Part of what makes Square (NYSE:SQ) stock intriguing is its potential. Based on current earnings, Square stock looks expensive and potentially overvalued. But the company’s opportunities for growth are what get investors and analysts excited, and explain why SQ stock deserves such lofty multiples.
One of those opportunities is the company’s Cash App. Like PayPal Holdings’ (NASDAQ:PYPL) product, Venmo, Cash App allows users to transfer money. In simplistic terms, Venmo and Cash App are app-based replacements for the expensive services that have been offered by wire transfer operators Western Union (NYSE:WU) and Moneygram (NASDAQ:MGI) for a long time.
The user base and volume of both apps are rapidly growing. But the question is how Square, in particular, can monetize those users. And that makes Cash App an interesting microcosm of the outlook of Square stock. Bulls see Cash App as yet another way in which Square can expand its services and drive growth for years to come. Bears see the product as another reason to avoid or even short SQ stock.
Cash App Posts Phenomenal Growth
Cash App’s growth has definitely been phenomenal, at least in terms of users. Square said on its Q4 earnings conference call that the app had over 15 million monthly active customers in December 2018 . On its first-quarter conference call, the company reported that the app’s volumes (the amount of dollars moved through it) had risen nearly 150% year-over-year in Q1.
Venmo is also growing explosively: In April. PayPal said the app had over 40 million active users. That doesn’t appear to be an apples-to-apples comparison to Square’s number, which was based on monthly active users. In fact, an analyst wrote this month that Cash App’s download growth was dramatically outpacing that of Venmo.
At the moment, it still looks like Venmo is ahead in volumes and users, but Cash App is coming on strong. Whatever the exact ranking, it’s clear that peer-to-peer transfer demand is growing exponentially, with Venmo and Cash App the clear leaders in the space.
Will Cash App Really Affect Square’s Earnings?
The skeptical response to that data is simple. Users and volume might be growing, but where’s the revenue? PayPal disclosed after Q1 that Venmo’s revenue had reached an annual run rate of over $300 million. SQ hasn’t disclosed the revenue generated by Cash App.
The company did say in conjunction with its Q1 results that it had raised its 2019 guidance for adjusted revenue by $30 million”primarily” due to the better-than-expected performance of Cash App. Cash App likely is a $100 million business, but it’s unclear whether Cash App’s revenue is higher than that of Venmo.
Of course, revenue isn’t all that matters, even to tech companies. And there are real questions as to whether Cash App is even profitable. Square kept its Adjusted EBITDA outlook intact. That suggests that Cash App’s bottom line isn’t rising as its top line increases.
If that’s the case, then is Cash App really all that valuable to Square and should it really be a driver of Square stock? If anything, it should lower the value of SQ stock, particularly at these levels. At $71, investors are paying over 13 times adjusted revenue (the company’s preferred metric, which excludes transaction costs) and a decent chunk of that revenue comes from the unprofitable Cash App. In that context, SQ stock is even more overvalued than it appears to be at first glance.
How Cash App Can Lift Square Stock
The bullish response, as Laura Hoy detailed this month, is that Cash App will increase Square’s overall engagement levels. According to that argument by those who are bullish on SQ stock, the app is simply another way for SQ to expand its reach. Although I’ve been skeptical towards Square stock, Cash App and other, similar efforts by the company have led me to compare it to Amazon.com (NASDAQ:AMZN).
Indeed, Square, which started with a simple credit card reader, has added more and more services. CEO Jack Dorsey has noted that the company now integrates Cash App with its payroll offering, allowing businesses to directly provide cash to underbanked or unbanked employees. Cash App also helps the company increase its foothold in the banking sector.
And Square does plan to further monetize the app. Former SQ CFO Sarah Friar said at a conference in November that Square had three paths to monetization. First, it can levy a 1.5% charge on instant payments. Secondly, it can offer a debit card based on the Cash App, which would allow the company to take interchange fees on the Visa (NYSE:V) network. And third, its Boost loyalty program allows retailers to send offers to users, with Square presumably getting some sort of payment in return.
The Battle Over SQ Stock
The bulls’ view on Square stock at this point is based on its potential from its moves into banking, better monetization of Cash App, and its entrances into the payroll business and (likely) accounting in general. Those who are uber-bullish on Square stock think that it will become an integral part of the entire financial system, much as Amazon went from selling only books to having its hand in almost everything.
Bears think that those initiatives are risky and/or immaterial. Moving into banking at the top of the business cycle exposes Square to credit risk. That risk is a key reason why big bank stocks like Bank of America (NYSE:BAC) and JPMorgan Chase (NYSE:JPM) are now so cheap. Cash App may have millions of users, but its earnings are minimal at best. Given Square’s likely inability to raise fees on Cash App, it never will be a big profit maker. And so investors who are focusing on the company’s “opportunity,” making them willing to pay a great deal for Cash App ‘s revenue – are simply overstating Square’s potential.
For now, I still lean toward the bearish side on SQ stock. So much growth already is priced into Square stock that it’s difficult to see how SQ can outperform.. But if Cash App and similar efforts make Square a part of the daily life of more worldwide users, perhaps that will be enough over the longer term to offset concerns about its fundamentals.
As of this writing, Vince Martin has no positions in any securities mentioned.
