Thoughts on SQ

I think there is some angst on SQ perceived slowing revenue growth. If you look at the companies overall combined revenue for the past 2 years you see the following:

40%
44%
47%
50%
60%
68%
64%
59%

The growth rate dropped the past 2 quarters.

But if you dig deeper, this is not so alarming. SQ has several sources of revenue, the most relevant being subscription based (high growth, recurring, and high margin) and transaction based (slower growing, low margin and non-recurring). As an investor, I like the recurring, fast growing, high margin kind better). SQ breaks out the revenue numbers and here is the subscription revenue growth for the past 2 years:


Y/Y     1 yr growth  % subscription (of total)
 99.3%	103.2%       24.7%
 84.4%	 92.4%       25.3%
 96.0%	 95.5%       28.1%
 97.8%	 94.6%       31.6%
126.9%	104.2%       34.9%
155.3%	123.0%       38.6%
144.5%	134.1%       41.8%
125.4%	137.2%       44.8%

The growth rate of SQ’s subscription business is blazing fast, faster than any of the growth rates of any of my other investments. Now SQ acquired 2 companies which adds to the growth: the organic growth of their subscription revenue was still 97% (note it was 95% in Q1 last year so the growth rate did not slow).

Going forward, Weebly and Zesty are now part of SQ so growth from these acquisitions is relevant and should be considered going forward. Take a look at the 3rd column above: the percentage of SQ’s revenue from subscriptions is steadily rising, increase from 25% to 45% in the last 8 quarters. This percentage will continue to rise and will probably hit 60-70% in 2 years. The bottom line is that the high growth, high margin, recurring revenue is becoming a larger and larger share of SQ’s business and it is becoming more and more relevant to SQ’s financials.

For the above reasons, the overall revenue growth decline is not concerning to me and not a reason to sell out of SQ.

Chris

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It’s a little confusing that Square is taking a beating today while Alteryx is up 10% on lower growth rates. Could be because of size, but you would think that comparatively, square is a more valuable company than Shopify since it operates in the same space but has a lead in merchant/payment adoptions.

Just been bizarre the treatment SQ has gotten in the past 6 months. Maybe market is missing the subscription revenue story as you say, but I don’t understand why it’s been such a dog

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It’s a little confusing that Square is taking a beating today while Alteryx is up 10% on lower growth rates. Could be because of size, but you would think that comparatively, square is a more valuable company than Shopify since it operates in the same space but has a lead in merchant/payment adoptions.

Just been bizarre the treatment SQ has gotten in the past 6 months. Maybe market is missing the subscription revenue story as you say, but I don’t understand why it’s been such a dog.

It’s not cheap and it’s larger than some of these other fast growers.

That being said, it’s competitive position is quite strong and it looks to have a long runway for growth longer term. It’s a long term play for me, a medium position just outside my top ten. I can easily see this being a several hundred billion dollar company within 10 years. I’m willing to patiently hold this one. It’s like ANET for me - should continue to have solid growth for years but may require a little patience at times.

In the meantime, I’m more than happy with my top positions of AYX, SHOP and TTD.

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It sure looks relatively cheap to me

Let’s just compare to AYX (which itself was relatively cheap until this morning’s move) and SHOP

AYX: 24 P/S (from yahoo)
SHOP: 27 P/S (from yahoo)
SQ (adjusted revenue): 16 P/S (28.7b market cap and 1.77b adjusted revenue)

Forward looking based on guidance:
AYX: 16.7 (6b and 360m)
SHOP: 19 (28.6b and 1.5b)
SQ: 12.8 (28.7b and 2.25b)

You could argue Alteryx should be more highly valued because it’s growing from a smaller base, and I’d agree, but SQ is the one with the higher growth rate. As far as Shopify, it’s valued the same as SQ while having lower current revenue and lower growth rates. Even if you are basing forward growth rates on guidance, SQ is 42% for 2018-2019 and SHOP is 40%

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When I first started reading about SQ I understood them mainly as a payment processing system, but it seems like they are adapting to be much more than that. Payroll and Invoice are interesting to me, once a small business integrates Square they can almost shift ALL aspects of doing business to their platform (payroll, payroll taxes, sending invoices, setting up recurring payments, pseudo-bank account with the cash card, etc)

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It sure looks relatively cheap to me

Let’s just compare to AYX (which itself was relatively cheap until this morning’s move) and SHOP

AYX: 24 P/S (from yahoo)
SHOP: 27 P/S (from yahoo)
SQ (adjusted revenue): 16 P/S (28.7b market cap and 1.77b adjusted revenue)

Forward looking based on guidance:
AYX: 16.7 (6b and 360m)
SHOP: 19 (28.6b and 1.5b)
SQ: 12.8 (28.7b and 2.25b)

You could argue Alteryx should be more highly valued because it’s growing from a smaller base, and I’d agree, but SQ is the one with the higher growth rate. As far as Shopify, it’s valued the same as SQ while having lower current revenue and lower growth rates. Even if you are basing forward growth rates on guidance, SQ is 42% for 2018-2019 and SHOP is 40%.

