Buy-now-pay-later (BNPL) has been growing in popularity. So, it’s not surprising that Square (NYSE: SQ) would want to enter the space. It was surprising, however, that the company chose to make a huge acquisition to become an immediate large player in this growing category.

And, while Afterpay (OTCMKTS: AFTPY) may not be a company many American investors know about, it’s a company with a growing audience in a fast-growing space. Still, it was a bit shocking to see Square purchase the Australian company for $29 billion (roughly a quarter of its market cap).

Anirban Mahanti joined the August 2 edition of “7investing Now” live from Sydney, Australia to break down what the deal looks like and why Square likely chose to buy Afterpay rather than build its own BNPL infrastructure.

A full transcript follows the video.

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Dan Kline: But that is not the big story today. The big story today is we’re going to talk about Square (NYSE: SQ) buying Afterpay (ASX: APT). This was a big deal. Normally on a Sunday, we’re a little bit sleepy. We’re putting together some notes for the week. This hit us out of nowhere Matt Cochrane shared Hey, wait a minute square reported its earnings a few days early. Why did they do that? They did that because they announced they were purchasing Afterpay, a buy now pay later company for $29 billion in stock. This is an all-stock deal and your Anirban Mahanti it is 220 in the morning and Sydney, Australia, but you’re under lockdown. So there’s not much else to do. Why don’t you tell us a little bit about Afterpay. This is of course an Australian company.

Anirban Mahant: Yeah, so Afterpay has been, you know, the, at the vanguard of leading the tech charge the FinTech charge in Australia. It’s really popular down here. So like buy now pay later as an idea is very simple, right? You know, you want to buy something today, you don’t have to pay for it in installments. And the idea has been around for a long, long time. Here in Australia, something called laybuy, which is basically your buy something for Christmas, you know, you buy it, you basically put some money down, and then you periodically pay for it and you pick the stuff up at Christmas time.

Afterpay basically took that idea and turn it on its head and said, well, you can have the item now. And the retailer gets its money now. The consumer then pays after pay in installments over time, of course, then how does Afterpay make money? Well, Afterpay actually makes money from the retailer. The retailer basically pays a cut to Afterpay. And the reason they pay cut is the basic idea is that well, you know people want to buy something and have it now they’re willing to, you know, spend money. And therefore the retail is essentially getting additional transactions, the retailer is willing to take a cut on that. So that’s the basic idea. It has been humongously popular here in Australia. And it’s actually taken gone to the UK, it’s actually popular in New Zealand as well. And then as has gone to some of the U.S. Eastern, mostly the eastern seaboard. Most mostly actually California and a few other places that the thing has taken off in the US. Yeah, but that’s basically the idea. It’s the antithesis of credit cards.

Dan Kline: Yeah, so you’re not paying a premium. And as we’ve talked about, I used to run a toy store. So we did layaway, we would take the item, put it in a closet, and you would make payments and then you would pick it up in theory at Christmas. In reality, a lot of people never finished and it left a bad taste in their mouth, they stopped being customers. So this in theory is really, really good for retailers. But let me ask the Afterpay question before we get into the valuation here. What’s the differentiator here? Because I know today I was on Amazon. And I bought about $60 worth of eyedrops and it asked me, Do you want to split this payment up over 12 months? Of course, I don’t because it’s $60 worth of eyedrops. It’s not a big-ticket item. We’ll talk more about that later. But what’s the advantage of being Afterpay? This was not a name that was on the tip of my tongue as a US consumer, Affirm (NASDAQ: AFRM) was really the one that came to mind. So why is Afterpay a $29 billion company?

Anirban Mahanti: Yeah, still a couple of things here. That’s, that’s worth giving mind. So Afterpay is almost like a verb here in Australia. Right. And I, you know, again, I can’t speak to how well it is, I mean, now entrenched in the US, although the gross merchandise volume from the US is now much larger than I believe than what it is from Australia. So I mean that basically taking hold. One way to think about this is it, the best way to look at is the gross merchandise volume, right? So how much transactions in total dollar volume is going through the Afterpay channel, right? Or Afterpay payment volume. That is in on for 2021 was about $21 billion. That is up from 5 billion in 2019. That massive growth right?

I mean, there is uptake for this. And I think you know I happened I was a bear for this because again I had the same question that you said Why would I have to Afterpay I’ve got credit cards I can just put on a credit card and pay off the credit card. What I realized over time is maybe you and I are not the demography. You know that is targeting. You and I are probably the type of people who are okay to have a credit, but there are people who don’t want to have a credit card. There are people who want to use after pay for, essentially, no, I would say budgeting or cash flow management, right. And one of the cool things about Afterpay is really about small money, like small money transactions, it’s not about buying a $10,000 item, and then sort of spreading that out. Now there are buy now, pay later models for that as well. But that’s not what Afterpay actually specializes in.

