Zip Co deal is evidence of cost competition in BNPL sector, UBS says

Yesterday’s Zip Co (ASX:Z1P) update on its Visa partnership was “significant”, UBS says.

But equities analysts at the bank also say it marks further evidence of cost competition in the sector.

The Zip Co announcement was one of two big BNPL stories, as market leader Afterpay (ASX:APT) hit the $100 mark following a tie-up with Westpac.

The update from Zip Co related to its “Tap and Zip” feature, after the company said it had been granted a Principal Issuer licence.

The new status allows Zip Co customers to use their service in any retailer (physical store or online) where Visa is accepted.

The service will operate with a virtual card which can also be added to Apple and Google wallets.

BNPL competition

To monetise its new distribution channel, Zip Co will make revenue via the interchange fee for transactions processed on its cards.

UBS said the average interchange fee for debit card transactions on Visa or Mastercard in Australia is 0.43 per cent.

That is “materially lower” than Afterpay, which charges between 3-7pc, and Zip Co’s margins on its core platform which UBS estimates at 2-3pc.

“We highlight that this is further evidence of competition in the BNPL space,” UBS said.

Looking at the broader sector, UBS noted that BNPL platforms are only available at around 13 per cent of Australian merchants.

So partnering with a global payments company gives Zip Co a new channel to significantly expand its addressable market.

However, UBS said Zip Co also runs the risk of cannibalisation.

They could process more payments at the cheaper interchange fee, but at the expense of higher margins on the Zip platform.

Another risk is that it may lose customer signups on the merchant side.

For now though, UBS said signup risk may be negated because merchants can generate free marketing reach by accessing Zip Co’s existing customer base.

They also added that the Tap and Zip model gives the company some downside protection risk, in the event that merchants are freed up to pass on the BNPL margin fee.

Currently, Afterpay’s model works on the basis that it can legally force merchants not to pass the fee on to customers.

Moving to a lower-margin interchange model means Zip Co is less reliant on merchant fees, and more reliant on “consumers funding the economics of their payment choice”.

Such a position will protect Zip Co in a scenario where “BNPL providers are prevented from imposing ‘no surcharge’ clauses in their merchant agreements”, UBS said.

Throughout the torrid 2020 rally in BNPL stocks, UBS equities analysts have typically been more bearish on the sector.

When Afterpay hit new record highs above $90 in late-August, the bank valued the stock at less than $30.

UBS values Z1P at $5.50, which is around 20pc less than its current valuation above $7.