Getting right into it, I’ve been keeping one eye on Square from a distance. It’s one of the few stocks I used to own and always felt like it should be performing better, and honestly the lack of stock performance is really the only reason I sold (back in late 2019). I did take Square on a date earlier this year when it dropped to ~$35 but I broke up with it after it doubled, as I thought the relationship was about to go south. Clearly I was wrong on that one!!
In all seriousness though, my immediate impulse on Square during a pandemic with mandatory lockdowns was that their seller ecosystem would be severely hurt and that would have a substantial impact on Square’s performance. I bought it at ~$35 because I thought that was just insanely low and just part of the selling tantrum at the time. I never planned on holding it very long because of what I mentioned above.
Now the stock is at $241, doubling and then doubling again since I sold it. You can’t win them all! But, I’ve cleared the fog from my lenses and took a fresh 2021 look at Square in a quest to better understand the great performance. Performance isn’t the only reason I’m looking - I’ve been thinking about how Square’s Seller business should recover in 2021 as a “re-opening” trade of sorts, and I also wanted to learn more about how Square is leveraging Bitcoin given the feeding frenzy around crypto right now. In short, the time seemed right for a deeper dive to see if there’s Saul Investing Discussion worthy growth going on under the covers.
So, here we go….
From what I can tell, Square started breaking out their Seller Ecosystem revenue from the Cash App ecosystem in Q2 2019 (I wasn’t able to find Q419 and Q120 for some reason). Square’s PR and Marketing teams do a pretty clever job of breaking out the numbers in their press release to make things look AMAZING, but of course some of that is just a facade and you have to peel the onion back to know what’s really going on.
First, you have to just ignore the big numbers you’re used to looking at or that Square wants you to look at, things like Total Revenue and Gross Profit in particular. The fact that they had 140% YoY and 62% QoQ revenue growth in Q3 is not what it looks like. The biggest reason for that is Bitcoin. Bitcoin accounted for 1.6 of Square’s 3.1 billion in revenue in Q3, that’s 52% of total revenue, but Bitcoin is a zero-margin business for Square and has been for the past 3 years. But, if part of Square’s strategy is to use bitcoin as a vehicle to drive more traffic to CashApp, then it makes perfect sense why this works.
So what data points can we find that give a truer measure of the growth and where the business is going? Focusing in on CashApp first, lets check out the revenue and expenses. On the surface, you see what appears to be decelerating Gross Margins for CashApp, with the most recent quarter being a paltry 19%. However, you’ll see that’s primarily due to the explosion of bitcoin revenue at zero-margin, where the cost of revenue of bitcoin alone was 95% of total CashApp revenue this past quarter, pushing that Gross Margin down. However, if you take bitcoin out of the picture, the numbers get very, very interesting. CashApp’s transaction/subscription Gross Margins rose to 81%!!, and that specific revenue as a percent of total revenue jumped to 33% and 32% respectively from 13% and 14% respectively the previous year!
Q219 Q319 Q419 Q120 Q220 Q320
Cash App (Revenue)
(+)Transaction-based $16,966 $19,216 $53,657 $80,721
(+)Subscription/Services $118,442 $139,539 $271,156 $354,110
(+)Bitcoin $125,085 $148,285 $875,456 $1,633,764
Cash App (Expenses)
(-)Total Cost of Revenue $155,152 $183,550 $919,206 $1,683,471
(-)Bitcoin $122,938 $146,167 $174,438 $299,426 $858,041 $1,601,615
% attributed to Bitcoin costs 79% 80% 93% 95%
*Cash App Gross Margin (Total) 40% 40% 23% 19%
__*Cash App Gross Margin (Transaction/Subscription) 76% 76% 81% 81%__
**Cash App as % of Total Revenue (excluding Bitcoin) 13% 14% 33% 32%**
And that’s not just the pandemic pushing their Seller business down. Look at the CashApp-specific growth numbers. The numbers are exploding across the board, with Transaction-based at 320%!! YoY And Subscription/Services at 153!! YoY. That’s the high margin stuff!
