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Should Facebook Drop Libra and Buy Square?

Leo Sun, The Motley Fool

Facebook's (NASDAQ: FB) recent introduction of Libra sparked waves of regulatory opposition both at home and abroad. Facebook plans to integrate the open-source cryptocurrency into Calibra, a mobile wallet that will add digital payments to Messenger and WhatsApp.

Facebook claims that Libra will solve payment issues for 1.7 billion unbanked people worldwide. Regulators, however, claim that the platform could be used for money laundering and other illicit transactions. Facebook's recent privacy debacles, which resulted in a $5 billion settlement with the Federal Trade Commission, also raise concerns about Calibra's security.

Stacks of coins with digital charts in the foreground.

Image source: Getty Images.

Would it be easier for Facebook to simply scrap the Libra project and buy a well-established digital payments company instead? CNBC's Jim Cramer, who stated that Facebook's cryptocurrency ambitions were "doing more harm than good," recently suggested that it buy Square (NYSE: SQ) for $70 billion, "blow out Square's payments network worldwide," and turn Square Cash into Facebook Cash. That's a bold suggestion, but does it make sense?

Why Facebook might want to buy Square

Square disrupted the POS (point of sale) industry with mobile payment apps for smartphones and tablets. Square's hardware was cheaper and easier to set up than traditional POS devices, and its cloud-based apps helped businesses accumulate and analyze customer data.

Square expanded its digital ecosystem with additional services, including its Caviar and Zesty food services, Square Capital lending unit, Instant Deposit platform for sellers, e-commerce services platform Weebly, and industry-specific bundles of apps like Square for Restaurants and Square for Retail.

For consumers, Square launched the Cash App, a peer-to-peer payments app that competes against PayPal's (NASDAQ: PYPL) Venmo. It also offers a physical debit card, Cash Card, which is tethered to the app. Square Cash processed $30.8 billion in payments last year according to Cornerstone Advisors, compared to $64.2 billion on Venmo. However, Square Cash surpassed Venmo in total downloads last summer according to Nomura Instinet, and Square claims that the app more than doubled its user base to 15 million in 2018.

Square's entire ecosystem processed $84.7 billion in payments in 2018, marking 30% growth from 2017. Therefore buying Square would give Facebook the payments infrastructure to advance its fintech and e-commerce efforts -- which include peer-to-peer payments on Messenger and WhatsApp, shoppable posts and in-app checkouts on Instagram, and shopping videos on Facebook Live.

Facebook could also bundle Square's merchant services into its business pages and ad services, making its platform a cohesive one-stop shop for businesses. Facebook would also gain a foothold in the cryptocurrency market with the Cash App's bitcoin feature, which lets users directly buy and sell bitcoin. If bitcoin's price stabilizes, the integration of those payments into WhatsApp or Messenger could help Facebook reach the same unbanked users it's targeting with Libra.

Square Register.

Square Register. Image source: Square.

Why Facebook probably wouldn't buy Square

The synergies between the two companies are easy to spot, but a takeover could be tough for two reasons: profitability and valuation.

Square isn't consistently profitable on a GAAP basis. It was only profitable in one quarter in 2018, and that was attributed to a one-time gain from Eventbrite's IPO. It posted a net loss of $38 million in the first quarter of 2019, compared to a loss of $24 million a year earlier, and it expects to stay unprofitable this year.

A $38 million loss is tiny relative to Facebook's $22.1 billion in net income last year, but Facebook already faces significant earnings pressure from regulatory fines, legal expenses, investments in privacy and security, and its expansion into lower-margin markets. Wall Street expects Facebook's earnings to decline 6% this year, and buying an unprofitable company like Square won't boost its earnings.

Square currently has a market cap of $34 billion, roughly 15 times its adjusted revenue forecast (which excludes transaction and bitcoin costs, as well as deferred revenue adjustments) this year. That valuation isn't cheap, but it's reasonable relative to its forecast for 43% growth.

However, a high-growth company like Square would likely only sell itself at a premium. Cramer's suggestion of $70 billion, more than double its current market cap, would value Square at over 30 times this year's adjusted revenue. For context, Paypal trades at less than 8 times this year's sales -- but it's expected to generate just 16% sales growth this year.

Facebook ended last quarter with $45.2 billion in cash, cash equivalents, and marketable securities, so it would need to fund a large portion of the deal with stock or debt. Buying Square would only boost Facebook's annual revenue by a low single-digit, and weigh down its earnings -- so it might not be worth the trouble.

The key takeaway

An acquisition of Square by Facebook is an intriguing idea, but it doesn't make enough sense to be taken seriously. It would be a great fit, but Square's lack of profitability, its high valuation, and Facebook's bottom line blues all indicate that deal won't happen anytime soon.

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Randi Zuckerberg, a former director of market development and spokeswoman for Facebook and sister to its CEO, Mark Zuckerberg, is a member of The Motley Fool's board of directors. Leo Sun owns shares of Facebook and Square. The Motley Fool owns shares of and recommends Facebook, PayPal Holdings, and Square. The Motley Fool has the following options: short October 2019 $97 calls on PayPal Holdings and short September 2019 $70 puts on Square. The Motley Fool has a disclosure policy.