Klarna Group

Klarna reported second-quarter results well ahead of guidance, but tempered expectations on full-year revenue and volume growth, citing weakness in German retail spending. Transaction margin dollar guidance was raised for the full year but still fell short of our expectations.

Why it matters: Klarna flagged weak retail spending trends extending into the third quarter and does not expect a reversion this year. Klarna's exposure to discretionary spending and 23% revenue contribution from Germany amplify this soft regional outlook. The weaker growth outlook offsets much of the momentum from Klarna's new payment service provider, or PSP integration, its deal to become the financing engine of Apple's product leasing program in the US, and generally improving profitability per US dollar transacted. Profitability per transaction is on the up, despite the weaker top-line outlook. Alongside the growth in the higher-margin fair financing product, subscription revenue is starting to make a dent. Active subscriber count increased to two million from just a quarter million a year ago.

The bottom line: We lower our fair value estimate to USD 38.30 per share from USD 45 per share. Visibility into Klarna's volume growth trajectory has declined, resulting in a material 2 percentage-point-per-year reduction in our volume growth expectations. Offsetting some of the lower volume growth, we now assume greater revenue contribution from subscriptions. We model 7% of active customers paying subscription fees in the next 10 years from an immaterial base in 2025. Our narrow Morningstar Economic Moat Rating is unchanged. We anticipate the PSP integrations to drive further merchant growth, strengthening Klarna's platform and attracting more customers. As Klarna is beginning to monetize its network, we expect returns to improve materially.

The top-line guidance cut overshadowed an overall strong second quarter for Klarna, with transaction margin dollars of USD 446 million easily beating guidance of USD 395 million. Klarna earned 1.14% per US dollar of transaction volume on a TMD basis, up 4 basis points from last year. Due to its product mix of a heavier tilt toward short-tenor loans, 40 days on average, Klarna is showing a material gap in profitability per dollar transacted. Additionally, Klarna is only beginning to meaningfully monetize its customer base, offering subscriptions that provide cardlike benefits such as cashback. Over time, the rapid growth of the long-tenor fair financing product, and the partial decoupling of revenue from transaction volumes via subscriptions, should improve Klarna's profitability profile.

Klarna is now live with JP Morgan Payments as a default-on payment option. This is the seventh big PSP to grant Klarna this status. As a result, merchants will automatically offer Klarna at checkout unless they actively opt out. We view this as a material driver of Klarna's reach, expanding the value a Klarna account and ultimately subscription can offer its customers.

Part of the top-line guidance cut is also attributable to an accounting change for the fair financing loan treatment under IFRS. Instead of booking an upfront loan loss provision and then collecting interest income for the remainder of the loan's maturity, Klarna will now book a gain on sale for all fair financing loans it offloads via forward flow agreements. This reduces revenue and costs at the same time, while being more capital efficient. The effect is largely presentational.

Guidance for the third quarter was disappointing after a strong first half of the year. Apart from the mentioned outlook in Germany, Klarna will increase spending on marketing in the third quarter to convert its new JP Morgan Payments default-on status into meaningful customer wins in the fourth quarter.

Lastly, Klarna announced the transition of its chief financial officer and chief marketing officer, with both staying on until the beginning of next year to facilitate continuity.

Our fair value estimate is $38.30 per share.

We have tempered our 2026 volume growth assumptions, now only penciling in just below 18% versus 22% in 2025. We anticipate lower growth in the pay later product, driven by Klarna's exposure to Germany, where this product is more dominant, and retail spending is showing weakness. Absolute fair financing volume growth remains high, although the mechanics of a higher base drive down growth rates toward 70% in 2026 from 120% last year. We believe that default payment method status will drive merchant growth first, as more merchants can easily activate Klarna as a payment method at checkout, and customer growth will follow as a result. We assume a 15% GMV compound annual growth rate over the next five years. We expect Fair Financing to grow about 37% per year, albeit heavily front-loaded during the next five years. Pay Later should grow about 13% per year. We model for credit costs to be flat to slightly down in 2026 compared with the year before, as the offloading of Fair Financing forward-flow volume moves provisions of receivables off Klarna's book. From there, we expect Klarna’s underwriting model to improve further and its customer cohort mix maturing more toward customers with higher credit scores. We model a credit crunch in 2031, where we spike credit costs over GMV to 132 basis points from 60 basis points the year prior, to approximate a full credit cycle in our explicit forecast period.

We also model bull- and bear-case scenarios, which result in fair value estimates of $44.50 per share and $31.20 per share, respectively. In our bull scenario, we model Klarna's default payment method status in the PSP payment stacks to drive even greater adoption rates with merchants and customers. In our bear case, we model for merchants to display a more muted appetite for Klarna’s payment method at checkout.

We believe Klarna has a structural competitive advantage that will enable it to earn positive economic returns above its cost of capital over the next decade. More specifically, we believe Klarna's two-sided platform enjoys the benefits of a network effect, which culminates in our narrow moat rating. We think Klarna and other BNPL-native firms are structurally advantaged compared with a card network-based BNPL solution. Among BNPL-native firms, we view Klarna's size in both merchants and customers signed to its platform as a network effect that we believe will result in excess returns.

