Square: Killing It

Summary

• Q2 earnings show solid growth with little signs of slowing down.
• A sizable Australian acquisition will help scale.
• Bitcoin trades helping drive traffic and usage.
• Cash app still strong as small business returns.
• Shares are going much higher.
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shulz/E+ via Getty Images

We love financial tech stocks, and near the top of the list is Square (NYSE:SQ) which we have traded several times. That said, whilst being a great trading stock, the easiest move is to buy and hold over the next five years. The company is a fintech disruptor, and it is growing like wildfire. The company just reported some stellar earnings, and is showing no signs of slowing down. What is more, an expensive, but well-timed acquisition will help the company scale. While valuing the company on traditional metrics is near impossible, we implore our followers to think very long-term here and believe the company will grow into its stretched valuation. We rate shares a strong buy the closer they are to $200.

Q2 earnings were solid

Keep in mind ever since the company allowed access to cryptocurrency (bitcoin), revenues have taken off. In the just announced quarter, net revenue was $4.68 billion up an incredible 143% year-over-year. Excluding bitcoin (BTC-USD) transactions, total net revenue in the second quarter was $1.96 billion, up 87% year over year. While this is still massive growth, you can see how much the bitcoin assets mean to the company. On the whole, gross profit was $1.14 billion up 91% year-over-year. Solid.

Transaction revenue surges, but watch GPV gross profit

Revenue from transactions was $1.23 billion rising 80% year-over-year, while gross profit was $543 million, up 85%. The Street may be disappointed with the fact that volumes were less than expected, despite surging from a year ago. Square processed $42.8 billion in GPV up 88% year-over-year. Transaction-based gross profit as a percentage of GPV was 1.27% down 2 basis points year over year and down 5 basis points quarter over quarter. That was a weakness that the Street might also jump at. You have to remember, with the stretched valuation of this high growth fintech stock, the slightest negative can irritate the shareholder base and trigger selling. We would welcome the selling and encourage a buy.

That said, subscription and services-based revenue nearly doubled as well to 685 million while gross profit was $561 million, up 90% year-over-year. Keep in mind the acquisition of TIDAL was a big boost in the quarter, but the organic growth was solid as well.

Cash App and Bitcoin

The biggest driver of overall growth was the amazing Cash App. Cash App generated $3.33 billion of revenue while delivering $546 million of gross profit. This is huge growth. Revenue rose 177%, while gross profit nearly doubled. Again, bitcoin was a large part of this. If we back out bitcoin, Cash App revenue was $606 million, up 87% year-over-year.

Keep in mind the prices of bitcoin were falling for most of Q2. It was volatile. Volatility helps with trading revenue, but expect even more positive profit power if bitcoin prices start to rebound. Which, they are, in the last week or so. We think that the cryptocurrency access is huge for the company. Just how big is bitcoin for Square? HUGE. Cash App brought in $2.72 billion of bitcoin revenue and $55 million of bitcoin gross profit in Q2. This was up three-fold from last year. It is major.

The company itself is taking money in putting it straight into owning bitcoin. According to the release:

In the fourth quarter of 2020 and first quarter of 2021, we invested $50 million and $170 million, respectively, in bitcoin. As an indefinite-lived intangible asset, bitcoin is subject to impairment losses if the fair value of bitcoin decreases below the carrying value during the assessed period. In the second quarter, we recognized a bitcoin impairment loss of $45 million on our bitcoin investment. As of June 30, 2021, the fair value of our investment in bitcoin was $281 million based on observable market prices, which is $127 million greater than the carrying value of the investment.

As you can see, there is serious cash on the line here. As such, expect the stock to continue to trade with a slight correlation with the price of bitcoin. However, the bulk of the business is still transaction based, and we have not even touched on small business

Small business is coming back

One of the biggest customers and drivers of revenue for Square are small businesses. They are coming back now that the COVID crisis is improving and the world is reopening. Small businesses as part of the broader seller ecosystem was responsible for $1.31 billion of revenue and $585 million of gross profit, both up over 80% from a year ago. Once again, solid growth.