Afterward, I have an Afterpay account, just to give you an example. My Afterpay credit limit is $1200. And actually, it is $1200 because I’ve spent some money on it, it used to be $200. So when I first applied from Afterpay card, I got $200. And I could spend up to $200. So I spent a little bit then over time, because I paid it back, you know, it increased and now it’s like $1200. And it’s basically linked to my Apple Pay. For me as a, and I’m the other type of consumer who probably doesn’t need Afterpay. I use it because I can. And it’s very simple to use, you can pay online, it’s linked to my Apple Pay, and it gets you know, they take out the for payments that needs to be taken out over the fortnight by Apple Pay. You know, I still get my points, which is, which is interesting way of doing things.

The other side is I think like any of these systems of any of these ecosystems, right? They depend on a couple of different things. One is you have enough consumers using it? Do you have enough merchants using it? So Afterpay today has about what about 16 million? I think customers 16 million users or, you know, clients, type people like you and I. That’s up from you know, massively up over the last four years. It’s got about 100,000 merchants you know, using that allow Afterpay to be used. That’s that’s a pretty big base of users, you know, that are using Afterpay. It’s a little bit of an ecosystem in that sense.

Dan Kline: So let me jump in here. First, let me set the table. You’re watching 7Investing Now. I am Dan Kline, he is Anirban Mahanti. We would love your questions and comments. We are coming to you a little bit late. We open with some technical difficulties, but we see a ton of you watching. So we would love your questions about this. So this deal now we talked about the brand name a little bit and I want to get into that a little bit more later. But is the opportunity here, that Square has this massive network of relatively small and midsize merchants that can’t offer this type of service.

If I go to my local farmers market, and I want to buy I don’t know $80 worth of gluten-free products, which is something I’ve done or or I want to go to the the meat market and buy you know a roast and stuff that can get fairly expensive. In theory that payment is going to happen on Square so I could essentially finance my you know, fresh fish purchase or my candles or whatever it is at the farmers market over X amount of months using Afterpay is that the market square is going after here.

Anirban Mahanti: That’s a great point. So yes, so Afterpay. Let’s set the table here. Exactly like you said. Square is really popular. For example, here in Australia too. Exactly. When I go to the farmers market, I see everyone with those Square terminals, getting the payments, right. But there’s no Afterpay on it. Right. So Square’s, got merchants of different types. Squares got the SMB is mostly. Square is trying to go upstream in terms of its merchants, right? It wants to have enterprise merchants. Afterpay actually has enterprise merchants right after perhaps would have deals with you know, chains. And, you know, most of the big retail chains would be using would be with Afterpay. So in a way, it’s complimentary. They’ve got SMBs Afterpay, has got enterprise, if you merge the two together, you essentially are, you know, up and down the stack in terms of your customer merchant base. So that is definitely one of the plays here.

And the other play would be the consumer side, right? So Afterpay has got the Afterpay app, Squares got the cash app, merge the two together, and you have essentially expanded the ecosystem, right. And I think it might be worthwhile for us to think about that. If you if you think about the total reach that you can achieve by just cross-pollination, you’re just expanding the market opportunity here. So I think that’s in a way after Square is paying for the brand name, and is you know, doing a bit of customer acquisition is doing a bit of much acquisition. And you know, and you can then sort of do a bit of cross-selling. It’s not a traditional cross-sell in that sense, but it is cross-sell. If you think about the way they think about how the apps are gonna evolve.

Dan Kline: So this is a massively growing space, but let’s ask the question that we probably got asked the most in some of the social media run-up to this. Why would you spend $29 billion to buy something that you could make for, I don’t know if the numbers 10s of millions or hundreds of millions, but it’s not going to cost you 29 billion? What was the reasoning behind buying this already, you know, growing company, but certainly not a company that necessarily screams $29 billion valuation.

Anirban Mahanti: Right. So yeah, it’s really a couple of valuation. But maybe if I don’t know, if Sam can pull up the chart we had for the merchants at this point. If you can pull the chart for them, the just the, the merchants. If you look at the the complementarity here, right. So Afterpay has 100, 100,000. Squares got millions. But look at the difference in the channel, right, the channel difference is Afterpay is based mostly online, and Square is mostly offline. Or he says it’s a big chunk offline. One has got to enterprise customers one is SMBs. And mid-market. One is primarily retail. Another is primarily mix of different things. Now, there’s a there’s a complementarity of geographies, right?

Sure. Square can build this, but how much time is it going to take to build this is the number one question. Number two question is, you’re acquiring a brand here, right? I mean, you can you know, anybody can make it. But are you going to get the brand? Are people going to associate, you know, the buy now pay later the leading brand with Square? Or is it going to be with Afterpay, so having the appropriate brand is important. So you’re paying for the brand? That’s number two, you’re paying for the already existing ecosystem. You know, that’s number three. Is the valuation right? You know, we can talk about that. But I think that there are good reasons why I think this can’t be built, at least by by Square immediately or in the near term. The other important thing I think bear in mind is the space is heating up. Right. So you said there’s Affirm that at least five different buy now pay later here in Australia itself.

Dan Kline: Anirban, let me give you some numbers here. And when I say give you, you put this into the doc. More than a third of American consumers used to buy now pay letters later service by July. According to a study this summer. 20.8% of all buy now pay later users tried it for the first time in 2020. So 2020 is last year that’s not that long ago. And pay later apps download have surged 155% to 8.43million. Shooting up to 1.4 million in September up from 650,000 downloads in the same month period. Last year. Is this just a case of this is the moment and if you’re not in it with a ready-to-go product, it’s going to move on without you?

