Why is the Zip Co share price rebounding?

Ahead of today's announcement, shares in the BNPL operator were down 87% in the last 6 months but is reversing the trend during early market trading.

It looks like the rollercoaster ride for Zip Co Ltd (ASX: ZIP) shareholders is finally heading in the right direction, at least for now.

After being used to steep falls in the stock for most of the last year, investors in the buy now pay later operator were treated to a sharp 12% hike in share price during early morning trading on Tuesday. At one point the price of shares rose to 55 cents.

By comparison, ASX-listed shares in US payments giant Block (ASX: SQ2), which now owns Zip's bigger rival Afterpay, were down 4%.

What is boosting the Zip stock price today?

Shares in the biggest remaining pure play BNPL stock on the ASX have surged as the market cheered after Zip Co's announcement on Tuesday that it had abandoned its long-pending $490 million takeover of US-focused rival Sezzle (ASX: SZL).

On the other side of the deal, shares in the no longer acquired Sezzle crashed nearly 30% to 29 cents each at the time of writing.

In separate statements, both companies said they had mutually agreed to end the merger agreement in light of the current macroeconomic and market conditions. Zip will pay Sezzle US$11 million to cover transaction costs.

"We believe that mutually terminating the merger agreement with Sezzle at this time is in the best interests of Zip and its shareholders, and will allow Zip to focus on its strategy and core business in the current environment," Zip chair Diane Smith-Gander said in a statement to the ASX.

The market has been speculating for weeks now that Zip would be forced to take the pragmatic decision to drop the all-stock acquisition of its smaller rival, given the changed conditions and the collapse in its own share price, caused in part by the equity dilution at a discounted share price to secure funding for the deal.

The deal, first confirmed in late-January, had valued Sezzle at a 22% premium to its then-share price of $1.78. At the time Zip's shares were trading at $2.25 each. But both companies have come under sustained pressure since then amid a broader market rout.

According to Refinitiv data, only 2 of the 8 analysts who still rate the Zip stock hold a "buy" rating on it.

Cloudy outlook

The signs had been clear after Zip said last week it would wind down its small-business lending operation Zip Business as well as close down personal finance app Pocketbook as part of a push to cut costs.

Other BNPL peers have also been forced to face reality in recent weeks as the entire sector faces headwinds from the aggressive interest rate upcycle.

Smaller Australian rivals Humm and Latitude similarly abandoned their merger plan, BNPL rival Openpay Group (ASX: OPY) has halted its foray into the US, while Swedish BNPL giant Klarna raised funds that slashed its valuation from US$46 billion a year ago to just US$6.5 billion.

With none of the Australian BNPL players as yet profitable despite 3 years of explosive growth, the slim-margin business model is being squeezed by their need to fund interest-free payment offerings amid rapidly rising cost of funds and cautious spending by consumers.

Investors are also turning away due to increasing competition and the prospect of much higher regulatory scrutiny. Tech giant Apple recently announced its move into the BNPL space, joining the likes of financial giant PayPal, and Australia's own Commonwealth Bank and NAB.

Afterpay and Zip Co are also among the 5 BNPL businesses facing increased scrutiny of their business practices as part of an inquiry by the US financial regulator. Similar regulatory oversight is also being implemented in the UK and Australia.

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