News broke last night that Affirm, a well-known fintech unicorn, could approach the public markets at a valuation of $5 to $10 billion. The Wall Street Journal, which broke the news, said that Affirm could begin trading this year and that its IPO options include debuting via a special purpose acquisition company, also known as a SPAC.
That Affirm is considering listing is not a surprise. The company is around eight years old and has raised north of $1 billion, meaning it has locked up investor cash during its life as a private company. And liquidity has become an increasingly attractive possibility in 2020, when new offerings of all quality levels are enjoying strong reception from investors and traders who are hungry for equity in growing companies.
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But $10 billion? That price tag is a multiple of what Affirm was worth last year when it added $300 million to its coffer at a post-money price of $2.9 billion. There were rumors that the firm was hunting a far larger round later in 2019, though it doesn’t appear — per PitchBook records — that Affirm raised more capital since its Series F.
This morning let’s chat about the company’s possible IPO valuation. The Journal noted the strong public performance of Afterpay as a possible cognate for Affirm — the Australian buy-now, pay-later firm saw its value dip to $8.01 per share inside the last year before soaring to around $68 today. But given the firm’s reporting cycle, it’s a hard company to use as a comp.
Happily, we have another option to lean on that is domestically listed, meaning it has more regular and recent financial disclosures. So let’s learn how much revenue it takes to earn an eleven-figure valuation on the public markets by offering consumers credit.
Affirm’s business
Affirm loans consumers funds at the point of sale that are repaid on a schedule at a certain cost of capital. Affirm customers can select different repayment periods, raising or lowering their regular payments, and total interest cost.
Synchrony offers similar installment loans to consumers, along with other forms of capital access, including privately-branded credit cards. (Verizon, TechCrunch’s parent company, recent offered a card with the company, I should note.) Synchrony is worth $13.5 billion as of this morning, making it a company of similar-ish value compared to the top end of the possible Affirm valuation range.
To better understand what scale Affirm would need to operate at to achieve a similar valuation, let’s dig into how Synchrony operates and how it makes money.
Synchrony’s operations
Synchrony’s business is largely a credit-card focused affair, with just a fraction of its scale stemming from consumer installment loans. However, as we know that credit cards are a lucrative business, this may actually paint Synchrony in a flattering light. Regardless, the Australian firm struggled in the second quarter with falling revenue and declining profit, due in part to a divestiture and part to COVID-19.
Synchrony wrapped Q2 with $1.78 billion in consumer installment loan receivables, its product most similar to what Affirm offers. In the period, those loans generated interest income of around $37 million. That works out to an average yield that Synchrony calculates at around 9.6%.
That $37 million in interest income is modest compared to what the rest of Synchrony’s business generates, with the company seeing interest income of $3.4 billion in Q2 2020 and net interest income of $950 million “after retailer share arrangements and provision for credit losses” in the three-month period. After adding $95 million in net other income (interchange, etc), the firm managed to squeak out $48 million in net earnings after taxes.
Affirm doesn’t offer credit cards, so to use Synchrony’s results to sketch out how large the startup’s installment loan business would need to be to generate enough revenue to support a $10 billion valuation, we have to get creative. We’ll effectively have to scale Synchrony’s installment loan business by a multiple until the income it generates matches what its credit cards generate, from which point we’ll add various discounts and caveats.
Synchrony’s installment loans have about half the yield of credit cards at the company, meaning that we’d need lots more installment loan volume to make up a similar credit card income result.
This is where the math gets a bit silly: Synchrony would need to scale its installment loan volume by around 100x to match its credit card interest income. We’re being simplistic to a degree, as it is not clear that installment loans and credit cards have similar write-downs (they don’t, of course), and other factors. But to generate its present-day leading revenue stream from installment loans instead of credit cards, Synchrony would need to have well over $150 billion in outstanding receivables. That’s a lot of money.
Synchrony is worth more than the upper-end of Affirm’s purported IPO valuation hopes, so a smaller total installment loan volume would be needed to make the math check out. And, of course, there’s growth to consider, which further dilutes the required loan base.
Smaller, but faster-growing
The more quickly-growing a company is, the more highly valued its revenues are today. Synchrony shrank in Q2 2020 when compared to Q1 2020 and Q2 2019. So, we can discount the amount of installment loans outstanding that Affirm would need to make its incomes match a $10 billion price tag, as it is growing, and thus will have more valuable revenue.
But even discounting needed installment loan volume by 30% to help bring valuations in line, and another 50% to allow for Affirm’s expected growth rate, we’re still looking at an outstanding installment loan of $50 billion for Affirm to be worth $10 billion before final reductions. The real number would be smaller given write-off differentials between different consumer debt types, and the difference between Affirm’s average installment loan yield and Synchrony’s. Let’s be generous and say that those are worth another 40%, bringing our estimate for installment loans at Affirm to $30 billion?
We’re far enough down the rabbit hole that my confidence is flagging, but what we can say from all this is that even at relatively attractive interest rates, a $10 billion valuation will necessitate a very large installment loan base at Affirm.
That fact is compounded by the fact that consumer debts are seeing rapidly worsening rates of repayment in 2020 per Forbes, which reported in April that Affirm was “changing loan due dates on a case-by-case basis” to help borrowers. The credit quality of Affirm’s loan base could be in flux, necessitating a larger base of loans to generate the same net income.
But who cares, when the public markets are behaving as they are? Vroom is worth $6.5 billion, or about 102x its trailing gross profit. Nothing makes sense at the moment for stocks that the market crowns as above boring things like operating leverage. So perhaps Affirm should just get out while the getting is so good that Lemonade is worth $3.5 billion, despite having just $82.5 million in trailing revenue.
Right?