Disclaimer

SEZL is a microcap and is best suited for small funds and PAs. I submitted this write-up for entry to VIC on December 17th when the price was $14.5/share. Despite the recent share price run-up SEZL remains a compelling opportunity which I would like to share with the VIC community. I've adjusted the valuation numbers from my initial write-up, the rest stayed the same.

Summary

Sezzle (SEZL) is a profitable “buy now pay later (BNPL)” company - isn’t it good enough for a thesis? LTM PE is 22.4, FY2024e PE is 14.

Reasons to buy:

• Industry with tailwinds. Despite the fact that most of the BNPL companies have lost more than 90% of their value after post-Covid tech valuation collapse, the BNPL phenomenon itself is here to stay. Penetration in the US is still low compared to the UK or Australia and there is evidence to suggest penetration will keep increasing. On Cyber Monday, BNPL usage hit an all-time high, with a staggering increase of 42.5% compared to last year, totaling $940 million in online spending, according to Adobe Analytics.
• Management. Sezzle founder and CEO, Charlie Youakim, already has one successful exit in the payments space on his resume. He now owns more than 40% of Sezzle. Despite the crazy valuations of the company in 2021 and 2022 he never sold a single share. Another BNPL company Zip was about to acquire Sezzle for $350m in 2022 but the acquisition fell apart due to deteriorating market conditions which tells us that CEO is not exactly an empire builder either. He bought nearly $1m worth of stock just three weeks ago on the open market and so did one other director.
• Valuation. Bankruptcy and dilution are off the table since the company went from losing $75m in 2021 to losing $38m in 2022 and to turning profitable in 2023. Revenue is growing at a healthy clip and management expects it will keep doing so profitably. Sezzle might be the only BNPL company in the world that is not burning money which is an achievement on its own. Profitable fintech company profitably growing revenue 25% a year valued at NTM(e) PE of 14 is a great deal.

Why does this opportunity exist?

• Company listed on NASDAQ in August 2023 while still being listed on ASX. The delisting from ASX is in process and will be finished in January 2024. The whole transition was not executed well. Australian retail is selling. Liquidity is low. 
• This is basically an undiscovered Australian microcap (until recently) that has not been written up on Seeking Alpha or VIC (until now!) and is not discussed much on Twitter or Reddit. 

Writeup layout:

I’ll start with generic thoughts on consumer credit and will follow with a description of the BNPL concept and its development from the 2010s to today. Then we’ll talk about Sezzle in detail - company history, management, business development, products and financials. I’ll conclude with valuation and risks.

Consumer credit

There are three types of consumer spending behavior. First one is when a person wants something, has the means to get it but decides not to, presumably for some benefit in the future. This is popularly called “delayed gratification” in various areas of our lives. Famous marshmallow test is the best one to describe the phenomenon. Second type is the most straightforward one - a person wants something, has the means to get it and gets it. Third type is an anti-”delayed gratification” or “instant gratification” which is when a person wants something, doesn’t have the resources to get it but uses any tools available in the system to make it happen anyway with likely negative consequences in the future. As civilizations progress they create more and more tools in their toolboxes to fuel the growth of type number three. 

Before modern day credit card was introduced, options to get something you want without having the money to do so were indeed limited. What could you do? Borrow money from friends or family, rob someone or simply steal the thing you want. Interestingly, there was one more option but it was not necessarily “instant”. It was called a layaway program and was available at certain merchants. Customer would put an initial amount, the merchant would take the product off the shelf (lay it away) and then the customer would go on and pay the entire amount in a number of installments within a certain period of time. After the last payment, the customer would take the product home. If the customer couldn’t pay at any point, the merchant would refund the money that had been already paid and put the product back on the shelf. This method was popular after the great depression not only because people didn’t have much money but also because the supply of goods was limited and people wanted to make sure they “book” the product before it was gone.

