Affirm: The Next $100B Bank??

TL;DR

– Why Income always beats equity

– Creating the New Bank of Affirm

🧠 The Takeaways

Today we’re buying Affirm for $15.9B to dominate the future of consumer financing.

Affirm needs to get fit. There’s no reason a 43% Gross Margin biz is spending 80% of Rev on Overhead.

Move Upstream. Create a consumer bank to own the money flow.

Create a Digital retailer built around the value prop of consumer payment terms.

+ Why Income matters more than equity.

LBAB Community –  Why I completely changed how I invest.

Over the past couple of years, I’ve changed my investing focus from building equity to creating multiple income streams. After a conversation with one of my friends in IB it changed how I see everything.

I know that compounding growth in the market is the greatest value creation of all time. Obviously, the longer you do it, the more will be created. 

All praise the Lord of Compounding.

But the question my friend asked me that changed everything…

That question was the nail in the coffin where my friend turned + won the conversation at the same time.

I’ve been making long term equity investments for a long time under the premise we’re all sold in America:

Build up enough equity through saving income to retire.

Harvest the equity in retirement as income.

Whatever is leftover is inheritance or charity donations.

But this is backwards.

Everybody thinks you should work for 30–40 years to build holdings that generate enough income for you to support yourself after a number that used to mean you’d died in 10 years. 

But why not build multiple income streams now to support yourself, so you can decouple the need of working and generating an income? As opposed to doing equity-heavy investing and waiting 40 years.

If you can build the income streams to be greater than what you spend the excess turns into additional buying power in the near future or equity.

That’s the fundamental way that I’ve changed my personal finances.

I’m thinking: 

How can I turn the money I’m making (that I would otherwise be investing) into additional sources of income?

How can I stack those additional sources of income to replace my current income needs?

How can I completely decouple my working hours from those income streams?

This runs against the FIRE principle of generating a few million in equities that you can live off selling off ~4% of the total value/yr for the rest of your life.

Which sounds like a bear hibernating.

But why not invest in asset classes that are generating monthly income (in excess of needs) instead of building up wealth to sell it off wealth?

Owning bizs, real estate, and even public dividend-paying securities that cover my needs + generate excess income means I can invest (and make) even more.

If I net $10k/mo. from these other income streams and I spend $5k, the rest can go into additional income sources. Taking the overflow from one bucket and filling another one up. Repeating the cycle.

If I do it well, creating diversity of income producing assets that gain in equity value over time.

And the streams carry over long after I retire: I can pass them down in an estate. Instead of my kids/grandkids burning down a big number, they’d start off with a baseline income. In theory they’d be set forever. 

It protects hard work and generational wealth rather than leaving it all to chance.

Let’s Examine This Biz

Affirm, the premium Buy Now Pay Later (BNPL) provider, is burning too much money trying to become the future of consumer financing.

Trading at $39.36/share with a $13.4B market cap, Affirm is -63% it’s Jan 2021 IPO. This biz should be growing at the same rate while burning a fraction of the current cash it’s torching.

Financial Summary

TLDR Analysis: Comically high Overhead

Gross Profits had a BIG jump. 😍

Sales/Marketing + SG&A Cuts in the right direction but not enough. 😰

Lost half a unicorn. Which is half as much as last year, but still… 🤮

This biz operates like an 80% margin SaaS biz, but it’s really a 40% Gross margin tech-enabled Finance platform.

They need to align their Overhead structure accordingly. This biz is growing fast, has great potential, but it doesn’t need to light a mountain of cash on fire getting there.

It also needs to get its Financial costs in order as their Gross Margins have decreased from 50% in 2021 -> 43% in 2024. There’s so much money to be made in this biz, but the biz needs to survive to unlock it.

Let’s Fix This Biz!

Here are the 3 moves we’ll make to turn Affirm into the next $100B mega-financial player.

1) Get Fit

Affirm’s P&L is a borderline war crime. 

It’s honestly shocking they’ve continued to get so much funding post-IPO given their Unit economics and out-of-control spending.

Let’s be honest. Affirm is a Financial company, not a purebred 80% margin SaaS biz like they’d like everyone to believe.

If you split their Operating Expenses into Financial-related expenses required to service their customers (not proper accounting, but I’m calling these COGS) and their traditional Overhead (Sales/Marketing, G&A, etc), their ludicrous spending becomes obvious.

COGS (how I’m defining it) is 57% of Rev and has been climbing dramatically (was 50% of Rev in 2021). Leaving them at  43% Gross Margin for 2024.

Their regular overhead (Engineering, Sales & Marketing, and G&A) are 80% of Rev. On a 43% Gross Margin biz, I hope you see where the problem lies.

I’m not saying they need a full Elon slash and burn, but they need a half Elon at least.

They need to get a handle on their financing costs and get Gross Margins back to >50% while getting overhead to <50% at the same time.

There’s a case to run this biz as Ramen profitable (barely profitable) since they don’t have real CAPEX investments. 

Bottom line: There’s no reason this biz should be burning this much cash.

What makes it unacceptable for me is that they’ve paid employees $1.4B in Stock Based Compensation (SBC) since 2021. And it’s been consistently $400m+/yr.

We can argue about how it shows up in the P&L all we want, but the biz has remained highly unprofitable while diluting their shareholders by a unicorn+.

Takeaway: 40% Gross margin transactional bizs can’t afford to burn like a real Tech biz.

2) Move Upstream – Create a Consumer Bank

Affirm is a consumer finance biz marketing itself as an AOV booster for brands. It’s a genius way to acquire consumers for free, but their true aspiration is to become a consumer finance app.

