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Affirm Holdings is Now a Compelling Opportunity

James Chapter 1 verses 2-3 state, "Consider it pure joy, my brothers and sisters, whenever you face trials of many kinds, because you know that the testing of your faith produces perseverance."


Trials - pain, hardship, and difficulty or many other ways to put it, are never enjoyable. It could be something unexpected that jolts my daily routine, or it could be a goal I have set, that quickly becomes a painstaking grind versus the exciting culmination of what I am working towards.


But God, through the Bible tells me to "consider it pure joy.....whenever you face trials of many kinds". I know one thing that is a fact of life, achievement and success are only crafted through adversity. Jesus Christ faced the ultimate trial, sacrificing Himself for the world, while deserving no punishment. Perseverance is something that can lead to unmatched commitment and integrity, as an investor, this a core principal I attribute to my success as I commit all aspects of my life to God's Word.


This brings me to today's topic in Affirm Holdings, Inc. (AFRM). I had diligently analyzed Affirm's potential back in December of 2020, and concluded that I would not likely consider initiating a position for the portfolio. However, any company that I scrutinize remains in the database, especially once they begin trading from an IPO process.


My initial concern with Affirm was not with the growth potential and current trajectory, but more so with the company's ability to achieve Cash Flow, CF, inflection and sustain margin improvement moving forward.


However, as I have posted on Twitter, Inc. (TWTR) and Gab, upon further review of updating my model for the next two fiscal years, FYs, the investment opportunity has become much more compelling as Affirm has witnessed its Stock Price, SP, decline from nearly $140 per share towards $100.


Affirm Review

Sometimes it can be challenging to get the high-level snapshot of what a company's business model is predicated on. Certain times it's worth considering whether the difficulty is a red flag for the company. The most important paragraph from Affirm's prospectus filing is listed below verbatim.


"Our point-of-sale solution allows consumers to pay for purchases in fixed amounts without deferred interest, hidden fees, or penalties. We empower consumers to pay over time rather than paying for a product entirely upfront. This increases consumers’ purchasing power and gives them more control and flexibility. Our platform facilitates both true 0% APR payment options and interest bearing loans. On the merchant side, we offer commerce solutions that are highly effective demand generation and customer acquisition tools. Our solutions empower merchants to more efficiently promote and sell their products, optimize their customer acquisition strategies, and drive incremental sales. We also provide valuable product-level data and insights — information that merchants cannot easily get elsewhere — to better inform their marketing strategies. Finally, our consumer-focused app unlocks the full suite of Affirm products for a delightful end-to-end consumer experience. Consumers can use our app to manage payments, open a high-yield savings account, and access a personalized marketplace."


Efficiency and simplification with the use of technology are two key areas that investors should not discount. Roku, Inc. (ROKU) has essentially taken a legacy function from the old-school players including Comcast Corporation (CMCSA) and AT&T Inc. (T) including distribution, advertising, and subscription Revenues. Roku is on the cusp of building the most efficient pricing and marketing mechanism for the future streaming world.


To this point, Affirm's ambitions of creating efficiencies and transparency for fees and payment deferrals on the consumer side, complimenting merchant services has strong potential to grow robustly. We'll get into the core metrics later on, but Affirm is already witnessing strong inflection for the business. In a sense, Affirm is building a platform serving as a middle-man between merchants and consumers and originating banks.


Investment Thesis

The key investment thesis for Affirm includes the following:

  • Continued growth of digital commerce and pay over time solutions

  • Adoption of technology-driven platform

  • Expanding usage from existing consumers and merchants

  • Expansion of network diversity, and mix of funding relationships

  • Mix of business on the platform

  • Ability to effectively price credit risk

Affirm is focused on commerce continuing to become increasingly digital, which will drive more transactions for financial performance. For Q1 of fiscal year, FY 21, more than 90% of Affirm's gross merchandise volume, GMV, was processed online. As digital commerce grows, the Affirm payment option will grow.


Integration of merchants and consumers on the platform are critical in sustaining network effects, brand power, and the company's core focus of pay-over-time payment solutions. Expanding merchants on the platform is key to creating this effect. The app-based approach is something that resonates with millennials and generation Z, so growing the value proposition through consumer transactions for merchants remains key.


As Affirm scales, there is an opportunity to increase the usage of existing consumers and merchants as well. The goal is to create an experience that naturally encourages repeat usage of Affirm from consumers. For merchants, increasing average order value, AOV, is the objective. Affirm has reported that use of its platform after other payment methods, has led to 92% and 85% higher AOVs before refunds.


Affirm's diversified funding relationships include warehouse facilities, securitizations, whole loan forward flow arrangements, and partnerships with banks. Affirm believes that given its short duration and performance of assets, funding can be recycled quickly, resulting in a high-velocity, capital efficient funding model. Equity capital has been reduced from 15% at FY-end 2018 to 8% as of Q1 FY 21.


Differences in product mix relate to different loan durations, APR mix, and varying proportion of 0% APR versus interest-bearing financings. Low AOV products generally benefit from shorter duration, but also have lower Revenue as a percentage of GMV when compared to high AOV products. Affirm expects that its commercial agreement with Shopify to offer Shop Pay Installments and recent Split Pay offering will increase the mix of shorter duration, low AOV products. Differences in the mix of high versus low AOV will also impact results, including affecting average frequency of transactions per active consumer and Revenue as a percentage of GMV, which will decline in the medium term to the extent that a greater portion of our GMV comes from these and other low-AOV offerings.


