Afterpay – The Future Of Buy Now Pay Later [SGO 18]

Joining me to geek out on this company called Afterpay and the future of Square is Tee Leng aka Tee. He runs Heritage Fund which manages family wealth and he’s also a bottom-up stock picker where he picks from the ground, look at the fundamentals, but he has changed his view from deep value all the way more towards the kind of growth-centric ideas. 

We will be doing an episode with him on Chills with TFC so if you have not followed us on our other podcasts or our YouTube channel, please check out all the other stuff if you have not yet to see his shift… why from deep value all the way to growth as a company. 

After merger, Square will be its largest position at some point in managing the whole company’s capital so let’s try to understand a little bit more about where he sees things and the future of Afterpay. 

For your reference sake, this episode was recorded on the 24th of October. I decided to put it earlier, because… they merge already. Our discussion today is solely for education and entertainment purposes only. It does not serve as any form of advice or recommendations. Thank you for loving what we do and empowering us financially to do more for you. Join our Telegram group for further discussion. Let’s geek out!

Okay, so we’re back with another episode of TFC Stock Geekout and we are with Tee today. Does everybody call you Tee? 

Tee: Yeah, everyone just calls me Tee. After studying in the UK, the British people can’t really pronounce Chinese names so I just cut it in half and it just stuck that way. It’s much easier as well.

Reggie: I mean, tea is a thing with them, so it is what it is. Yeah, we are in the house today together with Tee and we’re going to talk about this company that is supposedly a very big part of your portfolio position. It’s this company called Afterpay. 

Tee: Yeah, it got bigger especially after Square bought it out. I mean, we were both shareholders of Square and Afterpay. We liked both companies… both companies combined together now. I do like it more. I think Afterpay makes Square much more complete in certain sense. So yeah, it’s probably the biggest position now if you actually consider Square and Afterpay together.

Reggie: Tell us more about Afterpay. It’s not the first payment company that we’re talking about in the space. What are your thoughts about it? What do they do? How does it work? All that jazz.

Tee: Afterpay is more in the Buy Now Pay Later industry. I do believe that this Buy Now Pay Later, it’s still in its infancy stage in Singapore. We don’t actually see it that prevalent yet as compared to the West. Afterpay actually started out in Australia. It’s probably the number one Buy Now Pay Later company in Australia and they have actually expanded to US as well. 

Growth rates there have been tremendous. It’s been great. Of course, there’s more competition in US as well as other names like Klarna which is a Swedish name. There’s Affirm which is backed by GIC. I do believe that there’ll probably be other names out there as well, but yeah, that’s essentially the whole Buy Now Pay Later… it’s a new trend. It’s a new fundamental shift that I actually do see happening, but probably not really happening as fast in Singapore. I guess, Singapore is a small country. Things don’t happen as quickly. If you look at our STI (Straits Times Index), things do move quite slowly.

Reggie: Fair, fair. Okay, so what about Buy Now Pay Later that you think is interesting? For a lot of consumers, there are a lot of retail investors… as a consumer landscape, when they look at it, it’s just well, you get to buy things earlier and then you cut it up into a few payment chunks. But as an investor, what’s so exciting for Buy Now Pay Later?

Tee: Buy Now Pay Later in layman’s terms… what we actually understand is like instalments. You buy a house in instalments. If you go to Harvey Norman, you go to Courts, they do have these kind of instalment plans. Interest free, (it) allows you to split up the payment over X amount of tranches and you could actually collect your product at the onset when you actually make the first payment.

That’s essentially the same thing but what’s really exciting me is that I do believe that there’s actually a shift in mindset. People are becoming… or rather the younger generation, which is the target audience of Afterpay and many of these Buy Now Pay Later companies, this younger generation, if you actually understand them, there is actually a shift in the mindset. 

The shift actually is not just about Buy Now Pay Later. Buy Now Pay Later is like any other instalment plan but I think fundamentally, what I’m actually looking is the shift in spending mindset which makes me more comfortable with Afterpay. 

