Recently Pat McKeough replied to a Member of his Inner Circle interested in a stock that specializes in payment processing and also seeks to extend its subsidiary enterprise in small business loans. Square Inc. was co-founded by the creator of Twitter and a fellow entrepreneur eight years ago. The company first issued shares in November 2015.
Pat observes that Square faces strong competition from leaders in the field such as Apple Pay and Pay Pal. Also, its recent loss of a major client demonstrates the challenges that can arise with big retail chains. He also notes that the company’s expanding loan business depends on a relatively sound economy.
Q: Hi Pat: I would appreciate your advice on Square Inc. Thanks.
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A: SQUARE INC. (symbol SQ on New York; www.squareup.com) provides payment processing services to over 3 million merchants in the U.S., Canada, Australia, Japan, Ireland and the U.K.
The company supplies clients of all sizes with a square-shaped card reader that plugs into their smartphones or tablets. To make a sale, they swipe the customer’s credit or debit card through the reader. The device then wirelessly transmits the information to a payment terminal. Square also provides the software that handles all aspects of the transaction. It typically charges merchants a 2.65% fee per transaction.
The company also helps its clients improve their marketing by establishing their customers’ spending patterns and analyzing other sales data.
Square operates two other businesses: Square Capital, which provides cash advances to pre-qualified merchants, and Caviar, a food delivery service.
Jack Dorsey, the creator of Twitter, and entrepreneur Jim McKelvey, co-founded Square in 2009. Dorsey is now CEO. He holds 39.0% of the voting power.
The company first sold class A shares (one vote per share) to the public on November 19, 2015, at $9.00 a share. Through class B shares (10 votes per share), insiders hold 58.2% of the voting power.
Square’s revenue jumped 741.9%, from $203.4 million in 2012 to $1.7 billion in 2016. Due to heavy investment in its operations, losses worsened from $85.2 million (or $0.71 a share) in 2012, to $171.6 million (or $0.50 a share on more shares outstanding) in 2016.
In the three months ended June 30, 2017, the company’s revenue rose 25.8%, to $551.5 million from $438.5 million a year earlier. It processed $16.4 billion in transactions in the second quarter, 31.2% higher than the previous year. Square lost $16.0 million (or $0.04 per share) in the quarter compared to a loss of $27.3 million ($0.08) a year earlier.
The company holds cash of $920.3 million, or $2.41 a share. Its long-term debt is just $350.0 million.
Growth stocks: Company plans to form a bank based in Utah
Square’s technology has earned it high customer-satisfaction and retention levels. However, it will need to keep spending substantial amounts on product development and marketing to maintain and grow its market share. Its competitors include increasingly strong leaders in the mobile payments field such as Apple (Apple Pay) and PayPal. (Both are recommendations of our Wall Street Stock Forecaster newsletter.)
In addition, Starbucks, an early adopter of Square’s payment technology, switched to another payment processor late last year. The loss of Starbucks points to another challenge for Square: retaining its larger retail clients. The company’s service works well for “micro-merchants” such as food vendors, tradespeople, and single-location stores and restaurants. But big chains require very sophisticated point-of-sale technology and software that fits with their computer networks. It is uncertain whether the company can increase its research spending to keep up in this rapidly changing and competitive area.
Square hopes to maintain its growth by expanding its Square Capital business. It issued 49,000 merchant loans totalling $318 million in the latest quarter; that’s 68% more than a year earlier. However, it faces strong competition from more-established online lending services such as LendingTree. It began operations in 1998.
Recently, the company announced that it plans to submit an application to form a bank based in Utah. The unit, to be called Square Financial Services Inc. would offer loans and deposit accounts over the Internet to small businesses and be capitalized with $56 million in cash.
Any downturn in the economy, and a subsequent rise in loan defaults, could become a big problem for the company as it expands in this new area. Moreover, banking regulators could impose new rules on these services as they become more popular.
Inner Circle recommendation: We don’t recommend shares of Square Inc.
While I don’t disagree about the overall analysis and longer term risks associated with this novel andingenious payment solution for crafters and small businesses, I was able to generate a 29.7% gain on Square Inc Class A.com betwen April 19 and June 12 of this year. This was possible because of some specific publicity about the company. I do not hold a position in [SQ] presently.
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While I don’t disagree about the overall analysis and longer term risks associated with this novel andingenious payment solution for crafters and small businesses, I was able to generate a 29.7% gain on Square Inc Class A.com betwen April 19 and June 12 of this year. This was possible because of some specific publicity about the company. I do not hold a position in [SQ] presently.