The small detail in Zip’s results that spell out the longer term challenge for BNPLs

Zip shares fell 7.7% following resumption of trade on Tuesday after the company announced a $491 million all-scrip takeover of US BNPL Sezzle.

The merger, offering a 31.7% premium on Sezzle shares based on the 30-day volume weighted average price, is another sign of an expected consolidation of the crowded BNPL market following Square’s takeover of market leader Afterpay, and Latitude’s $335 million cash and scrip offer for fellow BNPL Humm in January.

Investors receive 0.98 Zip (ASX: Z1P) shares for every Sezzle (ASX: SZL) share, based on Zip’s spot price of $2.21. Just after 10.30am, Zip hit $2.04.

The company also delivered its half-yearly results yesterday, painting a grow story for the H2 CY21, with revenue up 89% year-on-year (YoY) to $302.2 million and transaction volumes up 93% to $4.5 billion. Transaction numbers rose 147% to 36.3 million and customer numbers 74% to 9.9 million.

The acquisitions of Middle Eastern payments platform Spotii and European BNPL Twisto in late 2021 contributed to the growth story, including $3.7 million in revenue generated by acquired entities.

And while Zip co-founder and global CEO Larry Diamond lauded the merger “a transformational transaction” expected to deliver immediate scale and growth towards profitability, the results to December headed in the other direction.

The Group reported a loss before tax, depreciation, amortisation and share-based payments of $157.6 million (excluding non-recurring items) compared to a loss of $14.9 million in the prior corresponding half year. The company said it had invested in employment, marketing and other expenses in H2 to support the growth in revenue and expansion into new markets.

On the join venture front Zip ploughed US$50 million into Indian BNPL ZestMoney last September for an 11% stake, and upped its stake in Philippines BNPL TendoPay by 10% to 35% for US$2 million.

Gross profit fell by 23% and the BNPL fintech posted an after tax loss of $214.3 million.

But there appear to be plenty of headwinds during the second half of 2021, with the company reporting its cash transaction margin declined to 2.1% (from 3.7% in HY2021) “reflecting rising bad debt costs reflective of current credit headwinds as well as increased weighting towards rest of world”.

The company said it is “addressing its risk decisioning policies and collections and recoveries processes to immediately address credit performance”

But it’s also worth noting that the weighted average interest rate on loans outstanding at 31 December, 2021, was 3.08% compared to 3.67% at 30 June, 2021.

And there’s another key metric that’s also falling, as it is with many BNPLs, in a sign that the golden days may be coming to an end.

The company said its revenue margin – a percentage of total transaction volume (TTV) – “remained strong” at 6.7% , outperforming its peer set.

But that figure was 6.9% in the first half of 2021, and 12 months ago in H2 CY20, sat at 7.1%.

Looking ahead, Zip said that in the medium term it expects to deliver a cash transaction margin of 2.5%-3%, with revenue as a percentage of TTV of 6.5% to 7%.

Should it come in at 6.5%, that’s yet another drop in the margin. And increasing competition amid a battle for market share, not to mention pushback from the retailers bearing the brunt of the costs associated with that margin, means the longer term trend is likely to be a smaller skim of transaction volumes.

That means BNPLs have to keep growing just to stand still.

Announcing the results, CEO Larry Diamond said there had been a shift in the external environment, that was “arguably quicker and more severe” than the company first forecast.

“Accordingly, we have refined our strategy with a focus on sustainable growth in our core markets, maintaining strong unit economics – particularly credit performance, broader cost management, right-sizing our international footprint, which accelerates our path to profitability,” he said.

“We have already taken decisive actions in line with this focus.”