Zip Co: Execution is key

About the author:

Author name:

By Richard Coles

Job title:

Senior Analyst

Date posted:

01 March 2022, 11:00 AM

Sectors Covered:

Insurance, Diversified Financials

• Zip Co's (ASX:Z1P) 1H22 result had been pre-released and disappointed on higher bad debts and operating expenses than we expected.
• The acquisition of Sezzle makes clear strategic sense for Z1P, in our view, and management's renewed focus on accelerating Z1P’s path to profitability is what investors will want to hear.
• However, clearly there is a bit of a trust me factor being asked by Z1P management now, with the company not expected to be cash EBTDA positive until FY24 (post acquiring Sezzle), and with a disappointing 1H22 result and some apparent hiccups in the global roll-out strategy, pointing to some recent execution issues.
• We make significant downgrades to FY22F/FY23F EPS>0%. Our price target is lowered to (login to view). ADD maintained on longer-term upside.

The result, the Sezzle deal, and the capital raising

Z1P's 1H22 result had been largely pre-released. Broadly the key takeaways were that while revenue (A$302m, +89% on pcp) was per consensus, Z1P's cash EBTDA (-A$108m) was well below our estimates (-A$34m) due to a combination of:

1. higher bad debts than we expected (2.6% of TTV vs 1% in the pcp) on a worsening US credit environment and reflecting Z1P’s entry into newer geographic markets.
2. higher other operating expenses (A$120m vs MorgansE A$87m) stemming particularly from higher marketing spend (-A$75m vs -A$26m in pcp) tied to Z1P's global roll-out. The result also had a A$45m goodwill write-down on Z1P's UK business as the company focuses on markets closer to profitability.

Z1P also announced it will acquire BNPL peer Sezzle in scrip deal valuing Sezzle at A$491m. Z1P has identified EBTDA synergies of A$130m from the acquisition (A$60m-A$80m are cost synergies) and it expects the deal will help Z1P become EBTDA and cashflow positive by FY24.

In conjunction with the Sezzle deal, Z1P is also undertaking a A$149m institutional placement (+A$50m SPP) at $1.90 per share (a 14% discount to last close) to provide the capital runway to execute on delivering the Sezzle synergies.

Key thoughts

Clearly, the Sezzle deal makes strategic sense for Z1P. The deal increases both Z1P’s global transaction levels (currently A$7.9bn) and customer base (currently 9.9m) by around ~30-35% respectively. It gives Z1P a materially stronger position in the key US market, with Z1P/Sezzle customer overlap being relatively contained (25%). A stronger product mix and enhance distribution channel mix are other benefits.

We expect the market to remain skeptical on the revenue synergies in this deal, however, they do seem to have a logical basis, in our view, e.g. the potential to win more merchants with a larger combined customer base, and the ability of Sezzle customers to shop anywhere with Z1P’s app driving higher spend in new categories, etc.

Everything Z1P management is saying is about altering their go-forward strategy will be what the market wants to hear, e.g. a focus on sustainable growth in core markets with the aim of accelerating Z1P’s path to profitability, and taking measures to rightsize the business etc.

However clearly there is a bit of a trust me factor being asked by Z1P management now, with the company not expected to be cash EBTDA positive until FY24 (post acquiring Sezzle), and with a disappointing 1H22 result and some apparent hiccups in the global roll-out strategy, pointing to some recent execution issues.

Forecast and valuation update

We make significant downgrades to FY22F/FY23F EPS >50% reflecting softer earnings forecasts post the 1H22 result. We also incorporate the Sezzle acquisition and associated capital raising. Our price target is lowered to (login to view).

Investment view

Clearly the global environment has changed for BNPL operators and for investors it’s now not a space for the faint hearted. We do, however, think the global growth opportunity remains large for companies that can execute in the BNPL space. The scale provided by the acquisition of Sezzle and a more considered growth agenda, could see Z1P be one of those winners, and with Z1P now trading on 2x revenue, we maintain our ADD recommendation.

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