Is anyone but me purplexed with SQ?

Investment Analysis Clubs Saul’s Investing Discussions
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Hi Everyone,
I posted this on the SQ board, and would love your thoughts as well…

I get Matt’s point about Eventbrite and Caviar. I am a fan of the Caviar sale. I don’t care about Eventbrite. I also love the sequential growth of >$500k GPV over the last 3 quarters (19% 22% 26%), cool!

But what bothers me is the deceleration over the last year in GPV (29% 28% 27% 25%) and adjusted revenue (68% 64% 59% 46%).

What PS should we pay for an excellent company in the payments space? My guess is PS ~ 12. Where are we today? PS ~14. Our adjusted PE ~ 114 .

This is a RICH valuation. Why? For good reason, the cash app. That has not been monetized. Cash app could lead to awesome results in the future.

On balance, I am bothered by the total direction of the business. I don’t think that it supports a PS of 14. I plan to trim my 6% allocation in half. I’ll be happy to increase that if the Cash Ap starts to contribute meaningfully or if the GPV growth trends start to reverse.

At the end of the day, the declining GPV/revenue growth in the retail space against a backdrop of a possibility of an extended trade war doesn’t seem like the best place for my money. It also may be more difficult and costly to gain larger customers damaging growth prospects further.

Anything I am missing here?

Best,

bulwnkl

PS As always, if I wake up one day and wouldn’t be excited to buy a company, I’m going to sell.

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Bulwinkl,

I saw the 13% drop in Adjusted Revenues and decided to exit SQ following my review of the report (which was after hours).

My reasoning is pretty simple, their adjusted revenue has slowed at a rate of 4%, 5%, and then 13% in the last three quarters. I’m typically okay with linear deceleration but the 13% was a little jarring.

I redeployed equal parts into MDB and ESTC and a small added to PD.

I didn’t read into Bitcoin or Cavier, etc, I simply looked at the revenue slowdown and made my decision. I did the exact same thing the day before with TDOC.

I may reconsider adding SQ at a later date - as I believe in the long term ecosystem - but my concern is that SQs accelerating slowdown in growth. I’d rather be in stocks growing faster.

Just a Fool’s take

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What PS should we pay for an excellent company in the payments space? My guess is PS ~ 12. Where are we today? PS ~14. Our adjusted PE ~ 114 .

This is a RICH valuation. Why? For good reason, the cash app. That has not been monetized. Cash app could lead to awesome results in the future.

Is this a rich valuation? It all depends. VEEV and PAYC are growing at much less than 40%, but their valuations are much higher than SQ’s. Why? Well, they’re profitable, with PE’s around 80, not too much lower than SQ’s. SQ’s net margin still has room to grow, so their PE may shrink faster than PAYC’s or VEEV’s. Also, I believe SQ will continue growing faster than these others, even if it’s 40% instead of 50 or 60.

So what’s 40% growth worth? It depends on profitability. It depends on consistency. We’ll see what the future holds, but I’m betting SQ can continue a la PAYC and VEEV. But SQ is a much larger company (mkt cap is 30 billion and revenue run rate is over 2b). They won’t double every year or two, but if they can do something like Paypal (PYPL) has since they became a stand alone company, I’ll be pretty happy.

Bear

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Revenue growth:


Q217 40%
Q317 44%
Q417 47%
Q118 50%
Q218 60% <<< Weebly (4/26/18 for $365M), Zesty (4/19/18 for $90M)
Q318 68%
Q419 64%
Q119 59%
Q219 46% 
Q319 38% <<< Guidance midpoint
Q419 33% <<< Guidance midpoint

They purchased Weebly and Zesty in Q2 2018. I think that this made the revenue in Q318 through Q119 a non-apples to apples comparison and inflated their revenue growth figures. Also, it seems that the 13% point sequential drop from Q119 to Q219 is partially due to a return to a mostly apples to apples revenue comparison. So it seems that I thought that the growth was higher than it actually was. In Q319, revenue growth will return to apples to apples because Weebly and Zesty were in SQ for the entirety of Q318.

