Monday 07 May 2018 by FIIG Securities shopping Opinion

High yield bond issue another way to go shopping with Afterpay

The high yield bond market continues to grow ahead of the FIIG High Yield conference on 17 May, with a new bond from Afterpay and news that Virgin Australia is preparing to issue in AUD
A version published in The Australian on 5 May 2018.

Afterpay, the consumer finance company that broke new ground in the market with its “buy now, pay later” system, has been a very successful share investment. With an estimated one in four online fashion purchases going through the company, the news that it has issued a high yield bond is bound to get wide attention.

At its simplest, an Afterpay bond allows investors to be “on the other side” of the rising level of transactions at the company that does not charge interest and remains outside the national credit code.

Afterpay’s bond has a four year term, makes half yearly interest payments in October and April and will pay a fixed rate of between 7.25 and 7.50 per cent per annum.

This is an attractive equity like return in a low yield environment.

Few large well-known Australian companies issue in the domestic high yield market, preferring to issue bonds in the US which is a much larger market with many more investors. Yet earlier this week, Virgin Australia signalled they will be doing a series of debt investor presentations, looking to raise funds in the domestic market. While this is a first, they have issued in USD and currently have a 2021 maturity bond trading at 7 per cent per annum yield until maturity. This is an exciting development as the AUD market opens up and becomes a real alternative for those companies previously forced to issue in the US.

Back to Afterpay. This company, Afterpay Touch – to give it the proper name, is part of the ASX300 and listed on the stock exchange in June 2017 following the merger of Afterpay Holdings Ltd and Touchcorp Ltd.

Pay Later generates 80 percent of the revenue and drives outstanding growth.

The Pay Later business is like a modern lay-by for millennials who comprise about 67 per cent of the customer base. They shun debt and like to manage expenses and the Afterpay platform brilliantly targets them. There are approximately 700,000 customers able to access over 5,000 retail merchants including all the Super Retail Group brands, such as Rebel and Supercheap Auto, as well as large department stores such as Myer and Big W.

Pay Later requires customers put down a 25% deposit and commit to four equal instalments over six to eight weeks. In return, customers get immediate access to their goods or services purchased. Afterpay are paid by the merchant based on the value of the transaction, which averages around 4 per cent. The service has been shown to increase retail sales, it helps the customer manage expenses and Afterpay gets paid – but it also wears the credit risk that the customer will not make the remaining instalments. 

If for any reason users fail to make a payment, they are charged a $10 fee and another $7 if the payment hasn’t been made in seven days. Failure to make a payment then puts an immediate stop on new transactions.

The high growth company has yet to make a profit but the potential is significant, with it just signing a New Zealand merchant and its aspiration of expanding into the huge US market. As at 1 May 2018, Afterpay had a market capitalisation of approximately $1.29 billion.

Afterpay needs access to capital to pay the merchants for the goods upfront and to sustain growth. That’s why it is raising money. Just last November, NAB increased group funding from $200 million to $350 million over a two year term. The facility is secured against Afterpay’s receivables. In order to expand into the US, the company has been working to establish further receivables funding of $200 million.  So, funding secured by receivables may rise rapidly.

A key risk for bondholders in the new transaction is that they would sit behind secured bank funding in a liquidation scenario and that there is no limit to future secured receivables borrowing. A significant counter to the position is that the group has agreed not to pay dividends at any time while the bonds are outstanding.

Like any investment, the question you need to ask yourself is does the return compensate for the risk involved? 

One of the ways I would assess the deal is to compare it to bonds issued by companies in the same or similar sectors. zipMoney is one of Afterpay’s competitors but works differently and has different criteria for customer screening.

It issued a two year high yield bond in 2017 that was also subordinated, however the key difference is that zipMoney bonds are secured against a pool of receivables. The bond has floating interest payments and is expected to mature in May 2019. It is currently trading at a yield to maturity of 6.3 per cent per annum.

Simply, the Afterpay bond matures three years after zipMoney and offers circa 1 per cent per annum more but does not offer security over the receivables of Afterpay. Both bonds have complex structures and anyone interested needs to get the debt related research and better understand the risks involved. The high yield bond market is an exciting new market, well worth investigating.

Note: High yield refers to bonds that have a sub investment grade credit rating or are not rated and consequently offer higher rates of return to compensate. 

FIIG Research has decided not to DirectBond Afterpay bonds.