Everything changed in 1950 when the first modern day credit card was invented. It was called the Diner Club which was first used at a few local restaurants. The idea of the card came from an incident when a gentleman had forgotten his wallet at home while at a dinner in New York. We could say that at the time the card was not exactly a means to buy something you couldn’t afford but more a convenient way to make purchases without carrying cash. In 1958 Bank of America introduced BankAmericard to 60,000 people in Fresno, California. This was the first card to offer revolving credit which means if you had balance outstanding at the end of the month you could roll it over to the next month for a fee. In 1966 an alliance of banks rolled out a Master Charge card to compete with BankAmericard. Master Charge card was later renamed to Mastercard and BankAmericard became Visa in 1976. The love affair between the two, which continues until today, officially started.

Fast forward to today and we have US credit card debt crossing the one trillion-dollar mark only 65 years after the first revolving credit was introduced. “Civilization is the limitless multiplication of unnecessary necessities” quote attributed to Mark Twain (which quote is not) is a good description of what happened. “A river of red ink runs through American history” quote by Lendol Calder also fits well here. However, an important point to make is that while the modern-day consumer credit phenomenon is less than a century old, the notion of “credit” itself is as old as time. I guess there always were secret handshake deals and hidden illegal loans in place just to make a simple purchase happen when people didn’t have the full amount to pay. Credit cards just made it all transparent and trackable. Humans always wanted to get more than they could afford and found ways to get it.

Why all the trivia? First, it was fun to learn about these things. Second, BNPL is just another form of consumer credit (despite being often sold as a payment company) and I think it was important to cover how the story started. 

BNPL

Customer

BNPL stands for “buy now pay later”. BNPL gives consumers an opportunity to purchase a product or service without paying full price. Instead, the full price is split into a number of installments over a certain period of time. As long as the customer makes payments on time there is no interest fee, no penalty fee and no other fee. The golden standard of BNPL today is known as “Pay-in-4” which is four payments in six weeks (42 days). First payment is due at the moment of purchase. When a customer buys something with a $100 price tag, they pay $25 right away, and then they pay $25 three more times in two week increments. As the BNPL industry evolved, so did the product offerings. Today, customers are offered Pay-in-2, Pay-in-full, and other longer term payment options with interest through BNPL. We’ll discuss these later. First, we need to discuss the customer.

The first time I heard about BNPL was while watching an interview with an Australian small cap fund manager about five years ago. He explained the BNPL concept of “Pay-in-4” and talked about a company called Afterpay which had been implementing this concept very successfully. The first thought I had was “who in the world would use that?” and I dismissed even looking at the company. Don’t we all make mistakes? 

BNPL definitely falls under the third type of behavior we discussed - the customer does not pay the full price but gets the product or service right away. The most popular way to execute the type number three is through a credit card. BNPL is the only alternative. Indeed, until BNPL came along there was very little room between credit and debit for making a payment (physical cash filed under debit for the purpose of discussion). We have two groups of BNPL users: first group of people don’t have a credit card, second group of people do have the card but chose not to use it and use BNPL instead. First group could be further divided into two subgroups: subgroup A who can get a credit card but chose not to, and subgroup B who simply cannot get a credit card. People in subgroup B (majority of users) turn to BNPL out of necessity as a consequence of having no other options. The stats confirm that - most BNPL companies focus on consumers with less than $50,000 in annual income and are likely to have bad credit score without access to credit cards. 

For people in the first group and subgroup A BNPL is part of a lifestyle, conscious choice. These are mostly millennials and Gen Zs. Data is quite controversial because there are articles saying “Gen Z is ditching credit cards” and there are other articles claiming that “Gen Z faces fastest-growing credit card debt of any generation”. Arguably, Gen Z is the true manifestation of the “instant gratification” lifestyle so I’d think the second narrative is more true. Despite this fact, we do have a cohort of people who prefer BNPL services to credit cards. Generally, the reasons for this preference are overall aversion to debt and credit and ability to use BNPL installments as a budgeting tool. It could also be possible that this group of people simply maxed out their credit cards and now turned to the next alternative to spend more. Interestingly, in the case of Sezzle, 50% of their 2.5 million active customers do have credit cards.