Anirban Mahanti: Yeah, so that’s a that’s a good one. Right? So here’s what you know, typically, consumer tech or consumer technology gets invented in the U.S. and then gets exported elsewhere. Seldom does it happen that is invented somewhere else. And then it gets exported outside and into US. So I think it gets imported into the US. So I think buy no pay later sort of as a category has just started taking off in the US. It’s just caught the prominence because there’s all these you know, there’s Klarna there’s you know, Affirm there’s, you know, Afterpay all competing, you know, we’re hearing that Apple is going to launch it PayPal has launched its final period.

Right. So there is that buy now pay later is well established here in Australia so I think this is a question of you know, a model that has worked really well here which with a huge and here’s the thing people would think that you know, the consumer base for this is well you know, those people who don’t have enough money. It’s actually not it’s quite affluent people are also using the system one of the credit cards. So it’s there is a I think sometimes what happens is there’s just a change in model in terms of the simplicity of getting it you know, there’s no credit checks, it’s a very simple application that credit and naturally increases and that sort of trend is flowing over there. And I think the market has just heated up and people are realized that a lot of people actually appreciate this, this approach for payments. So I think that’s what’s really happening again. Hard to say is it a moment right now but it appears like you know, this is sort of you know, that the wind is blowing in that direction that people are looking for buy now pay later type of solutions.

Dan Kline: So Square has some knowledge about your finances because in the US, buy now pay later has at least with the big players largely not been an application. Amazon did not ask me to apply. They just offered. My American Express Platinum which is normally a pay your whole balance off card will offer For me to split payments for no fees on certain items, and it’s not necessarily the biggest ticket purchases I’ve made. I’ve tested it out just to see how it works. Not that I necessarily needed to do that payment. And it’s like sometimes like a $200 purchase, they’re just like, do you want to split this up over four months? Six months, 12 months? Is it possible that because Square has knowledge of your bill-paying knowledge of some of your cash flow, that they’ll be able to extend this benefit the way Amazon has, without asking for any sort of an application? And that application? It’s worth noting does not involve a credit check. I’m pretty sure.

Anirban Mahanti: Yes, so like if you think about if you think about buy-now-pay-later from from Squares perspective, right, so guess what the Cash App, they have knowledge about what you’re doing with that app? Right. So they could therefore use that app to facilitate a buy now, period, type of model? I think that makes complete sense. You know, I think the underlying sort of, you know, checking for the credit in the underlying credit, evaluation model, underlying fraud detection, model, underlying willingness to pay overtime, all those things, I think, can be carried over from what Afterpay has been doing here locally, and globally onto Square.

But, again, I think the critical thing is how many people actually have that buy now, pay later app, right? I mean, it’s one thing that you’re going to pay at Amazon, and Amazon is offering you the opportunity to buy now pay later it versus you want to buy something from some retailer, you know, random retailer online, are they actually going to offer it? And this, that’s not going to be the Amazon buy now pay later, that’s likely to be a big buy now pay later player who’s going to be able to offer that because that’s what the retailer is going to be signing up with. Right so the merchant and has to sign up with the with the payment modality, right? Because the ultimately the payment is made by the buy now pay later to the merchant. So I think for the big merchants, it’s okay, those like the Amazons.They can take the credit, I guess the credit risk, so to speak, but are the others going to take the credit risk? They’re not going to take the credit risk? Right. So I think that would be the play. In my in my view,

Dan Kline: We’re gonna take Roberts’ question in a minute. But I want to ask the question, Is this an incredibly cash-intensive business for Square to be taking on? Is Afterpay? If they’re essentially paying the merchants, they have to have an awful lot of cash on hand? Right?

Anirban Mahanti : That’s a great question. So this is the this is a common misconception, right? So this is this beautiful model. So think about it. You actually, let’s say you have $1,000, right? So $1,000 as available in your in your in your pocket. Zip pay, the buy now pay later Zip Pay. You could offer the $1,000, that thousand dollars was actually being lent out effectively only for six weeks, right? Because you make an initial upfront payment, and then you pay the remaining over every two weeks.

So, you know, between six to eight weeks, you paid off that amount. So let’s say Afterpay is giving $200 to some consumer to pay effectively to buy, say, jeans, right, or shoes. That $200 is recouped in six, you know, six weeks, six to eight weeks, right? Effectively, you can turn around the $200, you know, 52 divided by six, effectively eight times, right? So you can you could you could take the $200 and then make it you can lend it out effectively, eight times, so you can cycle the money, which is which is how it really works, right?

Because then Afterpay goes out and borrows money, set a couple of percent interest rate to 2%. And then it’s probably extracting 4.5%, or 5%, from the from the merchant, but it’s actually getting the 5%, six times, right. If it is able to actually get that many transactions. Which is the other thing really right. What Afterpay talks about, which is how many times does a consumer transact with Afterpay, it’s really important, because that number is, you know, for somebody who has been in the Afterpay ecosystem, for a client, for less than a year is about four times. But if somebody has been in that ecosystem for four years, they transact using Afterpay 30 times, right. So that’s Afterpay’s game. Afterpay’s game is to make, you know, consumers use it more often. That basically means more efficient use of the cash that they’ve got.

