The COVID-19 pandemic is leaving a long trail of destruction in the retail sector that is the lifeblood of the buy now, pay later (BNPL) industry.
But the crisis may have come at just the right time for BNPL posterchild Afterpay Ltd (ASX: APT) even though its growth is likely to be stunted by the looming global depression.
For Afterpay though, it could be a case of "what doesn't kill you makes you stronger"!
Natural selection
This point was highlighted by Afterpay's competitor Zip Co Ltd (ASX: Z1P). Zip's co-founder Peter Gray predicted that a number of smaller BNPL players will not survive the coronavirus turmoil, according to Business Insider Australia.
"Historically, if you look at what plays out in a downturn or a significant change of economic conditions is typically the strongest one or the one or two larger guys will typically get stronger and stronger, while some of the smaller guys will struggle," said Gray.
In case there was any doubt, he was referring to Afterpay and Zip as the "larger guys".
Right time, wrong place
This is why the timing of the COVID-19 outbreak could be a blessing in disguise as Afterpay and Zip entered the recession as the industry leaders. Success always draws in competition and smaller rivals can exploit a second mover advantage by looking at what works and what doesn't.
But the sudden and sharp crash is likely to wipe out many of these aspiring challengers because the industry relies heavily on its ability to raise capital.
Cash may be cheap thanks to record low interest rates and unprecedented amounts of quantitative easing from central banks, but little of this liquidity will reach small companies.
Funding bottlenecks will choke
My contacts in the financial sector tell me there are lots of willing lenders/investors to companies but they are charging rates of between 10% to 20%.
While the federal government implemented a lending program to provide loans of up to $250,000 at low rates to SMEs, this alone won't be enough for emerging BNPL start-ups.
This is because the business model of BNPL companies are similar to banks. Its about the velocity of money – the ability for them to lend out the same dollar as many times as they can.
For that, they need a sizable pool of working capital. And because margins per transaction are slim, they need scale.
It's a catch-22. They need a lot of capital to grow but they can't get capital even if demand for BNPL remains robust.
Lingering risks to Afterpay
However, the post-coronavirus world won't be smooth sailing for BNPL leaders either. The risk of a sharp rise in bad debt from borrowers who can't meet their obligations is epitomised in National Australia Bank Ltd.'s (ASX: NAB) latest results and cap raise.
Companies like Afterpay will also be impacted even though the amounts it "lends" is small.
What may be greater risk are the expected wave of store closures in the global retail industry and increasing regulatory pressure from governments looking to protect consumers during the recession.
Further, retail experts are predicting that consumer buying behaviour will change due to the pandemic. For instance, fashion industry insiders think that there will be a move away from fast fashion to more sustainable practices.
Lower turnover in clothing sales won't be good news for the likes of Afterpay.
