then have seemed a massive $133bn, who in a million years would have imagined the value being not one but $2 trillion a decade later. Miracles can happen; indeed they are increasingly par for the course on this incredible US stock market.

Having said that of the two stocks featured below one is based and quoted in Australia and the other, although US-quoted, is currently an entirely Chinese business. What they both have in common though is that they are classic US-style super fast growing technology driven businesses. They are also very much on US-style valuations, hence the scary but exciting tag

Afterpay  APT  Buy @ A$88.50  MV: A$25.4bn Employees: 650+  Next figures due: 26 February  Times recommended: 4  Price when first recommended: A$54.52

The more I study Australian buy now pay later (BNPL) business, Afterpay Limited (APT), the more excited I become. It is a classic example of a business winning the battle for territory that I wrote about recently in connection with US online used car sales business, Carvana.

One simple indicator of APT’s growth is that in 2016 the group had less than 30 employees. The latest figure is over 650. Another stunning metric is for underlying sales, which relates to sales made by all the merchants on the system using Afterpay. In 2016 this figure in billions rounded to zero; in 2017 it was A$0.6bn. The latest figure for the year to 30 June 2020 was A$11.1bn and they say that with their latest funding they have the capacity to grow this number to $30bn+. There are not many businesses in history, which have grown faster than this one.

Note that underlying sales are sales made using the platform, not the sales reported by the group, which are a small fraction (less than five per cent) of this figure. Reported group sales have also grown dramatically as can be seen in the table (including forecasts) shown below.

The technical picture is great. You can see the chart above; they don’t come much stronger. Remember that this stock has shown incredible share price growth partly because it floated only a year after the business was formed, when it was still virtually a start-up. These guys are in a hurry!

The shares crashed spectacularly in March 2020 as investors feared the virus-inspired lockdown was going to lead to massive defaults by customers on their BNPL payments, for which APT was on the hook since it funds its customers’ purchases. The company put out a statement in mid-March saying both business and balance sheet were fine. At around the same time Chinese technology giant, Tencent, swooped in and acquired a five per cent stake in a stunning vote of confidence. The shares turned around  and recovered as fast as they had declined, especially when trading results revealed the business was indeed growing as rapidly as ever or actually even more rapidly thanks to the virus-inspired boom in e-commerce.

The business looks so simple that you might imagine anyone could do it. Customers buy inexpensive stuff like clothes and beauty products for which they make four payments staggered over fortnightly intervals. They don’t pay interest but the merchant pays a fee averaging around four per cent from which APT covers its funding costs and makes a gross profit called the net transaction margin. This was 2.3pc in the just reported period to 30 June and the company aims to keep it around two per cent.

At first sight it seems astonishing that such a simple business is valued at over A$25bn (50 times sales), especially when the company is losing money and consuming cash. Part of the reason is that the seeming simplicity is the result of a surprising amount of behind the scenes complexity (rather like Google Search, which seems simple but only delivers such amazing results because of sophisticated technology).

Another key reason for the high valuation is the growing evidence that in a competitive market Afterpay is winning the battle for territory. As many CEOs say building a great business is at least as much about execution as it is about having great ideas.

This is a battle for massive stakes. The total addressable market is so huge it is hard to put a figure on it – effectively a large chunk of global retail spending, which is running at around US$25 trillion. On 24 August the group announced that it was buying Pagantis, a BNPL and credit business operating in southern Europe, for around €50m with €45m of the consideration payable in cash or shares and deferred for three years. The credit business would be immediately discontinued and the business model switched to Afterpay’s, albeit trading in Europe as Clearpay, the trading name used in the UK.

Pagantis operates in Spain, France and Italy, has permission to operate in Portugal and is applying for a licence to operate in Germany. APT noted that the e-commerce market in these four countries, not including Germany, exceeds €150bn and for the whole EU is around €300bn.