If Afterpay doesn’t have this shift in the spending mindset, I’ll be quite worried because people will probably be spending on Afterpay if they have actually mixed up their credit cards and all that kind of stuff. They want to turn to alternative sources of lending, hence they will turn to Afterpay and you probably see high credit risk (in) people shopping on Afterpay. 

But because of the shift in spending mindset for the younger generation, it makes me more comfortable with Afterpay that hey, people… the younger generation shopping Afterpay is not that high a credit risk. They actually have the cash in the bank balances but because of the shift in the spending mindset, it’s safer. These people are much safer. 

If we look at the default rates of Afterpay… the people shopping on Afterpay, the default rate as of last fiscal year 2020, it’s only 0.85%. In a lending business, it’s normal. You cannot say that you have 0% default rates. Even our banks have a certain amount of default rates, otherwise known as non-performing loans. Singapore banks… on non-performing loans, which is one of the lowest figure already, it’s about 1.5 – 1.6% so for Afterpay, it’s 0.85%. 

I think they are doing way better. It’s almost half of our local banks. I’m not too worried and like I said, I have actually looked at the statistics how things have actually been shifting in terms of the spending mindset for the younger generation. It makes me more comfortable investing in a company like Afterpay. 

Reggie: Yeah. So what is this shift in spending mindset? Where were we and where are we going towards? How is it changed? 

Tee: I guess… maybe let me give you some experience, my own experience. I studied in London and when I was spending my time in London, I didn’t have a credit card. I only used a debit card and most people in London actually use debit card. To me, I was fine with it. How much cash I have in my bank, I spend based on my means. I don’t overspend and I felt it was safe. I won’t accidentally spend too much because I know roughly how much I have in my bank account. If the card doesn’t cross, it means that the amount is too large for my bank account to actually handle. I like the concept of the debit card. 

When I moved back to Singapore, most people I know in Singapore use a credit card. I was like “hey, why should I get a credit card when the debit card is actually serving me fine?” So I continued using the debit card. The only reason why I decided to get my own credit card was because of the entire miles game. I wanted to collect miles, earn the miles to actually redeem for business class tickets which I guess most… it’s another trend but we will not talk about that trend. 

That’s the whole reason why I got myself a credit card. Even though I got myself a credit card, I only have one credit card until today as compared to my parents. I remember going out shopping at a certain mall, you have to use a certain credit card because on weekends, you get more points, more bonus points… In certain restaurants, you have to use a certain credit card because there are certain privileges and all that kind of stuff and I didn’t want all of that. 

To me, it was a huge hassle, having to remember which card to be used at which mall, which day etc. I didn’t want all that hassle. To me, the only reason why I got credit card was for the miles. Essentially, I just get the best credit card which gives me the best mile conversion. 

But I thought that maybe this thinking was only isolated for myself. With value investing, that’s one thing I’ve learnt that… your kind of thinking is probably a bit more unique. You do not actually represent the entire population or the mass population so I thought maybe this thinking of mine was exclusive in some ways to myself. 

It’s only after hearing my wife tell me about her friends in Australia were buying clothes, buying undergarments and all… small ticket items but paying in instalments. My first response was “is your friends… overspend?” Have they maxed out all their credit cards that they are so desperate that even clothes, small ticket items like $50 have to be paid in instalments? 

Because as Singaporeans, the only time we hear this word “instalments” is probably when we buy big ticket items like a car or a house. We only pay that in instalments. It got me started thinking… very curious. I started looking into the industry and I was like hey, after looking at the numbers, in terms of what I talk about the shift in spending mindset, I realized that this thinking of mine, liking to spend on a debit card, only wanting to have one credit card, it was not exclusive to myself. 

The younger generation in Australia, in US… this research was actually based in the US, was that the younger generation actually don’t like to spend so much on credit cards. Only 33% of them have actually a credit card and more of them are spending on debit cards. Even though they might have a credit card, they only have one credit card. 

