2023-08-23 08:30:00 ET
Summary
- Marqeta recently announced the renewal of its partnership with Block.
- While some pundits claim Marqeta's business concentration is nearly 80% Block, the reality is that true concentration is closer to 50/50 following this renewal.
- Furthermore, Marqeta is still arguably a top five next-gen FinTech business on earth, implying that it will grow rapidly in the years ahead atop its renewed foundation.
- With $1.4B in cash, no debt, and a stabilized, foundational book of business, as well as a repaired Go To Market motion, I believe Marqeta should be a $10/share stock today, were the market truly efficient.
In summary, I'm happy with all we have accomplished this year. We have renewed our partnership with Cash App , Afterpay, and 50% of our non-Block volume. We significantly reduced our operating costs and solved our go-to-market problems . We did all this while winning against the competition, having acquired in a company, and integrating its product in record time in five months.
Simon Khalaf, CEO, Q2 2023 Marqeta Earnings Call [Contextualizing The Growth Of Marqeta, The FinTech Industry, And Businesses Within The U.S. Economy Broadly]
I understand that you likely expected me to start this consideration of Marqeta's ( MQ ) Q2 2023 and Marqeta's business broadly with a discussion around Marqeta's Block ( SQ ) contract renewal.
Indeed, the contract was renewed, and I believe the terms are quite fair for all parties involved. We will explore this assertion together later.
But I believe I could best serve you by first contextualizing the environment in which Marqeta's business currently operates. In fact, I think it would be hard to understand what's going on for Marqeta without first understanding the economic backdrop in which the business operates.
In short, the Fed, i.e., U.S. central bank, has embarked on a very aggressive financial suppression operation. That is, credit is "wickedly tight," so to speak, and this has served to send the rate of inflation in the U.S. careening downward from a peak of ~10% in 2022 to 2.97% as of the U.S.'s most recent Consumer Price Index [CPI] report.
U.S. Consumer Price Index Year Over Year Change
Real time estima tes suggest that inflation may decline below 2% shortly, which would precipitate fears of a deflationary bust, so to speak.
We can see this very aggressive financial suppression (economic suppression) via a series of charts.
Credit Card Interest Rates Hit All Time Highs
While Marqeta only recently released its credit card product, this interest rate serves to channel dollars in the economy into interest servicing as opposed to spending via debit cards, slowing Marqeta's growth rate ( as well as the growth rate of virtually every business in the economy ).
This higher interest rate broadly serves to slow economic activity; thereby, it slows the rate of inflation as well, and it's been working well, as inflation has fallen precipitously.
The same dynamics have been playing out in the auto and personal loan industries, also serving to collapse the rate of inflation.
Average U.S. Auto Loan Interest Rate
Average Personal Loan Interest Rate
Of course, these data points do not directly impact Marqeta's business, but they invariably serve to slow the growth of virtually all businesses in the economic system, including Marqeta.
To be sure, I understand that houses were bought with mortgages at 12% in the late '80s or early '90s. I believe the takeaway here is that the rate of economic growth for all businesses year over year gets compressed immensely (growth rates slow for all businesses in the economy) due to the rate of change of these interest rates year over year.
Of course, interest rates are not "Paul Volcker tight," but their incredible rates of change year over year have served to create dramatic slowdowns in economic and business growth, even if they don't serve to create total economic collapse, as some have speculated would be the case (despite credit being so wickedly tight already and despite inflation collapsing to such a large degree, the Fed has said that it may hike rates further, which is notable).
And these increases in rates, to remind you, have been spawned by the fastest rate hiking cycle in American history.
The Fastest Rate Hiking Cycle In American History
With this as our foundation, let's now turn to the good stuff!
Block Renewed: Demonstrating Marqeta's Embedding Moat
Marqeta announced today that it had signed a four year extension with Block to continue powering its popular Cash App card product. This extended deal to power the Cash Card is effective on July 1, 2023 and continues through June of 2027.
We believe this renewal demonstrates the value Block sees in the Marqeta platform and this partnership, exemplified by Marqeta's flexibility, innovation and breadth of service.
Throughout my ownership of Marqeta, I've been steadfast in my belief that the business has robust moats (specifically embedding moat) that would ultimately serve to retain Block on the platform.
My former analyst would often remark that "Block has ten teams building on the Marqeta platform," thereby illustrating the idea that Block had become deeply embedded into the Marqeta platform, and vice versa.
Now moving on to Cash App, we're excited to continue our partnership for another four years. We believe this renewal, as well as our renewal with Afterpay earlier this year demonstrate the value Block finds in our platform and our partnership. This value is exemplified by the scale, flexibility, innovation, and myriad of services we provide to Cash App and Block.
In 2022, I detailed the nature of the Marqeta platform, likening its embedding moats to the embedding moats of AWS. In describing Marqeta's embedding moat, I wrote,
Embedding
The embedding moat is one of Marqeta's most significant moats. We can think of it through various lenses, but one that really stands out to me is the lens of AWS.