Transaction details

Let’s have a closer look at the BNPL transaction. We generally have three parties involved: customer, merchant and BNPL provider. Let’s go through a hypothetical scenario: John buys a $100 bluetooth speaker from Jbl.com. At the checkout page he has an option to pay with a credit card but there is also an option to split the amount into four payments using Sezzle, so he only needs to pay $25 at the moment of transaction. John is the customer, Jbl.com is the merchant and Sezzle is the BNPL provider. Once the transaction goes through, Speakers.com gets its $100 which Sezzle provides, John spends $25 and has three installments of $25 left to pay within the next 42 days and Sezzle gets the first $25 John paid, a percentage of the $100 from Jbl.com for providing the service and a fixed per transaction fee.

What are the benefits for each party? John, as a customer, was given an option to pay in four installments interest free instead of having to pay full amount upfront. Jbl.com, as a merchant, provides optionality to its customer - both credit card option and BNPL option. Why is this important? According to various sources, more than 40% of consumers would delay a purchase or opt for a cheaper product if the BNPL option was unavailable. So, for merchants, BNPL serves as a tool to increase sales conversion for which they typically pay between 2% and 8% of the total sale price plus a flat fee per transaction. Lastly, the BNPL provider makes money as long as the fees it collects from merchants are greater than the cost of running the company. 

Typically, BNPL companies split costs in two categories - transactional and non-transactional. Non-transactional costs are normal SG&A, marketing, etc. There are three main transactional costs - processing costs, cost of funding and credit losses. 

Processing costs consist of transaction expenses to process payments and money paid to third-party vendors for checking background, credit history and other data which helps to determine spending limit for the customer (underwriting). 

Cost of funding is an interest rate company pays on its debt. Remember, when John buys the speaker for $100, Sezzle pays Jbl.com in full, gets $25 for the first installment and then collects the rest from John. To make this happen the company needs to have the $100 to begin with. BNPL providers typically fund these transactions with cash and debt. Oversimplified and idealized math on cost of funding is as follows. Say, John paid back all the money on time and Sezzle made $6 (6% on $100 transaction) in 42 days and now has its $100 back. There are 365 days in a year which means Sezzle can theoretically repeat the same thing 7 more times and make $48 total. If the initial $100 was funded at 11% APR Sezzle will pay $11 of interest to the debt provider and keep the $37. 

Credit losses account for the money that is never paid back by an end user. Not everyone is as diligent and responsible as John. Some people make that initial $25 payment and never pay the rest. 

To sum up, in order for the BNPL company to make as much money per transaction as possible they need to be able to charge higher merchant fee, reduce processing fees by improving technology and limiting third-party usage, and weed out bad customers who don’t pay back. All of the above should preferably be combined with favorable debt terms (needless to say, this part has been difficult since 2022).

Products

Why would a merchant pick one BNPL company over another? The first thing that comes to mind is price - the less merchant is charged the better. What if Company A charges 6%, Company B charges 4% but company A brings a lot more conversion with it? This can happen for different reasons: Company A has a larger active customer base, better product offering, better customer service, more recognizable brand, etc. Well, what prevents a merchant from offering both companies at the checkout? Nothing. That’s what most merchants do today: they offer multiple BNPL options for their customers just like it is possible to pay with Visa, MasterCard or Discover credit cards.

Why would a consumer pick one BNPL company over another? There are a few factors: spending limit that you are given at registration, number of available merchants at which you can use the service, fees you must pay in case of late payment, general brand recognition and, lastly, variety of products.

The standard product that every BNPL company offers is Pay-in-4. Next, there are Pay-in-2 and Pay-in-full. Pay-in-2 is popular for groceries and monthly subscriptions with the first payment due at the time of purchase and the second in two weeks. Pay-in-full option is typically used to get reward points and to demonstrate a good standing with a BNPL provider to increase spending limit in the future. BNPL is mostly an online product but customers wanted to use it offline. To satisfy customer demands many BNPL companies started offering virtual or even physical cards that can be used offline wherever Visa card can be used. To use this option, a BNPL company typically charges consumers $5 or $15 a month. Finally, BNPL companies started to offer long-term payment plans, normally up to 48 months with most popular ones being 3, 6 and 12 months, and APR of up to 35%. These long-term payment options resemble a standard lending business. 

