This market is brutal!
The Nasdaq is down almost 30%, a situation comparable to the bottom of the March 2020 crash. We would have to go back to the 2008 Great Recession to find a similar sell-off.
The gains made in the past two years are gone for most investors. If you feel angry, sad, hopeless, frustrated, depressed, or all of the above, you are not alone. Remember: Everybody is down BIG this year.
Big market sell-offs look like:
- A risk when we go through them (I shouldn’t have bought!).
- An opportunity in retrospect (I should have bought more!).
It’s one of the greatest paradoxes of investing.
Unfortunately, many investors focus on stocks that could do well “now” or in the next few weeks. So, to avoid catching a falling knife, they invest less during times that present the best opportunities.
However, if you invest with a multi-year time horizon, you could do much worse than accumulating shares of great businesses while they trade out of favor in the middle of a market crash.
When we think about Block (NYSE:SQ) and its recent stock performance, we have to put it in the context of a huge market rout for the fintech category. For example, the Global X FinTech ETF (FINX) is down almost 60% from its November high.
Despite the minimal contribution of Bitcoin to its gross profit (3% in Q1 FY22), Block is often considered a “crypto stock.” During a crypto slump like we are going through, it adds pressure to the share price while the fundamentals remain unchanged.
With a significant sell-off primarily driven by the market and the sector, is Block presenting a buying opportunity?
More Than The Sum Of The Blocks
Companies with a demonstrated track record of innovation tend to offer more upside potential. Block could be a dramatically different company in the decade ahead, as it keeps re-inventing itself.
A few quarters ago, I would have mentioned only two main ecosystems:
- Sellers-side with point-of-sale and managed payments.
- Consumer-side with Cash App.
However, additional segments have emerged:
- TIDAL (music streaming).
- Spiral (formerly Square Crypto).
- TBD54566975 (open developer platform).
And that’s without mentioning the integration of Afterpay within Square and Cash App.
Block offers an attractive profile for long-term investors:
- With the end of pandemic-year stimulus and normalization of consumer behavior, Block has tough comps in the quarters ahead, which could adversely impact the stock price.
- It remains to be seen if Jack Dorsey’s bet on Bitcoin is right.
- Fintech is increasingly competitive, with many companies building super apps and consolidating multiple services under one roof. So while Block is well-positioned, it may have a smaller piece of the pie.
- Block has created new revenue streams relentlessly since going public, and its TAM keeps expanding with new products and services.
- The synergy between its “blocks” can lead to improved retention and monetization across the board and will be harder to replicate for new entrants.
After leaving his role as Twitter CEO, Jack Dorsey is now fully committed to Block, which is excellent news for a company that has historically gathered very positive employee feedback on Glassdoor. Block was among Glassdoor’s Best Places To Work in America in 2022. I shared in a previous article how companies recognized as top employers outperform the market over time.
The Market Is Expanding With New Use-Cases
Block started rolling out the ability for teens 13 and above (as opposed to 18 and above previously) to deposit paper money at participating retailers like Walgreens and Walmart, which could drive further inflows into Cash App.
From the shareholder letter:
Historically teens have a higher mix of cash in their spend compared to the general population, which we believe underscores the opportunity to enable more teens to take advantage of the secular shift towards digital wallets.
It could expand the addressable market by 20 million users (Cash App has more than 70 million annual active customers).
Another tailwind is Cash App’s adoption of the Lightning Network, allowing free Bitcoin payments between cash app users.
Cash App remains one of the best-positioned to be a super app. The app has been ahead of Venmo in Google Search over the past three years.
According to SensorTower, Cash App was the 8th most downloaded app in the U.S. in Q1 2022, with about 8 million downloads (consistent with the two previous quarters). There were no other financial apps in the top 20.
The business has been flourishing and is on the right track to justify far more than its current ~$38 billion market capitalization over the long run.
The runway ahead is even more palpable when considering the $160 billion addressable market estimated by management.
The Seller ecosystem keeps expanding its use cases, such as:
- Square Capital provided PPP loans during the pandemic.
- Square Terminal is expanding internationally, now available in Japan.
- Square Register launched in critical markets like the UK and Australia.
- Square Marketing launched in Canada and Ireland to engage customers.
And there could be a lot more to come.
Afterpay: The New Kid On The Block
Management started integrating Afterpay’s buy now, pay later (BNPL) functionality with Square Online and eCommerce API in the U.S. and Australia.
Nearly 13,000 Square merchants have already adopted and processed BNPL sales through the first quarter, which grew Afterpay active sellers by 10%.
Afterpay could drive more conversion and sales for merchants, and the BNPL offering will be available for in-person payments later.
Meanwhile, Cash App is a lead generator. Block Head Jack Dorsey explained during the call:
And we’re just getting started integrating Afterpay into Cash App where we’ve already seen Cash App actives drive more than 35000 leads to Afterpay sellers during the first quarter.
At the end of March, Afterpay had:
- 144,000 merchants (+68% Y/Y)
- Over 20 million annual active consumers (+37% Y/Y).
An Intensifying Competitive Landscape
I always like to say that competition is a fact of life for thriving businesses.