There's this myth in the business world that companies "diversify their public cloud usage" into Azure, AWS, and GCP. But it's simply not true, and here is why:
As a customer uses more compute or storage with AWS, it actually spends less!
That is, customers are incentivized to do more business with AWS because AWS will give them discounts as they scale their usage.
This creates a powerful switching costs (embedding) moat that leads to businesses actually only using one cloud provider. Additionally, at a certain level of usage, it no longer makes economic sense to use any other provider or even to switch providers, as the company in question may not enjoy the same incentive structure with a competing provider.
Marqeta employs the same model: as customers scale their usage of the platform, they actually pay less! Considering the size of the companies operating on Marqeta (Klarna, for instance, has 150M users worldwide), this is a powerful moat for the company!
(Shared in 2022)
When asked about why a company like Block would diversify issuing/processing platforms, Mr. Khalaf, Marqeta's CEO, shared the following thoughts, which I believe reflect the content of the quote that I shared just above (describing embedding moats at AWS and Marqeta):
One of them is economical. And the second one is more stability, which is kind of like; you distribute your load on multiple providers so that you actually have some form of redundancy. We've addressed both as in like in the agreement with bake the economical incentive for us to capture the vast majority of the volume. Right and we've done a lot of work on the redundancy and the stability of the platform. And something we've demonstrated. So there is, we've almost reduced the reasons for diversification almost to something non-existent.
As is the case for AWS, bulk discounting creates incentives for customers to spend all or the vast majority on one platform.
If they diversify, they're reset to a lower tier with no bulk discounting, which increases their compute/storage or issuing/processing costs.
As it is for AWS, so too is it for Marqeta in this respect, and it creates a solid embedding moat for the business.
Understanding Revenue And Gross Profit Dynamics
Marqeta Q2 2023 Earnings Slides
In the previous section, I detailed for you what we should expect from the Block deal/partnership and any partnership Marqeta in which the partner's business grows substantially over the course of years or a decade.
That is, we should expect bulk discounting as the partner achieves certain levels of scale, just as we should expect bulk discounting from AWS as its partners (customers) achieve certain levels of scale.
To this end, the Block renewal, which included new bulk discounting, has created a near-term drag on Marqeta's gross profit growth rates, resulting in a contraction of 9-11% for Marqeta's total gross profit in Q3 2023.
Gross Profit is expected to contract between 9% and 11% with an approximately mid-to-high 20s percentage point decline due to the Cash App renewal.
Under normal economic circumstances (where rates aren't rising at the fastest rate ever, which is creating difficult year over year growth rate comps), Block's renewal would happen, along with the updated economics from bulk discounting, and it would be masked by the growth of Marqeta's book of business outside of Block.
But every conceivable thing that could conspire to make Q2/Q3 2023 bad quarters has happened, and "every conceivable thing" has happened all at once. That is, Block has not been the only renewal of this kind over the last 6 or so months. Many of Marqeta's customers now have much larger businesses than they did five years ago, and these customers have been renewing recently with bulk discounts as well.
Meanwhile, Marqeta's poor GTM motion (sales execution) from 12-18 months ago is revealing itself today (and its great GTM motion over the last 12 months will reveal itself in the year ahead).
And, as we know, the fastest repricing of credit ever, which has created immensely tighter credit, has served to slow economic activity and correspondingly Marqeta's growth rate.
All of these factors have conspired to make MQ's business look vastly worse than it is. But it won't always be this way.
- With the vast majority of Marqeta's legacy book of business, which has grown immensely over the last 5 years, now renewed at pricing that aligns with these customers' new larger sizes, we have a solid foundation of gross profits that has stabilized and will grow linearly upward, for the most part, over the next 4-5 years.
- With Marqeta's GTM motion having been fixed over the last 12 months, Marqeta's next layer of business will grow mostly linearly upward for the next ~5 years.
- With credit tightening likely almost over, based on the CPI now having a 2 handle, year over year growth comps (we certainly don't need ZIRP for Marqeta to do very, very well looking forward) will become much easier, creating higher nominal growth rates for the business.
All of this should conspire to create 30%+ gross profit growth annualized in the 3-5 years ahead, especially when we consider that embedded finance is a TAM that has decades of growth runway ahead.
Q2 gross profit was $85 million growing 8%. This growth is about 5 points faster than we expected, roughly a third of which was driven by stronger volumes and a remainder driven by unexpected incentive benefit. That was a catch-up from previous periods following a review with one of our network partners. Gross profit growth was low in the quarter for four primary reasons.
...
The first three of these factors will no longer be impactful by the end of this year, and we believe these were relatively unique situations that impacted us all at once because of how much our business accelerated coming out of the pandemic. The fourth factor will lap in Q1, 2024, and shouldn't re-occur based on our new contract with Visa.
Briefly Addressing Concentration
The reality has been and remains that concentration is not nearly as bad as most believe.
In fact, after the Block deal, gross profit dollar concentration is about 50% Block and 50% the rest of Marqeta's business.