To sum up, most BNPL companies offer short-term interest-free payment options with 1 to 4 installments, virtual or physical cards that can be used wherever Visa card is accepted, and long-term payment option where consumer pays up to 35% APR on initial purchase amount.

Industry

History of modern BNPL companies is relatively short but already full of interesting developments. Most of today’s household names were born in the 2010s to spearhead the industry with the BNPL concept. BNPL penetration was growing rapidly and the market quickly accepted the concept as customers absolutely loved the idea of payment installments. Leading up to decade end the valuations of BNPL companies (along with other tech companies) kept rising and an absolute peak was reached after Covid. High valuations resulted in industry consolidation as companies used their shares to acquire smaller players, typically to expand to different geographies. All of this bonanza was followed by the tech crash in 2022 with most of the companies losing up to 90% of their quoted value. Despite the valuation collapse the BNPL usage did not show any signs of stopping. According to a new report on the buy now, pay later market size, BNPL payment volumes in the US are forecast to hit $71.9 billion in 2023. This represents a 19.7% annual increase from 2022. Sales volumes are projected to continue increasing over the years. In 2024, the buy now, pay later market size is expected to further expand, to reach a total of $80.8 billion. A further increase of 20.4% is forecast for 2025, with total sales volumes set to hit $97.3 billion.

Key parameters of a typical BNPL transaction like merchant fees, credit losses and transaction fees are usually calculated as a percentage of total sales amount. There are different terms used in the industry for this amount but the most popular ones are Gross Merchandise Volume (GMV), Total Trade Volume (TTV), Underlying Merchant Sales (UMS), Underlying Sales (US). They all mean the same thing.

Klarna is the largest BNPL player in the world. It was founded in 2005 in Sweden. The three co-founders were way ahead of their time but they stuck to their guns and it paid off. Today, Klarna is an international company with 150m consumers and 500k retailers across 45 markets. Last quarter they announced their first profit of $9m in four years on a $580m revenue. Klarna’s valuation was slashed 85% post tech crash to current $7.85b figure. This still represents a whooping 164x annualized earnings or 3.3x annualized revenue valuation. They will IPO eventually. 

Affirm seems to be a recent market darling after having doubled in the last month - market cap today is $11.5b and EV is $16b. Holiday season and recent partnerships must have affected this price action. Affirm, a Silicon Valley based company, was founded in 2012 and IPO-ed in 2021 right in the middle of the tech valuation bubble. Today’s market cap is a pale shadow of what it was in 2021. However, Affirm is still valued at 6x revenue and is losing a lot of money. Latest quarter operational loss was $200m. They have 16m users and 266k merchants. More than half of their revenue comes from lending business (long-term payment option) and another half is the pure play interest-free BNPL revenue.

Zip Co, an Australian company, was founded in 2013 and IPOed in 2015 on ASX. Zip does its business internationally but main sources of revenue are Australia and the US. Zip grew a lot through acquisitions. Current US operation is largely a former competitor QuadPay which they acquired in 2020 for $296m. It is the most levered BNPL company I’ve seen - they have more than A$2b in debt with a market cap of A$340m. They are burning cash at a A$100m/year rate. Lately, US business has been turning around on cash burn but AU business looks really bad with credit losses trending up. Zip trades at 0.5x revenue and is an interesting company to watch.

Afterpay is an Australian celebrity. Afterpay was founded in 2014, IPOed on ASX in 2016 raising A$25m at a A$125m market cap and was acquired by Square (now Block) in 2021 at 40x revenue for $29m (A$39m). This was a handsome 312x from the IPO levels. Afterpay definitely set the tone for the industry at the time as it was growing very fast and was the most recognizable brand in the BNPL ecosystem. 

PayPal introduced Pay-in-4 product in 2020 solidifying the fact that the BNPL concept is the real deal. Out of 430m PayPal users 60m used the PayPal BNPL product. PayPal processed more than $20 billion of BNPL payment volume globally in 2022.