And I think this is the other thing where the acquisition comes into comes into play. The the cost of funding for Square is got to be lower than the cost of funding for Afterpay. So actually, the cost of funding goes down. And if you can keep the take rate which essentially the amount of money that you’re getting from the retailer, as a cut roughly the same, you’re actually expanding your margin. So I think that’s the other reason to be part of the bandwidth is that your cost of capital actually goes down?

Dan Kline: And is it fair to say what the retailer’s paying is relatively in line with what they’re paying credit cards anyway. So this is kind of a, just another financial angle as a retailer. Like, I know, when I ran a store, I didn’t want someone to pay with American Express, because they took a much bigger cut. Then, you know, and then you knew the nuances in some cases, like taking a debit card was better than taking your credit card. So is this just one where they just have to be in the competitive mix in terms of the the piece they take a bit?

Anirban Mahanti: So this is another great question to know the take more right to 4.5% to 5%. If that’s the take rate, that’s substantially more than what you would pay for, you know, the acquiring bank for you know, brick, transacting a Visa or MasterCard through, right. So it’s definitely more than that. The reason merchants use it is that they have seen that using having Afterpay actually lifts the average, you know, the total number of transactions that are going through their store, right. So in other words, they are getting those transactions that they will otherwise not have. So it’s worthwhile for them.

Right. And in the retail world, that’s what I say about the retail world, right? I mean, there’s everything is on discount all the time. So people, you know, instead of getting 30% discount, if you get 25% discount, and then you you know, give a little bit to Afterpay. It’s probably it’s okay. So it’s it’s it’s neither here nor there. But I think, yes, the transaction cost is higher. And it has to be because again, Afterpay is borrowing money effectively to lend out, you know, do indirect lending out to consumers, right?

Dan Kline: We’re going to talk about the mechanics of this deal, and how Anirban, whether he likes it, whether would have preferred they take on debt. Before we do that? I want to take a comment from RobertGCart, I hope I’m getting your name, right. And he says that it’s a good point, Apple could have built headphones streaming music app, but instead bought Beats to get to market. Yeah, but they paid what a couple billion, 4 billion maybe for beats. And really, they were buying a brand name. I don’t actually think Beats is a superior product, though. I am using Beats as we as we speak. So and I think you might be too. So is this that?

Anirban Mahanti : I’m using Apple.

Dan Kline: Did Apple based its own off of what it bought, perhaps it did. But that being said, was this just to get to market strategy?

Anirban Mahanti: Yeah, that’s a good you know, I love that comment from Robert. So I think Apple is unique, in that Apple hates to pay too much. And Apple bought Beats for not just the headphones, but actually bought it for music. Apple Music basically came from Beats the Beats, at the radio station is was the genesis behind Apple Music. So this is really a strategy thing. And some companies really like to buy fully evolved products. So afterpay, as a category is a fully evolved category is a category of itself, the categories under-penetrated, the category has massive runaway, there’s a lot of competition, definitely coming in anything that has got a massive runway it’s gonna see competition.

And therefore, one quick way to get to market is to buy the leader, right. And then basically push that instead of trying to be another competition with everybody else’s data. Apple is gonna be there. There’s PayPal, you know, there’s Affirm, theres Sezzle, there’s Zip, there’s so many of them, right? Instead of trying to compete in a crowded market, you just acquire the leader and then basically push with that that’s one strategy. Which is different from Apple’s strategy. Again, you know, I don’t have a view as to which one is better. I think, of course, you spend less, it’s better, but you know, not every company is Apple is what I like to say.

Dan Kline: Thank you for the comment Robert. Dorsen Rene, Rene Coronel Good morning, Daniel Delgado, thanks for tuning in. We hope you’re all still sitting here. We would love more questions and comments about what this means for the market. Before we talk about the actual mechanics of the deal I want to talk a little bit about it’s the second of the month. That means that yesterday, our new 7Investing recommendations went live we have an amazing array of picks. What’s interesting about our team is we’re all different. We have some conservative pigs, we have some daring pigs, we have some companies I’ve never heard of. I will say that I am going to buy somewhere between two and four of the picks in addition to mine, which is pretty typical. So if you’d like to know what our pickss look like what they are not and get our huge write-ups.

My write-up came in at about 3500 words this month and you don’t have to read the whole thing. You could just read the top-line takeaway or the sections you care about. We also all went over 30 minutes in our video presentations. Again, you don’t have to watch the whole thing you can skip around you can just go to the end to see what questions we asked each other however you want to use 7Investing. That is alright with us.

So if you’d like to become a member, go to 7investing.com/subscribe. Once you get there, all you have to do is give us either $49 a month, or $399 a year, that is a tremendous deal that is more than two months free. Exactly how much more I cannot tell you, but it is more. And for that you don’t just get our picks, you get access to our members-only call. You get access to a ton of members-only content. You get Max’s home address, you don’t get that. But you get all sorts of access to us and ability to interact. And it’s a ton of fun. We have a family vibe. I’ve said it many times here. We all enjoy each other’s company and company. And I think that extends to our interactions with members and other things we get to do.

