The BNPL industry has caught a lot of attention recently with firms like Afterpay and Affirm commanding nose bleed valuations. What hasn’t got as much attention is BPNL’s lesser-known cousin, Lease to Own (LTO). This industry is geared towards sub/non-prime customers who typically have a credit score below 650 or have no credit score at all. This is about 40% of the US population with an industry TAM of around 50B. Historically the industry was dominated by brick and mortar Rent to Own (RTO) players such as RCII and Aarons, who bought furniture/other items wholesale and then leased those items from their stores. However, over the last few years, retailers have been accepting virtual lease to own as a payment option from providers such as Acima, Progressive Leasing, and Katapult, rendering the previous business model obsolete.
For clarity, we will describe the difference between BNPL and LTO as they are two completely different industries, yet are seen as complements. The BNPL business model works by charging the merchant a cut of the revenue as opposed to charging an interest rate on the amount to the customer. These take rates are typically around 4% or so. The customer then makes 3-5 payments to the BNPL firm within the span of a month or so. The BNPLs typical customers have credit scores above 700. For Lease to Own, the customer is charged a usually exorbitant interest rate and the customer has 12 months to pay the final amount. Typically, the customer can buy the item within 90 days with minimal charges and this is done about twenty to thirty percent of the time. In short, these are completely different industries.
If the customer leases the item completely or does an early buyout, they can obtain ownership of the item. If they cannot continue paying, they can simply return the item and no longer have to pay. LTO is for customers who are unable to pay the full purchase price (within a short duration) for merchandise or who lack the credit to qualify for conventional financing programs.
Being that LTO’s market is people with lower incomes and without access to traditional financing, LTO financing is typically used when mandatory/emergency expenses crop up. These items are generally around five hundred dollars and can be anything from a new fridge to a new bed or a set of tires. The ratios between the categories these items fall in are fairly stable with furniture making up the lion’s share and electronics being a close second.
LTO has typically gotten a bad rap and is seen as a predatory lender- however generally this is the only/best recourse that subprime people have when compared to alternatives. And it is getting better with the newer virtual LTO players who have less costs and fees than brick and mortar player. Shown below are the options financially constrained people have when purchasing an item such as a 700 dollar fridge from three different sources- a virtual LTO, traditional brick and mortar LTO, and a credit card. Virtual LTO’s are almost thirty percent cheaper.
Virtual LTOs are not as bad of a deal when viewed in relation to the alternatives. They are cheaper as they have less employees, no large store footprint, etc and can charge less as a result. We believe the virtual LTO industry will coalesce to two or so players as it did with the brick-and-mortar RCII and Aarons. There is an element of first-mover advantage here and path dependency as the more retailers use a certain LTO provider, the more customers will use that service and so forth. The bigger players can also afford to buy more merchandise from retailers, pay more in advertising, exclusivity etc- bigger begets bigger. Another result is that underwriting will get better the more data there is, thus bad expenses (which hover between 8-10% of revenues) will drop off and the bigger players theoretically will have the lowest bad expense ratios.
A customer can buy effectively from three places, in a store (think big box retailer), online from large enterprises, and also from SMBs. How are LTO players supposed to reach all three? For large enterprise accounts, a sales force is needed for both e-commerce and brick-and-mortar. For SMBs, the convenience of integrating a Lease to Own option will be the determining factor. It currently takes merchants 30 minutes to add players such as Katapult as a payment option to their site.
The players in the LTO space are Acima (acquired by RCII), Progressive Leasing, and Katapult with each having different business models. RCII combines both a virtual LTO (Acima) with its physical store footprint, giving it an advantage on the surface with factors such as distribution and returns. Progressive Leasing, a virtual LTO spun off from Aarons has traditionally focused more on brick-and-mortar lending, they have kiosks at retailers' stores and the employees there inform people that don’t qualify for a larger purchase about LTO. Lastly, there is Katapult who is the smaller upstart exclusively focused on e-commerce players and as a result, saw huge tailwinds last year. PRG and Acima dominate the LTO brick and mortar industry currently with each bringing in 2B and 1B respectively per year in 2020. Traditionally Acima and Progressive have focused on brick-and-mortar space however have recently moved into e-commerce as COVID has shifted the landscape. E-commerce currently makes up about 15% of their total revenue, roughly the same revenue as Katapult. The graph below depicts the above companies and their makeup in 2020. We will be diving into RCII, PRG, and KPLT for the rest of this article.
RCII acquired Acima in late 2020 with the logic being there would be synergies between their store footprint and Acima’s payment platform. What is interesting is that Aaron’s took the exact opposite approach and spun off their LTO platform into a standalone company (PRG). Aarons originally acquired PRG back in 2014 from a private equity group for 700mm. Taken PRG’s market cap today- Aarons had a nice 24% CAGR return. The reasons cited for their purchase mirrors that of RCII and Acima. These are an increase in margin because of the ability to re-lease returned equipment as opposed to selling it to third parties to lease,having tons of data to make their underwriting better, and upselling their current customers. However, the virtual LTO and the traditional business model are at odds with one another as the former renders the latter obsolete. It’s superior in almost every way. Pure leasing players without a physical footprint are a fundamentally better business model. Virtual LTO’s have better margins, less equipment to re-lease (as customers buy objects they actually want as opposed to having to select from RCII//Aarons catalog) etc. RCII and Acima will likely follow the same trajectory as PRG and Aarons.