While the sale of Caviar is a positive because it will jettison a lower margin business that is no longer strategically important and enable more investment in the more strategically important aspects of the business (seller and Cash), it will remove a whole lot of their subscription revenue but also improve average margins:

So let me help you break it down a little bit on Caviar. We’ll be able to share a lot more with the relevant financial statements, including and excluding Caviar, upon the close of the transaction expected to happen later this year. But just to give you a little bit of boundaries as you kind of model the business. From a revenue scale perspective, Caviar is the second largest component of our subscription and services revenue stream where we did $251 million in revenue in the second quarter. We’ve now disclosed key revenues for Cash App, which was the number one driver of our subscription and services revenue stream. Capital is the third. So you can kind of benchmark within there, backing into a figure within range for Caviar.

From a margin perspective, as a delivery platform, Caviar has lower gross margin profile than the remainder of our revenue streams related to subscription and services. There are ongoing costs associated with Caviar, including fees for couriers and the revenue share with restaurants that have made it the largest component of subscription and services-based cost.

There’s a lot to like about SQ and it is already profitable with profits growing quickly (but the P/E is well over 100). They are disrupting financial services.

But I decided to sell all of my SQ position yesterday (it was a 4.7% position after the drop) because I think I can invest in fast growing companies than a 40-45% grower.

Chris

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There’s a lot to like about SQ and it is already profitable with profits growing quickly (but the P/E is well over 100). They are disrupting financial services.

But I decided to sell all of my SQ position yesterday (it was a 4.7% position after the drop) because I think I can invest in fast growing companies than a 40-45% grower.

Chris

Hi Chris,

I sold my 3% and change position as well in AH after the call. I may be wrong and re-enter Square at some point, but my thinking was similar as yours. I would think Elastic, as an example growing over 60% and sub $10 billion market cap could appreciate much faster than Square growing at low/mid 40’s and pretty large ~$30 billion market cap.

Matt

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My other concern with SQ is it’s low margins. Margins and growth together must be considered.

Let’s dive deeper:

Square has the highest growth rate (46% adjusted Rev) of the companies Bear mentioned PAYC (30%) and VEEV (25%)

Yet, when you consider what % of that growth is available after cost of revenue for to invest in more growth, pass to profit, invest in R&D, etc (I.e., gross margin) you find that a larger stream is being allocated to PAYC mgmt at (84% margins) and VEEV mgmt (75% margins) vs SQ mgmt (40% margins)

So what?

PAYC mgmt sees 25% growth in cash after cost of revenue

VEEV sees 19% growth in cash after cost of revenue

SQ sees 18.5% growth in cash after cost of revenue

Think about this…PAYC management is seeing 35% more dollars they can manage at 35% slower growth because of high margins

That’s why these high margin, high growth stocks are so powerful.

Just a Fool

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Bolding is mine

But what bothers me is the deceleration over the last year in [growth rates of] GPV (29% 28% 27% 25%) and adjusted revenue (68% 64% 59% 46%)…This is a RICH valuation. Why? For good reason, the cash app. That has not been monetized. Cash app could lead to awesome results in the future.

On balance, I am bothered by the total direction of the business. I don’t think that it supports a PS of 14. I plan to trim my 6% allocation in half. I’ll be happy to increase that if the Cash Ap starts to contribute meaningfully or if the GPV growth trends start to reverse.

At the end of the day, the declining GPV/revenue growth in the retail space against a backdrop of a possibility of an extended trade war doesn’t seem like the best place for my money. It also may be more difficult and costly to gain larger customers damaging growth prospects further. Anything I am missing here?

Hi bulwinkl,

Adjusted revenue actually took a huge jump this quarter if you look sequentially: the last four quarters have been $431, $464, $489, and then this quarter, $563… That was huge as a sequential gain. The two previous gains were $32 and $25, this one was $74!!!. What made it look small was that the comparison to the June quarter last year was comparison to another very big quarter. But a jump of $74 million sequentially from $489 to $563 doesn’t look like a danger signal to me.

The same thing about GPV. After flatlining at $22.5 to 23.0 billion for the previous three quarters, this quarter it was almost $27 billion! …Again, what looked like a weak comparison was because of that huge quarter a year ago. I don’t see a danger signal there either.

And look at adjusted EBITDA! Rate of growth dropped from 72% to 54% from the Mar quarter to this quarter! Wow, huh? …But the dollar value of the EBITDA actually ROSE 69% from $62 million to $105 million sequentially!!! (Again, tough comparison to a year ago). Do you see a cause for alarm there?

Cash App provided a substantial part of their adjusted revenue, even at this early stage. I’m puzzled by you saying that it’s not monetized yet.