But Anirban, let’s get back to talking about the story at hand today, the only story we’re going to talk about today, and that is Square paying $29 billion to buy Afterpay. They’re doing this in an all-stock transaction. They have not talked a lot about what the leadership’s going to look like how separate the companies are going to be. Why did they do this for stock and not borrow some of the money when cash is really cheap right now?

Anirban Mahanti: That’s a good one. So I mean, we could argue that Afterpay sorry, Squares stock is expensive, right? So I mean, I call it his bit of quantitative easing, if you’ve got if you’ve got a high-value currency, you can print some, and it causes a little bit of dilution, but not a whole lot of dilution. Right. So the Square couldn’t have paid as much cash because they didn’t have that cash. You know, I think the deal says that they could pay up to 1% of the transaction in cash, if Squared chooses to do so. It’s an all-stock deal, which is that they’re getting about .375, I believe is the correct number. Effectively, I think Afterpay shareholders going to effectively own I think 15% of the company or something is somewhere around that once the deal is done.

And why not take that? That’s an interesting, but I think that’s a philosophical question. To some extent, right. So debt is cheap, you can take debt, and you wouldn’t dilute shareholders. I think the problem though, is like in my view, is I think debt is great for companies that are hugely cash generative. So some someone like Apple can take on debt. And it makes sense for them to take on debt because they generate like, you know, gazillion dollars of free cash flow, like somewhere in the 80 to $90 billion of free cash flow. If you generate that much amount of cash per year, then you take on debt, and you can pay that debt off very easily. Debt typically cost comes with, you know, debt covenants, right. So they’ll come with some earnings covenants and things like that. All and Square, and Afterpay are really operating in the finance sector, where all you need is a little bit of something, and then everything can go haywire, right?

So that’s a very easy way I’ve seen so many companies get into trouble because they had debt that they couldn’t basically serve as their covenants. The covenant only if you could rewrite those covenants, and you don’t want to be in that nasty position of having to rewrite those covenants and things like that, because, you know, it’s some sort of, you know, consumer spending can be very, very cyclical, right? So, I think for that reason, I think it’s smart to do an all stock deal where you’re using essentially an expensive stock, or when it’s expensive, I mean, you know, on a traditional measure basis, right, you do an EV over gross profit, or you do an EV over sales Square is expensive. And then I’m saying that as a shareholder, I own I’ve been a shareholder of Square for a long time. And I continue holding the shares.

So I think it’s a smart way to go about making these transactions. In terms of leadership, the Afterpay leaders are coming in are the co founders, they’re coming on board as they’re gonna be running Afterpay inside Square. The question is, how long are they going to be running? It is, is too easy to be seen? And you will I think Jack Dorsey has an interesting personality, right. So he, he, you know, he’s it. He comes across as a strategic CEO, vision, a CEO who –

Dan Kline: Let me just jump in, I assume everyone watching would know this, but Jack Dorsey is the CEO of Square, he’s also the CEO of Twitter. So he’s in a very unique position where adding some really strong lieutenants running a big part of the business is not the worst thing. Just want to set the table for anyone who maybe doesn’t come to this sort of as wonky in the weeds as we are.

Anirban Mahanti: Yeah, so that’s, that’s I think, having strong management folks to, you know, potentially even take over a CEO and he could move on to being like, you know, an executive chairman or something like that is a potential. So I think it may be that there is a future for Afterpay’s management folks in the key people in overtime. So again, one of the things interesting is, you know, one way to look at this the deal is it was an expensive deal. On the other way to look at this, you know, the premium on these trading prices about only 20 25% right? It’s not a huge premium on the last traded price, so and definitely it’s actually well below the highs, the company hit somewhere around, you know, few months back. The stock was trading at about 160 Australian. The deal, I think is around 125. But of course, the deal varies with, with, with the square price a square was up 10%. So, you know, again, the market seems to be happy with what’s going on.

Dan Kline: Yeah, it’s important to stress that debt comes with risk. And this is a business where, if you told me Afterpay is up 300% at Christmas or 30%, during the Christmas season, or 3,000%? I’m not sure I would know what the answer is. So they need to maintain the ability to raise cash if they need cash to fund operations. And when I say fund operations, I mean, fund that six-week float because they could have that big of a holiday season. If you already have debt that can become tricky. You don’t want to have to rein in credit or not offer these deals at the busiest time of year where you should be acquiring customers because you don’t have the cash.

Anirban we’re going to talk about the historical financials. I know you have a graphic here but before we do that, I want to just acknowledge a couple of people. Scott Eisenberg says love the show listen every Monday when I’m at work. You can also listen on Wednesday and Friday but you don’t have to listen live this show is also at 7investing.com/livestream, it’s on our YouTube channel. You can find it on any of our Twitter’s. It is very easy to find this show. Robbie Shah commenting on our picks, which I talked about a little bit ago. Awesome picks, I already owned three of the pics so felt awesome.