Loan repayment underperformance would negatively impact interest-related income and gain-on-sale income. Additionally, incremental charge-offs may adversely affect future risk analysis, growth of GMV, and the amount of provisions needed to take. However, Affirm's ability to effectively price credit risk is what the company believes is a competitive advantage, in line with the flexibility of risk models to allow quick response to any changes in loan performance. Repayments are high-velocity, with an average duration of six months, allowing Affirm to quickly adapt and mitigate risk.


Valuation & Forecast

As I always mention, when it comes to a company's valuation and forecast, I like to deconstruct things by the key financial metrics that investors should consider. I do this on a Trailing Twelve-Month, TTM, basis. For Affirm, these include:

  • Net Cash Position: $895 million (includes most recent IPO proceeds)

  • Revenues: $595 million

  • GM: 30%

  • OCF / Percent: ($55) million / (9%)

  • FCF / Percent: ($65) million / (11%)

  • Shares Outstanding 246 million

  • Gross Merchandise Volume (GMV): $5.3 billion

  • Active Consumers: 3.9 million

  • Transactions per Active Consumer: 2.2

  • Merchants: 6,500

Affirm is experiencing substantial growth with Revenue growth continuing to double since FY 18. Revenue growth is up nearly 100% from the previous year for Q1 FY 21. This was led by Merchant Network Revenue, Interest Income and Gain on Sales of Loans. Gross Profit, GP, has marginally declined likely resulting from lower AOVs. Cash Flows, CFs, remain negative, but have shown improvement as the company continues to scale.

From a valuation perspective, Affirm has an Enterprise Valuation, EV, at $25 billion and is trading just below 43 times TTM Revenues. Since the company is not yet CF positive, it makes no sense to consider any other metric than EV/Revenues. The multiple is steep, but growth remains robust, and at this level, is expected to be sustainable for the near-term.

I always model out two years to look at growth trajectories and investment opportunities. For Affirm's key metrics the following is assumed:

  • Net Cash Position: $750 million

  • Revenues: $1.56 billion

  • GM: 30%

  • OCF / Percent: $78 million / 5%

  • FCF / Percent: $60 million / 4%

  • Shares Outstanding 272 million

  • Gross Merchandise Volume (GMV): $10.6 billion

  • Active Customers: 7.5 million

  • Transactions per Active Customer: 2.6

  • Merchants: 10,000

I am modeling Affirm to average approximately 75% Revenue growth over the next two FYs. At the same time, I am expecting their GP to remain stable despite increased Revenues from lower AOVs. I am also modeling CF inflection beginning in FY 22.

At a SP around $106, Affirm is trading around 16 times FY 2022 Revenues, and just over 370 times FY 22 OCF per share estimates. With Affirm's potential to sustain robust growth, I am modeling a valuation with an EV at 30 times Revenues and 600 times OCF per share being justifiable. This would afford an 18-month Price Target, PT at around $171 per share, or around a 61% premium from the today's closing SP.


Some may think that a 600 times OCF per share multiple is outrageous. For companies targeting disruption and highly robust growth over the next decade, I would contend that it is highly normal for these types of multiples, especially during CF inflection. We can look to other companies including Datadog, Inc. (DDOG) and Okta, Inc. (OKTA) that were trading north of 600 times OCF per share. Today, both trade north of a 200 times multiple, but have already proven their ability to grow into valuation, even with today's premium SPs.


Palantir Technologies (PLTR) is another example whereas today, the company trades over 800 times OCF per share. But I am modeling them to trade 150 times OCF per share by 2022, at a SP of nearly $35 per share. Affirm is at a very early stage of the business, and a 600 times OCF per share multiple is not as extreme as some may believe. Many of these newer companies, if successful, will be trading at a much more reasonable multiple as we approach 2030. The problem is, if investors wait for that to happen, they will have missed most of the best investment returns by then.


Conclusion

Fintech is an area that I am looking to build more exposure to within the portfolio. I currently own Square, Inc. (SQ), SoFi via Social Capital Hedosophia Holdings Corp. V (IPOE) warrants, and Ribbit Leap (LEAP) warrants. With Affirm's jump towards $140 initially after IPOing, I felt today was a great opportunity to initiate a position as the SP had dropped back towards $100 per share.

I am prepared to defend the position in the event market circumstances lead to a lower SP. I expect further robust growth to occur based on existing arrangements and digital spend. Since Affirm's focus is in delayed payment, they don't necessarily consider the competitive market entirely, but there are larger players that will likely be going public sooner than later to also consider as well.


The key aspect I will be focused on will be Affirm's Revenue performance, and CF inflection potential. As the company continues to scale, Working Capital has showed consistent improvement. Reconciliation of Net Income is where I will be paying the closest attention as I feel visibility is not as clear, but still affords potential.


In closing, perseverance will remain key as is the case with every holding within the portfolio. Not one holding in the portfolio or public company for that matter, will ever escape the pressure of negative sentiments and/or attack. The key to success is to have the right tools and resources to execute under pressure.


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