This is the shift: the credit cards per generation per person has actually been decreasing by each generation. I was like yeah, I can actually relate to this. I understand why. I also do like spending on a debit card, but because of the miles game, I got myself a credit card. I could relate to this and looking up the research, reading up surveys that these researchers have actually done… interviewed these younger generation. 

The reason why the younger generation are more wary when it comes to credit cards is because they have actually seen their parents go through the global financial crisis and they could actually see first hand the detrimental effects of using credit and too much credit so psychologically, I guess it affected them to the point whereby they prefer to just use debit cards more and more. It’s this shift in spending mindset. 

Sometimes, talking to some of my friends here… I don’t know about yourself. Even your taxes, your income taxes… the Singapore government allows you to pay via GIRO over 12 months or at one shot. I do have some friends who will actually pay over 12 months. Not that it… 

Reggie: Really? 

Tee: Yeah, I do know of people who would actually do that, even to the point of credit cards, there’s date due by… they will actually set the payment to be that date due by even though if it’s five days later, 10 days later, they will do that. Not that that cash sitting in a bank account would make you huge amounts of money… in certain sense that working capital is not going to change anything but it’s just more of a mindset that “hey, if I can keep it in my bank account, why not? Why should I hand over the money even though I have the money over to the banks or over to these merchants so quickly when I can actually just keep some spare cash in my bank account?” 

That’s essentially that shift in spending mindset I’m actually talking about. The people shopping on these Buy Now Pay Later platforms, they are not high credit risks. If we understand this shift in spending mindset, we will realize that the individuals shopping on these platforms are actually of a lower credit risk. 

Reggie: That is interesting. Essentially, Buy Now Pay Later is a pseudo credit structure. It’s like… very instalment basis and you’re not really loaning anything and you’re just splitting up your payment and in your view, it is challenging… the credit card dominance out there in the market. This is a dynamic shift in how people use their money. 

Tee: These Buy Now Pay Later platforms, you have the option. You can either link it to your bank account. You can link it to your debit card. You can link it to your credit card. It’s not exclusive to payment via debit cards or bank account only but because of the shift in spending mindset, it’s essentially just making me more comfortable, making me understand that hey, these people spending on these Buy Now Pay Later platforms, they are not of a high credit risk. 

But if there is no shift in spending mindset, people still love shopping on credit cards, they could easily just link the Buy Now Pay Later platform to their credit card. That’s a big problem to me that, people are paying in instalments and not just pay… are they paying in instalments? They are using credit. They’re borrowing money to actually pay in instalments as well. That’s a huge problem to me. 

That’s why I say that this Buy Now Pay Later… it’s also riding on another fundamental shift, that shift in the spending mindset, which makes me comfortable with the Buy Now Pay Later platforms. 

Reggie: Nice! Okay, so what is the Buy Now Pay Later business for these companies? How do they make money? What is their model? 

Tee: So each company, each Buy Now Pay Later platform probably has different…

Reggie: We just focus on Afterpay. 

Tee: I can only tell you about Afterpay. I have not really looked at these other companies and to be fair, when we invested in Afterpay, all these other Buy Now Pay Later platforms weree not listed yet. There was not much of a comparable back then as well. 

For Afterpay, I thought their revenue model actually makes a lot of sense. You think about it, for credit cards, they only make the real money when you don’t pay up. Come end of the month, you don’t pay up, that’s when they will charge you really high interest rates. That’s when they really make their money.

To me, that model doesn’t make sense. There’s a huge irony there where there’s a huge conflict of interest. It’s the same way as a hospital. You go to a hospital, you go to doctors because you want to get cured but a hospital as a business only makes money if you are sick. So as a doctor, do I actually want to be curing you or do I actually want you to continue being sick? Curing you essentially hurt my own wallet, but then prolonging your sickness and all that stuff is going against my Hippocratic Oath. 

That, to me, is a huge contradiction in the revenue model. (On) one hand, you have your ethics. (On the other) hand, it’s your money, your income and all. How do you actually balance the two?

