Square (NYSE:SQ) was one of the hottest names of 2020, with shares surging 262% over the past one year. At first glance, that might make sense. After all, it is a payments company and e-commerce surged thanks to Covid-19. However, Square actually missed out on the e-commerce fun almost entirely. Its payments business grew by a mere single digits rate in 2020. Instead, SQ stock is really up mostly on its bitcoin trading operation. In my opinion, that’s a flimsy foundation.
The funny thing about Square right now is that, when you look at its core payments business, it had a very weak 2020. To me, that’s not shocking. Square primarily provides payment services for small businesses and many of those businesses closed permanently due to the pandemic. But, it’s not like SQ’s payments business was growing much before this year, either.
So, make no mistake. For now, SQ stock is simply a derivative of bitcoin. And that’s not necessarily a good thing.
SQ Stock and Revenues Are Much Less Than Meet the Eye
Put simple, Square’s reported revenues are going up primarily due to gimmicky no-profit bitcoin transactions that are unreflective of its actual operations.
For example, imagine if brokerage firms like Charles Schwab (NYSE:SCHW) reported all their customers’ stock buys and sells as its own revenue. That would seem absurd! Yet that is what Square is doing in its bitcoin dealings. The company books 100% of its customers’ bitcoin transactions as its own revenue, even though it obviously only gets to keep a tiny fraction of that.
To be clear, what Square is doing is legal and proper accounting. This accounting treatment is a quirk of the cryptocurrency space — at least for the time being. However, it’s ridiculous when analysts who should know better are pointing to these non-core revenues as if they’re meaningful to the bottom line. According to this logic, Charles Schwab, Ameritrade and the like would be the largest and most valuable businesses in the world. Obviously, they’re not.
With the price of bitcoin surging and crypto trading volumes sure to rise, Square will probably report even bigger top-line numbers next quarter. But little to none of it will actually translate to profits for the company’s shareholders. The firm is just a middleman earning a negligible take on the bitcoin transactions.
To put numbers to that, Square reported $1.63 billion of bitcoin “revenues” in Q3 but earned a paltry gross profit of $32 million on those purported sales. After accounting for the corporate overhead associated with the bitcoin operations, Square is probably outright losing money facilitating these transactions.
If anything, then, the bitcoin business should be viewed as a marketing ploy to get more people to use the app. And, to be sure, it’s been a highly successful one — at least so far. But moving bitcoin around at an effectively 0% profit is not an actual end business that will generate results for shareholders. People using the bitcoin trading service need to convert into customers of Square’s other, much higher-margin businesses. So far, that hasn’t happened to a considerable degree, hence the low profitability.
Core Business Is Still A Low-Growth Disappointment
Square is usually thought of as a payments company. Yet, that core business has been underwhelming for many years. For instance, recall that SQ stock did a whole bunch of nothing for almost two years following its initial public offering (IPO). This was because its core payments business was barely growing as big customers like Starbucks (NASDAQ:SBUX) left its service.
In fact, Square actually lost $71 million processing those payments for Starbucks. Basically, the company is good at generating meaningless, no value-added revenues. It did it with SBUX and now it’s doing it with bitcoin.
Plus, Square is not so good at earning profits. As it turns out, it’s hard to build a large business around small enterprises. That’s because SQ’s best customers would graduate to cheaper payment platforms as they got bigger. Meanwhile, churn is high in the pure small business space because those sorts of enterprises tend to go out of business quickly.
Over the past nine months ending in September 2020, the company’s “transaction-based” revenues grew just fractionally, from $2.24 billion last year to $2.36 billion. Meanwhile, bitcoin revenues — which again are not meaningfully profitable — soared from roughly $339 million to $2.81 billion. However, bitcoin revenues could theoretically go to $10 billion or $100 billion and it wouldn’t put much more cash in shareholders’ pockets. Yet, somehow shares have jumped higher on this meaningless bitcoin noise.
The Verdict
The company’s management team is smart enough to realize that it has a big problem. Its payments business is a clunker, just as it has been since the IPO. Even during a historic run in e-commerce, Square’s payments growth ran even slower in 2020 than its usual plodding pace. The platform’s transaction fees are too high and its clientele simply aren’t as attractive as the competition’s.
Hence, Square’s push in directions like Cash App, bitcoin and — most concerningly — its spin on payday lending. That’s right, the company launched a plan last year to lend consumers money at 60% annual interest rates. Needless to say, this is not the sort of high-quality business you’d expect in a stock trading at 291 times forward price-earnings.
Square has also taken out a banking license, as it wants to make loans to its vendors. That’s also not a high valuation or margin business. Long story short, this name is trading like a hot software company, yet it is a collection of middling to outright junky businesses.
So, SQ stock may keep running up as long as bitcoin does, but beware. When the crypto party ends, shareholders are going to get left holding the bag on a wildly overpriced stock. It should be valued far less. SQ was trading at $60 before bitcoin started running. Given that the payments business has barely grown since then, the stock should drop back to around $60 in due time.
On the date of publication, Ian Bezek did not have (either directly or indirectly) any positions in the securities mentioned in this article.
Ian Bezek has written more than 1,000 articles for InvestorPlace.com and Seeking Alpha. He also worked as a Junior Analyst for Kerrisdale Capital, a $300 million New York City-based hedge fund. You can reach him on Twitter at @irbezek.