This latest deal gives an insight into the speed with which APT is moving. This company was only born in 2015. It is already dominant in Australia and New Zealand, Some two years ago it launched in the USA, where it has over 5m customers out of a group total of 9.9m as at 30 June 2020. A year ago it launched in the UK and has reached 1m customers even faster than it did in the USA.

In recent days it has confirmed that it is launching in Canada, a country with 36m people and GDP around US$1.5 trillion v Australia with 24m people and GDP around US$1.2 trillion. It is on the move in southern Europe (see above) and has even made a small acquisition in Singapore to lay the groundwork for Asian expansion and is exploring possibilities to expand in Asia with shareholder, Tencent.

More recently a giant Japanese financial institution, Mitsubishi Financial Group, so Japanese corporate royalty, has announced that it has a notifiable five per cent stake, which might be helpful when Afterpay arrives in Japan.

When I look at what Afterpay is planning I feel as though I am in a strategy meeting with Alexander the Great. I can imagine that they have a map of the globe on their wall rapidly filling up with pins. They are plotting world conquest and are moving at blitzkreig pace.

Afterpay doesn’t do credit checks. They do turn down some people, I am not quite sure why but most people can walk into a shop with an Afterpay facility and buy something for 25pc down and three fortnightly, interest-free payments straight away, a capability which would certainly get me to spend more, not that I need much encouragement. They also don’t report you to the credit agencies if you don’t make all your payments. They don’t want to jeopardise your chances of getting a mortgage for a handful of dollars. What they do is pause your ability to buy anything else with Afterpay until you have paid. There are late fees but these are capped at a low level, interest is never charged and they say they are very ready to listen in genuine cases of hardship.

They have also launched a rewards scheme for good customers, which is most of them. APT doesn’t need credit checks because they keep the good customers and the unreliable ones stop being customers.

It’s not big money. The average order is around A$150 and the typical outstanding balance is around A$190. The regulators are always sniffing around but APT is right to say that their system works better than credit checks and is far more customer friendly.

In July Afterpay raised A$770m with a fund raising. Allied to existing assets and loan facilities the group has over A$2bn of liquidity and growth capacity. The group has already said it is targeting underlying sales of A$20bn plus by the 21-22 financial year. It now says that its liquidity would support sales of A$30bn+, clearly hinting that this may become a new target. Incidentally, to grow in five years from a standing start to a war chest of A$2bn is itself a staggering achievement.

You can do some even more interesting sums on where the group might be going. As time passes customers use Afterpay more and more. The oldest customers from the 2016 cohort in ANZ are now using APT for 25 transactions a year. It’s obvious really; why pay cash if you can pay in four without any interest penalty. Based on an average order value of A$153 that would mean each customer from that cohort spends A$3,825 a year with Afterpay. In the calculations below I have rounded that up to A$4,000 to allow for modest future growth in the order value and/ or number of transactions.

The group also says that customers everywhere are increasing transactions as rapidly or more rapidly than the original cohort. Meanwhile the number of customers is growing fast. An average of 17,300 customers was added daily during FY20. In Q4 this grew to 20,500 and the rate of growth is likely to keep climbing as new merchants and territories join the platform. I can see the time coming when new customers are joining the platform at a 10m a year rate (based on 20,500 a day the number is already rising by roughly 7.5m a year).

By 2022 the group could easily be approaching 25m customers v 9.9m now. In time these customers could each be spending A$4,000 a year with the platform, which points to underlying sales of A$100bn (25m x 4,000) at some admittedly unknown future date. Again, using rough figures around five per cent of underling sales percolate through to APT reported sales.

This implies group sales of A$5bn several years from now v the just reported A$519m for the financial year to 30 June 2020. We then halve that sales number again to reach a net transaction margin of A$2.5bn, which is analogous to gross profits for another type of company. We then need to take operating costs (administration, sales and marketing and research and development) from that to arrive at a profit figure.  I haven’t done the homework to put a figure on this number but I do have a broad brush guess below.

