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Affirm Holdings - What is Going on?

1 John Chapter 3 verse 11 states, "For this is the message you heard from the beginning: We should love one another."


I like to use daily Bible verses that I receive, and there have been many the past week speaking of the importance of love. Why is love so important? It is important because God loved me to send Jesus Christ to atone for my sins, and not just mine, but everyone in human history. If God loves me enough to do this, I need to obey God's word and express similar love to others.


So should I love Wallstreet and analysts? That was a joke, but seriously, they have a role to play and clearly are made up of many exceptional people, who like me, are flawed. In other words, it's always easy to get frustrated with an analyst call that tanks one of my holdings. But I always need to recognize that they are doing their job, and I have a need to do mine. Their perspectives and insights are a great thing to have access to as part of the process.


Before getting into the details, here's the erratic chart for Affirm Holdings, Inc. (AFRM).

AFRM went public early in 2021and rocketed north of $100. By March 2020, the SP was severely lower and stayed in this position for a while until later in the summer. The key catalyst driving the SP were the announcements of Apple, Inc. (AAPL) in Canada, and Amazon, Inc. (AMZN) both entering into partnerships with AFRM. This led to an all-time high just below $180.


AFRM's declines from prior highs have been largely impacted by the market's selective and continued attack on aggressive growth companies. Compounding this was the company's recent earnings report where the SP has plummeted from nearly $80 to just above $37 in a week. This begs the question, what is going on with AFRM?


I think it is important to provide the key statement from the company's CEO Max Levchin.

We feel great about our progress. We remain quite un-pivoted and focused on delivering long-term, compounding value to all our stakeholders: consumers, merchants, employees, and shareholders.

This is important because while the markets got ahead of the company's potential with the partnership announcements for AAPL and AMZN, the fact remains that AFRM's best interest and focus is to grow its scale and platform utility as broadly as possible to unlock substantial investor value.


Here's some other important key statistical takeaways.

We estimate that this year Affirm processed 1.6% of all U.S. online transaction volume for the Black Friday-Cyber-Monday period, another triple-digit increase from last year – simultaneously a momentous number and a signifier of just how early we are in this market.
We’ve rolled out Cash-Back Rewards for participating merchants, delivered the unique Adaptive Checkout, launched the Affirm Super App, and the Affirm Chrome Extension, and introduced the beta version of super-simple, consumer-friendly Crypto Savings.
Affirm had more than 168,000 Active merchants on our platform as of the end of calendar 2021, largely thanks to our partnerships with online commerce platforms. In aggregate, Affirm is now present on sites that account for more than half of all U.S. e-commerce and that number continues to march higher every day.
In our second quarter, year-over-year GMV growth accelerated to 115%, from 84% in the first fiscal quarter. Moving beyond the testing phase of our collaboration with Amazon before the holidays was a significant driver of this growth. However, if you exclude Amazon, our GMV still doubled year over year.
Our focus on using exceptional technology to drive growth and improve efficiency has been a winning strategy for Affirm, and we never stop finding ways to optimize and deliver even more value. This shows up in our results in a number of ways from new partnerships to longstanding relationships. For example, over the last three years, our relationship with Walmart has grown as we proved the value of our products. We expect similarly great things from our other major partnerships with time.

All-in-all, AFRM is tracking with some substantial growth characteristics for the following key metrics:

  • Active Consumers: 11.2 million

  • Transactions per Active Consumer: 2.5

  • GMV: $11.9 billion

For me, there are two short-term issues that will likely continue to see AFRM gyrate in a volatile trading fashion. First, and this was raised during their earnings call, AFRM's Take Rates (Net Revenue and Net Revenue Less Transaction Costs) are being forecast to not change by much despite the increased guidance for GMV.


Second, the company's ability to witness Cash Flow inflection is not clear either. This was also raised on the call with respect to "profitability". Before the last quarterly report, AFRM actually was sporting an OCF margin north of 20%. This was completely eradicated during the most recent quarterly report, with AFRM burning north of $200 million over the LTM period.


So the answer to the initial questions, what is going on with AFRM, can simply be stated as investors are wrestling with the timing of expectations and how to value the company accordingly.

With that being said, shifting gears to AFRM's high-level financial model forecast, I am expecting the company to continue seeing extremely robust core metric growth for Active Consumers, Transactions per Active Consumer, and GMV largely stemming from partnerships with AMZN and SHOP.


