Troubled buy now/pay later lenders try to turn a corner

Klarna, a pioneer in the buy now/pay later market, hasn't been profitable in about five years, and it reported a $1 billion loss for 2022. But there are some signs of better days ahead for the Swedish payment company and its peers.

The BNPL industry in general suffered in 2022, hit by falling valuations and stock prices, layoffs and the threat of crackdowns from regulators expressing concerns over the impact of mounting consumer debt resulting from loans. BNPL lenders are looking to diversify, often by graduating their merchant and consumer customers to products that provide more reliable revenue.

"We are making concrete progress towards profitability," said Sebastian Siemiatkowski, co-founder and CEO of Klarna, in a letter that accompanied Klarna's semi-annual earnings report. "Beyond payments, we have made strategic investments to solve real problems identified through customer insights in the shopping journey."

The company's earnings report could have been a snapshot of the BNPL industry at large. Klarna reported substantial growth, impressive progress, product diversification, and confident outlook — but there was also a copious amount of red ink, as 2022's $1 billion loss sits on top of the $680 million loss it reported in 2021.

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A key challenge for BNPL providers will be tweaking business models to adjust to rising interest rates, said Andrew Edem, the Germany-based head of innovation at U.K.-based digital payments provider PPRO, which has been tracking BNPL firms' strategies globally. "If you've concentrated heavily on zero-interest financing and charging the merchant for it, you may need to find a different business model going forward because there are only so many knobs the merchant can turn. Ultimately, you're going to have to raise interest rates or tighten underwriting, which will hurt volume," Edem said.

Here is a look at how some of the market's best-known companies are attempting to make 2023 a better year — and how some of the past year's challenges haven't entirely gone away.

Klarna

Klarna's fourth-quarter 2022 loss was about $90 million dollars, down from a loss of $158 million in the fourth quarter of 2021, suggesting an improving financial picture. It also reported gross merchandise volume of about $80 billion for the full year 2022, or 22% higher than 2021's GMV of about $67 billion.

The Swedish company also reported credit losses fell for the past two quarters, reaching 0.58% of GMV for the fourth quarter and 0.68% for the full year, suggesting a downward trend. Klarna attributes this to its focus on returning to profitability by the second half of 2023.

Klarna's expansion in the U.S. is also paying off, as it has attracted 34 million American consumers, putting the U.S. on pace to be Klarna's largest market in terms of revenue by December, surpassing Germany. Klarna has 150 million customers globally.

It also raised $800 million in 2022 and added products such as a Visa debit card that allows consumers to use installments to pay at Visa merchants. Recent client wins include Booking.com, Samsung, and Instacart. Klarna also launched a marketing campaign at shopping centers and began charging late fees in the U.K. earlier in February.

And while Klarna conducted high-profile layoffs in 2022, it said it has no existing plans to downsize in 2023.

"The shift in investor sentiment from a total focus on growth to profitability has also had wide-ranging effects," Siemiatkowski said.

Sezzle

BNPL lender Sezzle this week reported total fourth-quarter revenue of $38 million, up from $32 million the prior year. Most notably, the company reported net income of $500,000 in the fourth quarter, as opposed to a $26 million loss in the fourth quarter of 2021.

In an effort to reach profitability, Sezzle in the past year pulled out of India, Europe and Brazil, reduced marketing spending and laid off more than a quarter of its staff. The company projects an additional $10 million in revenue in the next 12 to 18 months will come from a new "pay anywhere" card, pay by click in the Sezzle app and expanded bank partnerships. And a recent drive to add premium members brought in more than 132,000 subscribers.

"Fiscal year 2022 will go down as a watershed moment for Sezzle," siad Charlie Youakim, executive chairman and CEO of Sezzle, in the company's earnings report. "We went from a company that reported a $75 million loss for 2021 to exiting 2022 with net income in the fourth quarter."

Affirm

Affirm recently laid off about 20% of its staff, an announcement it made as it reported fourth-quarter earnings earlier in February. Like many BNPL firms, it had fast growth, but its overall financial performance didn't resonate with investors concerned about a broader economic downturn. Affirm reported revenue of $400 million, up from $361 million a year earlier but less than analysts' expectations of $416 million.

The company also reported a loss of $1.10 per share for the quarter, up from $0.57 per share the prior year and less than analysts' expectations of a loss of $0.98 per share.

CEO Max Levchin attributed the losses, and the layoffs, to hiring a larger team than the company could support. Higher interest rates have also contributed to pressure for the BNPL sector.

Ingenico

The payment technology company, which is in the midst of a long-term strategy to diversify beyond point-of-sale hardware, earlier in February entered partnerships with Klarna and Splitit.

By adding BNPL to its existing line of in-store payment offerings, Ingenico can build a new market for installment lenders that have mostly relied on e-commerce. The move will help Klarna's expansion in several markets, as well as give the firm a way to pair payments and lending at checkout.

Splitit differs from most BNPL lenders by drawing on unused credit card balances. Both it and Klarna can potentially benefit from accessing Ingenico's network of more than 1,100 merchant acquirers and more than 40 million point of sale terminals globally.

Consolidation ahead?

The pressures on individual BNPL firms create the likelihood of consolidation, which could happen through mergers or dissolution, according to analysts.

Australia, which was one of the first global markets to embrace instant BNPL loans, is experiencing such disruptions. Openpay was one of the country's significant BNPL providers until recently, and earlier this month, the company froze its operations shortly after posting record results.

The Melbourne-based fintech struggled last year as interest rates rose and access to capital tightened. Openpay exited the U.K. market in January 2022 and unwound its U.S. Opy operations in June. In early February, Openpay went into receivership, despite announcing record quarterly revenue of $10 million on Jan. 31, 2023.

Despite talk of potential buyouts, it's unclear whether BNPL providers can easily merge, due to their divergent business models. Last year Australia-based Zip called off its merger with U.S.-based Sezzle, shortly after two other Australian BNPL firms — Humm and Latitude — called off a proposed merger.

Klarna has emerged as a major BNPL player in the U.S. and claims to have stabilized its operations through layoffs and diversification of services. "Now they face the problem of sustainability, and as the BNPL market consolidates, I would look for them to make a significant acquisition this year," said Patti Hewitt, a payments industry market research expert in Savannah, Georgia.

Looming regulations

For the last three years, U.K. regulators have been making plans to rein in the country's booming BNPL lending sector. Early this month it finally published draft legislation to regulate BNPL loans. The move will give the U.K.'s Financial Conduct Authority powers to authorize the BNPL industry to ensure operators follow guidelines and consumers are protected with disclosures of lenders' responsibilities, mandatory checks to see if consumers can afford BNPL loans and processes for consumers to complain about BNPL lender abuses.

In the U.S., the Consumer Financial Protection Bureau published a detailed report on the BNPL industry in September 2022, following a market-monitoring query of top providers including Affirm, Afterpay, Klarna, PayPal and Zip. The report didn't set out any potential regulations, but it signaled areas where it's likely to set down rules, said Steven Appelbaum, a partner at the law firm Saul Ewing.

"The BNPL industry is still evolving, but I believe the CFPB will come out with regulations at some point in the not-too-distant future that are going to make the BNPL industry more closely aligned with the credit card industry," Appelbaum said. "There will be more fulsome disclosure requirements from lenders to consumers, and more Know Your Customer requirements imposed on BNPL lenders. There will probably also be rules requiring BNPL operators to report outstanding installment loans to the credit bureaus, and report when they pull consumers' credit scores, because right now there's no consistency across the industry on that."