All in all I felt happy in increasing my stake to a still small 3.55% of my portfolio, at a 15% discount from the day before.

Best,

Saul

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vs SQ mgmt (40% margins)

JAFbrblev,

I’m not sure what you mean. Square’s gross margin on adjusted revenue are over 80%. Are you looking at their margins on total revenue (including pass through transaction revenue)?

Bear

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I am absorbing all this…great threads on SQ.
Basically at this price level you get a time machine taking you back 1 year.

I never benefitted from owning SQ in the past, so thinking it may make sense here.
Agree on the long-term view of looking at industry peers like PYPL, Visa, Mastercard and how they have thrived as larger caps.

One comment on the comparison to VEEV and PAYC: VEEV is definitely in a class by itself…could be argued little-to-no competition. Not certain on PAYC, but in their niche they may be best-in-class. Point is that the competitive landscape is a bit different for SQ, and perhaps that can also be an attribute towards why those 2 get higher P/S than SQ.

Also - a thought on how we view upside on 40% growers vs 50%+ type growers.
There was a nice post to a great article earlier here: https://discussion.fool.com/below-is-a-link-to-an-article-i-beli…

The article summarizes research findings from a study of 3,000 software and online-services companies conducted by McKinsey aimed at understanding the factors that predict sustained growth rates (i.e. your question). A few of the most relevant findings are outlined below (all of this is specific to software companies):

  • Software companies with 2-year revenue CAGR >60% when they hit 100 MM in revenue (“Supergrowers”) were 8x more likely to reach 1 BB in revenue than those growing <20% at 100 MM

  • 85% of “Supergrowers” were unable to maintain their high growth rates (defined as >40% once they reached 1BB in annual revenue) and once lost, less than one quarter were able to recapture them (and even if they did, they went on to create less shareholder value than companies who maintained consistent growth, which are extremely few e.g. Amazon, Tencent, Saleforce, Adobe)

  • Supergrowers generated 5x the shareholder returns then “growers” (where growers are defined as two-year revenue CAGR between 20% and 60% at 100 MM and between 10 and 40% at 1 BB)

The whole point of me sharing that was when our companies hit $1b+, it is perhaps constructive to not punish them for no longer being 50% growers, but per the study it appears we should still expect them to hover at or above that 40% line if we want a predictive view into how they may continue to grow (in share appreciation) moving forward.

CRM and NOW are two SaaS titans, well above $2b and even $3b runrate…no longer quite at 40%+, but valuable (like VEEV) because of market share and FCF and/or profitability at their scale.

Completely different businesses, but perhaps analogous and constructive for us to think about how SQ will ramp up from a $1b runrate / $30b mkt cap company from here.

In general, it seems “turnaround candidates” are always a waste of time, whether it was NVDA or ANET or now NTNX…hoping your stock returns to their glory days.

In the case of SQ, as GC showed with the historical revenue trends, I am not sure they ever really slowed down or if growth was just artificially high due to acquisition (shades of what we see with Twilio + Sendgrid now?) and if they stay at 40% from here, perhaps the stock has good upside after going nowhere for a year.

This was a bunch of random musings, but essentially I am wondering if it is time to move SQ off my watchlist, even if it is just for a rebound given how much they were beaten down on top of the lack of appreciation in the stock the past year.

Dreamer

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Saul,
Any thoughts on the bitcoin impact on SQ’s business?
NVDA cratered due to being artificially high for a few Q’s thanks to bitcoin-related mining that led to huge increases in gpu sales. Once bitcoin price collapsed, so did interest in bitcoin mining and gpu sales plummeted.

I don’t get the sense there is anything ominous with bitcoin and SQ, but given the very volatile nature of bitcoin (it could go back to $1000 or up to $50k…who knows) I am leery of outside influences to stocks that are less predictable.

I still don’t really understand what/how bitcoin and SQ intersect and what it means for SQ. Sounds like it was somehow $2m in net profit, so not a big deal overall, but does it influence and cause fluctuations in the revenue numbers?

Dreamer

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Any thoughts on the bitcoin impact on SQ’s business?

My main thought on Bitcoin as it pertains to SQ, it was a very successful mechanism to attact people to join CashApp which can now be motorized more. I think this has been a huge factor in making CashApp the most popular and most downloaded cash app out there. Will there be other benefits to Bitcoin for SQ? I think that’s still uncertain and I wouldn’t try to speculate on that.

