Long Growth Runway For Square

Summary

• Square was founded in 2009 to make credit card payments more accessible to sellers.
• In the last 10 years, the company has evolved into more than just that.
• Revenue soared during 2020, led by its Cash App ecosystem.

Photo by Clay Banks on Unsplash

Business Model

Its products and services are distributed into two main groups, Seller Ecosystem and Cash Ecosystem. The first aims to facilitate sellers running their business. The second is a parallel ecosystem of financial services to help individuals manage their money.

Although most of its revenue comes from its operations in the US, it operates in Canada, Japan, Australia, Ireland, Spain, and the UK.

• Seller Ecosystem

The main revenue source is the fees that the company charges for transactions, subscriptions, and services. The catalog of products and services includes more than 30 items grouped in software, hardware, and financial solutions.

Among the software solutions, there is its flagship Square Point of Sale, a customizable POS that adapts to multiple business types. The offering includes other solutions that cover specific businesses, such as Square for Restaurants, Square for Retail, and Square Appointments. The company also offers tools to enable sellers to build their own online store and further other functionalities to track their business data and insights.

The hardware portfolio includes products to facilitate card payments, such as portable payment devices, Square Stand, which enables an iPad to be used as a payment terminal. Square Register is a tool that combines the company's hardware, point-of-sale software, and payment technology.

The financial services include managed payments, making it available to sellers accepting payments in person or online. Square also offers a free business prepaid debit card, and it also facilitates loans to qualified Square sellers. The services also include Square Payroll, which allows retailers to manage their employees and pay wages.

• Cash Ecosystem

The Cash App Ecosystem offers peer-to-peer services, which include storing, sending, and receiving funds. Customers can use Cash App to store funds by receiving money from other Cash App customers or transferring money from a bank account. Square also offers a Cash Card, a debit card that users can use to purchase, linked directly to a customer's balance. The Cash App provides the functionality to invest in US stocks and exchange-traded funds (OTC:ETFS) or buy and sell Bitcoin.

Actions to Increase Market Share

When looking at the total addressable market (TAM) of its two ecosystems, it seems that the company is just scratching the surface of its potential. According to the September 2020 Company Overview, its seller ecosystem represents a TAM of $100 billion, having a penetration rate close to 3%. Its Cash App ecosystem represents a $60 billion market opportunity, for which the company had a penetration rate of less than 2%.

Square has taken several steps to keep increasing its market share. In 2020, the flourishing of e-commerce was an opportunity for launching new tools and services to support the upward trend. Last year, it released a new payment tool designed for small businesses looking to rapidly transition to e-commerce. With Online Checkout, sellers who were not Square's clients could simply create a link for any goods or service that they want to accept payment for.

The company also launched new services targeted at restaurants, a new on-demand delivery giving the option to dispatch deliveries without paying commissions. Another feature was its QR codes, which enabled the customer to check the menu, order, and pay.

Other measures to strengthen its Seller Ecosystem included the launch of its newest developer tool, Terminal API, that connects Square Terminals to the Point of Sale systems, regardless of the platform or operating systems it's been developed on.

Finally, a further step towards its finance business segment included the actions for opening its own bank. In 2020, Federal and state banking regulators approved an application to start its bank in Utah. The bank, Square Financial Services, Inc., is expected to launch in 2021. The primary purpose will be to offer small business loans for Square Capital's commercial lending business and offer deposit products.

Cash app ecosystem leading growth

In the fourth quarter of 2020, total net revenue was $3.1 billion, up 141% year over year. Cash App delivered outstanding growth in the fourth quarter, generating $2.1 billion of revenue, a 502% increase y/y. The main driver of this growth came from bitcoin revenue which represents 81% of total revenues of the segment for the fourth quarter and 77% if we look at the full year. Excluding the net payments from bitcoins, growth is not less impressive, with 127% y/y growth for the last quarter and 137% y/y for 2020.

Regarding its Seller Ecosystem, net revenue was $987 million for the last quarter, representing a 5% increase y/y, and 3.5 billion for the full year, increasing 2% y/y.

Gross profit also had a positive performance, reaching $803 million, up 52% year over year and 45% for the full year. The Cash app was responsible for 47% of the quarter's gross profit, increasing 162% y/y, and 138% y/y excluding bitcoins, while its seller ecosystem represented 53%, rising 13% y/y.

In the fourth quarter of 2020, bitcoin volumes per customer were up more than 2.5x compared to last year. Even though most of the impressive growth seen in the Cash App was led by bitcoin revenues, it is important to mention that bitcoin's gross margin is relatively low. Throughout 2020, the gross margin was 2% on average. For the last quarter, the cryptocurrency contributed 11% of the gross profit from its Cash App ecosystem and 5% of the total gross profit. According to management, offering bitcoin has helped increase engagement in other products from the Cash App.

Although total net revenue has shown a substantial increase during the last quarter, gross profit has shown deceleration in its growth. This was coming mainly from its Cash App ecosystem, which y/y growth reached 212% during the third quarter, and 162% during the last quarter.

Source: Graphs composed by the Author as per Square earning results

The number of active users of its Cash app ecosystem continues its rising trajectory, reaching 36 million monthly in the last quarter, up more than 50% year over year, and scaling more than 10x over the past four years.

The Gross processing volume (GPV) increased 11,8% in the last quarter. From this growth, most of this volume comes only from online channels and omnichannel (sellers who have taken an in-person payment and an online channel payment), reflecting the pandemic's impact and the shift to e-commerce. The total y/y increase for 2020 was 6%, showing signs of a losing speed in the rapid growth it had in the last 5 years.

Source: Graphs composed by the Author as per Square earning results

The last point to mention is the increasing investment of the company in bitcoin. In October 2020, it invested $50 million in bitcoin, and later on, it added $170 million worth of the cryptocurrency during February this year. Its total bitcoin holdings represent approximately 5% of its cash and cash equivalents, indicating an average price of about $51,235 per bitcoin.

Valuation

Looking at its valuation, the company remains relatively highly-priced when looking at its P/E and its main peers, such as PayPal. Nevertheless, it is fair to mention that expected growth rates are much less impressive for the latter.

Last quarterly reports have shown an EPS for 2020 of $0.48. With a current stock price of $230, this gives us a total P/E of 479.16. If we add the expected growth for this year to the equation, this represents a total PEG of $10.89, indicating a high premium to pay for investors.

Source: Table composed by the Author as per Square earning results and Yahoo! Finance.

Conclusion

The company had substantial growth during 2020, and it is expected to continue its expansion throughout this year. There is a long way to go with an addressable market combined for its two ecosystems of 160 billion.

Most of its recent growth was driven by the Cash App ecosystem, which revenue was led by the gains coming from its bitcoin offering. Even though this has an enormous impact on its net revenues, the cryptocurrency gross margin is relatively low, having a less significant effect on total gross profit.

A correction to its price could be expected this year, more likely if it does not please its shareholders with the similar outstanding growth seen during 2020. For long-term investors, the company offers an attractive opportunity for the years to come.