Apple Pay Later was first announced in 2022 and released to a limited number of users in the US in early 2023 followed by a full release in the US in October. Goldman Sachs partnership plays a key role in this product so it is unclear how Apple Pay Later would progress since Apple pulled the plug on the partnership.

Australia, US and Europe are not the only regions where BNPL gained traction. Southeast Asia and the Middle East enjoyed a healthy pickup in BNPL users as well. Low credit card adoption and general aversion to debt make BNPL a great solution for consumers in these regions. Akulaku and Kredivo are the largest players in Indonesia. Akulaku with its $600m revenue, $5.7b GMV and 30m users raised $200m in December 2022 at $1.7b valuation. Kredivo raised $270m just in March of this year making it a $1.3b company with $160m revenue. Tabby is the most promising company in the Gulf Region with 30k merchants and $6b TTV. They are moving their HQ from Dubai to Riyadh and raised $200 million in its Series D funding round, achieving a valuation of $1.5 billion or 12.5x revenue. Important to note here that PayPal is an investor in Tabby. Speaking of household name backers - eBay is an investor in UK BNPL company Zilch. Zilch has 3m users with £30m in revenue and is valued at 53x revenue or £1.65b.

As we can see, despite the collapse of BNPL valuations in 2022, more funding rounds are getting done in 2023 at yet lofty prices. Most of the industry is still in a land grab mode burning money. There is a trend in the industry worth pointing out: a shift towards a lending side of business as opposed to the interest-free pure play BNPL option. Affirm claimed that in the latest quarter 74% of their total merchandise volume consisted of interest-bearing loans. Companies do make more money with this approach but I doubt it is a good solution for already financially vulnerable consumer. 

Sezzle

Story

Charlie Youakim, the 5th of six children in an immigrant family, holds a mechanical engineering degree from University of Minnesota. He started his professional journey as a software developer in a payments industry, went back to his alma mater for an MBA and sailed off into the entrepreneurship world right after. He co-founded Passport in 2010 and exited in 2015. Passport became a leader in software and payments for the transportation industry. After the successful exit Charlie wanted to leverage his knowledge in payments but in the retail sector this time. So he called up his college ping pong buddy Paul Paradis with an idea to create a company that would drastically decrease transaction processing fees for merchants. This is how Sezzle was born in 2016. The idea didn’t work though - the usage was low and Sezzle couldn’t find the right product-market fit. So in 2017 they pivoted - they discovered a new popular thing called BNPL was trending (Charlie’s wife saw an Afterpay ad on social media) and decided to make a shift. Needless to say the decision worked and the product took off almost immediately. Charlie is still the CEO with a $250k salary, owns more than 40% of the company, lives in Minneapolis and works from Puerto Rico during winters. He recently bought almost $1m worth of stock on the open market and so did one of the directors.

Sezzle, although founded in 2016, became a BNPL company in 2017. Two years later they IPOed on ASX. The reason for choosing the ASX listing as opposed to the US listing was the familiarity of Australian investors with the BNPL concept (thanks to Afterpay story) and the fact that you can IPO there with a much lower market cap. Just like everybody else in the industry, Sezzle enjoyed crazy valuations up to 2022 following the standard “grow, burn money, raise money” routine. They initially started their operations in the US and Canada but then expanded to Europe, Brazil and India. In February 2022 another Australia-based BNPL company Zip announced an all-stock deal in which they were to acquire Sezzle for $330 million (A$491m), based on Zip's share price. Deal fell apart due to “deteriorating market conditions” according to the announcement made later in June which stated the mutual agreement to stop the merger.  In August 2023 Sezzle listed on NASDAQ and a bit later announced voluntary delisting from ASX. Shares will be fully delisted from ASX in January 2024.

Right after announcing the acquisition deal with Zip, Sezzle decided to pivot from growth to profitability. Within two years they went from losing $75m to being profitable. They shut down operations in Europe, India and Brazil and reduced headcount by 20% in North America. Today Sezzle is a Minneapolis-based company with remote-first culture and operations in the US and Canada.