So, no it's not 80% Block and 20% Marqeta. It's about 50/50, and the 50% that is not Block is growing 2.5x the portion that is Block.
The increasing revenue concentration is weighing our overall margin since our Block margin is over 40 points lower than the rest of the business. Our Q2 gross profit growth, excluding Block, Klarna and normalizing for items like the unexpected incentive benefit, is about two and a half times faster than the business as a whole.
Of course, 50/50 still isn't exactly great. This still represents substantial concentration.
But what's the solution? A robust sales pipeline and a strong Go To Market motion! Which was one of the key issues that has led Marqeta to become so wickedly undervalued (I personally believe it's a $10/share stock as of today, but I do acknowledge the near-term issues that have created the valuation depression).
Fixing The Go To Market Motion
In our last consideration of Marqeta, I noted that the company, under our new CEO's leadership, had rectified its GTM issues; data for which I shared below:
Q1 Update On Marqeta's GTM (Sales/pipeline) improvements:
Second, in terms of how we go to market, the changes we made to the sales organization over the past six months continue to pay off. After a strong end to 2022, our bookings in Q1 exceeded our target. The number of deals closed in Q1 was approximately the same as the number of deals we closed in the entire second half of 2022, a testament to the built up demand for our services, our strong competitive position and improvement in sales operations, all accomplished without a material increase in headcount. While it usually takes 6 to 12 months to translate these bookings into material gross profit, the strengths of our bookings gives us a good leading indicators of growth for 2024.
As of Q2, based on the data we're receiving from Mr. Khalaf, the pipeline has further strengthened, indicating that the GTM motion continues to improve.
Q1 Update On Marqeta's GTM (Sales/pipeline) improvements:
In addition to the Cash App renewal, we've steadily improved our execution across the company. We've seen considerable sales momentum in the last three quarters after implementing the changes in our go-to-market organization in the fall of 2022.
Our bookings for the last three quarters combined grew 150% from the same period a year ago.
Notably, we saw a 50-50 split between net-new customers and expansion deals with existing customers setting us up for a durable growth into 2024.
On a sequential basis, our bookings for the second quarter grew 60% from the prior quarter driven by embedded finance, which accounted for two-thirds of our bookings.
These deals require, in some instances, 12 months to fully come online and begin generating economics (gross profit) for Marqeta, so we will have to wait until 2024 to see very meaningful acceleration in growth for Marqeta. That said, we have a fantastic foundation on which to build from here. I will summarize this train of thought in just a moment for you in the concluding thoughts of this update.
But, before we do that, I'd like to discuss the way in which Marqeta fits within one of my principle frameworks for investment.
Growing In An Inverse Bubble
In addition, o ne third of the deals we signed in the quarter were flip deals, where we replace an incumbent provider, and that speaks to our superior platform in scale. In similar to the first quarter, our international business continues to be a source of new customers. As over 40% of net-new customer bookings came from markets outside the United States. We expect that international momentum would be a key growth driver going forward and represents a key advantage for Marqeta. Our single stack platform allows customers to easily launch a more than 40 countries where Marqeta platform is enabled. The most recent expansion is in Brazil with our new partner Fitbank. This partnership gives us a foothold into the largest fintech market in Latin America, and one of the fastest growing fintech market in the world, and where many of our existing customers also have growth aspirations.
Over the last couple weeks, I've often discussed the idea that we buy vertically integrated, highly differentiated platforms that are dramatically more attractive to consumers within an existing industry.
We call this framework "buying companies within Inverse Bubbles," or Inverse Bubbles, for short.
I spent a great deal of time discussing this in our recent consideration of Coupang (CPNG), so I won't belabor it here.
That said, I believe Marqeta is another quintessential example of a "new entrant" that has created a superior product that is capturing market share within an existing industry (in this case, on-prem issuing/processing/embedded finance would be the existing industry with hundreds of billions in total existing spend, and Marqeta's vertically integrated, cloud-native issuing/processing/embedded finance product has captured and will continue to capture market share).
Through this lens, I believe Marqeta has a very long runway for growth, and its recent sales pipeline success substantiates this thinking.
Concluding Thoughts: Summarizing The Thesis
To very concisely conclude, here are the major takeaways from the quarter:
Congrats to the MQ owners out there on the contract extension. My concise, summarized thinking as of today:
In short, MQ has stabilized (renewed contracts) its ~$330M gross profit book of business out to about 2027.
Now it's time to layer on the next chunk of business (which we've been doing, data for which I shared in this note) + reaccelerate current book of business as we exit the fastest repricing of credit ever.
I expect 30%+ gross profit growth at various points in the next half decade, as the legacy book of business accelerates growth and as the new book of business gets layered on top of this already growing book of business and as we emerge from this "once in an empire" interest rate hiking cycle.
$1.4B in cash; no long term debt.
Visa ( V ) and Coatue bought in at $2B in 2019.
Currently trades at $1.69B in enterprise value. Strongest the business has ever been.
Thank you for reading, and have a great day.
For further details see:
Marqeta: Solid Foundation On Which To Build