Square’s deal for afterpay is a hit. Why confirm could be next.

investors seem to love

Square

‘s deal to buy the buy now, pay later” company

Afterpay,

driving both stocks — and shares of rival Affirm — significantly higher.

Square (ticker: SQ) announced the deal for the Australian company on Sunday, saying it plans to pay $29 billion in an all-share transaction. Shares of Afterpay rose 20% in the Australian market and US depositary receipts rose 35% to $95 in US early trading.

Square shares rose 10% to $273, in part because of the deal news. The company also released second-quarter results that generally outperformed Wall Street’s forecasts.

The deal also cancels other shares in the buy-now-pay later or BNPL space. Notably, Affirm (AFRM) jumped 14% to $64 as investors speculated it could be the next takeover target.

Afterpay pioneered BNPL services in Australia, where it has become a popular way to pay for individual items in travel, fashion and other industries. Afterpay then expanded to Europe and the US

Consumers using it can pay for goods in customized monthly installment plans, usually at zero percent interest for the first four months.

BNPL is gaining popularity because interest rates are ultra-low, reducing costs for consumers. Other fintech apps have entered the market, including Affirm, a pure game on the industry, and PayPal (PYPL).

Apple

(AAPL) is also developing a BNPL service with

Goldman Sachs Group

(GS), its credit card partner, according to recent media reports.

Square wants to integrate Afterpay into its Cash and Seller apps, linking the service for consumers and merchants. The deal should allow small merchants in Square’s network to offer BNPL purchases. It will also expand Square’s global presence as BNPL has gained popularity in Europe along with Afterpay’s home market, Australia.

While the $29 billion price seems high, Square says the deal will contribute to gross profit growth, although it will result in a small drop in adjusted operating margins in the year after the deal closes, based on earnings. before interest, taxes, depreciation, and amortization, or Ebitda.

Wall Street’s early view of the deal was positive. The combined company is advancing the “holy grail” for Square: to become an upscaled two-way network, connecting the Cash app for consumers and the merchant for merchants, wrote MoffettNathanson analyst Lisa Ellis. “Overall, we view the Afterpay acquisition as strategically attractive for Square,” she said.

Ellis is not deterred by the price of 29 billion dollars. It gives Afterpay an enterprise value of 35 times gross profit for the next 12 months, she estimates. That’s above the 27 multiple for Square and slightly higher than Affirm’s multiple of 32, although payment processor Adyen (ADYEY) is 58 times, she noted.

Mizuho’s Dan Dolev also praised the deal, writing that it takes Square further into the $10 trillion global online payments market and should increase gross revenue for the company. He said it would add $32 in average revenue per user. While the price isn’t cheap, he wrote, the long-term benefits “outweigh the short-term valuation concerns.”

Dolev also sees the deal helping Square further its other ambitions: developing payment systems in cryptocurrencies such as Bitcoin and the broader ecosystem of decentralized finance on blockchain networks.

Bitcoin is already a huge sales engine for Square, acting as a broker and custodian for the crypto. The company’s total revenue of $4.7 billion in the quarter was up 143% year over year. Without Bitcoin, the figure would have jumped 87% to $2 billion.

“We believe Afterpay strengthens the fundamentals in the long run as SQ gets closer and closer to the

JPM

of the future,” he wrote, referring to JPMorgan Chase (JPM).

Still, BNPL stocks have been weak this year. Before the start of trading on Monday, Afterpay was down 17% and Affirm was down 42%. Square was also a laggard, up 7% versus a 12% gain for the

Nasdaq composite

e index, excluding Monday’s moves.

Steep valuations have been a hurdle for BNPL and payment stocks. There are also concerns for the sector that favorable market conditions – ultra-low rates and a largely hands-off regulatory environment – may not last. Afterpay has already faced some regulatory backlash in Australia.

The Biden administration is likely to push for more consumer protections than Donald Trump’s Republican administration. And the Bank for International Settlements – a group of global central banks and regulators – has published a paper stating that fintechs should be regulated more like banks. According to a report in The Wall Street Journal, the paper argues that regulators should look into Big Tech’s potential “spillover” on the financial sector, and that “specific safeguards” may be needed.

For now, the deal could mark the start of a wave of consolidation as other tech and financial firms strive to grow in BNPL. “Afterpay will help Cash App maintain and expand its role as a leading diversified digital banking/financial services ‘super app’ as that market consolidates,” Ellis wrote.

“This deal sends a pretty strong signal to the market that what is dismissed as a feature of existing payment systems is a category in its own right,” said a senior executive at a BNPL firm.

BNPL can survive a period of higher rates, he said, as merchants will continue to subsidize zero percent short-term loans to continue boosting sales. And if credit card rates go from 15% to 20%, consumers are more likely to opt for BNPL, as zero percent or even 5% will seem more attractive for a few months.

BNPL still accounts for just 2% of total payments markets, the executive noted, leaving plenty of room for growth.

Whether retailers and banking regulators endorse that future remains to be seen.

Write to Daren Fonda at daren.fonda@barrons.com

.