2023-11-11 23:49:44 ET
Summary
- Marqeta extended its partnership with Block through June 2028.
- Its Q3 update and Investor Day cleared a lot of fundamental uncertainty.
- However, the transition to growth and profitability is going to take longer than expected.
- Investors need to be patient as GAAP profitability is still years away.
Introduction
Marqeta ( MQ ) is a leading modern issuer processor that allows enterprises to launch customized card programs that are highly configurable, scalable, and simple.
The company recently signed new deals with its largest customer, Block ( SQ ). The new deal is structured differently which led to fundamental uncertainty in the near term, as I mentioned in my previous article .
However, management gave us an update during the earnings call and Investor Day, which gave us much-needed clarity on the long-term growth and margin profiles of the company.
Investors don't like uncertainty, so this update was important to rebuild shareholder confidence, and ultimately drive share price appreciation.
Despite renewed optimism, investors have to wait a long time before the company turns profitable.
Growth
Q3 Total Processing Volume, or TPV, was nearly $57B, up 33% YoY and 6% QoQ. This is exceptional growth in the face of a deteriorating macroeconomic environment, reflecting the continued adoption of modern fintech applications.
Of important note, the faster growth among smaller customers means that concentration risks are decreasing.
- Top 5 customers grew 32% YoY
- Non-top 5 customers grew by 42% YoY
Speaking of which, Marqeta announced multiple extensions to its partnership with its largest customer, Block ( SQ ), further confirming Marqeta's strong value proposition. As part of the new deal, Marqeta will be Block's default issuer processor in existing and future markets outside of the US.
- Cash App program extended through June 2028 (previously until June 2027)
- Square Debit Card program extended through June 2028 (previously until December 2024)
As previously mentioned in my previous article, there were a lot of moving parts in the new Block deal. To recap, the Block extension:
- Changed Revenue recognition from Block, drastically decreasing Net Revenue .
- Reduced pricing for the Cash App program, which — to a lesser extent — negatively affected Gross Profit .
- This dynamic consequently leads to Gross Margin expansion .
That being said, management warned that Revenue would drop by ~50% in Q3, solely because of the new Block deal. However, it turned out to be less severe than expected, with Marqeta recording Net Revenue of $109M in Q3, which is "only" down by 43%. This also beat analyst estimates by $13M.
I was expecting some negative reaction on the stock due to the apparent massive drop in Revenue. Perhaps, trading algos and robotraders would dump Marqeta shares automatically due to the seemingly horrifying revenue plunge.
Instead, the stock rallied 18%+ following Q3 earnings, likely due to another Block partnership extension.
Regardless, Net Revenue numbers will continue to be distorted, at least for the next few quarters. The important thing is that TPV growth remains robust as Marqeta remains the global standard for modern card issuing.
Marqeta continues to take market share as evidenced by the fact that 25% of net new customers in the last year were flip deals — or deals in which these customers were previously working with a Marqeta competitor.
In addition, following the Block extensions, Marqeta has now signed contract renewals accounting for over 75% of its TPV, which should drive future growth for years to come.
Profitability
That said, I would ignore Net Revenue right now and focus more on TPV and Gross Profit.
As mentioned earlier, TPV growth looks really good. On the other hand, Gross Profit is under some pressure.
In Q3, Gross Profit was $73M, down 9% YoY, due to:
- Reduced pricing from the Cash App renewal — the change in Cash App Revenue recognition does not have an impact on Gross Profit.
- Renewal timing of certain Non-Block TPV.
- Full lease incentives lost on two of its customers.
Despite the decline in Gross Profit, management believed that they do not expect to see the Gross Profit impacts above, to reoccur, "due to changes in how we approach customer deals and contractual language".
Gross Margin for the quarter was 67%, substantially higher than previous figures, again, due to how the new Block deal is structured.
Gross Profit Take Rate, which management claims is the best proxy for pricing, is on a downfall, reflecting the reduced pricing with Block. As of Q3, Gross Profit Take Rate was 0.13%, which is lower than usual, thus raising concerns about Marqeta's pricing power. This is the first quarter where the new Block deal is factored in so it's still unclear wear Take Rates will trend from here.
Moving on, Q3 Net Income was $(55)M, slightly better than the prior quarter's $(59)M. But because of lower Revenue, Net Margin plunged from (25)% to (51)%. Ouch.
Nevertheless, Marqeta is still sitting in huge losses primarily due to High Stock-based Compensation, which was $45M in Q3, or 42% of Revenue. Yes, that's chronically high.
Adjusting for SBC and other non-cash expenses yields an Adjusted EBITDA of $(2)M in Q3, representing a (2)% Adjusted EBITDA Margin. This is better than last year's margin of (7)% so Marqeta seems to be gaining operating leverage.
Whatever it is, Marqeta is still severely unprofitable on a GAAP basis and SBC is still unsustainably high. In addition, Take Rates are worsening, which reflects lower pricing power.
I need to see improvements in all three of these metrics moving forward.
Health
On the bright side, Marqeta maintains a strong balance sheet with $1.3B of Cash and Short-term Investments and virtually zero debt. As of this writing, Net Cash represents 40% of Marqeta's Market Cap of $3.1B.
That said, Marqeta's Net Cash position has been dropping over the last few quarters due to the Power Finance acquisition as well as the company buying back shares aggressively.
In Q3, Free Cash Flow was $41M at a 38% FCF Margin — this figure may look high but it's just jacked up because of lower Revenue. On a TTM basis, FCF was a mere $18M, so nothing to be excited about.
In terms of its capital allocation strategy, management mentioned during the Investor Day that the company will primarily use cash in hand for acquisitions and share buybacks.
