There was an ominous feeling in the air when Square (SQ) first went public last month.
Sure, the Street had yet to shake off the nervousness brought about by the August correction — but there was another problem, too: IPO trends from 2014 and 2015 didn’t exactly foster a feeling of optimism. From El Pollo Loco (LOCO) and GoPro (GPRO) to Fitbit (FIT) and Etsy (ETSY), a significant number of high-profile Wall Street newcomers had plunged from their highs, falling below their initial offering price.
SQ hasn’t yet fallen victim to the “busted” IPO narrative, but it hasn’t made any great moves in the opposite direction either. And after taking a closer look, I’m still not a long-term fan of the company.
SQ Stock’s Competitive Outlook
SQ is a minnow hunting with killer whales: management had a wider window to build their market presence than anyone expected because big payment networks dragged their feet on embracing mobile payments. But now that Apple (AAPL) is getting serious about phone-as-wallet (along with others, including Alphabet‘s (GOOG, GOOGL) Android Pay ), SQ’s situation looks a little more bleak.
First, let’s look at this from the side of consumers. People who shop at the kind of retail points that SQ attracted are younger, hipper and tech-forward. They have credit cards, but their phones are already glued to their hands at all times. Given the choice, these consumers are the first ones who would jump at the chance to leave the plastic in the wallet. (And maybe they’re the only ones, too, but that remains to be seen).
Supposedly one in six shoppers are using contactless payment now, and 5% of all phones are used to make transactions on a monthly basis. That’s not huge penetration yet, but it’s much better than the miniscule adoption we saw a year ago. Transactions is a volume business, so every incremental concentration or dilution of share-of-wallet matters.
Apple in particular is now hitting SQ right where it built its franchise. That’s not a positive long-term factor.
So let’s look at this from the retailers’ point of view. If SQ was their primary payment solution, they would definitely embrace a phone-to-phone (or more likely, phone-to-tablet) option as well in order to keep their hippest customers happy. But they’ll also keep their SQ systems as long as they can in order to run the cards the other 95% of their customers hand over.
Every cent that goes into phone tap instead of card swipe at these retailers cuts into SQ’s revenue stream. I have a hunch that these establishments represent a majority of phone tap transactions now and in the near future, so really, any traction at all for tap turns into direct pain for SQ.
iPhone Change Could Cut Out SQ
To make matters worse, Apple and has the power to decide the future of SQ systems simply by mandating that the earphone port (which I talked about last week) stays or goes. This becomes a problem for SQ retention, as SQ retailers hate the Android ecosystem and love the newest phones.
Will retailers deliberately keep an outdated phone or tablet on the store floor to keep the SQ swipe? As long as they still get a lot of people who pay with credit and debit cards, sure. But once the plastic stops coming out, SQ is gone, along with that clunky old device from 2014.
So here’s the main question: can SQ build a physical card reader that attaches to some other port on a mobile device?
It’s possible the company switches over to Lightning port capability, but that’s a whole lot of reengineering that could get expensive.
The company could also build its own standalone device — but, again, that’s expensive and a drag on profits.
All of this is hitting a company that’s handling $1 billion a year in transaction fees but has yet to turn a net profit. It’s clear SQ needs a lot more scale to make the business work.
On the bright side, $1 billion a year is a decent user base, which means SQ could potentially be an attractive acquisition target.
Hilary Kramer is the editor of GameChangers, Breakout Stocks Under $10, High Octane Trader, Absolute Capital Return and Value Authority. She is an accomplished investment specialist and market strategist with more than 25 years of experience in portfolio management, equity research, trading, and risk management. She has extensive expertise in global financial management, asset allocation, investment banking and private equity ventures, and is regularly sought after to provide her analysis on Bloomberg, CNBC, Fox Business Network and other media.
