On January 31, 2022, Block Inc (NYSE:SQ), formerly known as Square (but still retaining the “SQ” stock symbol) closed on its purchase of Afterpay. On balance, this should be a net positive for SQ, although it may take the long term for it to work out. This is because the $29 billion deal was done 100% in Square stock, diluting the existing shareholders.
Afterpay is Australian-based buy-now pay later (BNPL) credit provider that allows users to buy with “point-of-sale” credit. This should be a net positive for SQ stock since it will allow Square to compete with PayPal (NASDAQ:PYPL) and Affirm (NASDAQ:AFRM).
These companies already offer this BNPL type product to online buyers (mainly millennials who take advantage of it).
The CFO of Block, Amrita Ahuja, told CNBC on August 2, 2021, that she believes the deal is accretive, although she did not say over what period. Nevertheless, she made this point: “it’s rare for Square which is growing at 91% in Q2, our highest growth quarter as a public company, to find another company that at scale is accretive to our growth and if you look on an LTM basis, Square grew our gross profits 71% year over year, Afterpay grew theirs 96% year over year.”
What this means is that Afterpay will help Block’s top line, its revenue line. But whether it will work out on a bottom-line basis, especially after the additional shares, is another question.
How Afterpay Works
Afterpay makes money by charging mostly online merchants a fee for allowing consumers to buy their goods. There are four payments, 25% of the price, each two weeks apart. The first is at the point of sale, so the item is paid off in six weeks. There are no interest rates for the consumer, but if they are late there is a state-regulated late fee. The more the consumer uses the BNPL line with Afterpay and has a good payment record, the higher the limit.
Merchants like this since they do not have to finance any line of credit. They pay a fee but get higher sales (known as “conversion”) and tend to get repeat customers. Block likes this since most of Afterpay’s sales are with non-U.S. merchants, and its Square operation has just 15% of its sales with non-U.S. merchants.
BNPL Scale Could Make AfterPay Profitable For Block
The problem, however, is that Afterpay is not profitable. In fact, Afterpay has made nothing but net income losses.
For example, its public documents (it was trading on the Australian Stock Exchange) show that in the six months ending December 31, 2020, Afterpay lost 76.5 million AUD ($55.5 million). At this rate, the company will lose $111 million annually for Square.
However, I suspect that both Afterpay and Block hope that with the additional scale that Square will bring ($41.7 billion in Q3 gross payment volume). Moreover, if Block moves to allow Square merchants to accept crypto payments, as PayPal and Affirm have recently done, there could be even more gains for both Afterpay and Block.
What to Do With SQ Stock
At this point, we don’t know the exact number of new shares that have been issued to Afterpay. But we can assume that the acquisition price was about $122 or so (the price on Jan. 31).
That implies about 238 million shares were issued ($29 billion) or about 50% to 51% of its pre-merger total of 462 million Class A and B shares prior to the merger. This means that there are now approximately 700 million shares outstanding and the dilution effect is about one-third to 34% (i.e., 238 million /700 million).
Giving up one-third of Block’s shares for an acquisition that is not yet profitable takes a lot of faith. However, management claims the deal is accretive, so that might be a good thing for the long term for patient investors in SQ stock.
On the date of publication, Mark R. Hake did not hold any position (either directly or indirectly) in the securities mentioned in this article. The opinions expressed in this article are those of the writer, subject to the InvestorPlace.com Publishing Guidelines.
Mark Hake writes about personal finance on mrhake.medium.com and Newsbreak.com and runs the Total Yield Value Guide which you can review here.