Earnings are positive, though could be stronger if operational expenses are controlled but we aren't complaining

We are not going to complain about a fintech that is in supreme revenue growth mode that is earnings positive. And the company is earnings positive. While a FWD p/e ratio is laughable over 100, or more, we want you looking at the degree of growth. Net income was $204 million. They did have a gain of $77 million by selling their DoorDash investment. Net income was $173 million when excluding that and the aforementioned loss related to the impairment of its bitcoin investment. Operational expenses are high however. Operating expenses were $1.02 billion up 64% from a year ago. Make no mistake, they are commensurate with the huge rise is sales, but the more controlled these expenses are, the better earnings will be.

Nice to see EPS growing

Overall, net income per share was $0.45 on a basic level. If we back out the DoorDash sale and the impairment on bitcoin basic EPS was $0.39, while adjusted EBITDA was $360 million surging from the $98 million a year ago. Overall adjusted EPS was $0.66 a huge $0.48 increase from a year ago. And things are only going to get better.

A new acquisition, pricey but interesting

In conjunction with this weekend's earnings release, Square agreed to buy Australia's Afterpay (OTCPK:AFTPF) for $29 billion (all in stock by the way) to add buy now, pay later abilities. While Afterpay shareholders can take some of it in cash, on the whole, Square is paying roughly $125 per share for Afterpay in Australian dollars, or a 30% premium. That is pricey. The deal will not close until 2022, so the actual fiscal terms may differ at that point. Afterpay shareholders will own approximately nearly 20% of the newly combined company on a fully diluted basis. It is a massive transaction. But Afterpay has had its own immense growth and has surged in popularity. We believe this deal and the capabilities it will bring to Square's users is accretive, and the company will reap the benefits immediately in 2022. For more on Afterpay, we recommend this column here.

Take home

Make no mistake, Q2 earnings were incredibly strong. The inclusion of bitcoin trading has been a massive benefit to the company as transactional revenue has surged. Small business is coming back and that has led to a big rebound in seller-based transactional fees. This supreme growth fintech is also earnings positive. The acquisition of Afterpay is a huge move to get into the buy now, pay later business which is growing in popularity, specifically among millennials a primary user of Square services. While traditional valuation metrics are not at play here, we urge our members to consider the fact that the company is growing like wildfire. The closer shares get to $200 the more bullish we are. However, shares are a buy at present levels for the long-term.

Analyst’s Disclosure: I/we have no stock, option or similar derivative position in any of the companies mentioned, but may initiate a beneficial Short position through short-selling of the stock, or purchase of put options or similar derivatives in SQ over the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Comments

[Pineside]

I am becoming more and more confident in SQ; recently added on two or three occasions.

I'm really liking their strategic growth moves; and fintech is a very big runway.

Might end up bringing this one up to the % of portfolio I have allocated to AMZN, GOOGL, TSLA, ANET, and UI (about 3-4% each).

[stuck]

The valuation of this company is outrageous. You got to be kidding me. It overpays for a company with overvalued stock. That looks good. But no one really knows what Square is going to do with it.....And the stock goes up. This is not an investment, it is chasing hot air.

[Boraxis]

@stuck
Which valuation metrics? P/E? SQ is keeping the earnings around zero to fuel the 87% revenue growth (ex bitcoin). Division by a small number is a large number. Other metrics are actually pretty decent.

Keep in mind that this is a company almost doubling revenue yoy, with a pristine balance sheet (all debt is convertibles), that is also profitable. It's expensive, but as in life, good things are expensive.

[canyon]

@stuck
You don't understand Fintech, and disruption. You probably said the same thing about valuations of AMZN, FB, etc. years ago. One would have been equally correct (wrong) if one did.

[Buyandhold 2012]

Yes, Square is killing it.

Up 2,610.25% in the past 5 years.

Only 2 stocks that I follow have done better

Enphase: Up 10,129.61%

Shopify: Up 4,488.94%

And only one stock that I own has even come close.

RH: up 2,188.69%

[TomAndrew]

@Buyandhold 2012 Afterpay up 4193% in only 4 years. Not a bad combination.