For Afterpay, I felt that it was much better. It’s more fair. There’s no conflict of interest. There’s essentially three stakeholders. You have the merchants, you have the customers and you have Afterpay themselves. In these whole instalments, they don’t charge you any interest. It’s interest free. Even if you default on the payment, at most they’ll just charge you a late payment fee which is a fixed amount and there is still no interest charge. 

The real money comes where they actually have this commission, the take rate where they actually charge to the merchants, which is 3 – 6%. Smaller players pay about 6%, larger players pay about 3%. That’s the revenue model of Afterpay. 

That actually makes sense to me. You see, customers, they don’t get charged all this interest and all that kind of stuff. It’s fair to them. For the merchants, whatever the customers actually check out from the merchants, there’s a 3 – 6% take rate which is given to Afterpay. Where the merchants actually benefit from this whole equation is that… what research has actually shown and this has been proven with real life case studies is that people with this Buy Now Pay Later when you can actually pay in instalments, the checkout baskets are actually much larger. Deducting off your higher take rates as compared to credit cards and all that versus the bigger checkout baskets, net net, the merchants actually still win. That’s why the merchants are actually winning in this equation. Of course, Afterpay benefits in the sense that they have that 3 – 6% take rate. 

Reggie: Okay, that’s cool. That’s cool. How are their financials looking like then, over this period of you investing in them? How have they grown? How have they changed? What are some of the numbers there?

Tee: In terms of revenue growth, it’s about… if I remember correctly, about 100 – 110%. That’s really driven by the expansion into US. In terms of… are they profitable? They are not profitable yet. The Australian segment is already profitable because that has been been around for much longer period of time and of course, COVID definitely helped as well. 

But because they are actually wanting to expand outside of Australia, they’re channeling all their profits into the US to actually expand that market base they actually have in the US and that’s the reason why they’re not profitable once again. That’s essentially the financials of Afterpay.

Of course, now Square has actually bought out Afterpay. We have to wait till this entire acquisition is over to actually see that pro forma income statement, balance sheet statement, and all that with the two companies joined together. 

Reggie: Top line revenue growth, about 100%. What are the other numbers looking like, from the debt, from… what are the things that you look out for when you’re trying to understand this company? 

Tee: When you look at it… comparing… we talked about my previous style of investment, it’s pre-COVID. The new style that… we have actually adapted to post-COVID. We are still going through COVID, but in that sense, post-COVID. There has been a lot of changes. We try not to focus too much on the numbers now because now, it’s really about the quality of the business, the qualitative aspects, the management and the business model… does it resonate with us etc?

The numbers… we do look at it, but it’s not our main focus anymore. Some numbers are like… I shared with you, the top line is going 100+%. In terms of the leverage and all the debt levels, it’s not a huge issue. It’s a net cash position so that’s not really a bigconcern to us. It’s still cash burning, but we understand why it’s cash burning because they are actually trying to expand to the US market. 

Their default rates, which to me in a lending business is probably the most important figure, it’s low. It has actually been trending downwards. From 2018 to 2020, the default rates have been trending down from 1.5%, if I remember correctly, to 0.85%. I don’t know what’s the new numbers, but it seems like this is actually shifting downwards because if you think about it, not only is there a shift in the spending mindset that I talked about, but this platform, once you actually default on payments, you are essentially locked out of it. You can’t continue purchasing. 

In some sense, you’re weeding out those black sheeps. Over time, as the black sheeps are being weeded out of this platform, what you’re left with is more of the good sheeps, so to speak. That’s why I feel that the default rates will actually be trending downwards. Overall, things have been looking good for the company. I’m not too worried and it’s great. Like I said, Square have actually acquired Afterpay. 

Reggie: Yeah, sure. Share with me more, why do you think it’s great that they have acquired Afterpay and what is the structure like after acquisition? 