In Q3 alone, Marqeta repurchased 11.5M shares for $64M, at an average price of $5.62. And ever since September 2022, the company has spent $212M to buy back ~36M shares.
To put that into perspective, this more than offset new issuance since IPO. In other words, the effects of shareholder dilution from high SBC have been completely negated by the share buyback program.
As of Q3, Marqeta still has $88M available under its buyback program. At this rate, the company will announce another buyback program in Q4, which is another catalyst for the stock.
Outlook
Management provided more clarity during the earnings call as well as the Investor Day.
Here's management’s midpoint guidance for Q4:
- Revenue down by 46% YoY
- Gross Profit down by 9% YoY
- Gross Margin in the high 60s
- Adjusted EBITDA Margin of (3.5)%
I would ignore Revenue and Gross Profit at the moment since there are too many moving parts, but in terms of Gross Margin, "high 60s" seems to be the new baseline for the company.
Here are more details provided during Investor Day.
In the near term, expect more pressure on both the top and bottom lines due to the Block renewal. However, as Marqeta fully laps the Block renewal, expect Revenue to reaccelerate by ~25% in the second half of 2024. This trend should continue in 2025 and 2026.
The same goes for Gross Profit — expect the metric to reaccelerate in 2025 and 2026.
As for Adjusted EBITDA Margin, expect the metric to turn positive by the second half of 2024.
To be honest, management's financial targets seem underwhelming to me. While all this information provided much-needed clarity — which is good since investors don't like uncertainty — it seems that the transition to growth and profitability is going to take longer than I would've liked.
Just look at the bottom of the slide above. Management expects GAAP Net Income profitability by Q4 of 2026.
That's three years from now!
While there's fundamental certainty now, the outlook, in my opinion, seems disappointing.
Guidance aside, the long-term opportunity remains attractive for Marqeta.
According to the CEO, Marqeta only has a 1.5% market share based on the total card volume processed by the card networks in the US, Canada, and Europe, which is more than $15T. Marqeta is barely scratching the surface.
Embedded finance is growing rapidly as well, and Marqeta should be at the forefront of it, especially in the issuing-facing side of the payment ecosystem. According to management, embedded finance volume could grow from $2.6T today to $7T by 2026.
In addition, Marqeta recently launched its new credit platform which could replace legacy credit card issuers due to its speed-to-market, customizability, and scalability. As we all know, the credit card industry is massive.
At the same time, Marqeta is already seeing strong demand for its payment solutions as global fintech investments rebound. As you can see, Marqeta saw strong bookings since Q4 last year, which should translate to robust Revenue growth in the years to come.
Valuation
Turning to valuation, Marqeta now trades at an EV to Gross Profit of just 5.3x. It once traded as high as 100x so based on historical standards, Marqeta looks cheap.
Looking at my DCF model, I've updated my assumptions based on management's long-term financial targets.
- Revenue : Follow analyst's estimates for 2023 and 2024, and then assign a 25% growth in 2025 and 2026, which is in line with management's guidance of "mid-20s" growth. For the remaining years, I expect growth to slow down to just 12% by 2032.
- Gross Margin : Marqeta achieved a Gross Margin of 67% in Q3 and management guided for "high 60s" in Q4. I believe this is the new baseline for Gross Margins but I will assign a long-term Gross Margin of 65% just to be conservative.
- FCF Margin : FCF Margin was as high as 38% in Q3. Remember that the reduction in Revenue due to the Block renewal will increase FCF Margin, assuming all else is equal. But to be extra conservative, I will assign a long-term FCF Margin of just 24%.
Based on the assumptions above, I project a $1.8B Revenue for Marqeta, at a FCF Margin of 24%.
Using a discount rate of 12% and a perpetual growth rate of 2.5%, I arrive at a fair value estimate of $7.35 for Marqeta, which is slightly higher than my previous estimate given the clarity that we now have.
This is higher than the average analyst price target of $6.83.
Based on the current price of $5.87, I see a potential upside of 25% for Marqeta stock.
Despite the undervaluation, I won't be adding to my position as I think Marqeta's stock may not see much appreciation in the near term, particularly due to negative growth and unprofitability.
That said, I see three catalysts for Marqeta stock:
- The first catalyst is additional share buybacks, which should happen in the next quarter, but I don't think it'll bring much optimism.
- The second catalyst is returning to growth mode in H2 of 2024, which is a year from now.
- The third catalyst is GAAP profitability in Q4 of 2026, which is three years from now.
As you can see, there isn't much catalyst for Marqeta stock in the near term which means that the stock may trade sideways for a while.
However, Marqeta has a perfect track record of beating estimates, and if they continue to do so, the company might just reach its financial milestones earlier, which could rerate the stock higher sooner than later.
Risks
Competition
Marqeta faces tough competition from legacy processors like Fiserv ( FI ) and other fintech firms like Adyen ( OTCPK:ADYEY ). These competitors have unprecedented scale and have more complete payment stacks which customers may favor over Marqeta.
Concentration
Block accounted for 50% of Marqeta's Revenue in Q3. Although this is down from 73% last year, it's still a very significant portion. Thankfully, Block extended its partnership with Marqeta, so investors can breathe a little — at least for the next 5 years.
Thesis
Marqeta is going through a lot of structural changes as of late, particularly with its new contracts and financial reporting — this created a lot of fundamental uncertainty.
Fortunately, both the Q3 update and Investor Day clarified a number of questions that investors had in mind, especially as it pertains to the long-term growth and margin profile of the company.
This clarity is bullish.
However, investors need to be very patient on this one since GAAP profitability remains years away.
That aside, the company still has a long growth runway ahead as the leader in modern issuing processing — the Block renewal and a robust deal pipeline are proof that clients favor Marqeta.
For further details see:
Marqeta: Bullish Clarity