Q319 Q419 Q120 Q220 **Q320**
Rev Growth (Cash App)
*(Transaction-based) (YoY) 216.26% **320.07%**
*(Transaction-based) (QoQ) 13.26% 50.44%
*(Subscription/Services) (YoY) 128.94% **153.77%**
*(Subscription/Services) (QoQ) 17.81% 30.59%
*(Bitcoin)(YoY) 599.89% 1001.77%
*(Bitcoin)(QoQ) 18.55% 86.62%
So, can we just “take bitcoin out” when we look at these numbers? I think it’s absolutely reasonable to do so. Here’s what Square says about bitcoin in their quarterly release ”Our role is to facilitate customers’ access to bitcoin. When customers buy bitcoin through Cash App, we only apply a small margin to the market cost of bitcoin, which tends to be volatile and outside our control….Bitcoin costs are the total amount of bitcoin that we purchase. We purchase bitcoin to facilitate customers’ access to bitcoin.” What real operating costs then are associated with their providing bitcoin to their customers? Probably zero or close to it. As one point of reference, I took a look at their total operating costs.
Even with bitcoin pushing down the operating margin, it’s almost negligible! R&D, S&M, and G&A have all taken sizable drops as a percent of total revenue in the past 6 quarters!
Q219 Q319 Q419 Q120 Q220 Q320
Total CoR (Transaction-based) $490,349 $519,312 $519,241 $465,779 $388,106 $522,680
Total CoR (Subscription/Services) $60,119 $63,352 $50,276 $40,711 $50,169 $66,786
Total CoR (Hardware) $33,268 $35,672 $40,504 $34,372 $28,315 $45,220
Total CoR (Bitcoin) $122,938 $146,167 $174,438 $299,426 $858,041 $1,601,615
**R&D (% of Total Revenue) 15% 13% 13% 14% 11% 7%**
**S&M (% of Total Revenue) 13% 12% 14% 14% 13% 11%**
**G&A (% of Total Revenue) 9% 9% 9% 9% 7% 5%**
Operating Margin 3% 5% 4% 2% -2% 2%
As far as CashApp vs. Venmo from a competitive standpoint, maybe someone else can share the hard numbers, but “soft” data last month from Ark Invest’s director of research Brett Winton shows, in terms of “search volume”, CashApp’s increasing penetration relative to Venmo. It’s a really cool looking visual of CashApp vs. Venmo overlaid on a map of the US and time lapsed from 2016 through 2020 - https://twitter.com/i/status/1341083874042892288. Winton calls this a “crude proxy for gross customer additions”, so take that for what you will.
So what about the “recovery” in 2021 in the Seller Ecosystem business? I think it’s already started to show signs. QoQ growth from Q2 to Q3 was 34%, 24%, and 41% for their Seller based transaction, subscription, and hardware sales respectively I’m imagining that may be a bumping ride but as things reopen, even if it’s a bit later in 2021, those numbers should continue to rise.
Q219 Q319 Q419 Q120 Q220 Q320
Seller Ecosystem (Revenue)
(+)Transaction-based $758,544 $797,406 $628,915 $844,573
(+)Subscription/Services $89,552 $99,315 $75,119 $93,412
(+)Hardware $22,260 $21,766 $19,322 $27,294
Seller Ecosystem (Expenses)
(-)Total Cost of Revenue $523,148 $554,603 $407,656 $555,948
*Seller Ecosystem Gross Margin (Total) 40% 40% 44% 42%
Q219 Q319 Q419 Q120 Q220 **Q320**
Rev Growth (Seller Ecosystem)
*(Transaction-based) (YoY) -17.09% 5.92%
*(Transaction-based) (QoQ) 5.12% **34.29%**
*(Subscription/Services) (YoY) -16.12% -5.94%
*(Subscription/Services) (QoQ) 10.90% **24.35%**
*(Hardware)(YoY) -13.20% 25.40%
*(Hardware)(QoQ) -2.22% **41.26%**
In summary, if you look at the growth in CashApp and the meaningful Gross Margins, the likely recovery of their Seller business in 2021, and bitcoin as simply low-cost, zero-margin way to drive additional traffic to CashApp, especially in the current crypto-crazed climate, then I think this is a pretty rosy picture for Square at least through 2021. Even on valuation, it’s trading at somewhere between 14x EV/S TTM and 25x EV/S TTM if you take bitcoin revenue out of there - right now that stacks up pretty good against our other stocks. They also had a big spike in EBITDA this quarter which I didn’t have time to get into. All in all, I was pretty impressed when I looked at it through this lens and decided to take a ~3% position in Square today.
Just a reminder - if you want to research posts on this board (Square related or otherwise), this search tool is really worth your time once you learn how to use it. https://discussion.fool.com/great-news-we-have-a-search-engine-3…. So much great stuff from the board contributors over time…
-Chris