Square (NYSE: SQ) is one of those companies that looks like it would be a great value investment on paper. It is in a cash business, and Square’s services are very popular I see its readers everywhere and know many small business people that swear by them.
Square’s business model looks like a recipe for generating a lot of float. The company makes its money by charging a 2.75% fee per card swipe or digital wallet use. It makes even more money on keyed in transactions with a 3.5% fee and a 15¢ charge.
This might add to a lot of extra cash because Square processed around $50 billion worth of credit card transactions in 2016 according to Recode. The company is developing other sources of revenue such as Square Capital. That and Square’s modest share price; $16.94 on April 18, 2017, make many people think value, but is it?
Is Square a Value Investment?
Despite the appearances, Square is not a value investment because it is not making money. The last earning report; that dated December 31, 2016, casts series doubts upon Square’s business model and reports that the FinTech provider is thriving.
Some of the evidence that Square is not making money includes:
- A negative net income of -$171.59 million at the end of 2016.
- A negative profit margin of -3.36% for fourth quarter 2016.
- A “free cash flow” of -$24.86 million at the end of 2016.
- Revenues of just $1.709 billion on December 31, 2016.
- Assets of only $1.211 billion at the end of 2016.
- Cash and short-term investments of $511.93 million.
- Generating just $23.13 million in cash from operations.
- Generating $90.74 million in cash from operations.
These are not the financial numbers of a thriving company. They are the figures of a very sick company that is close to the death spiral.
Despite its business model, Square is not making any money and appears to be burning through cash. That’s going on in spite of growing revenues, Square started 2016 with $1.267 billion in revenues and finished with $1.709 billion. The revenue growth is impressive but it might not be enough to sustain Square as a standalone company.
Does Square have a Future?
The Square boosters out there will claim that the company will start generating a lot of float at some point in the near future. That’s doubtful because of the state of the Fintech industry these days.
There are some serious threats to Square out there including bigger and better financed rivals; such as PayPal (NASDAQ: PYPL), MasterCard (NYSE: MA), Visa (NYSE: V) and American Express (NYSE: AXP). Other threats include big banks; such as JPMorgan Chase (NYSE: JPM), and technology companies like Apple (NASDAQ: AAPL) and Alphabet (NASDAQ: GOOG)- which are marketing their own payment solutions.
A longer term threat is cryptocurrencies; such as Bitcoin, which offer the potential of a cheaper, faster and more secure payment option. Bitcoin offers major advantages including the capacity for long-distance transmission of money, international remittance capacities and the ability to hedge funds against inflation. Another attraction to bitcoin is its recent growth in value.
The popularity of bitcoin-enabled digital wallets will be a particular threat to services like Square because they will enable small business people to combine banking, investment and payment processing with one solution. Merchants will like that because it eliminates fees and cuts costs.
All this means Square’s future prospects are not as rosy as the bulls claim. It will probably stick around but struggle to make any real money.
Square will be Acquired
My prediction is that Square will probably get acquired. One potential buyer is American Express which needs new sources of revenue. Square’s network of merchants would be a logical extension of Amex’s ecosystem. Another probable purchaser is Ant Financial which is looking for ways to enter the American market. Some other potential suitors include big banks, Walmart (NYSE: WMT) which is on a buying spree, and PayPal.
One thing is certain though, Square is a lousy investment. It punished shareholders with a return on equity of -34.17% on December 31, 2016, and pays no dividend. Stay away from Square folks; even though it offers a good service, Square is a lousy stock that makes no money.