[siestadreamer]

Do I understand correctly…you’re bullish but may initiate a short position?

[The Bank]

I want to preface my comment below by acknowledging that I know very little about Afterpay so please don't get upset with me if I'm not getting it but I suspect that a lot of other people don't know much about Afterpay either but are too intimidated to ask questions about it. For the record, I have owned SQ stock and have been debating about whether to get back in. Here's what concerns me. Am I the only one who sees a lot of risk in this deal? $29B for a company with the following 5 year net profit figure as follows (FYE 2020 at the far left):

Net Income (19,780.0) (42,861.0) (8,976.0) (9,620.0) (3,552.3)

Not only that but they also need to demonstrate that they know credit risk and how to price it. I mean I thought I saw something float across the CNBC screen that the Afterpay business model will allow a customer to buy something at a store by swiping and then paying the bill off in 4 equal installments at 0% interest as long as they keep making payments on time. If the customer goes delinquent then they charge him interest. I just wonder how they can make that business model profitable. Visa and Mastercard charge double digit interest rates to make this business model work. Grateful for whatever enlightenment folks can provide.

[Cursus]

@The Bank The issues you are bringing up are very important and seem to be dismissed by many commenters. The big credit card companies / issuers do not want the business demographic that is SQ's core clientele. They didn't want this business because it cost too much to service for each dollar of revenue. This business customer base also represents a relatively greater credit risk.

I think you are also correct to wonder if SQ has the correct intellectual capital to monitor risk. Certainly some risk parameters can be manage through algorithms, but there are lots of edge of bell curve events that algorithms can't assess. Ask the guys at Long Term Capital about that.

Everyone should note that SQ keeps emphasizing gross margin and gross profit instead of net profit. I think they do this because it is not clear that SQ's core business is actually scaling up profitably after all costs are factored in.

SQ's involvement in BTC and Tidal seem like a distraction and are very questionable from a business and P&L standpoint. Management seems more interested in their hip bonafides than real profits. This stuff looks cool, but does it make any actual profit?

Certainly SQ shares are worth something, but most probably only a fraction of the current share price. This is one hugely overvalued stock. The author of this article indicates there is no proper way to value this organization. That should be a big warning sign to investors. That is not something to gloss over.

Shouldn't this company have already scaled up to real net profitability by now?

[The Bank]

@Cursus Thank you for some interesting enlightenment on this subject - especially in your first paragraph. I did not stop to think about the attraction of this business to the major credit card issuers and was intrigued to hear that this business was considered unattractive by them. While I think I am going to hold off on buying shares of SQ for now, I will say that I am a little concerned for my long positions in V and MA. I have long felt that the credit card companies have gotten away with making outsized economic profits and couldn't help but wonder if an entrepreneur couldn't come in and undercut on pricing after which the business would never be the same.

[Cursus]

@The Bank compare the gross margin of V to that of SQ. It is very revealing.

It is a difficult market to invest in overall at this point. In general shares are fully valued to overvalued. Artificially low interest rates are driving up PE multiples.

V and MA are great businesses especially during periods of inflation. They are both part of an oligopoly. These are low asset toll booth businesses. One has to decide if they are traders or investors. That said, if shares get egregiously over valued I have been taking some profits. Real interest rates can’t remain negative indefinitely.

Good hunting.

[Pineside]

Really like the strategic business acquisition of Afterpay.

Doubled up my SQ share count this morning; I think this compqny probably has a ton of growth ahead of it.

[Killnthecurve]

@Pineside Yeah probably but what are they going to do if people don’t pay back? Take a loss?

[canyon]

@Killnthecurve
What arrangements might they have with merchants when for such scenarios... what might they create in the future?

What other accounts (like CashApp or crypto holdings) might they have with those customers defaulting... what provisions might SQ have there (e.g. collateralization) or what provisions might SQ add to such accounts in future.

Lots of risk-mitigation potential I think.

[Killnthecurve]

@canyon I agree. I asked my broker and he said that this is part of the reason Wells Fargo got out of personal loans. The problem is that the American public buy things they can’t afford, waste money paying premium on Starbucks coffee, etc. There is a dearth of financial literacy in the US. That being said I’m long SQ, I think they'll figure out how to be successful.