These numbers already paint a picture of an exciting, fast growing business with excellent prospects of delivering dramatically higher sales and eventually profits in the future. One of my other thoughts but this is even more speculative is that ultimately the APT business model could deliver operating profits of around one per cent of underlying sales (net transaction margin of around 2pc less operating costs). On this assumption A$100bn of underlying sales would deliver around A$1bn of profits for a business that might still be at an early stage of a sustained period of high growth.

A key element in APT’s success and another reason why I am so bullish of this business is that it has the two funders at the helm and they seem like hugely talented individuals. One of them, Nick Molnar, who had the original idea for the business, is still only 30 making him Australia’s youngest and fastest to get there billionaire.

Another key element is the group’s ability to add merchants to the platform. More merchants attract more customers, who attract more merchants in a powerful Netflix-style virtuous circle. Since FY16 the number of merchants has grown from 300 to 55,400, having grown by 72pc in the latest year. We are also promised some exciting announcements on new merchants joining the platform in coming weeks and months.

APT is adamant that it is striving for a solution where everybody wins, merchants, customers and Afterpay shareholders of whom Molnar and Eisner are the biggest. Merchants have to pay a fee for sales made using Afterpay and some moan that they need to sign up to stop sales going to merchants who do offer Afterpay but all the signs are that merchants using Afterpay do better than they would without it. Afterpay says that merchants partnering with APT see a 25pc plus lift in average order value, a 20pc plus rise in conversion rates from looking to buying and a 20pc plus rise in frequency of ordering. They have testimonials from happy merchants and insist that one of the drivers of their rapid advance into new geographies is requests from their multinational retail partners.

The group is also working hard not just to attract new customers and merchants but to keep the ones it already has. It has introduced a programme of rewards for customers, who regularly make their payments and already drives over 90pc of sales from repeat purchases by existing customers.

The group has an app called The Shop Directory, which lists merchants, who offer payments by Afterpay. This is used by customers to find shops and by Afterpay to generate referrals for merchants. In Q4 2020 the platform generated an average of 14.5m referrals per month for retail partners.

Another innovation is designed to help merchants sell internationally. “Cross border trade rolled out between ANZ and UK with the US and Canada to be completed in early 2021. New regions will follow once launched. Cross border will enable a global platform that removes borders between our customers and retailer partners and facilitate an additional revenue stream for Afterpay in due course.”

Last but not least is their strategy to offer the Afterpay facility not just online but for in-store purchases, which is still an even larger market than online. They recently launched Afterpay in-store in the US and in the ANZ region where it has been available for a while in-store APT sales rose 81pc in 2020 v 2019 despite the impact of the virus.

I hope you get the picture that I think Afterpay is a phenomenally exciting business and a great investment opportunity. My best guess is that within five years the share price will top A$400 to value the group at an incredible A$100bn (£55bn).

Australian stock markets are open overnight for UK-based investors so I place stop orders with IG, which are executed automatically, while I am sleeping. If the share price falls rather than rises so my stop is not triggered I lower the stop buy price the next day and so on until it is triggered.

The table below shows historic results and forecasts for APT in local currency. The assumption in the table of pre-tax profits trending towards 20pc of sales by 2023 (actually 18.4pc) is not a million miles from my guesstimate above that profits, when they start happening, should be around one per cent of underlying sales.

This is also what Afterpay’s North American head, Melissa Davis, said about why the group is being so successful.

“Afterpay has seen an uptick in interest for its BNPL services, largely because it offers customers payment flexibility. Consumers are looking for ways to exert more control over their spending, while still enjoying frictionless, mobile-based checkout experiences. One of the best things a retailer can do is give payment options to consumers to make their purchases as seamless and easy as possible. While Afterpay got its start in eCommerce it continues to expand its in-store payment options, buoyed by demand from both consumers and merchants. The goal isn’t to merely build out systems for eCommerce customers, but also to recognise that all shoppers will likely prefer some flavour of omnicommerce going forward. Afterpay aims to ensure that consumers’ options in one channel are just as available in others. We think about not just the online shopper or the digital consumer, but also about how to service that omnichannel shopper. How do we make sure that wherever they’re shopping – whether it’s online, in-store or buy online and pick up in-store – we’re able to offer that same seamless experience across every touchpoint?

