We’ve been keen followers of AfterPay since last year. We issued a BUY on AfterPay on the 14 September 2017 (click here) and said, “We like the business and we think this stock could be potential ten bagger. Buy now.” The stock was trading at $4.61. It’s now $14.91. That’s a three-fold increase. Bravo. If you still hold AfterPay you’d be punching the air in delight, you’ve done well. But now, we think it’s time to sell.

By now, you’ve probably heard all the huff and puff about the AfterPay phenomenon that’s sweeping this country. It’s of no surprise. Gen-Y or Millennials they’re called, want it all and they want it now. Most don’t have the money, so AfterPay is the perfect answer. Its share price is evidence enough. APT shares have rocketed 43% this week alone driven by millennial madness. This week’s rise came on the back of encouraging plans to expand into the US, shares are up almost 400% in the year to date. Investors welcomed the news as they digested the massive upside potential from this recent announcement. The US consumer market is absolutely huge. It will launch a partnership with lifestyle giant Urban Outfitters, who have sales of about $US3 billion across the US. It has also signed preliminary agreements with 50 other US retailers which include names such as Lorna Jane, Cotton On, Margaux and P.E. Nation. So far, so good. But is it?

In a nutshell, AfterPay is the Gen-Y lay-by system on steroids. It’s great for those that don’t have sufficient funds to purchase an item they otherwise couldn’t. Smells a bit like a credit card? Keep reading. AfterPay makes full payment to the retailer, on your behalf. All you have to pay is 25% of the original purchase price. The remaining 3 payments are made every fortnight. Essentially you now can buy four items for the price of one.

AfterPay will send you reminder emails, letting you know, well in advance, that it is about to direct debit your bank account. The service appeals to millennials. People aged between 18 to 34 make up 67% of its customer base and over 85% of transactions occur on debit cards rather than credit cards. Millennials don’t like credit cards and are wary of getting into debt. This works well because AfterPay technically isn’t a credit card.

The best part about AfterPay is that it’s so easy. A simple online form takes a few seconds to complete. No credit checks. No ID checks. No rejections. You’re ready to buy now and pay later, all interest-free. Hard to believe isn’t it? Anybody can open an account. Heck, you could probably open an AfterPay account for every bank account and email address you’ve got. You could even do it under bogus names. Essentially, AfterPay allows customers to buy now and pay later even if they cannot repay their debts. In some instances, shoppers are allowed an AfterPay account, despite having a terrible credit rating. Shoppers are signing up in droves to the fee-free payment instalment plan because they simply can. You’d be crazy not to.

What’s the catch, you ask? There isn’t one. Well, that’s of course if you pay on time. Miss an instalment and you’ll cop a $10 fee. Do it again within a week, and you’ll cop another $7 fee. Miss all of the repayments on any purchase and it will end up costing an extra $68. Ouch. But fair enough. It’s business. The message here, pay on time. There is, however, a limit. Once you’ve established a credible track record, the maximum you can purchase is $1500. That’s the perfect limit to keep you from overextending yourself and to keep you in the system.

But let’s say you do miss a payment. Your account is temporarily suspended until AfterPay successfully direct debit amounts owing. They’ll attempt to direct debit your account until your bank account has sufficient funds. The moment you get paid, the money’s gone. But on the bright side, you’re in the clear. You can do it all again. More buying, more debt and more fees. The circle of the AfterPay life continues.

How does the AfterPay model work?

AfterPay earns the majority of its revenue from fees paid by retailers. AfterPay charges roughly 4.17%. It also makes money on late payment fees. They make up 17%-25% of revenue. In 2016-17, the company made $23m in retailer fees and $6.1m in late fees. Bad debts were $3.3m. The 4.17% is a small fee for the retailer who would otherwise not make a sale. AfterPay takes all the risk. The retailer is paid regardless if the customer defaults. The risk to AfterPay is if the customer defaults, there is no recourse. Hence the late payment fees.

What are the hidden problems with AfterPay?

