2023-09-21 10:00:42 ET
Summary
- Block has seen a success with its Square Ecosystem and Cash App Ecosystem, but shareholders have not benefited from the company's growth.
- The company has struggled with profitability and cash flows, and its operating margins have fallen despite improving gross margins.
- Insiders have been selling the stock, suggesting a lack of confidence and this opinion diverges from Wall Street.
- I rate this company as a Sell till I see actions friendly for shareholders.
I understand the sentiment with Block (SQ). Holders of the stock are puzzled by the recent behavior. The company has grown but the recent stock price performance has been abysmal. Most bullish views cite their growth and their success with their products with valuation being deemed fair in light of their growth. I beg to differ mainly for two reasons -
1. The growth of the company and the growth for shareholders are two different things i.e. shareholders have not seen the benefits of its growth in the last two years
2. Mismanagement of gross profits
While I welcome news of success with their products, until I see these benefits flow down to the shareholder, I remain a skeptic of being an investor in this company.
Products and Ecosystem
Block is a growing financial services and mobile payment company now but it had humble beginnings and started off with its product "Square reader" which enabled merchants to accept credit card payments through a smartphone or a tablet. The company faced great success with this product as it was revolutionary and enabled small businesses to process card payments through a simple, affordable, and mobile solution.
Fast forward to now, the company boasts of two main ecosystems and has seen great success with them.
Square Ecosystem
Square Banking has a suite of financial services that connect with sellers to offer access to payments, sales, savings, and personalized financing options. With products like Square Loans, Instant Transfer, and Square Debit Card, the company is committed to expanding its banking offerings to assist sellers in managing their cash flow. Its product suite currently encompasses over 30 software and financial services offerings with Credit Card being its latest offering.
Cash App Ecosystem
Cash App is used to make peer-to-peer payments and the ecosystem now includes Cash App Taxes and Cash App Pay.
Cash App Taxes has been well-received, promoting direct deposit adoption and increasing inflows per active account. Cash App's emphasis on commerce is evident in Cash App Pay, which offers a streamlined payment solution for both sellers and consumers, with strategic partnerships expanding its reach to a broader range of merchants, particularly targeting Millennial and Gen-Z customers. The company is seeing strong growth in Cash App Pay transaction volumes.
Many of the products that they have introduced have been a hit with their customers and these products have only made their ecosystem more sticky. There is no further evidence of this than when we see how well their business has taken off.
The last two quarters have seen an average revenue growth of 25%. Gross profits have also held up well and gross margins have taken a shot in the arm in the last three years. But I would say this is where the good news stops.
It has been unable to convert any of this into profits or cash flows. As its gross margins improved, its operating margins have fallen.
LTM has seen its SG&A at $3.9B, its R&D at $2.4B, and its total operating expenses have increased by 32.2% while revenue has grown by 20.8%! This definitely sheds a new light on the revenue story. Even if you ignore the R&D and reason it out by saying it would pay off over the long term, SG&A alone has increased more than the revenues. The company recognizes this and hints that they will have to make improvements in this area. This is what the CEO had to say in this regard -
For sales and marketing, we have focused on efficiency to drive acquisition while decreasing spend. We have pulled back on brand spend and more experimental channels across our ecosystems, in favor of channels with more proven returns.
This past quarter, we also decided to wind down operations in certain markets, including Cash App's Verse brand in the EU, and our BNPL platform Clearpay in Spain, France, and Italy. These required significant investment, and the markets have not seen the growth and profitability we had expected over the past several years. We see an opportunity to shift these resources towards strategic areas that have a higher potential return on investment.
As we continue to drive towards our goal we may identify other areas where we aren't seeing the expected and necessary returns. We also continue to improve our cost structure for each of our ecosystems by identifying opportunities to expand our structural margins...
Growth that does not translate to shareholders
The company's actions through SBC have been highly dilutive on the stock.
The share count has almost doubled over this period but it would be more helpful to see how this has affected our key metrics.
Again the growth story starts breaking down when you see how shareholders have benefitted. LTM Revenue per share has been at $32.8 and when you compare this number to the LTM from June 2021 at $35.2, it is clear that we need to peel back the layers and not just cheerlead the revenue growth story. A similar observation can be made of operational cash flow. LTM CFO was $468M out of which SBC accounted for $1.14B (For the same period in 2021 OCF was $571M and SBC accounted for $489M). For me, this suggests a double whammy. Cashflows are suffering and revenue growth is non-existent on a per-share basis both of which do not inspire confidence for me to be a shareholder. I also want to tell you that there is a big difference of opinion here.
While both Wall Street and Seeking Alpha Analysts have mostly rated this as a buy, insiders are net sellers of the stock.
Insiders do not inspire confidence
I went back and tried to pick different time frames (1 - 3 years) and all time frames showed that insiders have been selling the stock and I could not see any buys. It can be a cause of concern when there is such an imbalance and suggests the dichotomy that exists between how Wall Street views the stock and how insiders have been heading for the exit.
Fairly Valued
I believe valuation is fair at present levels. There was a time when this was not true. But I guess that's what an 80% drop from all-time highs does to a stock. The current PS multiple of 1.5x looks favorable when compared to its peers. Since the company is growing its forward multiple looks even more attractive at 1.4x.
Crunching the numbers obtained from Seeking Alpha's components in the industry specific to where Block operates (Transaction and Payment Processing services), the average PS multiple is 3.4x and the median is 2.4x both quite above Block's multiple.
Wrapping up
I rate this company as a Sell. I am completely on board with their growth and impressed with how they have been able to expand within their ecosystem. My problem lies with the fact that there is much work to be done on profitability and additionally, shareholders have not been able to benefit from their growth. All of this is further confirmed when insiders have been net sellers of the stock.
When would I change my thesis? There have been some encouraging words by the management on how they would like the rope in costs and also how they recognize SBC is factoring into their results.
Leaders across our company are now looking at the true full cost of their businesses, inclusive of share-based compensation. This has led us to pull back on our pace of hiring, to be more targeted in hiring for critical roles, and to focus more on performance management.
For me, I would like to see this in action before joining the chorus of stockholders in the company. For now, its suffice to say that I am a believer in the company but not a believer as a shareholder.
For further details see:
Block: Shareholders Have Been Blocked From Its Growth