Good points.

Recent movements in these stocks have moved SHOP up to a similar market cap, moved AYX and SHOP up in P/S and made SQ look relatively cheap now.

AYX, even after it’s recent meteoric rise, is still only 1/5 the size so you could argue it’s still relatively cheap. The SHOP and SQ comparison is a little more difficult to understand. SHOP has doubled in only 4 months so it’s gone from relatively cheap to more expensive in quick fashion. Given short term irrationality and momentum trading, I doubt there’s any long term significance. It just means SQ is probably a good buy here.

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Was in a sushi place other day and Square reader read my credit card and emailed receipt in stunning time. Literally a few seconds. And the merchant raved about company. I can’t see how they lose this one merchant, ever. Anecdotal, yeah, but likely true for many. And TAM of “war on cash” obviously gigantic.

That said, fair or not, meaningful to long term or not, the CEO is not out there banging the drum for the stock. He’s managing a much higher profile company that is constantly dealing with real crises around the world. This leaves a void that has to be a 5-10% haircut on short-term price. No way to quantify it but if Dorsey left Twitter and went full-time Square stock would rise, big time.

I love the company, but no way am I riding with a leader who is not working for my money full-time. He’s incredible to get both this far but still can’t get my head around that. Watch Stoeker, McKinnon, Ittycheria, Lawson - warriors for their companies. Only other CEO I can think of who runs multiple high-profile companies is Musk.

BD

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My analysis and thoughts exactly, Chris! I have a 6% position in SQ and will hold firm on it. They are a phenomenal company, with very solid management, and making excellent strategic moves to stay relevant and accelerate that growth in the very subscription revenue growth I want to see. With $29B market cap, They are the largest company I own, but I could still easily see them 3x to 5x larger And I’m very encouraged by this acceleration in subscription revenue growth.

Thank you for your post, Chris!

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AYX: 24 P/S (from yahoo)
SHOP: 27 P/S (from yahoo)
SQ (adjusted revenue): 16 P/S (28.7b market cap and 1.77b adjusted revenue)

Forward looking based on guidance:
AYX: 16.7 (6b and 360m)
SHOP: 19 (28.6b and 1.5b)
SQ: 12.8 (28.7b and 2.25b)

SQ should have a lower P/S than AYX because more than 50% of SQ’s revenue is low margin. Also, SQ’s high margin revenue has about 70% GM while AYX’s had >90% GM.

Chris

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Square continues to get more interesting as the price and valuation fall. At the same time, that makes it more concerning as well. What is the market seeing that we aren’t? It is a curious case. I felt similarly about Nutanix and that didn’t work out so well (to date).

Many of our stocks are doing quite well, but Square curiously lags. Does anyone have thoughts on this?

I’ve followed the company closely enough to understand the business to a certain degree. I’ll admit that credit risk is something I’ve tried to avoid completely and don’t understand Square potential credit risk during an economic collapse.

One thing I think the market perceives negatively is Square’s reliance on small businesses.

Any thoughts and insight are appreciated.

A.J.

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Square continues to get more interesting as the price and valuation fall. At the same time, that makes it more concerning as well. What is the market seeing that we aren’t? It is a curious case. I felt similarly about Nutanix and that didn’t work out so well (to date).

Three negatives which may be weighing on the stock include a slight lowering of guidance, a loss due to the Eventbrite investment and increasing competition in its space including SHOP.

dave

One big negative is lack of international opportunity. SQ is not easy to move beyond US compared to AYX, TTD or even SHOP. If US is moving into recession like late 2020/2021, it has highest risk. SHOP is exciting in that they is preparing to move in China, second biggest economy and very dynamic in e-commerce.

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"That said, fair or not, meaningful to long term or not, the CEO is not out there banging the drum for the stock. He’s managing a much higher profile company that is constantly dealing with real crises around the world. This leaves a void that has to be a 5-10% haircut on short-term price. No way to quantify it but if Dorsey left Twitter and went full-time Square stock would rise, big time.

I love the company, but no way am I riding with a leader who is not working for my money full-time. He’s incredible to get both this far but still can’t get my head around that. Watch Stoeker, McKinnon, Ittycheria, Lawson - warriors for their companies. Only other CEO I can think of who runs multiple high-profile companies is Musk. "

I have a contrarian view in that I have zero concern that Dorsey run both Twitter and Square. This is a relatively small responsibility if you compare it to any conglomerate in the world. Let’s use Buffett as an example - I’ve lost track of how many operating companies Berkshire Hathaway has but eyeballing it is over 60 from large entities like Geico to small ones like Dairy Queen. He’s got great managers in place and they run well. I know the next argument is they are much slower growth, which is true, but even a high growth company like Alphabet or Facebook is comprised of many unique business subsidiaries.

I think the key decision is do you trust Dorsey to hire A+ talent to run Square and do you trust the current leadership he’s put in place?

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SQ should have a lower P/S than AYX because more than 50% of SQ’s revenue is low margin. Also, SQ’s high margin revenue has about 70% GM while AYX’s had >90% GM.