The whole point of me sharing that was when our companies hit $1b+, it is perhaps constructive to not punish them for no longer being 50% growers, but per the study it appears we should still expect them to hover at or above that 40% line if we want a predictive view into how they may continue to grow (in share appreciation) moving forward.

My primary reason for selling SQ was that I could redeploy from a 40%ish grower to a 60%+ grower with a smaller market cap. Will SQ quadruple its market cap (probably) but how long will this take. Alternatively, can I find a smaller market cap company (a new one or one that I already own) that I feel has a very high chance to continue growing at hyper growth levels. I think so.

Other random thoughts:

  1. SQ’s valuation last year, IMO, was inflated due to the Bitcoin capability addition to CashApp during a time when Bitcoin was super hot. Did Sarah Friar recognize this and if so did her decision to leave when she did have anything to do with her opinion (assuming she thought this) of the elevated valuation? She could cash out her shares if she was no longer with SQ.

  2. I would be cautious on anchoring to last year’s high (see #1 above), and invest on the basis of your opinion of SQ’s future financial performance.

Chris

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Thanks everyone on the comments. I appreciate the margin discussion and backing out the Caviar contributions. Great discussion. I think will stay the course for now.

Best,

bulwnkl

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Everyone should put this ‘good sale’ into perspective.

Travel back in time and read an article like this. https://www.google.com/amp/s/www.cnbc.com/amp/2018/05/08/squ…

For me this somewhat abrupt change in direction and strategy indicates to me possible underlying management issues. Not as sound as everyone believes.

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For me this somewhat abrupt change in direction and strategy indicates to me possible underlying management issues. Not as sound as everyone believes.

So you are upset they are selling an acquired division that a journalist a year ago thought was critical for their new-at-the-time Square for Restaurants? I prefer to listen to mgmt directly.

It’s a wildly different time in food delivery than a year ago, must less 5 years ago when they acquired Caviar. In those 5 years, Yelp came and went (buying Eat24, then ultimately selling it to #1 Grubhub). Uber disrupted things w/ Uber Eats, then DoorDash took then #2 mantle from them. Grubhub has been acquiring like crazy. Caviar was in a sea of competition until being swept up by DoorDash. Food delivery apps are EVERYWHERE now.

Caviar was bought in 2014 for $90M, so the sale price of $410M means it was a great overall investment over 5 yrs. Yet Square has never been shy about its desire to upsell Caviar customers. It was originally acquired for getting into delivery but also for bringing restaurants that used Caviar into the Square ecosystem. And the acquisition paid off nicely on that front – today 26% of GPV is from restaurants, so Square for Restaurants is clearly making good progress, in a mere year, on expanding Square out of retail & services.

I recommend you take it from the horse’s mouth (Dorsey) on the reasons behind the divestiture. The earnings PR made their intensions w/ the sale clear - they see a better path of being neutral. https://s21.q4cdn.com/114365585/files/doc_financials/2018/20…

A new feature announced this quarter is Order Manager, which integrates Square for Restaurants with more than 20 delivery apps, so restaurants can handle it all on their POS system regardless of delivery platform used by the customer. So now, instead of owning their own competing delivery platform against those integration partners, they are opting to focus on being a neutral restaurant POS platform that integrates with ALL of them. I believe this is a wise move. Let the remaining players fight it out, and Square will win regardless of who ultimately takes the food to the door.

-muji
long SQ

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Wow, this has been a great discussion. Thanks to all of you.

As I was reflecting during the night, I had a few further thoughts which helped clarify my thinking. First of all, with regards to the following exchange, I think I figured out what it meant exactly:

Q - …you did beat the high end of the revenue guidance for the quarter. Now typically, that’s been accompanied by a raise in your annual revenue guidance. We did not see that this quarter, so I just wanted to get an understanding of why you decided to not raise the full year revenue guidance despite another very strong quarterly performance.

A - I’d urge you to remember that we just announced the coming sale of Caviar… We will update you after the closing of this transaction, which we’d expect to happen later this year, with respect to guidance for the rest of the year. Also remember, we raised guidance last quarter by $30 million, which was obviously more than the beat that we had last quarter.