Yeah, that to me, I love when we’re sort of providing the backstop for someone who owns something. They go, Oh my god, Anirban bought that. Like that’s great that That to me is something I’m very, very proud of, especially when it happens within the team when I when I pick something and someone says oh, I was thinking about buying that or Oh, I own that. I really like that feeling. And Yao Saying Sita and I’m probably pronouncing that incredibly wrong. Again, a little bit of a vision issue at this distance. Hey, everyone. Nice to see all of you here. Yeah, it is nice to see so many of you here with us when obviously this started a little bit rough this morning. With some technical difficulties. Daniel Delgado, we’ll get to your comments in a minute.

But Anirban, let’s talk about the financials here. Obviously, this deal is based on potential. This is a space that if you told me buy now pay later was 10 times bigger a year from now I think I probably believe you. I’m throwing out a lot of made up numbers here. But this area does seem because I have to admit, I was tempted to be like Why should I pay $60 for eyedrops all at once. Why not spread it out? Over course I’m gonna need more eyedrops before that would come due. So that would not be the type of thing you should be financing. But Anirban, you have a graphic here.

Anirban Mahanti:  Yes. So yeah, we we don’t need to really talk about this, we talk about the consumer side. I mean, this is the consumer side of the business where Afterpay has 16 million consumers. And 70 million on Square. And I think there’s a lot of complementarity here. Sam, if you could give us the third graphic that we had, which is the financials. Excellent, thank you. So if you look at the the gross profit numbers, of course, Squares significantly bigger than Afterpay. The thing to note though, is so the growth rate, the growth rate for Afterpay is higher, you know, on a on a year over year basis, or a cagr basis and a compound annual growth rate basis. So, I think that this does result in a guess in acceleration for the, you know, the combined Squares growth rate.

I think where this is gonna hurt though is in the, in the near term, at least, I think in terms of in operating profits. So Afterpay is not as profitable in on an operating basis as Square. so the margins are lower.  I think you know, you can expect there for the combined entity will have a lower margin. Of course, you could say that well, before $506 million of gross profit, you’re paying about $30 billion, or $29 billion. That’s a huge like, you know, it’s almost like a 60x. So exactly, as Dan said, this is basically for the potential if that 500 million is to become 5 billion and then you know, 10 billion, then there may be 50 billion over the course of time this deal will be worth it. If it is not well, then this will probably be an asset write down.

Dan Kline: Let me ask you a question that you asked in the document what happens to the take rate over time? You put it out it’s about 4.5% 4.5% is not out of line with what American Express takes from smaller merchants. I’m sure your giant players of the world get a better deal with American Express did that I did with a two location toy store chain. But that being said, do you see this number coming down? Or do you see uncertain areas? Maybe it could even go up if it’s if it’s riskier purchases?

Anirban Mahanti: Yeah, so this that’s a very interesting thing, right? I mean, the. So I don’t know what I mean, it’s it’s very hard to speculate what’s going to happen. It really depends on the competitive dynamics, right? So the thing about PayPal, for example, right, so PayPal is, you know, rolling out the solutions. If PayPal is going to charge zero, for rolling out, buy now pay later basically is basically taking it out of its existing cart that it has, then the merchant has to basically do the competition and say, Okay, I paid 3% to Paypal, but then the buy now pay later doesn’t cost anything. versus if I paid to, you know, your Afterpay will have to pay 4.5%. What do I do? I have a feeling as more players get in, the take rate is going to go down. That’s what should happen. But again, I think that also would be indicative of the market, expanding. More players getting in basically is indicated that the market is expanding this larger market opportunity that you know, and capitalism brings competition. So you know, you’d compensate for that by higher gross merchandise volume flowing through, so maybe it’s okay.

Dan Kline: We’re gonna talk about concrete competition. We’re gonna take Daniel Delgado’s question in a second, but I wanted to ask first, so one of the things I’ve always talked about with mortgages or lending in general, if my mortgage company has seen me pay my mortgage for five years, they once got a full picture of my, you know, my financial history.

Why when it’s time for me to get a new mortgage? Can they not just use that past history rather than doing the full background check? Is it possible that these buy now pay later firms look at someone like you or I who I know, I’m going to assume we both have very good credit? You know, I know I do. I have a bunch of credit cards that I pay off every month that I’m using, largely for points. What stops a company like Afterpay to go Okay, why don’t we finance a car for you and give you an even better rate? Or why don’t we allow you to make a big purchase? And I’m not saying a house, but maybe, you know, a $1200 computer or something like that, where there’s a lot of ability to expand here. And I’m not a credit risk based on, you know, based on my history of payments, which they would in theory have access to?

Anirban Mahanti:  Yes, Dan, that’s great. This is one of the things that they talk about in the merged entities goals, right. So buy now pay later for Afterpay in small transactions, taking the transaction volume up, is one of the things that they are talking about, which is sort of in line with what you’re saying, right? You know, if you’re not a credit risk, and you can spend more, and you will pay more, you know, you will pay it off over time, why not? This seems to be definitely an avenue over time for them to do. And, yeah, I mean, again, you know, and then for those maybe bigger transactions, the cut is smaller, but that’s okay. Maybe they take a smaller cut on this transaction, but they have this larger volume to take the cut off. So I think that’s a definite possibility over time.

