The very things that make buy now, pay later stocks appealing may come back to haunt them. Namely, competition, the law and their business model.

This sector has been so hot that 2019’s new entrant to the market, Splitit (ASX:SPT) rose 10 times in six weeks. But now its back at 52c. Afterpay’s (ASX:APT) bull run ended in early May and the share price has stagnated since.

Zip Co (ASX:Z1P) reached $3.88 in late May and is now $3.18. At one point earlier this year Regal Funds Management held 27 million shares but has gradually sold its stake down.

Has this been Australia’s dot com bubble? Well, not yet. All businesses are still operating – Afterpay made A$4.7 billion in the 11 months to May 31, 2019. Whenever the company has spoken to the media or investors, they’re told Afterpay is just getting started with its ambitions. But it faces three key threats.

Competition

The existing buy now, pay later stocks face two threats. First from new entrants. The most obvious is Sezzle who will be listing in the coming weeks.

Second, from established players. It is common to think that it is natural for all businesses to fall victim to start-ups that they don’t even see as a threat until its too late. An obvious example is Blockbuster collapsing after ignoring Netflix – in fact, Netflix went to Blockbuster offering itself on a silver platter.

But recently, in other technological sectors such as electric cars and groceries, established companies that can see upcoming threats invest to stay ahead. And being already profitable means they are in a better position than a competitor who is living off capital raises.

Last week, Visa announced it was trialling a buy now, pay later scheme among its shoppers.

“We expect instalments to become a foundational method of payment for checkout for both domestic and cross-border commerce payment transactions,” senior vice president Sam Shrauger said.

Peak Asset Management’s Niv Dagan told Stockhead,’ the market is certainly looking for “substance” and as the space is maturing and with the ability of a top-tier companies such as Visa, Mastercard or other payment providers to incorporate BNPL into their existing business model with the already-made distribution, this certainly poses a “threat” to AfterPay, Splitit and ZipMoney’.

The law

Raising this issue could easily outrage investors. Didn’t the government have the chance to regulate them back in February and decline to? While it did not give an express introduction, the Senate ruled a regulatory framework be constructed specific to the sector.

Both Afterpay and Zip said “we look forward” to working with ASIC and the government.

Remember last year when Afterpay allowed a 16-year-old with no credit history to order $300 worth of champagne despite only having $80 in the bank? Highly publicised incidents such as these draw attention to regulators.

The most obvious regulatory risk is if they have to conduct lending checks under the National Credit Act.

AUSTRAC has been investigating its anti-money laundering counter terrorism financing (AML/CTF) network since January 2015. AUSTRAC has said it will determine compliance issues and if further regulatory action is needed.

Based on past actions AUSTRAC has taken, it could include fines up to hundreds of million of dollars, or enforceable undertakings.

One of Afterpay’s bullish analysts, Goldman Sachs’ Ashwini Chandra reiterated a buy rating in light of this. While he said “we take no view on the outcome of the announced audit”, Chandra admitted it was a risk.

Their own business models

The sectors’ main advantage is making money through late fees rather than interest. By nature, late fees are only charged if payment is late and this could hurt both ways.

On one hand, if the company is making late fees, consumers will eventually scale back their purchases and pay “up front” — to the retailer.

On the other hand, if the company is not making late fees — there goes its key revenue source. Afterpay has previously said over 90 per cent of purchases go through without late fees.

In the 2017-18 financial year, Afterpay made $11m in late fees, lost $17.4m to bad debt and had an after tax loss of $9m . Although you have to go to page 43 of its 17-18 annual report to find it, Zip Co lost $22.5m. Splitit (which goes by the calendar year) lost $3.4m in 2017 and $4.6m in 2018.

Afterpay’s Nick Molnar previously compared his firm to a “modern-day lay-by”. Lay-by has long been offered by retailers, but enough of their customers pay up front that it can be sustainable.

Niv Dagan told Stockhead,’ There is no doubt that the buzz around ASX announcements has “fizzled out” over the past 12 months and the market is rewarding those companies with concrete figures, material purchase orders and positive cash flows’.

The buy now, pay later sector could rise for years to come. But it is not the smooth inevitable path that is has been made out to be and the traits that make it seem inevitable could also be its own worst enemy.

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