• Most BNPL stocks were down in May
  • Market commentators predict more credit losses to come
  • What Tom Ng of MA Financial Group believes will happen to BNPL stocks

Once the market darlings for investors, most BNPL stocks are now having a rough time of it.

It’s the first time the sector has ever had to deal with a rising interest rate cycle, and it’s putting a lot of strain on the business model.

Rising rates cause not only higher funding costs, but also higher rates of defaulting customers.

Zip Co (ASX:ZIP) has seen this effect firsthand. In its last quarterly update, the BNPL company said its credit losses had increased to 2.6%, which is over its target rate of 2%.

The former chairman of BNPL firm Humm (ASX:HUM), Andrew Abercrombie, has also warned of potential severe losses in the sector.

Abercombie said that loan losses in the struggling BNPL sector will worsen, and there was a “fundamental flaw” in the way BNPL companies were assessing the creditworthiness of customers.

His comments came after Financial Counselling Australia (FCA) found a sharp increase in people with BNPL debt seeking help from financial counsellors in the past 12 months.

Meanwhile, ANZ head of retail banking, Maile Carnegie, also told the AFR Banking Summit yesterday that people who use BNPL were twice as likely to default, a statistic which has been supported by public data.

So what does the future hold?

According to managing director at asset manager MA Financial Group, Tom Ng, investors will normally turn their focus to a company’s cash burn and operating runway when things don’t go as planned.

“I think listed BNPLs currently have a median cash runway of between two to three quarters,” Ng said.

“With the near constant debate about the sector over the last couple of years, the default view has emerged that consolidation must one day occur.

“While I broadly agree with that view, I doubt Zip, Latitude or Block are planning a classic roll-up strategy with the multitude of smaller players left in the space,” Ng added.

Instead, Ng says that he expects the smaller BNPL players to deploy one or more of these strategies in the coming months.

“The first is the shrink to greatness strategy. This means amputating the most capital intense businesses and consolidating operations around a tight, and hopefully sustainable core operation.”

He said that we’ve already seen this strategy with OpenPay’s (ASX:OPY) recent decision to reduce its origination and physical presence in the UK market.

“The second strategy is friend-a-friend strategy. This is the classic textbook move to get scale, unlock synergies, and find a wider shareholder base to support the ongoing burn,” said Ng.

“I expect to see combinations between companies in adjacent verticals like BNPL merge with consumer lending or payment companies.

“And the third strategy is the deeply discounted rights issue strategy,” said Ng.

This involves issuing rights or securities to “encourage” existing shareholders to support the business, or face being heavily diluted.

“In the game of chess, the ‘end game’ is defined as the stage when few players are left on the board.

“But the line between the middlegame and endgame is often not clear. Having observed the BNPL sector over recent years, my feeling is we are now quickly approaching that line.”

BNPL winners and losers in May

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Splitit Payments (ASX:SPT)

Splitit was the only BNPL stock to have risen in May.

The company has recently refreshed its growth strategy, and says it wants to become the infrastructure layer of BNPL.

Under new CEO Nandan Sheth, Splitit wants to leverage its unique technology and focus on distribution partners by offering white-label, Instalments as a Service solutions for partners and enterprise merchants.

Latitude Holdings (ASX:LFS) and Humm (ASX:HUM)

On Monday, Humm told its shareholders that selling its consumer finance arm to Latitude is in their best interest because the business is unprofitable.

In February, Latitude had proposed a $35 million cash and 150 million Latitude shares(worth $335 million) to buy Humm’s consumer finance business.

Former Humm chairman and 20% shareholder Andrew Abercrombie, however, said that the offer price was too low.

Abercombie said the Latitude offer was opportunistic, and and failed to take into account the future value of the business.

Talks are ongoing.

Zip Co (ASX:ZIP) and Sezzle (ASX:SZL)

Zip will soon wrap up its acquisition of Sezzle in a deal worth $491 million.

Zip believes the combined group could generate positive cash flow by financial 2024, after both companies underwent rounds of cost cutting initiatives.

The shares of both Zip and Sezzle have cratered by more than 80% each this year.

OpenPay (ASX:OPY)

Openpay’s operations in Australia and NZ continued to perform strongly in April, and the company says it remains focused on its target to deliver core profitability by June 2023.

Highlights for the month of April include:

– Revenue of $2.5m, up 69% on pcp
– 4,042k active merchants, up 14% on pcp
– 314k active customers, up 22% on pcp