Tee: It’s an all-out acquisition. Square essentially offered shares to Afterpay’s shareholders. It’s not an outright cash acquisition, it’s a share acquisition. They will be issuing new shares to actually acquire Afterpay. In terms of the valuation, yes, it was a premium to what Afterpay was actually last traded at. I think it was about 20, 30% thereabouts. 

In terms of valuations, I won’t say that I was ecstatic about it. It was not the best valuation. I do believe Afterpay is actually worth much more, much much more. But yeah, at the same time, I’m a Square shareholder so I should be happy that I got a good deal that we acquired Afterpay at a cheaper valuation. I don’t know whether I should be happy or not happy. 

But yeah, like I said, Square, you have the cash app, you have the seller ecosystem, essentially the buy and seller site but Afterpay is a Buy Now Pay Later product. It’s a great product but as a standalone company, it can actually exist as we have seen with Affirm, Klarna and all. But as a standalone company, I think there is a certain limitation to it. But if Square actually buys out this product and incorporates it into its buyers app, sellers app, it can be a better company.

That’s why I say that it makes Square more complete in that sense where they actually have acquired Afterpay and that’s why as a Square shareholder, I’m happy. As an Afterpay shareholder, I am happy as well and that’s the reason why we decided not to actually sell our Afterpay position. We decided that we will actually accept the Square shares and that’s the reason why I say that the combined version of Square and Afterpay will become the biggest holding within our portfolios.

Reggie: Nice! So going forward, Afterpay will be fully-owned company in Square and everybody will be a Square shareholder eventually. 

Tee: Yes.

Reggie: If that’s the case, then let’s talk a little bit more about the management of Afterpay. Who are they? What is going to happen with them after the acquisition? Why do you like them? 

Tee: The two co-founders… there’s Nick Molnar, I can’t remember the other co-founder’s name. But essentially, both of them will actually be joining Square’s management. They will still be running Afterpay and they will actually be converting their shares to Square shares as well. 

So yeah, it’s not like the insiders are selling out their shares. These two co-founders are great. If you have actually looked at their history, Nick Molnar actually started out selling jewelries online and doing it in instalments and all that….sorry, before he actually joined his other co-founder to actually launch Afterpay. 

If you’ve read his interviews and all… I can’t remember exactly, I can’t give you excerpts of what he said and all that kind of stuff, but I remember reading his interviews and there are quite a few, if you want to Google it. It’s great. He talks about how Afterpay is. He wants to make it into this sort of culture, otherwise known as like cognitive reference and I think he has actually achieved it. 

In some sense, a product or service can become a cognitive reference where people say “why not you Google this” where Google is in some… in other words, search. “Why not you stay in Airbnb” which essentially is why not you travel and just stay in someone else’s home. These kinds of products or services have become cognitive reference where you actually immediately link it to a certain action. For example, when we talk about hot pot, I don’t know about you, but the first thing that comes to mind is Hai Di Lao.

So there’s these kinds of cognitive reference and that’s what the co-founder essentially wants to achieve with Afterpay. The guy is really, really young. He’s not an old dude who is just doing something. He is really interested and you see this kind of… to me, when I look at management, I want to see management who have displayed signs of innovation and that to me means that the company that I’m invested in will continuously be pushing that total addressable market that they are actually facing. 

With Afterpay… Afterpay first started off as a Buy Now Pay Later platform but over time, there has been a lot of innovation stuff like… credit cards punish you when you pay late. When you don’t pay on time, they punish you. But for Afterpay, they actually will reward you if you actually pay on time. It’s the reverse kind of thing whereby if you pay on time after a certain number of times, they will actually reward you and say hey, because… let’s say… it works like a milestone. 

You play games, you have milestones and if each time you unlock a certain milestone, you get extra rewards. What Afterpay essentially rewards you is you can delay a payment by another two weeks, maybe you can skip this payment and shift it two weeks later. These are the kind of rewards that Afterpay actually gives if you keep on unlocking these kind of milestones. 

