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Will Square's share price maintain its current valuation?

Following a Q1 2019 earnings report which failed to meet expectations, Square Inc’s [SQ] share price closed May on a disappointing note. At $61.95, it was down 24% from its 28 February year-to-date high of $81.24. Comparing year-on-year values, shares have remained almost static, while its all-time high of $99.01 on 24 September 2018 now feels a fairly distant memory.

But despite the tumbling numbers, several analysts are still bullish on the internet company’s prospects, suggesting the share price may be seriously undervalued at present. In a note to clients, Guggenheim’s Jeff Cantwell reiterated his “buy” position, saying that Square’s long-term outlook “is improving significantly over time”, with potential for the stock to rise as much as 50%. Meanwhile, Buckingham Research’s Chris Bendler called Square his “top pick by far” among payment companies.Square's 1-year share price performance, CMC Markets, 05 June 2019

 

What’s driving Square’s growth?
Square is a tricky company to fit into any one category. Three-and-a-half years on from IPO, the fintech founded by Twitter’s Jack Dorsey has become a very different company: it went public as a payments processor, becoming a regular feature of retail locations with its trademark white, rectangular card readers; it has since expanded into business accounts, payroll management, money transfers and even lending. It is still loss-making, but also an early mover in the booming payments market, competing with Mastercard [MA], Worldpay [WP], PayPal [PYPL] and accounting software company Xero [XRO] at once.

Where analysts and investors place Square has implications for its growth prospects. In the eyes of the market, it’s still very much one and the same with its core payments business: after its Q1 results showed that gross payment volume (GPV) came in short of analysts’ estimates, the stock fell 7.7% overnight.

 

Market cap$26.81bn
Operating margin (TTM)-0.92%
EPS (TTM)-0.13
Quarterly revenue growth (YoY)43.5%

Square share price vitals, Yahoo Finance, 05 June 2019

 

At $22.6bn, GPV (which shows how much cash is flowing through Square’s various platforms), was a decline on the previous quarter, but still represented 27% year-on-year growth. This short-term decline, and the soft Q2 guidance which followed these results were enough to spook investors, making Bernstein’s Harshita Rawat wonder if the fintech had the “ability to continue to meaningfully outpace the market in a fiercely competitive merchant acquiring space.”

Still, other analysts like JPMorgan and Piper Jaffray see momentum for further growth, even as profitability remains temporarily elusive, with CEO Dorsey talking up treating Square’s various non-payment products as opportunities in themselves, rather than ancillary to the core payments propositions. 

 

One-stop shop
“Ecosystem” is the preferred way among Square’s management to describe the business. Put simply, the company wants to make it possible for customers to manage their businesses entirely within the world of Square. Today, it offers a whole suite of products, allowing merchants to manage their funds through a business debit card, take care of payroll, create their own marketing programme and even set up their own website, thanks to Square’s acquisition of website builder Weebly a year ago.

Square has even struck a partnership with delivery startup Postmates to allow retailers to deliver purchases to clients’ doors in the future. 

“All these tools reinforce one another,” Dorsey said at a JPMorgan event in mid-May. And according to chief financial officer Amrita Ahuja, all these different “bets” have been growing just as strongly as the core payment business: 50% of revenues for the last period came from products Square launched within the past five years, she said.

50%

Last period revenue from products launched in the past 5 years

  

Expanding that ecosystem won’t come for free: while management is keen to remark that at $20 per user, acquisition of new customers is a “fraction” of a traditional financial services firm, margins are set to come under pressure as most extra revenues are reinvested into growing capacity. The board raised full-year revenue guidance after Q1, but kept earnings before interest tax, depreciation and amortisation (EBITDA) unchanged, which Piper Jaffray saw as indications of thinning margins.

 

Under- or overvalued?  
While Square wants investors to look at quarterly adjusted revenues and EPS – which benefit from the inclusion of, among other things, stock-based compensation for employees, “deferred revenues” and the company’s stake in ticket marketplace Eventbrite – the actual bottom line remains negative: net loss actually increased some 60% year-on-year to $38m in Q1.

60%

Net loss increase year-on-year

Some analysts see the stock as bloated – even for a fast-growing fintech. “Valuation remains our primary investment caveat,” wrote Oppenheimer’s Glenn Greene in the wake of results, while Raymond James’ John Davis added that, while “there is nothing ‘wrong,’ we simply think the stock is unlikely to maintain its current valuation.”

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