Why is the Zip Co share price rebounding?

Posted: 17 March 2022 12:11 pm
News
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Shares in the BNPL operator have slid more than 78% in the last 6 months but performed strongly during today's trading.

It is fair to say investors in buy now pay later operator Zip Co Ltd (ASX: Z1P) have been on tenterhooks for the last few months as the slide in their stock continues unabated. So it would have come as a relief when Zip shares posted a substantial rebound on Thursday.

At the time of writing, the stock was up more than 13% at $1.61.

That momentum was also visible for shares of US payments giant Block (ASX: SQ2), which now owns Zip's larger rival Afterpay, with the stock up nearly 12%.

Why are Zip and Block surging higher?

The jump in the BNPL stocks is related to the US Federal Reserve announcing its first rate increase since 2018. Overnight, the central bank lifted its benchmark rate by a quarter percentage point and outlined plans for 6 more hikes this year.

While this is an aggressive approach to tackle rising inflation, The Fed's announcement was already priced in and did not deliver a tougher surprise as many had expected.

As such, markets rallied strongly overnight led by technology and financial stocks, both of which have been heavily sold off in recent weeks.

During normal economic cycles, investors shift from tech stocks, including Block and Zip Co, and target commodities and industrials as a hedge against higher inflation and rising interest rates.

But today's result shows the tech sell-off could have been overdone.

For instance, some tech giants on Wall Street are down 20% since November, while stocks such as Zip Pay have lost three-fourths of their value over the same period.

Now that the rate cycle is not looking as steep as some had feared, many of these growth stocks are seeing a rebound to higher valuations.

Firm outlook

Some of the weakness in the Zip Co share price is also due to the company's equity dilution to partly fund its deal to acquire smaller rival Sezzle (ASX: SZL).

However, the deal to acquire the US-focused Sezzle is seen as a positive over the medium term given the cost synergies for the combined entity, which could open up a quicker path to profitability for the BNPL operators.

The Zip-Sezzle deal is expected to deliver immediate scale and enhanced growth, particularly in the key US retail market, where Zip already operates through its QuadPay acquisition.

The integration will likely cost about $60 million over 2 years, but is expected to result in between $60 million and $80 million in synergies through lower employee costs and bringing the operations under a single platform.

Another $40 million to $50 million is expected to be delivered in revenue and margin synergies as the 2 companies combine their large customer base and merchant deals. It would also help Zip streamline capital allocation to the 13 markets it operates in.

The deal also gives an advantage amid the looming consolidation in the BNPL sector. So far this year, Block completed its buyout of BNPL leader Afterpay, while smaller rivals Latitude Financial and Humm have agreed to combine to create an operation with around 5 million customers.

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