Klarna – WeWork replay?

Despite the parallels, Klarna is not a re-run of WeWork.

• At a high level, Klarna looks like a re-run of WeWork although it is a much better company meaning that the only real issue I have is a stratospheric SoftBank-pumped valuation that is now causing great distress.
• Klarna is now enduring the hangover as it needs more money, but the market has some very different ideas about where it is prepared to put more money in.
• Peak valuation was achieved in July 2021 at $46bn but having had a brief look at it and the comparables, I suspect the right number is probably closer to $7bn.
• Klarna is classified as a Fintech company but at its heart, it’s a payment processor for e-commerce companies and also offers buy now pay later (BNPL) services on top of its core business.
• As with everything related to the technology sector and e-commerce, Klarna had a great pandemic which ended with SoftBank leading a $639m round at a valuation of $45.6bn.
• SoftBank has a horrible habit of throwing vast amounts of money at companies at valuations that make no sense and then getting into trouble when the market refuses to stomach the numbers further down the road.
• This looks a bit like a rerun of the WeWork fiasco but with the key difference that with Klarna it is just the valuation whereas with WeWork it was valuation, business model and corporate governance.
• There is nothing wrong with Klarna’s business model and as far as I am aware, the company is well run although there have been a few issues around overextending credit and data privacy.
• The company grew revenues 38% in 2020 to $1.07bn and then 32% to $1.42bn in 2021.
• However, the outlook for 2022 is much more difficult with inflation already crimping spending and consumers going back to physical shops.
• Hence, I would have thought that a generous estimate for Klarna’s revenues in 2022 will be around $1.8bn but of profit, there will be no sign as the company lost $730m in 2021.
• This means that on the last valuation, the company is valued at 25.3x EV / Sales (assuming a zero net cash position) which is obviously way too high.
• One of its closest peers is Affirm, which has fallen 89.6% from its high and now trades on 2022 EV / Sales of around 3.9x.
• These companies are roughly the same size and they both face the same current headwinds which are the spectre of regulation, inflation crimping e-commerce demand and Apple’s entrance into their market.
• Given Affirm’s greater exposure to the USA which is where Apple will be starting with its BNPL service on Apple Pay, the headwinds for Affirm look a little greater but I don’t think that there is very much in it.
• Hence, if I take the valuation that the market is giving Affirm, I arrive at a valuation for Klarna of $7bn, some 85% below its 2021 peak.
• WeWork was valued at $46bn at its peak and SoftBank ended up bailing it out at $8bn which sounds eerily familiar.
• Hence, it is no surprise to hear that the company’s overtures for investment were rebuffed at $25bn and again at around $15bn.
• In this climate, this still looks to be 2x too high and the deck that attempts to justify why Klarna should have a 100% premium to Affirm will make for some interesting reading.
• Hence, I think Klarna will be fortunate to raise money at $10bn and investors will probably demand a ratchet that covers them should the next liquidity event be less than that which they are paying.
• This will be hugely dilutive for SoftBank and its co-investors who put money in at $46.5bn and serves as yet another cautionary tale for SoftBank.
• There is every sign that the dominos are going to keep on falling until fundamentals and valuation are once again in line with each other.
• It is not until I can see this that I can start to think about calling the bottom but there are examples (like Alibaba) where the shares have fallen far below what the fundamentals point to.
• We are not out of the woods yet.