Square: The Gift That Keeps On Giving (NYSE:SQ)


Source: techstartups.com

Welcome Back!

Square (SQ) has been one of my top buy ideas since March this year, and even after a +250% rally from my March recommendation, I continue to remain bullish on the company. Today’s article is an extension of our recent discussion on Square’s Cash App (P2P) Ecosystem. I recommend that, before you read further, please peruse Square: This Multi-Bagger Is Just Getting Started if you haven’t already done so.

We will be covering the following points in this research note:

  1. Analysis of Cash App’s ecosystem and its latest business trends
  2. A fair-value guesstimate of Cash App on a standalone basis

So, let’s get started.

The Cash App Ecosystem

I’ve already discussed the functionalities of Cash App, but just to recap:

Cash App is a digital wallet that allows customers to easily send, store, spend, and invest.

Source: Square Investor Update March 2020

Cash App started out as a peer-to-peer (P2P) money transfer application at the end of 2013. Over the years, the platform has seen the addition of new and innovative products like Cash Card, Direct Deposits, Bitcoin Investing, Boost (rewards), and Equity Investing (with fractional shares). Recently, Square got its banking license, and I expect Cash App’s evolution to culminate in a futuristic digital bank. In my opinion, Cash App will begin lending operations some time within the next decade in the same way that it’s lent to the underserved of small business throughout its history.

According to Square, Cash App has a Total Addressable Market of $60+ billion in the United States at present. This figure could very well grow in the future as the company adds new products or expands into other markets. Since Cash App’s penetration of its $60 billion TAM stands at <2%, the eco-system has a long runway to grow its market share.

Source: Square Investor Update March 2020

The Rise Of Cash App

As you can see in the image below, Cash App MAUs have snowballed higher from ~7 million to ~24 million (~3x times) in the last two years. In fact, Cash App’s user growth rates of ~60% CAGR make it the fastest growing digital wallet in the United States. In the meantime, the industry leader, Venmo (PYPL), has seen a drastic slowdown in user growth.

Source: Square Investor Update March 2020

Cash App’s exponential growth in the last two years can be attributed to a pop-culture (it’s been mentioned in several rap songs massively popular rap songs) like following among the younger demographics. Cash App reaps impressive benefits from the network effect generated from a loyal user base when it comes to acquiring new customers and getting inactive users back on the platform.

CashApp Gained More Traction Than Rivals During COVID-19 Shutdowns

In March, Cash App was the second-largest player in the peer-to-peer (P2P) payment application and digital wallet space in the United States behind Venmo.

Source: www.google.com

However, Google (GOOG) (GOOGL) trends show that Cash App has been trending significantly more than Venmo in the last three months. Since these numbers are a precursor to growth in user accounts, I think Cash App could already be the largest P2P payment application based on monthly active users (MAUs) [more than 30 million].

Latest Business Trends

The reflection of Cash App’s high popularity in google trends data is evident from the latest announcements from Square related to the business trends observed during March-April:

Source: Square Q1 2020 Shareholder Letter

Thus, one can see that Cash App had its best month ever in terms of net user growth in April 2020. Since then, Cash App has consistently seen very high ratings on google trends data. In my opinion, Cash App added ~5 million new users during the first six months of 2020.

Square also made 11 million user accounts eligible for direct deposits. In May, the cash balances stored in Cash App accounts had risen to $1.3 billion.

Fair-Value Guesstimate For Cash App

To perform an accurate guesstimate exercise for Cash App, we must first of all look into its revenue mix. Let’s begin.

Source: Square Q1 2020 Shareholder Letter

As you can see above, Cash App had total revenues of $528 million in Q1 2020 (~ARR of $2 billion). However, Bitcoin revenues contributed to $306 million with minimal contribution to gross profits. Hence, we will not take Bitcoin into account for our guesstimate exercise. The subscription + services-based + transaction-based revenues generated from Cash App contributed to ~$222 million in revenue and registered ~80% gross margins. This segment has an Annualized Revenue Per Active Customer of $30.

Source: Square Investor Update March 2020

Since 2017, Cash App has multiplied its ARPU by 2x times, and the platform still has ample room for monetization.

Source: Square Investor Update March 2020

Square is famed for its product-velocity, and I expect the company to add several new products to the Cash App platform while potentially leveraging its banking license shortly.

Square’s Long-Term Vision Could Be Sensational

Square is simultaneously developing two financial technology platforms, i.e., Seller and Cash App ecosystems. As I mentioned earlier, Cash App could eventually become a full-fledged digital bank with millions of customers (it already is in many senses). On the other end, Square’s Seller ecosystem has millions of sellers. Square’s probable long-term vision is to merge them and extract value-add synergies for both Cash App users (Buyers) and Square merchants (Sellers).

Square could be on the verge of creating the holy grail of payment systems. By merging the Seller and Cash App ecosystems, Square has a closed-loop payment system (buyers and sellers) with no other intermediaries. Thus, Square will receive a larger share of the economics. On top of that, Square will be able to freely cross-sell services between and among merchants (Seller Ecosystem) and consumers (Cash App) without the hindrance associated with traditional payment systems.

Future Revenue Projections

Using the data from previous sections, we narrow down to the following table:

Year

ARPU

Active Users (in millions)

Revenue ($ in billions)

2020

$30

25-30

0.75-0.90

2025

$80-90

50-60

4-5.4

Source: Author

The estimates for 2025 are just my opinion based on conservative estimates for user growth and ARPU for the Cash App ecosystem. Since Bitcoin is a shallow margin business for Cash App, I do not factor it in for my guesstimate exercise in this section.

Using the lower end of revenues (2020) and assuming a free cash flow margin of ~35%, we get a free cash flow per share of $0.6. I also utilized a conservative revenue growth rate of ~30% CAGR for the next ten years. Here’s the fair-value of Cash App on a standalone basis (excluding Bitcoin):

Source: L.A. Stevens Investment Model

Thus Cash App alone is worth ~$60 per share, which half of Square’s current trading price of ~$120. If you’d like greater clarity on the valuation of the company, please refer to our more extensive valuation of the company in our most recent article (linked above).

Concluding Remarks

Investing in revolutionary, rapidly growing companies can be challenging; in that, we can’t always perfectly forecast the evolution of the company in the future. One of the greatest tools in our tool kit is to assess management and its vision. I have always listened closely to Jack Dorsey and his philosophies revolving around Square, and it has consistently led to me purchasing more shares of his company.

To that end, the growth potential for Square’s Cash App platform is massive. I expect Cash App to be a significant growth driver for Square’s free cash flow in the long term as new products are launched on the platform.

Square stock has rallied since my last article, but investors could still generate mid-teen CAGR returns on a base case ten-year investment.

Key Takeaway: I rate Square a buy.

As always, thanks for reading; remember to follow for more, and happy investing!

Beating the Market: The Time Is Now

There has never been a more important time in stock market history to buy individual stocks at the heart of secular growth trends. Mature market performers/underperformers and index funds simply will not cut it, as we face a decade during which there is absolutely no guarantee the overall markets will rise. 

This is why the time is now to discover high-quality businesses with aggressive, visionary management, operating at the heart of secular growth trends. 

And these are the stocks that my team and I hunt, discuss, and share with our subscribers!

Disclosure: I am/we are long SQ, GOOG. 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.

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