What she was saying is that first, selling Caviar will naturally reduce both total and adjusted revenue for the year. They are not sure exactly when the sale will be final so she wasn’t able to say how much, but in the meanwhile they didn’t want to raise guidance as they would normally, as the sale of Caviar would probably have to make them take take the guidance raise back, as they wouldn’t have those last few months of Caviar revenue. That insight really helped me understand what was going on.

Next, the sale brings in $410 million in close to 100% gross margin cash. It doesn’t get counted as revenue, but it is cash into the business. I don’t know how much Caviar brings in a quarter in revenue, and I didn’t try to find it, but since half of their revenue is transaction based and a bunch is Cash App based, there isn’t that much left, so I’ll estimate $40 million a quarter (I could be off by a factor of two, either up or down). Since they have “the lowest” gross margin in the subscription part, I’d give them the benefit of the doubt and give Caviar a gross margin of 40% (that seems high, actually for a hands-on business), which would give them quarterly gross margin this quarter of $16 million dollars, plus or minus. Now $410 million divided by $16 million is 25.6, so they will receive about 25.6 quarters of current gross margin (or almost 6.5 years worth) in this sale. (Yes I know it’s growing but I assume they’ll put the money into something else that will be growing.)

And they are getting rid of a unit that is facing a lot of competition, and which is getting in the way of them selling a delivery-service-neutral platform to other restaurants that don’t use Caviar.

It all sounds good, but we’ll have to wait and see.

Saul

A link to the Knowledgebase for this board is at the top of the Announcements panel that is on the right side of every page on this board.

For some additions to the Knowledgebase, bringing it up to date, I’d advise reading several other posts linked to on the panel, especially “How I Pick a Company to Invest In,” and “Why My Investing Criteria Have Changed,” and “Why It Really is Different.”

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As a reference point here is the performance of some of the stocks mentioned over the past year.

SQ: -2%
PAYC: 76%
VEEV: 101%
VISA: 27%

Needless to say it’s had a rough 12 months but that could certainly change moving forward . Based on the opportunity costs alone it seems like there are better places to deploy funds.

Some might feel PAYC or VEEV are overvalued when compared to SQ but if you factor in consistent growth, profitability, 98% subscription revenue (PAYC) to me those characteristics warrant a premium.

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As a reference point here is the performance of some of the stocks mentioned over the past year.
Past Performance Is No Guarantee of Future Results

🆁🅶🅱
If all my days were hills to climb and circles without reason
If all I was, was passing time, my life was just a season

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Hi muji,

I’m not upset at all. I thought it would be good to bring to the discussion a some-what non group-think perspective. The article is just to make a conceptual point.

To go into more detail on my train of thought…

As you said, Caviar was acquired 5 years ago. And at that time, its no secret that everyone is excited about the food delivery space and everyone had their own strategy around it. One thing for certain is that everyone already understood it was low margin and difficult because it is no different from a Lyft/Uber service except you deliver food instead of people.

It should not be a surprise to find out that delivering food is just as difficult to make money in.

The cost of purchasing caviar is not simple math. In five years I would consider how many millions were spent on developing features and integrating that service into Square, the training of staff to up-sell, etc… Not to mention strategically making this type of move to acquire customer growth through that channel / segment of restaurants which maybe didn’t go as planned. And their plan wasn’t to make it an economically viable higher margin portion of the business.

These were also five years of wasting time is a major opportunity cost. Put yourself outside of this situation - if you had purchased a business with the plan to leverage it and grow your company and only to sell it five years later… would you and your employees feel like it was an accomplishment or a failure of execution that led that decision?

The problem is that square was a first mover in the mobile payments space that specific innovation and it has greatly benefited from it. Now that it is reaching the limits of features and expanding within that product it is going to rely more and more on having superior management execution and strategy.

Best

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The Caviar investment is a great success for Square. Through Caviar, they get the access to restaurant business and built Square for Restaurant platform. This platform is the future and high margin/SaaS business. Now Caviar not only is lower margin but also make SFR not vendor neutral. So selling it is a great move.

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I think the market is coming to realize exactly how crowded the payments space will be, and that Square might end up being just one of many competitors. There’s the banks, there’s MA/V, there’s PYPL and AAPL and BABA, et al. It’s hard to stay on top.

Sarah Friar leaving was a huge blow in the eyes of the Street. Stuff like that gets you a lower valuation whether you agree with it or not. Just like GOOG got a higher valuation when they hired Ruth Porat as CFO.

Sold my Square last week, may look to re-enter at lower prices.

best,

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