Klarna has a two-sided network effect. As more active customers use the platform, more merchants will want to offer it at checkout. As more merchants offer Klarna's payment method and financing options at checkout, more customers will start signing up for Klarna.

Additionally, merchants within verticals show tendencies to focus on similar payment methods at checkout. The thinking is that a merchant does not want to lose a sale because of a different choice in payment options. As a result, BNPL providers can gain prominence in specific verticals because they entered these verticals early and focused their marketing and product development spending on serving merchants and customers best in that vertical.

Customers also benefit from more customers joining Klarna, as the availability of Klarna at checkout improves (merchant-driven). Moreover, Klarna's underwriting models improve as more customers join, resulting in increased spending limits and improved financing conditions for borrowers (for example, Klarna offering Pay in 30 days rather than Pay in 4).

Klarna competes primarily with BNPL pure plays and BNPL-capable fintechs, such as Affirm, PayPal, and Afterpay (parent Block), as well as BNPL providers utilizing BNPL features enabled via the card networks. We will refer to the first group as MDR BNPL and the second group as card-rail BNPL for the rest of this report.

MDR BNPL is a BNPL solution that relies on deep integration of the BNPL provider with the merchant. Merchants purposefully enter these types of integrations to drive checkout conversions, increase average order values, enhance ad-spending returns on investment, and offer shoppers custom-tailored financing options.

Card-rail BNPL relies on BNPL features of card networks such as Visa and Mastercard. Klarna's own Klarna card also falls into this category. Card-rail BNPL does not require merchant integration. Transactions are turned into installment loans after the purchase. Theoretically, any purchase made with a BNPL-enabled card can be turned into an installment loan.

While using a card-rail BNPL solution seems more appealing initially because of its wider reach (that is, customers are not limited by merchant integrations and can split their payments into installments anywhere that accepts cards), MDR BNPL has two benefits: (1) merchant integration, and (2) better unit economics.

The first benefit is that the merchant is incentivized to promote the BNPL provider in a symbiotic relationship. Merchant integration refers to a merchant actively selecting a BNPL provider to offer financing options to their customers. The merchant may choose to run a specific ad campaign to drive traffic to its website, supported by an attractive financing option such as 0% financing and installment loans for specific products or the entirety of its product portfolio. The merchant can build the additional costs of the BNPL provider into the purchase price. Ultimately, the merchant sees the BNPL provider as a conversion tool rather than a payment method. The merchant is incentivized to promote the BNPL provider, giving the latter a head start in the competitive race of checkout payment options.

The second benefit is better unit economics as a result of negotiated merchant discount rates versus card-based interchange. MDR BNPL can price the merchant discount rate based on the value it brings to the merchant. The largest determining factor of this value is the number of customers it has on its platform. The customer's lifespan on the app (a longer lifespan typically results in higher credit limits and a higher purchase frequency) and the ability to market a promotion via the BNPL provider's own app are other key considerations. Card-rail BNPL is limited to interchange and cannot provide the conversion and customer acquisition funnel tools that MDR BNPL providers offer.

The gap between MDR and interchange drives materially different unit economics of offering zero-interest financing. As a result, European and Australian card-rail BNPL struggles to compete on financing terms without having the benefit of merchants subsidizing the interest component.

In the US, the MDR versus interchange advantage is less pronounced. However, it is worth noting that issuing banks typically use the majority of the interchange to fund their reward programs. Reward programs are one of the strongest tools for customer acquisition and retention for issuing banks when providing credit cards. Klarna, on the other hand, does not rely on rewards to acquire and retain customers, but leans on its network of merchants that brand Klarna on their websites. Additionally, MDR-based BNPL is typically chosen for its convenience and lower risk of falling into revolving credit, while credit cards tend to be chosen for higher credit limits and the rewards attached to them. All in, card-rail BNPL using reward programs will see significantly weaker unit economics than MDR BNPL.

Merchants offering multiple BNPL providers at checkout, plus card-rails-based BNPL solutions layered on top of credit and debit payments, are often cited as preventing BNPL players from establishing dominant positions. While it is true that merchants can, and often will, offer multiple BNPL options at checkout, we don't think that this prevents Klarna from having a network effect-based competitive advantage.

Klarna's default-on status at major payment services providers will amplify its growth potential.

The network effect will solidify Klarna as a dominant BNPL player, allowing it to broaden its product range into other banking and embedded finance products.

A maturing customer mix will improve credit costs, purchase frequency, and average revenue spent per customer.

Klarna’s business model has not been stress-tested yet. Low delinquencies currently could prove to be a poor predictor of loss rates in times of stress.

Regulation around BNPL is still light and will tighten over time. This will close the regulatory arbitrage gap that Klarna and other BNPL players have been exploiting until now.

Funding costs may spike if credit spreads widen, threatening Klarna’s unit economics.