If You’re Considering Buying Square Inc, Ignore Bitcoin Hype

Square Inc (NYSE:SQ) has a number of very bright prospects to both drive future growth and make it a possible acquisition target. Those bright prospects have nothing to do with bitcoin, however, which is one reason why SQ stock has both jumped and cratered recently.

If You're Considering Buying SQ Stock, Ignore Bitcoin Hype

Fintech is big, and there’s a reason for it: demand. Financial services are part of the collective human experience, and the ability to pay for things no matter where a consumer may be has become an absolute necessity.

As technology progresses, so do solutions. The trick is creating a product that gets widespread acceptance relatively quickly. SQ systems are compact and easy to use. The software is robust, permitting sellers to manage orders, inventory, locations, employees and even payroll.

SQ stock has done well because investors seem to believe in its future. Its POS systems have caught on rapidly, and the company was able to rapidly scale. Gross payment volume rose from 23.8 million in FY14 to more than double to 49.7 million in FY16. GPV has further grown by more than 31% in the last quarter and so far this year.

Transaction, subscription and service fees all add up to a nice little business. The problem is that SQ stock is not supported by profits, and that’s what I don’t like.

Herein lies the problem of trying to become a new payment processor in a world filled with credit cards and Paypal Holdings Inc (NASDAQ:PYPL).

The top line for SQ is very impressive. For Q3, revenue grew almost 30% to $585 million. Subscription and service revenue almost doubled to $65 million. Because cost of revenue is essentially fixed in relation to revenue earned, it’s no surprise gross profit grew almost 45% to $218.6 million.

The challenge for SQ stock is its operating expenses. It costs money to develop products, as well as to market them, and to handle corporate overhead. Operating expenses thus grew, but not so badly that operating losses grew. In fact, operating losses were cut in half to $14.9 million.

The fact that net losses are shrinking after many years of increases is also excellent news. Through the first nine months of this year, net loss improved significantly. A $156-million loss last year was only $41 million this year.

These are all positive signs.

What I like about SQ stock is the potential, not only for much wider acceptance but for Square Capital, which the 10-K describes as:

“With Square Capital, we facilitate the offering of loans to sellers based on their payment processing history, and the product is broadly applicable across our seller base. We currently fund a majority of these loans from arrangements with institutional third-party investors who purchase these loans. We recognize revenue upon the sale of the loans to third-party investors or over time as the sellers pay down the outstanding amounts for the loans that we hold as available for sale. We also earn a servicing fee from third-party investors that we record as revenue as we provide the services.”

Square does not break out how much it has made in loans, nor complete loss information. It has “transaction, loan, and advance” losses as a line item, which increased from $12.88 million to $19.89 million. This is critical information because I suspect Square’s underwriting is in need of significant improvement.

This can be a very valuable source of revenue, and there is so much expertise in third-party providers for underwriting data and number crunching that Square’s upside could be huge if this program is expanded.

Reducing risk by having third parties fund and buy the loans is a great idea. However, by having transactional data, partnering with firms like Enova Decisions could give Square great underwriting data.

Bottom Line on SQ Stock

What will not drive the SQ stock price higher is any involvement with bitcoin, which remains a volatile and nutty fascination that will never be of any value to Square.

I do see Square being acquired at some point by one of the big players in processing, but not until it is clearly cash flow positive and profitable. For now, the $16-billion price tag is way too high to get involved with. However, in a big correction, it may be worth looking at.

Lawrence Meyers is the CEO of PDL Capital, a specialty lender focusing on consumer finance, and is the Manager of The Liberty Portfolio at www.thelibertyportfolio.com. He does not own any stock mentioned. He has 22 years’ experience in the stock market and has written more than 1,600 articles on investing. Lawrence Meyers can be reached at TheLibertyPortfolio@gmail.com.

Article printed from InvestorPlace Media, https://investorplace.com/2017/11/if-youre-considering-buying-square-stock-ignore-bitcoin-hype/.

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