The mobile payments company Square Inc (SQ) reported fourth-quarter 2015 earnings yesterday, and I must admit: The results were pretty impressive overall. But on Wall Street, an impressive quarter doesn’t always equate to a roaring endorsement of the stock.
Exhibit A: Square stock today.
Yes, Square shares were up 3% in morning trading, a reasonable response to a solid quarter. But a couple hours into the trading day, SQ had swung to a 6% loss.
Wall Street is myopic, and longer-term, SQ stock is an absolute rip-off at current levels.
But before we go there, let’s acknowledge how Square performed over the holiday quarter.
SQ Has Impressive Revenue Growth
Square’s total net revenue shot up 49.2% to $374.4 million, cruising past the $343.2 million analysts expected. This was driven almost entirely by transaction revenue, which SQ earns from merchants who use its point-of-sale devices. Transaction revenue jumped 44.7% to $298.5 million.
Transaction revenue can only grow that quickly if gross payment volume, or GPV, grows. GPV is the dollar amount of sales that merchants make using Square devices, and that figure soared 47% to $10.2 billion in the fourth quarter.
That’s all well and good, but at the end of the day, a business has to make money for investors to make money. And SQ stock hasn’t earned a penny in profits throughout its entire existence.
Major Questions Remain for Square
If there was a part of the fourth quarter that fell short for investors, it was earnings. Square had none. In fact, SQ stock lost 34 cents per share last period, double the 17-cent loss analysts expected.
It certainly shouldn’t be an immediate dealbreaker that SQ stock isn’t profitable right now, since it’s a relatively young business that’s investing heavily in its growth. But what is concerning is the company’s relationship with Starbucks Corporation (SBUX), which has been its single largest client by far.
In the fourth quarter, SBUX accounted for $47.1 million of Square’s $298.5 million in transaction revenue. One client, 16% of transaction revenue? That’s not exactly diversified.
Worse yet, Square’s relationship with SBUX has been unprofitable. On the $142 million in transaction revenue Square did with Starbucks last year, transaction costs were $165 million. Although Square was able to renegotiate the rates it charged SBUX to a more favorable percentage, Starbucks decided to call off the relationship, and will be pivoting to its own in-house payment processing system before their contract ends in the third quarter.
Obviously, that will hurt revenue growth.
Aside from Starbucks, there’s the issue of CEO Jack Dorsey, who is two-timing investors by serving dual CEO roles at Twitter Inc (TWTR) and Square simultaneously. Any time he’s spending at one company, he could be spending at the other, and the arrangement frankly seems unfair to shareholders in both SQ and TWTR.
But even apart from these glaring issues, the one that investors should perhaps be the most concerned about is Square stock’s valuation.
Specifically, Square declined to provide earnings-per-share guidance for Q1 or fiscal 2016. It did give guidance for earnings before interest, taxes, depreciation and amortization (EBITDA), but that’s not easily translatable into EPS figures.
However, since EPS is inherently lower than EBITDA, the company’s guidance for between $6 million and $12 million in full-year EBITDA makes Square’s stock price look wildly overvalued. At the midpoint of $9 million in EBITDA, that yields a year-end 2016 price-to-EBITDA ratio of roughly 400.
Sorry, but that’s too rich for my blood, Jack.
As of this writing, John Divine did not hold a position in any of the aforementioned securities. You can follow him on Twitter at @divinebizkid or email him at editor@investorplace.com.