Whilst on the surface AfterPay seems like a clever way to help a consumer purchase an item there is one common element, it targets the cash poor. As well as being a useful tool, it can also become a potential disaster for millennials.

For example. Let’s say you see a groovy looking $100 beanie. You have $100 in cash but you decide to use AfterPay because it will only cost you $25 today. You’ve got $75 left. You then decide to buy a $100 pair of Jeans for $25, $100 sweater for $25 and a $100 shirt for $25. You’ve now purchased four items, used all of your $100 and are on top of the world. But in effect, you’ve put yourself in debt by $300, payable every fortnight in $100 installments.

AfterPay exploits our inability to see or forecast the consequences of our actions in the future. Instead, we see the benefits of our actions, now, where they are noticeable. And Gen-Y are all about living in the now. The millennial YOLO motto means – You only live once. So you should seize the moment as it happens without a thought about money. The YOLO mindset spends first and won’t sacrifice happiness to save or invest. AfterPay breaks down an item’s price into four smaller, less noticeable amounts. Spending $25 now is an easy decision, whereas spending $100 makes you weigh up the benefits. The remaining $75 ($25 per fortnight) vanishes from the mind because it’s well off into the future. It’s called Hyperbolic Discounting. People choose a smaller, immediate reward rather than a later reward. For example, you have 2 choices. Receive $100 today or $125 in a week. Gen-Y is more likely to choose $100. Why? Because it’s an instant reward.

But here in lies a disturbing problem. After assisting a fellow Gen-Yer on an email she had received, we noticed in her inbox, more than thirty unopened ‘Overdue Pay Now AfterPay’ emails. We weren’t surprised. Seems like she was caught in the AfterPay debt trap. When asked about it, she said AfterPay was ruining her life. In one click, her well thought out financial plan had gone down the drain. All her pay was being eaten away by recurring debt repayments. Because AfterPay doesn’t charge interest, when debts are finally settled, the account becomes active again. The temptation to buy returns and you’re back in the AfterPay rabbit hole. Thing is, no one seems to care or is listening.

Even more surprising was the fact that she had more than one AfterPay account. She had three, connected to three different bank cards and email addresses. How is that even possible? Well seems it is possible because AfterPay doesn’t conduct a credit check or an identification check. However, I’m now led to believe AfterPay could be conducting ID checks. For some people that are cash poor, AfterPay is a real temptation that will ultimately end in tears.

Why does this all matter?

It matters because of its growing popularity, more and more young people are falling into financial hardship and getting caught in the AfterPay rabbit hole. That’s causing consumer advocates to issue warnings that AfterPay promotes irresponsible spending. In fact, consumer advocates say they are expecting to see more young people come to them with debt issues relating to Afterpay. Because AfterPay is not part of the National Credit Code it doesn’t need to discharge responsible lending obligations. It’s a loophole that could be closed very soon.

Our concerns are that regulatory giant ASIC is keeping a close eye on “buy now, pay later” schemes. AfterPay operates outside of credit consumer laws, so it is unregulated. It’s only a matter of time before this industry becomes regulated. That is the problem. An article in the AFR says AfterPay has caught the attention of the Consumer Action Centre. New legislation aims to target unregulated short-term credit like buy-now pay-later. The article said, “The legislation, which will now go through a period of open consultation, proposes to formally institute a recommendation of the Financial System Inquiry that called for a product intervention power be given to ASIC allowing it to intervene when there is a significant risk of consumer detriment.” The introduction of this type of legislation will undoubtedly hit AfterPay’s bottom line. The following factors should be considered: Consumer confidence and retail spending, legislation around new innovative payment providers, competitive landscape, and new entrants. Now we’re aren’t saying we don’t like AfterPay. What we’re saying, is that it is time to sell. As you know we were keen followers of the stock. After issuing a BUY at $4.61, its now $14.91. The stock trades on a ridiculous PE of 256x and its ROE is quite low at 5.59% rising to 6.99%. We’re calling the top. It’s time to lock in profits. We will keep a watchful eye from the sideline, but as the old saying goes ‘you don’t go broke by taking a profit.’