[Rjzq]

Great company, but has 15 years of growth priced in already. Valuation is nonsense.

[canyon]

@Rjzq
15 years of doing the same thing, maybe.
AMZN had 15 years of selling books online built in to it, but it grew to something bigger.

If SQ gets deeper into SaaS, merchant solutions like P&C insurance or procurement or new lending models, the 15 years of growth will be such an obsolete calculation (garbage in...). If. Some are investing in disruption, not CC transaction processing.

[Ronaldo123]

Not going to chase it after it goes up so much today. Will patiently wait for a correction.

[ddeatkine]

long since 25!! 😮

[2live4divs]

love SQ! will hold foreveŕ

[notAgainPlease]

45c earning for 280$ stock? Mkt cap more than GS and earning less than 40x ? I mean how much do they have to grow to generate profit as much as GS? This is an absurd valuation.

Buy now, pay later is going after low tier who will default and won't be able to pay back. Most good credit cards offer to split big amounts to their good customers anyway. Paying in stocks so huge dilution coming.

Also heard Apple is coming later this year for pay later so you can forget the 1B plus apple users who have a lot more money to spend.

I expect this to be below 200 in the next 6 months. Bought Jan 2022 200 put for 6$ this morning.

[raining2009]

@notAgainPlease I expect SQ to be over 1000 in 5 years

[Seeking more alpha than you]

@raining2009 I agree with Raining. Square will be higher in the long run than they are today.

[Select 65]

@notAgainPlease That’s what they said about Amazon 25 years ago!……..Great companies with great vision grow into their valuations……..SQ is one of those companies………….Very happy to be long SQ!……..(At a cost basis of just over $50!)

[canyon]

Let me beat you to it, fools:

No moat
Sky high valuation
Idiot/freak/liberal CEO
Why can't the lega, ah, dinosaur banks just do the same thing
Too much competition
V and MA will crush them

So glad I only sold 200 of my 700 shares at $90 something for a stupid double. Long SQ (and PYPL and PAGS and SHOP and V and MA).

[John Rhodes]

@canyon

I own no SHOP. It turned out better than I expected. C’est la vie!

[Rleaton]

@canyon that’s a great tall seller impression. You forgot about the part where he screams about the DTC powerlist no one cares about tho. Oh, and you forgot to write every other word In all caps

[Indica Trading and Investments]

Jim Cramer may suck but to this day I give him credit for telling me about Square at $45

[Lord Krungharr]

Wish I would have bought more on the dip....

[stuck]

I just can not justify the ridiculous valuation of this stock in this sector. WAAAAAAY overpriced, and Jack Dorsey just seems to be at 420 all the time. And if you think Square can take over banks, there are hundreds of these entities doing it better then Square.

[bullish bengal]

@stuck can you enlighten us with some of these hundreds of entities?

[Seeking more alpha than you]

@stuck what are the names of the top 10 entities doing it better than square?

[John Rhodes]

@Seeking more alpha than you

I understand and like PYPL more. Clearer picture, lower risk, less dependent on Bitcoin. However, SQ does seem to have special sauce.

We’ll see…

[Blue Scorpion]

Tired of parroting the same line...SQ is monster in the making. Going right after legacy banks and eating their lunch, but banks either too stupid to realize or too stupid to figure out what they should do about it. Maybe that's because SQ has not targeted any one particular bank but the entire industry. SQ is a huge company delivering small growth company growth #s.

Do your own DD.

Cheers!

[High Yield FIREVestor]

Multibagger, PT 800 🚀🚀🚀🚀🚀

[Quad 7 Capital]

@Investing4FIRE have to tell you it definitely has that chance we talked about it at our BAD BEAT round tables and concur it’s likely a double from here in the next 2 years.

[High Yield FIREVestor]

@Quad 7 Capital I will slowly and meticulously add to my current position...won't add anything today

[John Rhodes]

@Investing4FIRE

When are you buying? Price point?