RCII probably sees this and is trying to innovate to become a marketplace in which customers see all the different offerings they offer. We do not think this will work as LTO will be ubiquitous within 5 or so years- every website will have it as a payment option. Unless they heavy incentives to use their marketplace, it most likely will not work. A large plus is that Acima currently has the highest web traffic out of the three players along with the highest direct search-meaning people directly typed in the website name. This illustrates a greater share of mind with target customers. It has also furthered its offering by partnering with mastercard to create the first lease pay card and access mastercard’s payment network. This will be jet fuel to Acima’s business.
PRG is the elephant in the virtual LTO space with revenues greater than 2B, it is more than 2x the size of Acima and about 10x the size of KPLT (by revenue and by number of leases). It has been growing its leasing invoices at greater than a 20% CAGR for the last 7 years. Progressive Leasing is very positively received with an NPS of 62. Like Acima, PRG has been focusing on enterprise retail accounts but has now recently begun the shift towards e-commerce. E-commerce went from being 1% of revenues at the beginning of 2021 to over 14% by April! PRG has been putting a lot of resources into beefing up their e-commerce and mobile offerings as can be seen from most of their job openings being software based- contrasted with Acima’s job openings which mostly are sales positions. Another difference lies in mobile offerings with PRG’s mobile app far and away more used with over 30k reviews averaging 4.5 stars. KPLT has no mobile app and Acima’s has only 40 reviews(it is also buggy). A mobile offering is important as it lowers the activation energy to fill out an application, especially in a store. It also is another avenue besides a computer to complete an application.
KPLT became public via a SPAC in 2020. It has seen incredible growth in 2020 due to COVID causing a step change in e-commerce,a space they are solely focused on. Whereas Acima and Progressive saw little to no growth, KPLT grew revenues triple digits. However, there is an asterisk here as it was mostly from Wayfair. From their most recent filing, Wayfair represented about 60% of KPLTs revenue. KPLT focuses on reducing the friction for both merchants and customers. This means being as convenient as possible for merchants to plug KPLT as a payment option as well as for customers to apply and get approved. These plug ins are usually done on Shopify, Magento etc. Thus far they have approved 500k applications with a bad expense rate of 6%. A bad expense rate is one where the customer pays the initiation fee and no longer makes a single payment after that.
We do not ascribe a large advantage to KPLT’s e-commerce capabilities (after all Acima and PRG are already as big in their respective e-commerce sales-about 200-300mm on a forward-looking basis). One can also see below that more than 2x the number of people visit PRG’s and Acima’s websites than Katapult’s. Where KPLT probably has an advantage is in its brand. Out of the three players, KPLT’s reputation is the best. It has an NPS > 60 and has not been implicated in a suit yet. Both Acima and PRG have been implicated in FTC scandals for misleading customers. As a result, KPLT is more easily able to partner with BNPL players (as they do not want their brand affiliated with a predatory lender, not the best business for a BNPL company) and utilize their reject applicants to see if they qualify for LTO. This will be a significant revenue stream going forward and competitive advantage. See below for the waterfall effects of the partnership with Affirm. (Although the math is wrong, in the bottom line 60% of 390k is 234k, not 195k).
The most likely headwind is more regulation could occur around virtual LTO. The FTC recently fined PRG almost 200 mm for misleading customers and California (Dep of Financial Protection) just requested documents regarding PRG’s business practices. We expect this to continue.
Catalysts & Tailwinds
A reduction in stimulus checks will improve the ROIC of the LTO industry and expand the TAM. It is a bit counterintuitive but essentially items getting acquired earlier, for example before the 90-day mark, means a lower rate of return as LTO’s make money off the interest. All the LTO players have been seeing record early buyouts and thus fewer profits. Also, people with stimulus checks may not feel the need to use LTO as an option seeing that they have the cash. Both of these factors will contribute to the growth and profitability of the LTO players.
A tailwind for LTO is that retailers are more amenable to accepting it due to the popularity of BNPL. Alternative financing methods do not have as much stigma as they used to. This shortens sales times and will provide LTO with a longer runway.
Virtual LTO is an industry that generates around mid teens ROIC with the potential to double if bad expenses can be driven down and customers usage increases. Bad expenses vary across the players in this space from around 6 to 10% of revenues. These will only go down over time as more data will help with underwriting decisions. There is still a massive runway to the virtual LTO industry with only a 7% penetration rate. Given the stability of this industry (2008 hardly affected the LTO business), its growth, and the new breed of virtual LTO players, we believe this industry will be very fruitful in the years to come. As for the right horse to bet on, more work needs to be done but we believe PRG is the best positioned as they are the largest pure-play in the space along with being the cheapest to boot. KPLT will probably benefit from its partnerships however it faces steep competition from PRG and RCII. It also cannot compete on the enterprise front as that would require an enormous sales force. Lastly, RCII is composed of both a good business (Acima) and a slowly dying one, its retail store. We think merging the two companies will only slow down Acima, giving PRG a window to take more market share and become a long-term compounder.
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