AFRM has recently partnered with AAPL and AMZN, and as mentioned above, has existing partnerships with approximately 50% of U.S. e-commerce. A key aspect of this is the company's partnership with Shopify, Inc. (SHOP). AMZN is the largest e-commerce network, and SHOP is the fastest growing at scale. These will continue to provide very strong tailwinds for AFRM.


But back to analyst concerns with respect to AFRM's Take Rates off of GMV. Currently AFRM's Net Revenue Take Rate is just below 9.5%, while the Net Revenue Less Transaction Costs, RLTCs, is just below 5%. During the call, management alluded to a long-term 3-4% Take Rate for RLTC. I have modeled this accordingly for the mid-term towards the upper end. The slide below provides AFRM's tracking of Merchant Fee Rates for its product mix.

The other issue that investors are wrestling with is the increase in AFRM's Operating Expenses after Transaction Costs. This has increased to over two times RLTC, where it has been under this level the past few years. A major contributor to this has been SBC, but other key line items related to loans and transaction costs have also risen with all impacting Cash Flows.


Today, AFRM is unable to generate positive Cash Flows through reconciliation of Net Income, or through Working Capital. As AFRM's Take Rates have declined through the first half of FY 2022, it has led to increased Operating Expenses and negative Cash Flow performance. The current Cash Burn amount as mentioned sits at just over $200 million affording a negative 19% OCF Margin. AFRM's Net Cash position is strong at just below $1.6 billion, which at an assumed Cash Burn no higher than $250 million would equate to six years of operations.


With AFRM's recent Convertible Note debt raise, Gross Cash is at nearly $3.3 billion so there is ample Cash. This also suggests that AFRM will be looking to continue investing heavily into the business for the foreseeable future.


But back to the forecast above, I believe that the company is on track towards 80 million Active Consumers and over $40 billion in GMV. Levchin hails from PayPal Holdings, Inc. (PYPL) as one of the core founders so I do believe that Cash Flow inflection will be a part of AFRM's future. At some point, the company will be able to leverage its human capital growth to moderate growth while core metrics and Net Revenue continue to outpace growth.


I am conceding that Cash Burn will likely persist over the next two fiscal years and looking for year three to begin to highlight inflection potential. That being said, AFRM is now trading 4 times EV/Revenue for estimated FY 2023 Net Revenue. We also need to remember that AFRM is valued at $9 billion EV, when Square, Inc. (SQ) recently announced its intent to acquire Afterpay Limited (AFTPY) for nearly $30 billion. AFTPY's FY 2021 GMV was nearly 80% greater than AFRM's granted the company's exposure to the Asia Pacific region, APAC (largely Australia), and Clearpay were beyond AFRM. AFTPY Active Customers stood at just over 16 million versus AFRM's 11 million, and AFRM's Merchants dwarfed AFTPY by over 70,000. It should also be noted that AFRM leads AFTPY in the North America market, a clear premium market versus APAC.


AFTPY witnessed a Take Rate at just below 4% for its most current FY 2021, with Net Revenue barely exceeding that of AFRM, despite larger metrics. The company also had a nearly 10% Net Revenue amount defined by Late Fees, something that AFRM does not charge. I'm not going to get too much into my opinions of the stronger company, but AFRM's metrics clearly are superior to that of AFTPY and it is a shame that SQ will be acquiring them so that we will no longer have as strong of visibility.


Considering all this there's two things that pop out. One, AFRM is definitely undervalued egregiously today. Even at half of the AFTPY's deal, AFRM would be trading at $60. Two, I would not be surprised if suitors were circling like crazy right now to try to get a deal. I'm confident that Levchin won't sell out at the absurd discount AFRM finds itself in today (nice try Wallstreet).


The bottom line is that I believe AFRM is on the cusp of an appealing longer term opportunity. While it is extremely discounted right now, markets remain extremely erratic. I do have a Max AP in at $35 so depending on the market, I may initiate another accumulation at any time. I've adjusted my financial model to be more conservative with valuation, and expect expansion for the company's multiples in the coming years. Levchin is going to aggressively scale this business, which is the fundamentally right move. Investors need to think about the core metrics growth opportunity, and how AFRM will leverage its scale over time, leading to Cash Flow inflection.



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