Square Inc Has to Be Perfect to Meet Growth Expectations
Jack Dorsey is having a pretty good 2017. Square Inc (NYSE:SQ) stock is having a banner year: the SQ stock price now has risen 162% so far in 2017. Meanwhile, Dorsey’s first company, Twitter Inc (NYSE:TWTR) sits just off a 52-week high.
Source: Via Square
To be honest, I’m not a huge fan of either stock. I still think TWTR stock is overvalued, and I thought SQ stock had run too far just above $30 just last month. Obviously, with the SQ stock price up another 10%+, that latter article hasn’t aged well. But the concerns I laid out then remain valid.
Still, SQ is intriguing. The recent rollout of Square Register appears to have sparked some optimism, and Square earnings next week could keep the rally going. The payments space as a whole remains hot, with larger player PayPal Holdings Inc (NASDAQ:PYPL) itself up ~80% YTD. What concerns me about SQ stock at the moment is that it’s pricing in a lot of success. But if Square can become a legitimate force in the payment system, particularly for larger sellers, perhaps the run will have more legs.
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Square Register
Monday’s launch of Square Register drove SQ stock higher – though at this point it’s hard to tell whether broader optimism was responsible for the nearly 5% gain in the first two days of the week. The $999 offering, unlike Square’s small-business products, includes proprietary hardware, along with separate screens for the buyer and seller.
The question is whether Square Register really moves the needle for a company now valued at over $12 billion plus the ~$1 billion in cash on the books. To be sure, Square continues to target larger sellers and continues to have success in doing so. Nearly half of GPV (gross payment volume) in Q2 came from “larger sellers,” those generating more than $125,000 in annual volume. Also, 19% of the figure came from $500K+ sellers with that volume rising 61% year-over-year, against 32% for the business as a whole.
Square Register obviously is another step in the strategy to target larger sellers. More broadly, it’s an effort to make Square an integrated payment provider across all of retail, not just in small and home-based businesses. It’s worth noting that NCR Corporation (NYSE:NCR) stock is down 36% just since the beginning of March. And while there are other factors there (notably weakness in ATMs), it seems likely that the market is pricing in some level of success for NCR competitors in payments, among them Square.
SQ Stock Is A Growth Stock
And so there are long-term catalysts that seem poised to move Square higher. Square Capital is growing, with the company now aiming to start its own bank to support small business lending. Regional banks have protested against the move, which as InvestorPlace columnist James Brumley pointed out only shows their fears of Square’s potential.
Meanwhile, growth in the legacy business continues to impress. And Square looks well-positioned for what looks like a secular trend of corporate retail giants losing and independent retailers winning.
There’s the potential for real growth here. But as is almost always the case there’s also real risk. There’s a reason why nearly 30% of the Square float is sold short. Small business lending is a great idea in a good economy and a dangerous business when that economy turns. Square Register is an interesting offering for larger sellers but it’s very difficult to convince those sellers to change POS systems, given the time, difficulty, and disruption involved (associates have to be trained on the new machine, among other issues.)
Square needs big wins in both areas and even then, a stretched valuation raises risks of its own.
The SQ Stock Price
As good as 2017 looks through the first half, Square still is guiding for only ~$120 million in Adjusted EBITDA this year, implying a whopping 100x multiple. Even that figure excludes ~$140 million in share-based compensation, meaning that profits are negative excluding the dilution of existing Square shareholders.
Square can grow for years, and still look dearly valued at the current price. Given that the payment space as a whole doesn’t grow that fast (a rate a bit faster than the overall economy, as fewer transactions are done with cash), that multi-year growth is going to have to come from market share gains. Square definitely will take some share. But with everyone from Shopify Inc (US) (NYSE:SHOP) to Vantiv Inc (NYSE:VNTV) targeting the same space, competition will be fierce.
Again, Square’s growth isn’t coming to an end, and it very well may wind up being the ultimate winner. The problem is at the current SQ stock price is that nothing less than ultimate success seems priced in.
As of this writing, Vince Martin has no positions in any securities mentioned.
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