Does a Zip and Sezzle merger make sense to anyone at all?

Consolidation within the buy now, pay later industry is well underway.

Latitude (ASX: LFS) kicked off the year with the $335m acquisition of Humm’s (ASX: HUM) BNPL business. 

The market then said goodbye to Afterpay (ASX: APT) as it joins American payments giant, Block.

Now, Zip Co (ASX: Z1P) is circling its smaller rival, Sezzle (ASX: SZL). 

Both companies confirmed this morning that discussions are taking place, though only “preliminary in nature”. 

According to the Australian, Zip could be “paying a premium of as much as 50 per cent”.

Sezzle shares are trading 20% higher, Zip trails behind, up 3.1%. 

Does a merger make sense? 

Zip was level-headed in its response to media speculation, saying it will only pursue “transformational transactions that help accelerate the delivery of … enhanced scale in core markets, improved customer and merchant propositions and a faster pathway to profitability.” 

From a geographic perspective, acquiring Sezzle would enable Zip to tap into new markets including India, Brazil and parts of Europe. 

Sezzle services are currently available in Germany, France, Austria, Belgium, Netherlands, Spain and Italy, according to the company's website.

This would double Zip’s geographic presence from 9 to 18 countries. 

In terms of driving scale, Sezzle derives more than 90% of its market activity from the all-important US market, based on its latest third quarter 2022 results. 

Sezzle has more than 3m active users and 40,000 merchants compared to Zip that has a respective 5.7m and 18,500. 

The combined Group could have enough customers to contest Affirm and Afterpay, which have 8.7m and 10.5m active customers respectively. 

Valuation and profitability an issue 

Latitude's $335m acquisition of Humm has been viewed as turning point for BNPL valuations. Humm is expected to generate $100m in pre-tax profit and cost synergies in the next two years.

Sezzle is far from profitable, generating -US$31.2m cashflows for the 9 months to 30 September 2021. 

Zip walks a very fine line amid its takeover discussions.

Offer too little, and Sezzle will continue to operate as a competitor.

Offer too much, and it will compromise existing shareholders, especially amid a climate of plunging tech valuations.