Square stock dropped 14% on March 23rd on the short selling news from Hindenburg, claiming there is a lot of fraud going on in its flagship product Cash App. The statement from Hindenburg is barely strong or with sufficient evidence, so I think the short selling will only be short term.
Square ($SQ) stock prices hit a record high of ~$289 due to the increased use of cash transfer applications, and it has dropped a lot to under $100 after the peak price.
Block (previously Square), a software and financial services company founded in 2009 by Jack Dorsey and Jim McKelvey, has expanded from its original product of a payments card reader to a ~$20 billion company with a mission of economic access and empowerment. The company has six businesses that operate under this mission: Square, Cash App, Afterpay, TIDAL, Spiral, and TBD. Square began serving micro and small businesses that did not have access to accepting card payments, but has since expanded to serve consumers, developers, and small, medium, and large businesses. The company has over 40 products that combine hardware, software, and financial services. The two main ecosystems are the Square ecosystem, a B2B and B2C system that provides financial services and software to businesses, and the Cash App ecosystem, a financial consumer application for consumers that offers peer-to-peer transfer, cash cards, Bitcoin trading, stock trading, and other services. It’s been an exciting growth story since IPO in late 2015. It’s grown gross profit from $500 million to over $5 billion.
B2B Business
On the merchant side, Block serves around 3 million merchants, with 90% of them in the US, and also operates in Australia, the UK, and the EU, generating $2.3 billion in gross profit. On the consumer side, Cash App has approximately 100 million annual active users, with most of them in the US, but with Afterpay, they have some international footprint. When compared to large financial services businesses in the US, such as JP Morgan and Bank of America, the scale of Square’s ecosystem is comparable.
Regarding the P&L of Block, the merchant business has a 33% gross margin, and the payments business is profitable, with $2 billion of gross profit coming from the software and payments business. The bulk of gross profit in the Square ecosystem comes from the traditional payments, hardware devices, and software and integrated payments offering. Additionally, Square loans, Square card, and instant transfer contribute to the rest of the gross profit.
The cash card is a profitable opportunity for Block as there is no credit card company, and typically all the money goes to the bank issuer. Card issuing is a profitable opportunity for Block, and they are issuing cards to Square merchants as well. Owning the customer relationship is key, and a closed-loop network enables transaction efficiency and cost advantage over competitors such as Toast. Amex has been successful with their rewards program as they have a closed-loop system, and Block aims to do the same with their consumer and merchant ecosystems. The introduction of Afterpay provides a transaction connection between consumers and Square sellers, which benefits both parties. The software products provided by Square have an 80% gross margin and start to look more like a traditional software business.
B2C Business
Cash App product is a major contributor to the company’s overall profitability. In the fourth quarter of 2022, Cash App generated gross profit of $848 million, up 64% year over year. This represented ~50% of Square’s total gross profit for the quarter.
The largest contributor to the gross profit of Cash App is the instant deposit service, which charges a fee for users who wish to access their funds immediately. This service is estimated to account for roughly half of Cash App’s total gross profit.
In addition to the instant deposit service, Cash App also offers a Visa debit card, known as the cash card, which has become increasingly popular since its introduction a few years ago. The cash card provides users with access to their funds and can be customized to their liking, all at no cost. However, Square charges a fee ranging from 25 basis points to 2–3% per transaction when using the cash card outside the Cash App ecosystem. This service is estimated to contribute to around $500 million in gross profit for the app.
Cash App’s profitability is driven by several factors, including its large user base, its high engagement rates, and its growing revenue streams. Cash App now has over 44 million monthly transacting actives, up from 36 million in the same quarter a year ago. These users are highly engaged with the app, with the average Cash App user spending over $100 per month on the platform.
Cash App’s profitability is a key driver of Square’s overall profitability. The app is now one of Square’s most profitable products, and it is expected to continue to grow in the coming years.
Here are some of the reasons why Cash App is so profitable:
• Large user base: Cash App has a large user base of over 44 million monthly transacting actives. This large user base gives Cash App a significant amount of revenue from transaction fees.
• High engagement rates: Cash App users are highly engaged with the app. The average Cash App user spends over $100 per month on the platform. This high engagement rate allows Cash App to generate a significant amount of revenue from interest income and advertising.
• Growing revenue streams: Cash App’s revenue streams are growing rapidly. The app now generates revenue from a variety of sources, including transaction fees, interest income, and advertising.
In a word, Block is building a quite unique business empire, with both B2B and B2C ecosystems, network effect and rapid users growth around the world. As for the bearish points short seller Hindenburg point out, it just came from ex employees and seems not have proven evidence, and it does not affect the company’s overall business model. So I think the downside would be temporary, and giving the growth potential the stock should be a BUY from here at $60.
It is estimated that the fair value of Block’s share is $104, which is equivalent to 62.7 times the adjusted 2023 earnings. Although the decline in bitcoin revenue poses a near-term challenge, analysts anticipate strong growth in the long run. The projected total revenue will grow at a compound annual growth rate of 14% over the next five years and 12% over the next ten years, with seller revenue growing at a 16% CAGR over the same period. It’s expected that the Cash App area will drive growth, with Cash App revenue, excluding bitcoin revenue, projected to grow at a 23% CAGR over the next ten years. Management has previously indicated that the company can achieve a margin level of 35%-40% based on this metric, although no timeline has been given. Analysts projections assume that Block will ultimately achieve a margin level of 41%, equivalent to a GAAP operating margin of 15% at the end of the ten-year projection period.
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