Block’s ecosystem
Block, Inc. (NYSE:SQ) is a financial intermediary that leverages its Cash App platform to provide a peer-to-peer ecosystem for consumers, along with Square, a commercial and financial hub for merchants. While the company has other sources of revenue, we will focus on the overlapping merchant and consumer segments, which we believe are particularly valuable.
Cash App is primarily used for peer-to-peer payments, enabling users to easily send and receive money from friends and family. In addition, the company has made enhancements to the platform, including the Cash App Card and the Discover tab, which allows users to access a range of financial services and commerce options such as Bitcoin, stocks, and deposits.
The Cash App Card is a product offered by Cash App that enables users to make purchases and withdraw cash from ATMs. The company has been working to increase the accessibility and visibility of the Cash App Card and has also been adding features that complement existing ones, such as direct deposit, in order to showcase the full range of products and services offered by Cash App. Looking ahead, it appears that the company is focused on simplifying the user experience and integrating automation and artificial intelligence into the platform.
In the Square segment of the business, the company is focused on providing technology solutions that streamline operations and save time for small business owners. They offer products such as self-serve ordering, payroll, and team management to reduce the workload for business owners and improve efficiency for employees. The company is also working to further enhance these products with automation, enabling business owners to make more informed decisions and increase their chances of success.
Derive value from Block’s overlapping ecosystems
Square is seeking to expand the range of services offered through its Cash App platform, with a goal of becoming a primary financial services provider for users by offering a range of products similar to those offered by traditional banks. To realize this objective, Square is focusing on monetizing new products, becoming the primary financial services provider for users, and targeting higher-income demographics.
To achieve its goal of becoming a primary financial services provider, Square is using its seller base to drive closed-loop transactions between Cash App users and Square sellers, facilitated through the Cash App loyalty program, “Boost.” By closing the loop between sellers and buyers, Square aims to create a more seamless and integrated shopping experience that can attract higher-income demographics and increase sales.
The acquisition of Afterpay will also enable Square to launch its planned Cash App payments network, allow Cash App users to connect with millions of other merchants, and increase the value proposition of Square’s seller-focused products. It will also boost Cash App’s revenue by cross-selling Afterpay users into its suite of products and enhance BNPL underwriting with data collected from Cash App users. Below is the business model for Afterpay:
Consumers and sellers can mutually reinforce each other in a number of ways. A payment platform that stands out and offers a unique value proposition to sellers may be more likely to attract more sellers to use the platform. This, in turn, can drive consumer demand as more consumers are able to find and purchase from a wider range of sellers on the platform. This can increase consumer demand for the seller’s products or services, as more consumers are drawn to the business through the payment platform.
Block’s financial overview
Square and its consumer-facing app, Cash App, saw significant growth in the third quarter of the year. Gross profit for the company reached $1.57 billion, a year-over-year increase of 38%, while adjusted EBITDA hit $327 million. Cash App saw even stronger growth, with gross profit rising 51% year-over-year to $774 million. Square’s net loss for the quarter was $106 million, but it ended the period with $2.6 billion in cash and marketable securities. Here is a snapshot of the company’s bottom-line
The table shows impressive growth rates during the period. Gross profit reached a high of 40% in 2019, while OPEX hit a low of 24% in 2021. It’s important to note that these observations are not entirely linear. For example, we see a decline in gross margins coupled with improvements in OPEX, indicating that there is some fluidity between the two sections of the income statement.
Here is a snapshot of the trailing twelve months as of 3Q22:
Overall, we can see the same interplay between gross margins and opex. Additionally, revenue growth has stalled in 2022.
Block’s risks
Block is exposed to a variety of risks that could negatively impact its stock. One risk is the potential for integration issues with acquisitions. This can include write-down risks, where the value of the acquired company is less than initially thought, as well as culture risks, where the acquired company’s culture does not mesh well with Block’s.
There is also the risk that the acquired company is not able to grow revenue as intended, which could impact Block’s overall performance. The acquisition of Afterpay and Block’s entrance into the loan business also exposes the company to loan loss risk and duration mismatches on the balance sheet.
System failures that damage the company’s brand or cause a customer exodus could also impact the stock. Finally, the management’s ability to create an effective cost structure that makes the company profitable is crucial for the stock’s performance. These are just a few of the many risks that Block investors must be aware of, and they should keep in mind that there are additional risks not mentioned here.
The investment case for Block
The main reason to consider investing in Block is the potential for the company to create a strong overlap between its buyer and seller businesses, forming a two-sided network that could provide significant advantages. While the company has other initiatives that may contribute to future growth, we will treat them as potential upside and focus on the potential for the current business to be profitable.
To evaluate this potential, we will consider two scenarios: a bullish case with annual revenue growth of 25% until 2025, a gross margin of 40%, and operating expenses at 20% of revenue, and a bearish case with 10% revenue growth, a 30% gross margin, and operating expenses at 29%. Both scenarios assume an 8% annual increase in share count.
In our model, the probability of the bullish case is currently around 12%, but we believe this may be too low. If we assign a one in three chance of success to the bullish case, the company would be valued at around $98, representing a 66% return in the model.
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