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Why is the Zip Co Ltd (ASX:Z1P) share price falling on a record result?

Shares in Zip Co Ltd (ASX: Z1P) fell 2.4% to $1.02 on Thursday, after the company released results for the three months to June 2018, despite this being defined as a “record quarter” for the company. The stock partially recovered after having been down 7% earlier this morning.

Zip provides point-of-sale credit and digital payment solutions to the retail sector and to education and health industries. Its offer includes buy-now-pay later services and free budget planning app Pocketbook.

Results in the last quarter of FY18 were indeed an improvement on the previous quarter and record high figures.

Zip achieved its highest quarterly transaction volume, up 26% to $171 million. It also obtained a record high revenue of $13.2 million, an 18% increase on the previous period.

The number of customers increased 19% to over 738,000, with Zip now accredited with over 10,000 merchants. Customer engagement continues to increase: in the last quarter, 83% of all Zip transactions were performed by existing customers.

So why did the stock tumble today? There are two possible explanations, and both involve Afterpay Touch Group Ltd (ASX: APT), Zip’s big rival in the buy-now-pay-later space.

Shares in Afterpay are rocketing on the latest business update: underlying sales are up 39% over the previous quarter. Afterpay is not only bigger, it’s also growing faster than Zip. This may suggest that Zip’s result is good, but not so impressive.

Even the fact that Zip’s customer retention rates are increasing has a flipside: only 17% of transactions are made by new customers, a sign that the business might be peaking.

The second potential explanation for the cold reception of Zip’s result is that the company might be seen as a minor player in the payment solutions market, which is particularly tough on small players. Think of credit and debit cards, the most widely used non-cash payment services. These cards are issued by only a handful of players worldwide. How many buy-now-pay-later services can coexist in Australia?

Foolish takeaway

Payment services are characterized by a strong network effect. Consumers want services accepted by the most merchants. Merchants accept payment systems used by many consumers. Afterpay has 2.2 million customers and is accredited with over 16,000 merchants in Australia. Zip must fight to close the gap with its rival.

The good news is that Zip recently signed its largest partners to date: Super Retail Group Ltd (ASX: SUL) and Wesfarmers Ltd’s (ASX: WES) Officeworks.

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Motley Fool contributor Tommaso Autorino has no position in any of the stocks mentioned. The Motley Fool Australia owns shares of and has recommended Wesfarmers Limited. The Motley Fool Australia owns shares of AFTERPAY T FPO and Super Retail Group Limited. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. This article contains general investment advice only (under AFSL 400691). Authorised by Scott Phillips.

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