To fend off competition, Block benefits from two economic moats:
- Networks effects: As more users join Cash App, the value of the network increases, and so do the leads to Afterpay and merchants.
- Switching costs: For merchants using Square as the backbone of their financials, it becomes unlikely they would want to start from scratch with another ecosystem. The addition of other features over time (Capital, Register, Marketing, etc.) makes it a comprehensive, all-in-one solution unlikely to be disrupted by point solutions.
Talking about point solutions, Apple (AAPL) announced a new Tap to Pay feature for the iPhone earlier this year. The feature uses field communications technology to make all kinds of payments, including between iPhones. It essentially offers merchants an alternative to Square Register.
While this feature could eat away at some of Square’s addressable market, merchants are likely to look for comprehensive solutions with integrated financial services.
On the Cash App front, Block faces competition from other peer-to-peer payments apps such as Venmo (PYPL) or Zelle.
For buy now pay later, Piper Sandler recently updated its review of US teens’ habits and revealed that PayPal’s “Pay in 4” service was most frequently used, followed by Afterpay.
Again, one of Block’s strengths is how it might combine its payments business with BNPL and merchants’ solutions.
Q1 FY22 Earnings
As a reminder, Block completed its acquisition of Afterpay in January. As a result, management allocated the impact of Afterpay evenly between Square and Cash App.
Q1 FY22 Highlights:
Note that Bitcoin revenue has barely any gross profit impact and is highly volatile. As a result, the best way to evaluate Block’s performance is to focus on gross profit growth (and ignore the noise around revenue fluctuation).
- Gross payment volume grew +31% Y/Y to $43.5B.
- Gross profit grew +34% to $1.29B.
- Seller gross profit grew +41% to $661M.
- Cash App gross profit grew +26% Y/Y to $624M.
- Cash App represented 48% of the gross profit (vs. 44% in Q4).
- Adjusted EBITDA was $195M (-17% Y/Y).
- Operating loss was $226M (vs. a profit of $68M in Q1 FY21).
- Cash from operations was $229M in Q1 FY22 (vs. $29M used in Q1 FY21).
- Cash and investments were $4.8B.
- Long-term debt was $5.0B
- Overall gross profit grew +25% Y/Y.
- Seller gross profit rose +31% Y/Y.
- Cash App gross profit rose +17% Y/Y.
Block remains on a solid trajectory despite tough comps.
The sizeable net loss ($204M) was primarily driven by:
- $66M from one-time accelerated stock-based compensation.
- $50M from the re-evaluation of equity investments.
- $42M from Afterpay-related transaction charges.
- $31M from amortization of acquired intangible assets.
These costs are non-recurring and are not particularly noteworthy if you invest in Block with a multi-year time horizon. Square has been profitable on a GAAP basis in 2021 and is generating a lot of cash.
Cash App has become close to half of Square’s gross profit. The growth acceleration and margin expansion are stunning. It’s important to note that stimulus checks from the government boosted the inflow of money and the growth in previous quarters.
In June 2021, Cash App reached 40 million monthly transacting active customers. In addition, management has underlined a growing portion of these active customers engage weekly with the app. A growing community combined with increased engagement is all I can ask for.
More than 10 million Cash App accounts have bought bitcoin since the product was introduced. In addition, since April, US Cash Card users can receive a portfolio of their paycheck deposit in bitcoin with no transaction fee.
In the Square Ecosystem, larger sellers (with Gross Payment Volume > $500K) are growing the fastest. It shows that Square is moving upmarket.
- Overall Square GPV: +33% Y/Y.
- Sellers > $500K annualized GPV: +54% Y/Y.
- Sellers > $125K annualized GPV: +30% Y/Y.
- Sellers < $125K annualized GPV: +20% Y/Y.
Gross profit is growing faster than sales & marketing expenses, illustrating the scalability of the business. In the past five years, gross profit has increased +759%, while sales & marketing expenses are up +581%.
We can summarize the recent results as follows:
- Gross profit growing +25% organically – showing momentum.
- Sales & marketing expenses are growing slower than gross profit (see chart above), showing scalability.
- Significant cash and short-term investment position on the balance sheet (close to $5B) and positive cash flow from operations – showing sustainability.
SQ Stock Valuation: The Lowest Ever
SQ is down 75% from its previous high and mostly flat in the past three years.
Yet, fundamentals have dramatically improved, with gross profit and operating cash flow tripling over that time.
Today, Block is a $38B company:
As of this writing, SQ is trading at about:
- 8 times trailing gross profit.
- 34 times trailing operating cash flow.
If we look at the valuation since the IPO, Block is trading on the very low end of its valuation spectrum. The only other time you could buy SQ at such a low EV-to-Gross Profit multiple was at the bottom of the meltdown in March 2020.
So, Is Block A Buy After Q1?
SQ is the cheapest it’s ever been since going public.
The long-term thesis is alive and well, with the entire company’s value becoming more than the “sum of the blocks.”
While the competitive landscape will continue to evolve, the opportunity ahead remains gigantic for sellers and individuals alike.
The pressure on the stock price could continue in the short term, but the current entry point already looks attractive for investors with a multi-year time horizon.
What about you?
Is SQ on your watch list after erasing the past three years of gains?
Let me know in the comments!