As you show that you are a good credit rating individual, your spending limit is also increased as well. So it keeps on rewarding you when you display that “I will actually meet the payments on time” and these are the kind of innovation that I like to actually see happen in a company and management have actually shown that they have the ability to actually constantly innovate the company.

Even stuff like… they do a lot of social media. They always engage their audiences, their users. They will ask their users “hey, what is this… what’s the next merchant you would actually like to see on our platform?” and they will actually get the responses of their users. What actually happened… and they shared this case study was that the users all said that “we wanted to see Lululemon on your platform” and it’s actually quite a smart way. 

On one hand, you’re actually engaging with your audience. On the other hand, you’re actually gathering real data to actually show to the merchant and say “hey, my customers on my platform wants you to be on our platform”. Not only will it mean that your existing customers on our platforms shop more have bigger checkout baskets when you actually come on board our platform but you get access to this whole new other market of audiences who are not shopping with you yet but is on our platform as well.

So what happened was that Lululemon said “hey, we don’t want to be on your platform.” Afterpay said “sure, we won’t force you”, but the users, the customers actually bombarded Lululemon. They kept calling in, asking “are you guys going to be on the Afterpay platform?” to the point whereby the service, the hotline staff could not actually do what they were supposed to do and Lululemon said “hey, you know what? We will come on to your platform.”

Reggie: That’s like the Reddit effect, bro. Everybody wants it, then it happens. 

Tee: It is these kind of signs of innovation, ability to innovate that makes me like management as well. 

Reggie: Nice. Okay, but going forward, it will be part of Square. 

Tee: Yes. 

Reggie: What is the kind of competitive moat that you see in this merger and are you going to be like… it reaffirms your idea of this whole ecosystem now? What is the situation with that? Do you think it’s great to merge or do you think they would… 

Tee: I think it’s great to merge. Like I said, it makes Square, more complete. At this current point in time, Afterpay is growing quite well in the US but once they get incorporated into Square’s platform, they get immediate access to what Square has actually been building up, that X number of customers, merchants and all that kind of stuff. You’re essentially getting a huge leg up in the US market. They could probably reach there at some point in time, but being able to reach there faster, why not?

It’s that first mover effect, if you are able to actually build up that network faster, I would assume that itself is a huge competitive advantage as compared to let’s say Klarna, Affirm, who is actually still out there burning cash maybe, trying to actually acquire customers.

Reggie: Yeah, definitely. I agree with you and I think sometimes it’s always great to know when to merge, when to join forces, especially in an environment where everybody’s growing so fast. So what do you see the future of this whole ecosystem, the new Square together with Afterpay? Where do you think is the future of… I think most of us will know the business but how do you envision that growth trajectory? 

Tee: I mean… the thing about these kinds of growth companies and I don’t like to label companies, but if we have to use these terms, like growth companies and Square is one of those growth companies is that you don’t actually know where things will grow into. You just want to be invested into companies where you can see that optionalities. Optionalities… sometimes it’s when management has actually displayed signs of innovation, that itself is a huge optionality to you. 

Honestly speaking, I don’t know where it will grow into, but I know that this new company have huge optionalities. For example, you can ask me about Amazon in 2014, 2013. How am I supposed to tell you that in 2015, I can envision Amazon coming out with cloud solutions, there’ll be AWS (Amazon Web Services). Honestly speaking, I’m not Jeff Bezos. If I’m as good as him, I would have probably started the next Amazon and all that.

I’m not that. I only allocate assets, invest into companies. To me, it’s about pattern recognition, trying to find certain patterns that makes us successful companies successful and one of that pattern is that I like to invest in companies that has optionalities. It will give you a whole range of outcomes possible and yes, that’s what I’m essentially saying. Square, that new company will have huge optionalities. 

Over the years, we have actually seen Square come out and innovate many different things. When it first came out, it was just this Square dongle attached to an iPhone or a phone to what it is today where you have the cash app, you have the seller ecosystem where the cash app is constantly innovating as well trying to fulfill the needs of your customers, your cash, essentially your merchants to stuff like oh, you might want to do stock trading, you can do it on the cash app. People like crypto, you can buy Bitcoin on the cash app and these are all that kind of innovation, that kind of pushing the total addressable market and what I essentially call optionalities.

