Square Inc (NYSE:SQ) is a credit card processing company that wants to be on both sides of banking transactions, offering installment loans, backed by invoices, through its small merchant customers. It is part of a larger focus on banking that could lead, within the next year or two, into Square having its own bank. Or being bought by a bank.
Most credit processors specialize in one side of the transaction.
Either they have their name on the credit card and are serving consumers, like Citigroup Inc (NYSE:C), or they have their software inside a merchant terminal like First Data Corp (NYSE:FDC).
Both sides are, in effect, offering loans. You pay your credit card off a month after buying something. Merchants get their money once transactions clear. Credit held over time gets a cut on both sides of the transaction.
It is innovation like this which has investors excited by Square, although it may report positive earnings of just seven cents per share Nov. 8, after trading ends.
Upfront Innovation
Square sells at seven times its expected 2017 revenues because it is seen to be a fintech company, not an ordinary merchant processor. Processors may be overvalued, as I wrote on October 27, but fintech is a very hot niche.
Square’s innovation began with merchant terminals that were just smartphone software, and a one-size-fits-all discount of 2.75% to even the smallest merchants. Now the company is trying to expand beyond mini-merchants with kiosks in real stores with $125,000 per year in sales or more, using a $999 cash register.
In addition to chips and mag-stripes, the new register also supports contactless systems, and it has two screens – one facing the merchant, one facing the customer. Square’s chip reader, by contrast, costs as little as $29 and requires the card be handed to the merchant.
While most merchant terminals can tell a store owner how much business they did that day, the Square Register offers a host of accounting and financial services. The aim is that, over time, Square will become a merchant’s bank and hence the move toward a banking license.
Merchant Banking
The register has a lot of people excited, including our James Brumley, who calls it the “new hotness.” He sees the company offering small businesses “solutions” to problems, like making high-dollar sales, or integrating online and offline sales for small merchants, through a company called BigCommerce.
These solutions represent banking services, he adds, which is why banks are opposing Square’s efforts to get an industrial bank charter.
Square’s ambitions, and the stock market’s positive reaction to them, have made Square stock a “battleground” among InvestorPlace writers. The stock’s rise of over 200% in the last year has Chris Fraley and Laura Hoy concerned that its ambitions are priced-in before they’re being achieved.
The Bottom Line
I am on Brumley’s side in this one. You can get paid for potential.
It’s not that I expect Square to make a lot of money, either during this quarter or the next several. It’s that fintech is such a hot topic among banks that I fully expect a bidding war for the company.
There are many potential bidders with plenty of capital to afford the $14 billion market cap. Intuit Inc. (NASDAQ:INTU) is worth nearly $40 billion and could easily plug Square into its software niche. Paypal Holdings Inc (NASDAQ:PYPL) is worth $88 billion and has a compatible, Silicon Valley business culture. The biggest merchant processor, Visa Inc (NASDAQ:V) is like Square based in San Francisco. That’s not even counting the big banks that would love to plug this kind of small business solution into their banking offerings.
As Square shows these companies what is possible competition will increase, and at some point, my guess is, there will be a Square deal.
Dana Blankenhorn is a financial and technology journalist. He is the author of the historical mystery romance The Reluctant Detective Travels in Time, available now at the Amazon Kindle store. Write him at danablankenhorn@gmail.com or follow him on Twitter at @danablankenhorn. As of this writing he owned no shares in companies mentioned in this article.