We see younger shoppers, both millennials and Gen Z, selecting Afterpay because it gives them access to the best fashion and beauty brands with a payment option that allows responsible spending and control. Fashion retailers benefit from the opportunity to engage with a new, younger and highly valuable shopper who typically converts at a higher rate, buys multiple items at a time, and has a higher AOV [average order value]. In fact, retailers offering Afterpay see a conversion of approximately 20 to 30 percent higher than other payment methods.”

Chairperson, Elena Rubin, on Afterpay at the November 2019 agm.

“What sets us apart and makes us unique is: • We are not a bank or a traditional credit provider • We are a non-aligned, independent player • We are a retail technology company that delivers shared value to both retailers and customers • We’re about small purchases – average transaction is $150, with built-in consumer protections • The vast majority of our revenue is made from retailers paying a fee, as opposed to customers 4 Afterpay Touch Group Limited ACN 618 280 649 Phone: 1300 100 729 Level 5, 406 Collins Street, Melbourne VIC 3000 • Our primary focus remains on lifestyle purchases that appeal to our millennial customer base, the world’s most valuable consumer

Nio NIO  Buy @ $18.5  MV: $16.7bn  Employees: n/a  Next figures: 10 November  Times recommended: 2  Price when first recommended: $11.50

What makes Nio interesting is partly that it is clearly emerging as a contender in a very exciting space, a pure manufacturer of electric cars with no legacy fossil fuel business. The other attraction is its unusual business model. Cars and batteries are sold separately, or increasingly will be going forward and that means buyers have significantly lower entry costs and don’t have to worry about what happens when their car battery comes to the end of its useful life because the BaaS (battery as a service business model) means they will always have a state of the art battery for their car.

The era of fossil fuel cars is coming to an end. The new millennial generation coming to power in the world is too aware of the need to protect the environment to accept the damage done by fossil fuel cars. As electric cars become steadily more affordable and the charging/ battery swopping network becomes ever more extensive electric cars and maybe fuel cell (hydrogen-powered) trucks are going to take over.

This is going to drive (pun intended) massive growth in sales of electric fuel cars into the millions and then the 10s of millions. At the same time rapid advances in technology are going to make autonomous vehicles a reality. This in turn opens the door for car owning to be replaced by TaaS (transport as a service), where you pay only for usage with an all-in price covering rental, fuel, maintenance, insurance and road taxes. It makes far more sense because you don’t need garages or parking spaces and can choose your vehicle according to your particular needs for that journey.

As I noted in an earlier story Nio shares have recovered from around a dollar a year ago because a group of strategic investors, which I think means bodies associated with the local state government, stepped in to rescue the group from impending bankruptcy. Since then the group has demonstrated that it was worth rescuing by introducing new models and driving a rapid increase in sales, albeit from a low level.

It has also used its rising share price to raise equity capital on Nasdaq with US investors, possibly inspired by the dramatically rising Tesla share price, seeing Nio as a Chinese Tesla in the making. In June the group raised $493m before expenses and it has just announced a further equity issue to raise around $1.5bn, some of which may be used to buy shares back from the strategic investors.

Another thing that makes Nio a fun investment is the constant stream of exciting announcements, which highlight the rapid progress being made by the business and the scale of their ambitions. In August alone the group has announced vehicle deliveries for July. Deliveries of the ES8 and ES6 were 3,533 vehicles in July 2020, representing a robust 322.1pc year-over-year growth. The deliveries consisted of 2,610 ES6s, the company’s 5-seater high-performance premium smart electric SUV, and 923 ES8s, the company’s 6-seater and 7-seater flagship premium smart electric SUV. As of 31 July, 2020, cumulative deliveries of the ES8 and the ES6 reached 49,615 vehicles, of which 17,702 were delivered in 2020.