Chris, while that is true, SQ also has a much larger addressable market than AYX. SQ is deeply embedded in commerce as a whole, AYX is a niche enterprise service that most SMB has no need for. Of course no one can be sure what exactly the TAM is for each, if it’s $3 trillion for SQ and they can take 10% of the market (would take them a long time to get there) and $10 billion for AYX, you’d probably take SQ even if margin is lower.

You can also take this point and compare AYX and TWLO, why is TWLO valued so much higher than AYX on a P/S basis with its GM so low on a comparative basis?

Just trying to figure out why SQ is so cheap, that’s all

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Chris, while that is true, SQ also has a much larger addressable market than AYX. SQ is deeply embedded in commerce as a whole, AYX is a niche enterprise service that most SMB has no need for. Of course no one can be sure what exactly the TAM is for each, if it’s $3 trillion for SQ and they can take 10% of the market (would take them a long time to get there) and $10 billion for AYX, you’d probably take SQ even if margin is lower.

You can also take this point and compare AYX and TWLO, why is TWLO valued so much higher than AYX on a P/S basis with its GM so low on a comparative basis?

Just trying to figure out why SQ is so cheap, that’s all

My main point was don’t place much weigh on P/S to compare across companies. This ratio usually shouldn’t be used to make comparisons on valuation.

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From Seeking Alpha:

BTIG analyst Mark Palmer reiterates his sell recommendation on Square (NYSE:SQ), and with its shares down 9.4% other investors apparently agree.

He points to the fintech’s challenges in growing its total addressable market. Its initial market of micromerchants is limited, so as it seeks to increase its customer base by appealing to larger sellers Square faces more competition, Palmer writes.

That’s shown up in Square’s Q1 gross payment volume, which fell short of Palmer’s estimate, and weaker-than-expected Q2 adjusted EPS guidance.

“We believe SQ’s GPV deceleration and its unusual quarterly guidance miss may indicate that competition among larger merchants may be becoming more of a headwind for the company,” he writes.

Points to competition from First Data, PayPal and Shopify, as well as big banks.

I think this analyst has the reason SQ hasn’t been performing. The market doesn’t think SQ can move up market, and if it can’t, growth is going to slow soon because it’s going to run out of small merchants.

On the flip side, if it can, the stock will take off again when the market realizes it.

Jim (long SQ)

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The market doesn’t think SQ can move up market, and if it can’t, growth is going to slow soon because it’s going to run out of small merchants.

Nailed it.

However, interesting that the last two quarters have seen the highest growth ever on the $ amounts of loans issued by SQ. Not sure where the red flag is that they’ve suddenly gotten close to saturation, but here’s a yellow flag: organic subscription revenue growth.

Q1 2018: 98%
Q2 2018: 127%
Q3 2018: 117%
Q4 2018: 112%
(109% for 2018 altogether)

Q1 2019: 97%

The trend is steadily down after spiking in Q2 of last year…and apparently the market sees it continuing to head down fast. And apparently SQ thinks so too, otherwise overall revenue growth wouldn’t be slowing so much:

Guidance for Q1: 57% (actual as you said was 59%)
Guidance for Q2: 44%

Bear

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Again, I understand P/S is really only one component of how a market determines how much a company is worth, but when the argument for poor stock performance is that SQ growth is expected to slow because of guidance, that’s when it misses the mark for me

AYX guiding for 44% growth in 2019, SQ guiding for 42% growth in 2019, SHOP guiding for 40%, two are currently very in favor, SQ is not. It’s not just about current size either since SQ and SHOP are same mkt cap (and SQ has 50% more current revenue already AND is growing faster/guiding higher than SHOP)

When Bear points to guidance, well damn, all of our companies sandbag guidance, so what’s the difference? Just seems like it’s more so momentum than actual operating results. SMB total addressable credit/debit card volume was estimated at 3 trillion a couple of years ago, Square is doing about $100B annually, so less than 4% penetration? SQ is being punished for slowing revenue growth but SHOP isn’t. Problem is, what will be the catalyst that turns perception? Can’t think of much other than a surprise re-acceleration of adjusted revenue, don’t know that will come in the next few quarters (sub revenue has to continue to grow into a more and more meaningful % of adj rev)

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Everything is about probability.

If we look into the future, lets say 3 years.

The market is telling us it thinks it’s more likely for SHOP to be doing way better than SQ, based on SHOP having a higher valuation.

My Guess: the market (all investors as a whole) thinks SHOP, with Shopify plus, has a much better chance of continuing to move up market, than SQ does, thus has more growth potential,has more of a competitive advantage with larger customers, and that SQ is going to have a tough time when it runs out of small merchants.

And with each company just having earnings, the move has been more pronounced.

The opportunity we have as investors, is do we think the market is wrong?

Jim

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good point Gaucho
Ayn Rand was famous for saying that when things don’t add up ,examine your premises. Do we absolutely know that P/S is valid for comparing companies? P/E in’t enough, it has a long history of use but little evidence that one can out-do the market using it.
IMHO measurements that are available to all and that do not require original thinking to interpret are probably priced in.

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