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This whole article is a reformatted version of a big thematic piece I wrote in Q4-2019 during my hedge fund career. After latest earnings call and Q4 shareholder letter (on Square IR website) my confidence in Square has only gone up.
In this piece, I want to highlight high level thoughts about why Square is such a unique business and will be worth much more in future than what it is worth today.
- Unique Asset
Over last decade, payments have emerged as third growth vertical after Internet and Software. As core standalone verticals get more penetrated, convoluted business models with multiple revenue streams will emerge. Some of these will be very successful and command a high premium. Square business model is evolving very fast within this context. At IPO, Square reported $135M of net rev in Q4-15 with only 16% of rev from software and data products and 84% rev from core payment processing. There was no cash app at that time. Fast forward to Q3-2019 where Square reported $600M of net revenue with $280M coming from subscription, software, cash app etc. Core payment processing is only 50% of rev at this point. I believe companies that sit at intersection of these powerful trends will be next generation winners as they capture more wallet share of customer spend. As of now, there are only 5 such public companies that sit at payments / software intersection – Square, Shopify, Lightspeed, Bill.com, and Coupa. I believe all these are very powerful business models with software and payments embedded in them (there will be many more in coming years). First three assets – Square, Shopify, Lightspeed are typical PayFac (payment facilitators) with B2B2C model while bill.com and Coupa are more like B2B2B. Square out of these 5 companies has created a new rev line item through cash app (discussed below) that can be described as a close comp of Venmo (but much better) and hence resulting in a massive volatility in stock price over last 12-18 months as cash app grew in popularity. As investors do more work on Square in coming quarters and realize the potential upside and moat of business model, I believe stock will resume massive uptrend as it did in 2016 – 2017 time frame.
Square is innovating at scale and this innovation will result in faster revenue growth over next few years. Here is a snapshot of product innovation over last two years. [See point 3 – seller business]
- Cash App
Square has been working to create a “super app” for some time and finally it succeeded through cash app in last two years. As cash app became popular and Square mgmt. decided to spend more money in building cash app, they used less S&M spend in core merchant processing business. This resulted in a slower core but company has corrected it now (more on it later). As of now (Q3-19) cash app is doing $159M in subscription, services, transaction revenue on a quarterly basis (growing 100%+) and another $148M / quarter in bitcoin revenue. I believe cash app can be first super app in payments in USA – similar to Alipay. Cash app has just launched stock trading function and now you can buy fraction of a share on cash app. This is only possible with underlying crypto tech stack that Jack’s crypto team is building. Jack is in Africa to study how to bring cash app and payments to underdeveloped countries. A lot of investors haven’t focused on cash app, crypto upside because company hasn’t given out a lot of details. I can see a powerful narrative from tweets (my own mosaic theory around super app and rev potential). Here are some tweets and snapshots about cash app.
Three snapshots showing
- cash app looking to build sales team to scale rev massively (tweet came after Q3 earnings call and before my San Fran visit to company HQ)
- old tweet showing Jack hiking with Square Crypto team (only team that reports to him directly)
- Snoop Dogg tweeting about cash app (not a promoted tweet) – pure branding
Using cash app, square can finally establish a relationship between merchant POS and their customers as two sided network is very powerful. Using this, Square can launch it’s own square button and create a close loop network if needed. Square already has buyer profile on ~300M consumers linking card numbers with phone numbers and emails. This is very powerful.
Cash app can be next generation “neo-bank” with features like direct deposit, debit card, lending, crypto, stock trading etc. Through cash app, Square is just “scratching” the surface for various monetization methods and can create a high margin business over next few years (move away from P2P). As an example, 20% of cash app users are already using Square debit card with 35%+ incremental EBITDA margin.
- Core Seller Business
Square is adding functionality to core seller business at fastest pace among all payment companies that I cover (see chart above on product innovation). As Square is finding product traction in cash app and core seller business, company is moving away from non core businesses and is right sizing by selling Caviar and other businesses. For the first time in Q3-19, company disclosed core seller business EBITDA margins around 30% which is much better than street expectations. This means Square is investing very aggressively (cash app is at breakeven EBITDA margins but with scale, it will grow EBITDA). Square has multiple years to grow EBITDA margins and EBITDA $ making it one of the fastest growing company. As stocks multiple stabilizes, you should earn an IRR equal to EBITDA growth in coming years. Also 2020 will be first year after two years when Square will invest in seller S&M. Since payback period is stable around 4 quarters, it should result in GPV stabilization and some acceleration (can reverse engineer GP$ contribution from S&M$ and hence revenue and GPV).
I am expecting 2020 to be a stabilization year in GPV around 24-26% and then an acceleration in 2021.
Company has upcoming investor day in March and I believe mgmt. will highlight details around cash app and seller business and potential monetization path over coming years. Great companies usually do an investor day only when business is inflecting up or they have to share some great news. We have seen this dynamics around MELI and PYPL. This March investor day is a critical catalyst for stock.
- Mgmt. Team
Last point that I want to highlight is around mgmt. team. Square had a great CFO – Sarah Friar who left few quarters ago to become NextDoor CEO. This left a vacuum for few quarters as Sarah was kind of quasi COO and she honed beat and raise technique at Square. New CFO Amrita Ahuja hasn’t be that impressive so far but I believe IR team has done a great job in bringing her upto the speed in terms of setting expectations and how to communicate with the street. 2020 is her year to shine.
Since 2020 numbers are reset, mgmt. has right sized the business by selling non-core assets and focusing on core business (seller + cash app), sentiment is very mixed, I believe Square offers great risk reward over next 4 – 8 quarters.
Also as cash app and seller ecosystem grow and company moves upstream, Square should command a higher share of acquiring business. Shareholders will be rewarded to own this great asset.
Comments/footnote: Second chart is from sell side research. Views expressed are my own personal view and are subjected to change based on incoming information. I personally own Square stock. For any errors, mistakes, typos please contact me personally and I will fix them.