Products

Sezzle has traditional products which are similar to what others offer in the market and a few unique ones. The standard products that belong to Sezzle Platform are Pay-in-4, Pay-in-full and a Virtual Card. Sezzle Premium ($9.99/month) is a subscription service which lets you use Sezzle service in a larger merchant network, get higher rewards and discount deals. Sezzle Anywhere ($16.99/month) is another subscription service which lets you use a Sezzle Card anywhere where Visa is acceptable. Sezzle also offers long-term financing for high ticket items but they don’t carry any balance sheet or credit risk nor they collect interest from the consumer. Sezzle merely links lenders with consumers and collects a fee as a platform that makes the match possible.

The two unique products offered by Sezzle are Pay-in-2 and Sezzle Up. Pay-in-2 is exactly what the name says but for some reason no other BNPL company offers it. Sezzle launched Pay-in-2 fairly recently and had great success with it so I am expecting others to catch up on this offer. Sezzle Up is a program that helps consumers to improve and build up their credit score. Typically, BNPL companies do not report customer activity to credit bureaus. Customers who choose to participate in Sezzle Up give their permission for their data to be shared with credit bureaus and have a chance to improve their credit standing as long as they make payments on time. If they don’t, surely, the credit score will get hurt. Customers absolutely love the Sezzle Up product and I am not sure why other BNPL companies have not released a similar product.

It looks like Sezzle listens to their customers very carefully and offers their services at niche-y merchants where other companies don’t bother to go (Vape Tyson is a good example). You can find categories like “Small businesses”, “Black owned businesses”, “Ethical & Sustainable” in the Sezzle app.

If you want to reschedule a payment you can do so for free for the first time. After that it costs $7.50 per adjustment. If you miss a payment your account gets deactivated. To reactivate an account there is a $15 fee. Also, in Sezzle you can make free payments as long as you have an ACH connection. If you choose to use debit, credit or prepaid card for making payments there is a $5 convenience fee.

It is important to note a big difference between credit cards and BNPL - you can be in big financial trouble and keep using your credit card just making your problem even bigger but with BNPL you can’t do that because the moment you miss the first payment the whole account is deactivated. A BNPL company succeeds when their customer succeeds. 

Numbers

Sezzle reports two types of revenues: transaction and other. Transaction revenue includes fees from merchants, virtual card fees and convenience fees. Other revenue consists of reactivation, rescheduling and subscription fees. Subscription fees increased drastically (see below) within the last year and a half so I expect Sezzle will branch it out as a separate type in the reports soon enough.

            Q32023           Q22023           Q12023           Q42022           Q32022

T          $27m               $25.9m            $25.8m            $27.8m            $25m  
O         $13.8m            $9m                 $8.8m              $10.7m            $5.3m

Sezzle released Sezzle Premium last year and Sezzle Anywhere this year and already boasts 230,000 active subscribers for both products combined. This number is growing fast - last year this time they had only 88,000 subscribers. What the company is trying to do is to diversify their revenue and make it less dependent on merchant fees by directly involving consumers. It could backfire because we don’t know the churn rates which I assume will be quite high at the beginning. 

Provision for credit losses:

9m 2023          9m 2022          FY2022           FY2021
$12,667,346    $24,036,357    $29,437,179    $52,621,682

The line above is the major contributor to improving profitability of the company. Sezzle also reduced transaction fees by only allowing ACH payments for free, and took a cut on marketing spend and personnel. All of this combined made it possible to go from losing $75m in 2021 and $38m in 2022 to what I believe will be more than $5m profit in 2023. Free cash flow is still a little bumpy because of working capital changes. Receivables jumped quite a bit with rapid revenue growth. Sezzle also offers merchants an interest-bearing program in which merchants may defer payment in exchange for interest. Because of the sharp rise of base rates this program became unviable for merchants which is reflected in accounts payable dropping from $83m in Q4 2022 to $65m in Q1 2023. It slowly started to pick up after Sezzle changed their rate from 3.80% to 5.80% in March. I expect WC changes to normalize and we’ll see a steadier FCF line soon. We also should note that profitability was reached despite the fact that cost of capital doubled within the last year as Sezzle is paying hefty SOFR + 11.5% for its credit line. 