In their 10-K, they mention the words “Consumer” 419x and “Merchant” 293x.

The products they talk most about: 

The Affirm card:  A debit card with payment terms

The Affirm Marketplace: Affirm’s network to drive traffic to brands’ sites

When you look at their Rev, it becomes even more obvious. 52% of it comes from Interest Income from the loans they middleman to consumers.

Let’s say you put your $3,900 Gucci Handbag on an Affirm program with 2% monthly interest. Affirm is selling the loan on behalf of a bank to the consumer and takes a cut of the interest the bank charges. 

If we play this out naturally, the most lucrative play for Affirm is becoming a consumer bank (which also mitigates their largest risk).

If they run the payments and encourage consumers to deposit their paychecks into an Affirm account, it:

Gives Affirm the Holy Grail as a loan provider: consumers actual cash flow data.

Mitigates their largest risk: They can always directly pull the money if a customer doesn’t pay.

Makes them stickier with consumers and more attractive to Merchants.

By far the most important of all: Gives them deposits that they can turn around and loan out to consumers + their merchants. AKA eating more margin on their fastest-growing biz line. Getting a banking charter is no walk in the park, but if they can, it would fundamentally change their biz.

Takeaway: Always follow the money. That’s where the priority lies.

3) Launch the Layaway Costco

20% of Affirm’s processed GMV ($4B) happens through the Affirm Marketplace. Today, this operates like a massive Affiliate program, kicking consumers to the Brands’ websites.

They should launch the digital equivalent of an anti-Costco. 

Instead of customer bulk buying for a discount on economies of scale, Affirm’s main value proposition is passing along payment terms to their customers.

All retailers operate on the classic payment terms model where they accept and sell a vendor’s  (the brand) product, then pay them back over time.

As an example, let’s say I run a soap biz, and Costco is a Retail partner.

Costco buys the soap from my biz on payment terms. Usually Net 60-90. Meaning: if Costco purchases the inventory from me today, they don’t have to pay me for that inventory until Mid-Dec or Jan.

Costco places a Purchase Order (PO) from me and I ship them the product.

Costco sells the inventory over the holiday period.

(In a perfect world) Costco takes the cash from consumer purchases to pay me. 

Essentially Costco uses my soap biz (and all of their vendors) to finance the profits they’ll make selling my items to customers. Instead of charging Costco a % on the money I’ve “loaned” them, I’m taking the additional Revenue and prestige of selling in a retail partner as the value generated.

If you want to learn more here. This is a great short vid that explains it.

Affirm can play with this model by passing along the vendor cash float to consumers. In this case, they could arbitrage the vendor float to give customers payment terms to their customers instead of a discount. 

In other words, Affirm can tackle consumer affordability from 2 angles:

Adjust payment terms so consumers have more time to collect the money to “afford” products. The classic Layaway offering.

Adjust interest rates on products to give consumers more purchasing power (Similar to mortgage or car financing).

This strategy wouldn’t eliminate the need for discounting, but it would give a unique value prop to stand out as a new retailer in the industry.

My greatest hypotheses to test: how much margin can this protect by giving more consumers time to pay vs. % off? And how much could be passed along to the brand?

Affirm already has the value prop of a built-in customer base who purchase on payment terms (In 2023 – 88% of GMV came from Repeat customers).

They can enter via frequently financed purchases, including Furniture, Travel, Groceries, Big Bulk Purchases, and Expensive items in general. Then expand into new categories as consumers buy into this purchase pattern.

Credit cards are tackling the same consumer issue of how do I afford this item? Affirm can provide different flavors of credit that have traditionally been restricted to huge ticket purchases.

Takeaway:  Turn Payment terms into the next Retailer playbook.

Final Thought

The greatest bizs evolve over time, and if they play their cards right, they evolve into a bigger market than their original one.

It’s impossible to say if Max Levchin (Founder of Affirm + Co-Founder of Paypal) always thought about growing into the consumer market through the B2B segment.

But 1 thing is obvious now. 

The consumer opportunity, even if B2B is the path to get there, is so much more valuable than the original B2B biz model (offering Merchants payment options at checkout).

At the end of the day, Affirm needs to:

Run as many $$$ through their payment processing system as possible to…

Capture as much consumer purchasing data as possible, to…

Sell as many “good” loans as possible. 

That might not be what they say they’re going to do, but when consumer is the largest and fastest-growing Rev segment for their biz, it’d be foolish not to focus on it.

Today we laid out a couple of options of how Affirm can tackle it, and there will be many more angles of attack. But no matter how they paint this picture, loaning more money to consumers is how they become a $100B biz.

There’s a possible case that they can achieve the same staying on the B2B track. But power laws are already taking over this biz.

I also have to give it up to Shopify with one of the most intelligent investment moves I didn’t fully appreciate. 

In Jan 2021, when Shopify invested in Affirm, Affirm’s Rev from their Interest unit was almost equivalent to its Merchant Network Rev. Today, its Interest Revenue is 2x the size of Merchant fees.

Shopify was smart enough to see the trend: Affirm is really a Consumer Loan biz on the back of a payment processing biz. Shopify also understood the scale of how that would compound over time. 

(Similar to how 70% of Shopify’s Rev comes from payment processing.) 😉😉

Affirm’s stock is still getting absolutely hammered, so we’ll see how it performs long-term. But if they can get their costs in order and grow into the scale it should be at, this has the potential to be a huge earner for Shopify.