There is an old trading adage that goes like this. A stock that fell 90% is a stock that fell 80% and then halved. This is precisely what happens to many unprofitable and speculative companies such as To assert (NASDAQ:AFRM) Inventory. AFRM stock is now down 80% from its 52-week high, leading many traders to believe the stock is now cheap.
However, Affirm holders may find that the 80% drop soon turns into a 90% drop as the stock price continues to crash. In fact, in the end, there’s a good chance that Affirm will end up becoming nearly worthless.
Long story short, fintech companies are some of the riskiest businesses out there, and Affirm’s day in the sun is over. The company now faces a long dark night.
A company built around a gadget
Affirm is a company based on what is called “buy now, pay later” (BNPL) loans. Buy now, pay later allows consumers to buy goods today and pay for them later. Often this is allowed without interest charges.
If BNPL doesn’t seem very innovative, that’s because it isn’t. America has had rent-to-own, rentals, buy-over-time, layaway, and various other options for creative financing of consumer goods for decades. And, of course, credit cards themselves allow consumers to buy something now and pay later. Most credit cards charge interest, of course, but savvy consumers are able to find interest-free cards for a certain number of months or other similar maneuvers to get interest-free purchases.
In other words, BNPL is just a slightly new version of a very old lending tactic. And, in fact, many foreign markets have supported BNPL for decades. In some Latin American countries, for example, every time you pay with a credit card, they ask you how many “quotas” – or months of payments – you want for your purchase. Retailer accepts credit risk for payments and everything is automatically handled through Visa (NYSE:V) Where MasterCard (NYSE:MY) without the need for a third party.
In this BNPL landscape, companies like Affirm and Afterpay, which are now part of To block (NYSE:SQ), entered. Basically, they’re just offering another version of a short-term loan product. It’s nothing disruptive or exciting, it’s just plain old consumer ready. That said, lending is one of mankind’s oldest business models. Is Affirm a good lending operation?
Losses as far as the eye can see
In short, no, Affirm did not demonstrate any particular skill in its trade. During the last quarter, Affirm ggenerated $361 million in revenue. In doing so, it generated an operating loss of $196 million. That’s a negative operating margin of 54%. For every dollar Affirm brings in from its installment loans, it loses 54 cents.
Needless to say, any traditional bank that loses more than 50 cents on every dollar of interest it receives would soon be out of business. Is Affirm different because it’s a FinTech company instead of a bank? Not really. He always lends. And on a loan, if you don’t earn enough interest to cover your expenses, you won’t be long for the world.
The bulls were touting Affirm’s revenue growth. But, in the business of lending, turnover is meaningless. You can always generate more income by making bad or risky loans. You usually do not do want to invest in the fastest growing banks, as they may reduce their loan underwriting to achieve such rapid growth. In the case of Affirm in particular, its operating margin has been deteriorating lately anyway, so it’s not like the company is hitting a scale as it grows.
Affir Peloton Partnership
How did Affirm grow so quickly? Partly because it has been willing to lend against assets of dubious value, to put it mildly. One of Affirm’s main partners is Platoon (NASDAQ:PTON). Peloton was a hot smart bike maker for a minute in 2020. However, as quarantines ended, demand plummeted for Peloton bikes. Now many of them are used as clothes racks or sit in some dusty corner of people’s basements.
Peloton shares have plunged more than 80% from highs and the company has engaged in mass layoffs and production shutdowns to stem its bleeding. Affirm was a huge source of funding so cashless people could buy Peloton bikes. Will people continue to repay their loans for bikes they have stopped using? Only time will tell.
Either way, this type of empty calorie growth for Affirm is now working in reverse. As inflation spirals out of control and people begin to prepare for a possible recession, expect spending on frivolous consumer goods to fall sharply after the euphoria of 2021. And, just in case, Affirm loses huge sums of money from the revenue it generates regardless.
It’s fitting that much of Affirm’s apparent success has to do with Peloton. It was a fashionable fitness machine powered by an equally useless loan product. And now the two are diving together as the tailwinds of stay at home disappear.
Perhaps AFRM stocks can try to cut overhead and work their way to profitability. However, given the massive scale of its losses during a boom in consumer spending, it’s hard to imagine Affirm ever succeeding. If he couldn’t make money in 2021, what set of conditions could be better?
On the downside, imagine if we get a recession and people stop paying their installment loans. Affirm couldn’t even make money during an economic boom. Beware if and when a recession hits.
As of the date of publication, Ian Bezek held a long position in V stock. The views expressed in this article are those of the author, subject to InvestorPlace.com publishing guidelines.