I believe Sezzle did not stop looking for ways to cut costs. There are 5-6 job openings for tech roles in Colombia. Sezzle is likely arbitraging labor.

So far, the only negative KPIs we see are the numbers for active customers and active merchants. “Aren’t those the most important metrics?” one should fairly ask. And the answer is “yes”. The reason behind this decline was an outpouring of unprofitable merchants combined with Sezzle’s tighter underwriting policy which allowed for dramatic reduction of provision for credit losses. Number of active users dropped a good deal from 3.2m last year to a current 2.5m figure. Number of merchants dropped from 45k to 30k within the same time. Management expects this trend to flatline by the end of the year and reverse going forward. 

Unit economics provided by Sezzle in their presentations is a little bit confusing. The intent is understandable - to provide all line items as a percentage of UMS. For example, let’s take the latest reported Q numbers. Revenue was $41m and UMS was $470m which puts revenue at 8.7% of total UMS. Transaction expenses were 2.1% and credit losses were 1.4%. I find the top 8.7% misleading because only $27m out of $41m is coming from merchant fees, the rest is coming from subscriptions. That would put “merchant transaction” revenue at 5.7% of total UMS. Another interesting, almost anecdotal, definition is one for “non-transaction related operating expenses”. The main contributor to this “non-transaction expense” according to the company’s presentation is, hold your breath, “transaction expense”. I don’t think management has some devious motives to confuse us on purpose because one can take their paradigm of definitions and make sense of it (I did). I just think there is a better way to go about their numbers. 

I prefer to look at the line items and think how each would change over time in the future as revenue grows. It is a simple exercise. Numbers below are from the Q3 2023 report.

Revenue                                  $41m
Personnel                                 $11m
Transaction expense               $10m
Third-party tech                      $2m
Marketing                                $3.6m
G&A                                       $2.2m
Provision for credit losses       $6.7m
Interest expense                      $4.1m
Net income                              $935k
(after forex and other)

As revenue grows with both increased number of subscribers to Premium and Anywhere and higher UMS numbers due to further market recognition and new partners like WooCommerce (powers 20% of top 1m online stores) or Sportsman's Warehouse ($1.3b in sales) there will be minimal add to “transaction expense” line and “third-party tech” line. Significant portion (I expect around 30%) of further incremental revenue will drop to the bottom line. The business has exceptional operating leverage which we are about to witness with the release of Q4 numbers. Provision for credit losses will likely be higher in Q4 as an anticipation for holiday sales spike. Also, marketing expense is likely to increase next year because the company is finally ready to go back to growth mode. Profitable growth this time! I forecast FY2023 to end with $155m revenue and $5m net income.

Earlier in 2023 management had set a plan to achieve a $10m bottom line enhancement powered by a bank partnership they had been working on for almost a year and further cost cutting initiatives. 

Conversation with management

I couldn't get a hold of Charlie but did have a long conversation with Lee Brading - SVP of IR and corporate development. Lee was an investor in Charlie’s first startup - Passport. After Charlie’s exit Lee was going to follow Charlie in whatever next endeavor he was going to pursue. Lee owns about 100,000 shares today and never sold any to date, just like Charlie. 

Below are some pieces of information that I found interesting.

