'Operation Blue Sky': Inside Zip's struggle for survival

Citi analyst Siraj Ahmed, for example, raised his forecast for pre-tax cash income, depreciation and amortization (EBTDA) for 2023 and 2024 – the last years Zip hopes to move into the dark. However, in a sign of the uncertainty Zip still faces, Ahmed added a “high risk” rating to his “neutral” stance on the stock.

BNPL businesses such as Zip and Afterpay provide interest-free short-term installment loans to consumers, and seek to challenge the strength of the global credit card industry. They were the darlings of the market last year, but have since been inundated by a wave of negative forces: high bad debt, intensifying competition, and plunging technology valuations, as rising interest rates cause investors to demand faster profits from cash-spending companies.

In response, Zip unleashed a drastic reconfiguration of its business known internally as “Operation Blue Sky.” It promised to slash more than $30 million in employee costs, tighten new lending, halt plans for global expansion, and temporarily halt proposals to push for new products, such as cryptocurrency trading.

Gray, a financial industry veteran who co-founded Zip in 2013 with chief executive Larry Diamond, said it was a difficult period for the company and staff affected. But, in the end, change is about survival.

As a loss-making company focused on rapid growth, Zip relies on raised capital from investors to fund its operations. Gray said that as the market “collapses in the short term,” he had to prove he could turn a profit.

“I think it’s really important that we have that as a part of our underlying thinking – we don’t want to depend on the stock market to support our survival,” said Gray.

“We are in the fortunate position where we have sufficient capital to adjust our setup to deliver the results we want without needing to enter the market again.”

Gray admitted Zip did not expect a boom in bad debt, which has already accounted for 3.8 per cent of accounts at its flagship business in Australia.

“I think we’ve acknowledged that bad loans are performing outside our target range,” he said. But he argues that the company is tackling the problem by tightening its lending criteria, which flows quickly into lending performance as short-term loans roll in quickly.

Despite the recent rise in stock prices, many analysts remain skeptical about Zip’s future. Tom Beadle of UBS, which has a “sell” rating on its shares, last month said Zip’s credit risk appeared to be worsening – in contrast to the consumer loan portfolios of major banks, which were improving.

And even if Zip can curb bad credit and turn a profit, its latest changes still raise big questions. For one, when cutting expansion plans so deep, is it still classed as a growing company?

Gray argues that it can still grow with stricter lending standards, given the huge potential of the market in the US, where BNPL is much less common than in Australia. “Changing our risk appetite doesn’t always have to come at the expense of growth,” he said.

He also said there was still “burning ambition” to become a global company, despite announcing it would close its small business in Singapore and put operations in Europe and the Middle East under review.

Another big question still looming over BNPL companies is the entry of cashed giants into the sector: Apple, Commonwealth Bank, Citi and PayPal have all launched or announced plans to enter BNPL.

Some analysts have questioned whether a “pure game” BNPL company like Zip can compete with such a size, but Gray dismissed threats from what he called a “copycat.” He said the entry of larger rivals into the BNPL market had a “very minimal” impact on Zip, in part because the business did not provide the same digital services to merchants as the BNPL company.

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An important test for Zip will remain whether it can live up to its hopes of posting a positive EBTDA in 2024, against the challenging environment of calmer consumer spending.

For many investors, and analysts at Macquarie, there is still the possibility that Zip could get caught up in mergers and acquisitions activity as the industry consolidates. However, Gray indicated that Zip is unlikely to be looking for a merger opportunity – for now.

“In the short term, no, we are quite focused on our core markets in ANZ and the US, and speeding up the path to that profitability. So, it has to be something extraordinary that fits that purpose.”

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