Reggie: But are you concerned about Jack Dorsey?

Tee: What are you concerned about?

Reggie: Part-time CEO… 

Tee: I mean… hey, he has managed Twitter and he has managed Square. Both have become billion dollar companies. I can’t complain, right? I mean, both of us… even if we are full time CEOs, have we actually grown our company to a billion dollar company? I find that if we have not actually done so, it’s a bit presumptuous of us to be saying “hey, you’re a part-time CEO? How can this be? You shouldn’t be doing this kind of stuff.” 

But in actual fact, he has actually been delivering a lot of shareholder value back to shareholders so if he’s a part time CEO and he’s doing so well… really, I can’t complain any further.

Reggie: Great. That’s a good clear standpoint because it’s something that people talk about. So going forward, what do you think… the moats will eventually become like Square’s moats where it’s huge. It’s out there. Is there any thing specifically you want to add about the moats of the new Afterpay colliding with Square? 

Tee: I guess a lot of people essentially thinks that it’s a winner takes all market, but I don’t think that needs to be one winner. Even in the payments industry which has been around for much longer time, you essentially see there can be… there’s Visa, Mastercard, Amex and all of them are actually existing quite well. 

After that, you have PayPal, you have Stripe, you have Square etc and they are actually existing quite well as well. It’s not a winner takes all market. I think they can actually be a few players so I’m not too worried that it has to be a Square take all or Square-Afterpay take all, Affirm take all, Klarna take all. I don’t think the market needs to be drawn that way.

Reggie: Okay, cool. In closing, you’ve shared a lot about the company. We should definitely do another one for Square, since it’s a new(ly) merged company. Any specific risk factors that you want to point out for our listeners when looking at the company Afterpay?

Tee: The biggest risk factor would probably… and this has been discussed quite long and often will be the regulatory risk because if the regulators actually see Afterpay as a lending platform like a bank then you have to actually comply with different regulations. The management of Afterpay has been fighting this for the longest period of time and it essentially said “hey, in a lending business, your revenue model is actually by making money through interest rates but we are not making money through interest rates. Our revenue model is really different and that’s the reason why we should not be regulated the same way as lending platforms.” 

For the longest time, they have actually been able to actually defend that position. The regulators have not actually come down on them and start regulating them like lending platforms but that it’s still a risk. In the future, you never know when this could actually happen. Maybe one day, when regulators see that Afterpay is huge enough that they want to actually regulate like a lending platform. 

They could, but we will never know. We can discuss till the cows come home and none of us will actually have a conclusion but it’s just one of those risks that we are aware of. If it happens to me, we have to just probably trust that management would know how to pivot the business and that’s the reason… to me, investing in all these growth companies, I want to be invested in founder-led growth businesses. Because to me, when the founders are actually still around, still actually leading the company, founders are always at the forefront of the business, thinking two, three steps ahead, thinking about what is the potential pitfalls or potential problems that company will actually face and how to actually pivot the business as compared to a business that has actually been passed on to the second and third generation.

This thinking of ours lends a bit from experience, from our own personal family experience and that’s why it resonates with us that when it comes to investing companies, we want to be invested in founder-led companies. 

Reggie: Nice. Okay. So a lot of people talk about regulatory risks, but maybe paint me a little bit of colour. Why is regulatory (risk) a concern in this business? How does it affect the business in terms of their growth? What are we looking at? 

Tee: I guess, in a lending business like a bank and all, there are certain licenses you actually require. If you’re managing money, you need licenses and all and when regulators actually come down and scrutinize, it will create that extra hurdle. Not that Afterpay cannot overcome these hurdles, but it probably would make… life would probably be much tougher where there’s more scrutiny. You have to report more. Maybe the government will say that “hey, because you’re in a lending business, we want a certain take rate from you as well”. That’s what happened in China.