• Revenue from long-term payment option is very small, that is why it is not broken out.
• Banking partnership is underway. There are a lot of regulations related to payments in each state. Banking partnership will help to consolidate and streamline the operations on the payment side. Plus, some states do not let you collect certain fees if you don’t have a banking partnership. Legal side of things took much longer than expected (as always). I would expect this partnership to come to fruition mid next year.
• Drop in accounts payable was due to interest rate rising (in agreement with analysis above).
• Securitization of receivables will help with working capital. Sezzle will look into this once AR numbers reach the $150-200m mark. 
• Company is going to renegotiate their SOFR + 11.5% early next year. They were price takers of the current contract because they were put on the spot on covenants with Goldman Sachs when the merger with Zip fell apart.
• The BNPL industry experienced a massive institutional exodus in Australia after Afterpay was acquired. 
• Sezzle is not afraid of recession. Their customer is already in distress. Moreover, they expect more people to use BNPL services if the economy goes bad. Because Sezzle’s target is subprime customer they are not afraid of Apple Pay Later or PayPal Pay-in-4 as competition. 
• Sezzle doesn’t see much competition in the Pay-in-4 segment from Affirm. The ones they bump into a lot are Zip and Klarna. Klarna undercuts Sezzle by a large margin on merchant fees. Sezzle just walks away from these deals because they do not see unit economics feasible. As market demands profitability Lee says Klarna will have to revisit their previous contracts. 
• Walmart, Target, and other big players barely offer any fees to BNPL companies - usually less than 0.5%. That’s why to make unit economics work, BNPL companies charge subscription fees (Sezzle Premium or Anywhere) or higher per transaction fees to let consumers use the service at these big stores.
• Two years ago Sezzle had crazy growth during the Q4 holiday quarter but credit losses were extremely high as well. They learned their lesson and tightened underwriting during this holiday quarter. Lee says with this approach they can still grow but profitably and without big surprises on the downside.  
• Sezzle is ready for growth and finally hired a marketing chief. They were more than one year without a proper marketing leader.
• Colombia job openings are indeed labor arbitrage. In fact, Charlie was visiting Bogota recently to test the waters.
• Listing situation is definitely hurting the stock. In Australia Sezzle had 10,000 shareholders with 70 shares on average and 6600 shareholders with 7 shares on average. Retail will likely be slowly selling all the way until January. “Death by a thousand cuts” is how Lee referred to this situation. 

Overall, the tone of conversation was positive. Management is excited and determined to bring the company back to the above-billion-dollar line. Profitable growth is the key.

I’ll finish the section with Lee’s comments on the latest quarterly results from LinkedIn: “I must admit, it's funny and a little perplexing to see the market get excited about companies that continue to lose money, but less than they did before”.

Valuation

Share price                  $19.6
SOI                             5.7m
Equity                         $112m

Cash                            $65m
Lease + debt               $1.3m
Line of credit              $75m
EV                               $123.3m

PE LTM                      22.4

Paying LTM PE 22.4 for a business that is growing 25% a year in an industry with tailwinds is a good deal. If we look at relative valuations in the industry (which I am not a big fan of) numbers can get really crazy. Simple re-rate to 1x revenue is an instant 35% gain.

I expect another 20% growth next year and believe they will finish FY2024 with $185m in revenue and $8m in net income. That would put PE at just 14.

Delisting from ASX will result in transfer of remaining shares from ASX to NASDAQ improving liquidity of the stock. You can get Australian Sezzle shares (ASX:SZL) for a 6-10% discount to NASDAQ prices. Shares will be transferred on a 1-to-1 basis in January so one might want to take advantage of this discrepancy. Interactive Brokers charges $30 for the transfer.

Risks

• Subscription revenue growth stalling. We have witnessed tremendous growth of subscription revenue which came from active users who were already genuinely fond of Sezzle. It will be more difficult to acquire new customers as competition in the space is heating up. The management is very good at pivoting and solving new problems though.  
• CEO leaving. I highly doubt this will happen as Charlie is well determined to succeed. However, him leaving for whatever reason will change the thesis dramatically. 
• Upsetting the current user base. Here is an example. All Sezzle users could use the service to make purchases in Target. Now, Target is only available to Sezzle Premium subscribers. There are tons of negative reviews because of this change. This is obviously countered by a huge number of subscribers but still, there is a group of people who are not happy. A couple of wrong product decisions could cause a large number of customers to move to a different BNPL provider. There are plenty of choices.
• It’s a David vs Goliath fight. How can these guys compete with PayPal, Affirm, Afterpay and other deep pocketed household names? Doing right by their customers and knowing that there is plenty of market for everyone is the right attitude to mitigate this risk.

Conclusion

What we have here is a founder-led profitable BNPL company growing revenue 25% a year that is valued at 22.4x LTM earnings. I believe this represents a favorable risk/reward situation and the stock will be up by 50% by the end of 2024. Management seems to agree after having bought almost $2m worth of stock in November.