Dan Kline: Yeah, I look at this whole industry and like things that are supposedly disrupting the mortgage of the loan industry. They’re really not. Like Rocket Mortgage, it’s just a slightly different process, the underwriting is all the same. And then you look at something like insurance, where you’re seeing some truly disruptive companies. Lemonade pops to mind, you know, which is using algorithms and not medical exams, and I see some room for these companies.

But let me let me share one comment that’s in the doc that was shared by Andy Wolffarth on Twitter, he says, is Affirm in trouble? And this speaks to what Daniel Delgado said, if you want to bring that up. Sam. Daniel Delgado says, Is there enough space out there with all these companies like Square PayPal, ApplePay, Sofi, Visa, Citi Group, Stripe, and many more, which are the best companies? A lot of them are the best companies. I think there’s a lot of investable companies in this space. I think that’s a whole other show, maybe a podcast, where we get Matt Cochrane to join us as well. But I actually think historically, banks have been very investable. And these are kind of just extensions of banks, and many of them are just run really well. And the numbers are, are fairly obvious. So I’m not sure the success of Afterpay necessarily dooms Affirm. In fact, do you think it’s likely that you know, obviously, the Square market is an advantage because Square can say, well, we offer Afterpay? We’re not offering Affirm, but just like places offer Visa, MasterCard, American Express, in some cases, even Discover card, you know, maybe Diners Club, who knows, you could see Affirm, Afterpay, and maybe even a third player, right? There’s room for more at the party.

Anirban Mahanti: I think so i think so. So you could be duopoly or a you know, you know, triopoloy or  quadopoly or something like that could evolve. I don’t think this is a winner take all market and, you know, if it’s like a 10 trillion or whatever it is, you know, ecommerce spend, for example, globally. It doesn’t have to be a winner take all for some of these players to win. And I think the other point to realize is each company comes at it from a different perspective, right. So Apple Pay with installment payments, their objective is different from Square. Right, their job is to keep people happy with you want to do installment payments, and therefore we offer it right. It’s not necessarily about making money there, they will make money somewhere else. So and that could be you could think of that, you know, somebody’s you know, if somebody’s product becoming your feature somebody else’s, you know, feature that is a risk.

But, again, I think I think it’s big enough that you know, it, I don’t think it’s put Affirm at any danger as such. And maybe, you know, this this, you know, Affirm has a relationship with Shopify, I believe, right. So I mean, that is nothing that’s, for example, stop Shopify from saying, well, these guys, Square has bought, you know, this one, I’m gonna buy that one. And there could be more consolidation again, I don’t know. But that’s another possibility.

Dan Kline: I think it’s very likely you see either consolidation or an exclusive deal there, because this is absolutely a shot at at Shopify. That said, I am very bullish on both of these companies. I want to close out with with two questions here. The first is, is buy now pay later, something you age out of, because I’ve used it, but I’ve used it as like an afterthought. Because in general, when I buy online, if it’s on Amazon, I use my Amazon credit card, I auto pay that full bill every month. You know, unless it was a month where like, for some reason, like I bought like a, you know, $900 massage chair and it was I maybe I paid that off over two or three months instead by using one of these services. But is this something you age out of? Or will it just become like part of your life and part of your budgeting where maybe you use it more heavily, like the holiday season in the summer, and then you pay those debts off during the slower parts of the year, which I guess would be the spring in the fall?

Anirban Mahanti:  That’s a hard one for me to answer. Like, I feel there are –  According to Afterpay, there is a demographic which really is anti credit card. And the risk that you know, one of the things with credit card I think people forget is if you forget to make a payment, you are going to be slugged with huge interest. Right? You don’t you’re not slugged with huge interest in Afterpay. So I think, you know, just innocent from forgetting of, you know, forgetting the payment is a problem. And some people have been soured by that. So I don’t think this is bad. And like you I use Afterpay, when I can. I don’t have to do a checkout, I just use Apple Pay to instantly pays for you know, the addresses that. But, you know, out use, you know, I use Aay whenever I can, because again, why not? But I’m trying not to target demographics, as I just said.

Dan Kline: No, But we both are to a point at the higher end. So it’s not Afterpay, It’s not Affirm. But when I’ve had some unexpected large expenses. And I’ll give you two examples, we redid the floor at our other house that was a you know, roughly $11,000 worth of expense. And about 6000 of that was material. And I paid that off over six, eight months on a 0% interest card from the company, I bought it. When I got my laser eye surgery because I can pay for that using my wife’s health care account, which didn’t have the amount in it. I set that up to pay off over time, because it’s essentially free money that comes from her employer. So why not do it? So I do think there are things where like, if all of a sudden you came home today, and your air conditioning was shot, could you spend the 10, $12,000 on air conditioning? Or a new roof? Or whatever it is? Of course you could. But do you want to? Is it fun to do that? I think that’s where the higher demographic comes in. But obviously, you need 100 small customers to be able to get the cash to finance a roof or something at a relatively low margin.

But let me throw this out Anirban. You can comment on that. And then I’ll give you the final question. Unless any of you have any others you’d like us to ask. So if if you have something to say, say it now in the chat?