Reggie: Ant Financial. 

Tee: Yeah. When the regulators come in, they say that “hey, it’s an unfair model. You’re essentially passing on all the risk to the banks where you essentially take that spread. That’s not fair. You have to have a bigger share in terms of the liabilities. You have to put more cash upfront.” That’s the thing about bank. You need to have more share capital upfront, you have more working capital needs and that will lock up more cash within the company rather than you could have used that cash for other purposes.

Like I said, for Afterpay, maybe they can actually overcome these kind of regulatory risks but why go through all that hassle, you know?

Reggie: So before that, just put the regulator at bay. I think that’s the goal. 

Tee: That’s how companies grow the fastest. If China, on the very onset 20 years ago, was full of regulations, I don’t think Alibaba, Tencent, JD and all could have grown so quickly. Because you have to be… on one hand, trying to manage your business. On the other hand, you still have to actually manage all these regulations and all. It makes life tougher as compared to… the regulations is not actually keeping up with you and your business is actually growing much faster than the regulations can actually think of what to regulate about you.

Reggie: I know. I’m not regulated yet, but just filing taxes is already driving me nuts. I’m like my goodness! Closing the accounts and filing the tax, I’m like… ah, guys. So tiring, right? I totally hear you on that.

Cool! I think you’ve shared a lot of Afterpay. Eventually by the time this goes out and for everyone listening, Afterpay would have really been merged into Square so if you somehow became interested in Afterpay, then you can only buy Square. We can definitely have a different, separate discussion about Square in the future… what are the fundamentals of the company and what have you. 

So in closing, is there any other last words you want to add and share that you think we have not covered specific to Afterpay?

Tee: Probably just one last thing. Afterpay, it focuses more on the beauty and fashion business segment. They are not in… oh, you can pay your car in instalments, you can pay your house in instalments. They’re more focused on beauty and fashion only and that’s actually deliberate. The reason why they want to actually focus on beauty and fashion only because beauty and fashion products… your brand, what brand, what logo they actually put on their website, they want a logo… which in some words is clean, it’s fashionable, it’s trending. 

You don’t want to put a not trending logo on your platform. If you are a trending… let’s say, for example, Lululemon. I assume that you are trending. I don’t really buy Lululemon stuff, but it seems like most females actually like Lululemon. 

Reggie: It’s very female-centric. 

Tee: Yes, so if you put a logo there, which is like… let’s say for example, Sogo, I don’t know. Sogo, Metro…

Reggie: Oh my god. Sogo, Metro just tells your age, bro. 

Tee: Yeah, so in that sense, you are also conscious as Lululemon… what brand you actually want to plaster on your checkout page? You don’t want to be putting a brand there which doesn’t speak of you. If a brand is so out of trend… like you said, it speaks of your age. You want to put a trending logo there and that’s the reason why Afterpay only focuses on the beauty and fashion segment and not only that. 

You think about it, people who check out from Afterpay… I shared this company with my friends, this investment idea and my friends and some of my friends, the first thing they said “hey, there’s actually a loophole. I just buy the product and I default. I just pay that first 25% and I just default on the remaining 75% and I have the product. I don’t have to pay interest rates. The worst case is that I don’t actually spend on this platform anymore”, but that’s the reason why they focus on beauty and fashion because the resale value is not huge. 

You buy a lipstick, you will use that lipstick. No one is probably going to pay you any amount to buy your lipstick as compared to if they focus on electronics. Electronics have a better resale value because it’s more commoditized. You can buy a microwave, use it one, two times. You can sell it for maybe a 10% discount and someone will probably want to buy it from you. That’s the other reason why Afterpay only focuses on the fashion and beauty segment.

Reggie: Nice! Okay, cool. So for every one of you listening in, you should check out the company, read the reports and eventually you should look at Square also. Thank you, Tee. Thanks for joining us today. Take care. 

Tee: Thank you, Reggie. 

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