Square (NYSE: SQ) is coming public as a $1B revenue company with quite a few moving parts.
There’s the negative margin Starbucks business which is going away, plus the “ratchet” provision whereby prior investors will have their number of shares adjusted based on the IPO price to preserve their prospective returns. We suspect it will take at least a quarter or two for analysts and investors to get a better understanding of how the long-term model will develop for Square. It helps to have a starting point so we’re publishing our initial IV model which suggests a current price of just over $17/share. Interest in the PayPay (Nasdaq: PYPL) spin-off has been high and we expect Square will generate similar levels of activity.
Suffice it to say that the jury remains out on which players will be long-term winners in the payments game. In addition to Square itself, their strategy has implications for direct lending (Lending Club LC and OnDeck ONDK among others), marketing (Constant Contact CTCT, HubSpot HUBS, GroupOn GRPN) and possibly larger firms like** Intuit INTU**. The press has been guarded if not outright negative on Square for the last few years as speculation about their momentum and ultimate fate swirled around. Now that we have a concrete IPO we can sort through the facts as they stand. Here are the main points as we see them: Going beyond “just payments” and into data analysis, marketing and financial services seems like a good strategy for the SMB market that Square targets. Generally speaking small companies lack the resources and interest in decoding Google Places, AdWords and services like Constant Contact or Mailchimp. They are forced to invest in compliant POS services to run their business so additional benefits like financial services and marketing make sense. The cash advance business is another nice addition to services. PayPal has been pushing this too so it’s not unique. Compared to the rates that OnDeck charges for short-term money this might not be good news for them. This business should grow nicely and ultimately cuts into the territory that American Express occupies with small business owners. Like PayPal it’s easy to get going with Square. Since we don’t have a physical POS IPO Candy and IPO IQ use Stripe which suits our online needs best. However at the beginning we did use gateways like Authorize.net and there were many forms to fill out, approvals to get and ongoing costs. No SMB should have to deal with that. PayPal has been smart in making acquisitions like BrainTree. That gives them much newer technology to compete with Square. Starbucks was a big early customer for Square. Unfortunately one with negative gross margins! The relationship is ending and will ramp down to zero in 2016. The revenue loss is negative but is more than made up for by improved gross margins. We’re on the fence with respect to Jack Dorsey and the management team at Square. The next few quarters will be a real test for the team. Their aim to continue to be truly innovative in their experience, add more services and deliver “everything a company needs to grow” and improve margins will all be carefully evaluated. The two big questions about the long term model are 1) how high can transaction gross margins be and 2) how large can the software and data business be. Our initial estimates are in the model but they will be refined. In terms of execution it’s not known how Square will approach acquisitions. Companies like HubSpot (HUBS) or Constant Contact (CTCT) seem to make a good deal of sense and there are many others. If they are aggressive and good at integration this could be the only viable path to get big enough, fast enough. Our preliminary IV Model:
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