Anirban Mahanti: Well, look, I think I agree with you. Right. So the going upstream in terms of dollar volume is definitely a game that’s going to be played, it’s gonna make it more attractive to a wider range of customers. I think that’s definitely on the cards. It’s not what they do currently. But yeah, I think it’s not off the cards. Yeah, I’ll take the last question.

Dan Kline: No, it’s the theoretically this could be like a threat to credit cards in a certain sense, where, again, and I’ve talked about this a lot, the more a company knows about you, the less of a credit risk you are, and I’m not entirely sure that a credit score is always a good example of that. You know, history, some people are going to do anything they can to pay off debt, even if it means going without. Others are not going to do that because there’s not a lot of negatives to pushing credit card debt down the road. Unless you’re actually thinking of how much interest you’re paying.

One last comment from Doug Henning with a name I’ve never seen here before. So I wanted to get it in. Interesting, Square’s up 11% today or a $12 billion increase in market cap. That actually speaks to my last question. My last question here Anirban is this is a company I believe you are a shareholder of Do you like the deal now that you’ve had roughly 24 hours I know use the metric system. So it might be 10 or 100 hours over there, but roughly 24 hours to digest it? There is no metric time. That is, that is a joke. fueled from Battlestar Galactica. But that being said, Do you like this deal as a shareholder?

Anirban Mahanti: Look like Okay, so I like the potential of the view. I don’t quite like the price, as Matt Cochrane would say the price is high. So I think a lot of execution has to go really well. For the price to justify right. And, you know, I, you know, I would, I would have liked a lower price personally, as a Square shareholder. I think every square shareholder probably isn’t gonna say the same thing. But you know could have paid less. But, you know, maybe this is a battle that, you know, has to be fought, because otherwise it’s gonna lose the battle to PayPal, and others. You know, so maybe this is a battle that Square had to fight, and this is the way to fight it. But yeah, the price is high in you know, again, there’s no doubt in my mind, I think that that’s true.

Dan Kline: For those of you new to the program, you are watching 7investing Now. We do this every Monday, Wednesday and Friday. Normally, at noon, Eastern we had a bit of a technical difficulty. Anirban, I got one of those automated robo calls, saying that the internet would be down for 90 seconds, I got that 40 minutes after the internet went down for 90 seconds. If I had known that, I never would have left. But that being said, we asked you how you felt about the deal. By you I mean, the 7Investing Twitter audience. Sam Bailey, who’s been a trooper today, if you could share that I would love to close out the show with our finisher.

Do you think square did the right thing and agreeing to buy after pay for $29 billion? About 38% of you said yes. 21.5% said no 40.8% said too soon to tell. Anirban I would have said too soon to tell yesterday. I actually kind of have been talked into this deal. I actually liked the potential here. I think, look, it could hit a brick wall. But I don’t think so I think like we want to spread out our purchases. And look, will some customers get into trouble with this. Absolutely. But some customers get into trouble with credit cards. And would I rather you get into trouble with a financed pair of pants than a you know $4,000 vacation put on your your Visa. I actually think this deal might make sense without having really dug into the numbers.

Obviously, $29 billion is a very, very big number. But stock I don’t want to say it’s play money because obviously it is dilutive. But it actually kind of isn’t real money. Again, I know I’m being dismissive there, but I like what they did. I like the potential. You know, I don’t expect this to be a write-off, I actually expect this to be fairly transparent, transformative for Square. Your thoughts?

Anirban Mahanti: Yeah, I think I agree with you. I think, you know, the cabinet is expensive deal. There’s a lot riding on execution. But I think this this can be a, you know, a meaningful rocket ship, sort of idea for for Square. Basically takes it to the next level. So, I mean, I like the deal I like Afterpay as a company. I think they have been extremely innovative. Really, you know, thought leaders and, you know, and I think that has value, right? If you bring on people who are thought leaders who can think out of the box, I think that is meaningful. So you know, you’re acquiring talent as well.

Dan Kline: So Anirban, I don’t want to put you on the spot here. But is this the largest Australian mergers and acquisition deal ever done? It has to be it has to be right up there right?

Anirban Mahanti: Yeah, so I think this is the largest deal ever. It’s definitely the largest tech deal ever. So I mean, you know, this is you know, something again. This is a bittersweet thing because you know, this company is going to be off the ASX right. It has been, you know, a huge like it actually could invest in this company during the the the COVID downturn, you’d probably be up 12x or something like that in 18 months. So, you know, a lot of people a lot of retail money has been this a lot of people are gonna be rich because of the deal. I hope a lot of people actually decide to take and keep the Square shares and partake in the long term. But you know, again, I think this is good. This is good for the Australian tech community, you know, success in that sense.

Dan Kline: There are going to be a lot of other shoes to drop in this space. Anirban Mahanti, I know it is roughly three in the morning there at this time. So we very much appreciate you. I don’t know if it’s getting up or staying up. I’m not sure at this point. If you go to bed after this. Or if it’s just like when I when I traveled to England and it’s early in the morning and you know if I can stay up till like nine o’clock at night, I won’t have jet lag. So you can let us know on Twitter how you’re going to handle the rest of your day.

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