It has announced strongly improving second quarter results. “Beyond the strong order growth, we are proud to reach a milestone quarter with respect to the key financial metrics of the company, highlighted with the historically high vehicle gross margin of 9.7pc, lowest-ever operating losses and more importantly, a positive cash flow from operations for the first time in our history. We will continue to focus on improving operating efficiency across the company. Meanwhile, we stay committed to investing in the technologies and services to provide our users with the best products and experience in the future and to strengthening our leadership in the smart EV sector,” concluded Mr. Li. With the strong deliveries in the second quarter 2020, our vehicle margin significantly exceeded our target of over 5pc, attributed to the increasing scale, higher average revenue per vehicle, reduced material costs and improved manufacturing efficiency.”

It has announced its BaaS (battery as a service) business model and the formation of a battery asset company. “The BaaS model allows users to purchase electric vehicles and subscribe the usage of battery packs separately. If users opt to purchase an ES8, ES6 or EC6 model and subscribe to use the 70 kWh battery pack under the BaaS model, they can enjoy the vehicle purchase price with an RMB70,000 (US$10,000) deduction off the original price and pay a monthly subscription fee of RMB980 (US$140) for the battery pack. Meanwhile, the users will continue to enjoy the existing favourable policies such as purchase tax exemption and government subsidies for EVs. The first vehicle under the BaaS model has completed the process of license plate registration, insurance purchase, and auto financing. All users who purchase NIO vehicles are now eligible to place orders with the BaaS model.

On August 18, 2020, NIO, Contemporary Amperex Technology Co., Limited (“CATL”), Hubei Science Technology Investment Group Co., Ltd. and a subsidiary of Guotai Junan International Holdings Limited (collectively the “Partners”) jointly established the Battery Asset Company. NIO and the Partners will each invest RMB200m and hold 25pc equity interest in the Battery Asset Company respectively. The Battery Asset Company is dedicated to purchase and own the battery assets, and lease the battery packs to users who subscribe to the BaaS model.

The BaaS model has long been planned with our unique battery swap technologies. The successful launch of the BaaS model will enable NIO users to benefit from the lower initial purchase prices of our products, flexible battery upgrade options and assurance of battery performance,” said William Bin Li, founder, chairman, and chief executive officer of NIO. “As of today, NIO has deployed 143 battery swap stations across 64 cities in China, and completed over 800,000 battery swaps for our users. The advantages of our chargeable, swappable and upgradable battery swap technologies will continue to enhance competitiveness of NIO products, promote conversion to our premium smart EVs and create more value for our users.”

Finally it has announced on 27 August the latest equity fund raising. “NIO Inc., a pioneer in China’s premium smart electric vehicle market, today announced the commencement of the offering of 75,000,000 American depositary shares (the “ADSs”), each representing one Class A ordinary share of the Company (the “ADS Offering”). The company intends to grant the underwriters in the ADS Offering a 30-day option to purchase up to an additional 11,250,000 ADSs.”

The management team, led by founder, William Bin Li, looks impressive and is proving itself capable of the bold moves necessary to build a business in a highly competitive world. They remind me of Tesla in the aggressive way in which they are moving to seize what could be a huge opportunity and they have some powerful friends helping them to realise their ambitions. Bin Li also made it clear in answer to analysts’ questions that the group is by no means confining its attention to China and has ambitions to build a global business.

Will they succeed?  I don’t know the answer to that but if they do we are surely looking at a business valued in the hundreds of billions of US dollars and what is clear is that they are very much in the game. My hunch is that Nio is going to be a huge success.

The key to long term investment success is to have some massive winners in your portfolio; that is why I like owning shares in companies that might win big, companies like Afterpay and Nio, which, coincidentally, are currently on fairly similar valuations. The shares are going to be volatile but as long as the business model remains clearly intact and underlying growth remains strong don’t worry about the sceptics and don’t lose faith. If these companies continue to grow as I expect time is on your side as an investor.


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