Psalm Chapter 139 verses 13-14 state, "For you created my inmost being; you knit me together in my mother's womb. I praise you because I am fearfully and wonderfully made; your works are wonderful, I know that full well."
David wrote many Psalms in the Bible and as some may know, David had a tumultuous life. While he was the greatest king during his time, he clearly made terrible mistakes and decisions. His Psalms are important for a Christian to read and hear as they reflect his understanding of God's love and grace.
Investing is never perfect, just as life is not. It includes success and mistakes. I've been investing since 1998 in my late teens and have been fortunate to pick winners well, but have also made plenty of mistakes along the way. I've been building my databases and financial models for nearly 15 years now and the information I try to provide for retail investors is the culmination of this work (that never ends it seems). I like the words above "fearfully and wonderfully made". I always look to determine the best investment option as I'm a risk-taker, but I concurrently always diligently monitor the angles afterward as I am fearfully looking to be humble and prepared to manage those decisions.
The Fintech transition has been very bumpy to say the least. We've got a spectrum of players from the likes of the dinosaurs like JPMorgan Chase & Co. (JPM); the credit card network infrastructure innovators like Mastercard Incorporated (MA) and Visa, Inc. (V); the digital payment innovators like PayPal Holdings, Inc. (PYPL); and the business-focused payment innovators more recently like Block, Inc. (SQ).
SQ's space is getting more competitive by the day with companies like Fidelity National Information Services, Inc. (FIS), Fiserv, Inc. (FISV), GoDaddy, Inc. (GDDY), Shopify, Inc. (SHOP), Squarespace, Inc. (SQSP), Wix Ltd. (WIX), among many others looking to provide similar hardware/software services. There's always been the threat of Big Tech as well with Alphabet, Inc. (GOOG), Amazon, Inc. (AMZN), Apple, Inc. (AAPL), Meta Platforms, Inc. (FB) etc. And even companies with more niche areas like DoorDash, Inc. (DASH) and Instacart, Inc. (Private) are threats for hybrid delivery/payment services. Nearly everyone who is looking to innovation is focused on payment services, that has created a Fintech-stack.
The newest comers to the Fintech market include companies focused on Crypto Currencies like Bakkt Holdings, Inc. (BKKT), Coinbase Global, Inc. (COIN), FTX, Inc. (Private), OpenSea, Inc. (Private), etc.; companies looking to create uniform financial services and/or provide payment service products within the Fintech-stack to consumers, merchants, smaller financial institutions including Affirm Holdings, Inc. (AFRM), Marqeta, Inc. (MQ), Paysafe Limited (PSFE), SoFi Technologies, Inc. (SOFI), Stripe, Inc. (Private), among others.
I have determined the top options from this spectrum to be AFRM And COIN. The question I'm looking to review today is where does SQ fit within the Fintech future.
Before diving into my thoughts on SQ's future, it is crucial to note that SQ's fundamental assessment is complicated. In order to examine SQ's prospects, it is first necessary to deconstruct their corresponding Revenues and drivers. This is notable for the Cash App Revenue segment as most are very familiar with the Square Revenue segment, and Cash App's reported information needs adjustments to be more comparable across peers and to make things more clear for investors.
There are two key aspects for SQ's Cash App Revenue and they both relate to Bitcoin Revenue. First, Bitcoin Revenue includes the total transaction value of each Bitcoin purchase. From a Revenue perspective this is not apples-to-apples with how a company like COIN reports Net Transaction Revenue. As of the LTM for SQ, the company generated $8.2 billion in Bitcoin Revenue, which is better stated as Transaction Volume.
As a comparison, COIN for the LTM as of Q1 2022 generated $395 billion in Bitcoin Trading Volume, while SQ as mentioned, generated just over $8 billion, or around 2% of this. SQ's proportion of COIN's Bitcoin Trading Volume has been on a decline since the peak in 2020. PYPL has been even less successful in its Crypto endeavors and doesn't even report out any information for investors to consider as a result. This point is justification for questioning non Crypto-pureplay abilities to scale independent of relying more on platforms like that of COIN.
This brings us to the second point, using a true Adjusted Revenue metric to measure SQ's performance. As seen above, I've updated SQ's Cash App Revenue to adjust for the true Net Transaction Revenue for Bitcoin by subtracting the Bitcoin Cost of Revenue. This better illustrates Cash App's core dominant performer, Subscription & Services-Based Revenue which benefits from both peer-to-peer money transfers and Square sellers.
Putting it all together and we have a more clear representation of SQ's Revenue performance and a better understanding of how the Cash App Revenue segment should be accounted for to both provide a comparable against other peers like COIN or BKKT, while also creating a truer form of Revenue for investors. A great illustration from this approach is the highlight of how the 2020 pandemic year did not lead to substantial performance, while re-acceleration has occurred more recently in 2021 and thereafter.
This is also valuable, as analysts are modeling SQ's Revenue over the coming years, and it's not transparent as it includes SQ's Bitcoin Trading Volume, versus Net Transaction Revenue. I continue to model both for the time being to track both sides of how analysts are valuing SQ via EV/Sales, versus my valuation - again, more comparable against all other peers. This will be important as more Crypto-based and other Fintech companies go public over time.
Based on this, it is very important to consider valuation metrics for SQ based on an adjusted basis. For me, I view SQ's current EV/Sales at just below 6 times, and Adjusted FCF/Share multiple at 55 times. This is important to consider against peers as AFRM is trading 4 times EV/Sales (even with a nearly 60% move in two days), with FCF/Share currently N/A, and COIN is trading 1.5 times EV/Sales and 6 times Adjusted FCF/Share. Another point to highlight is SQ's Adjusted OCF Margin being higher based on Adjusted Revenue.
Framing how SQ's business model should be interpreted financially now affords the advantage of doing a better relative/peer review to determine optimal investment choices, while being able to monitor decisions and actions over time.
Why it Matters
The most important point on my mind right now as we transition through the past two years is where opportunities will go from these turbulent times. SQ's slowing performance during 2020, versus re-acceleration in 2021 is a prime example of this. Many Big Tech peers witnessed a similar occurrence, but are now poised to see waning growth prospects and corresponding potential investment returns.
For Fintech, it's tougher, similar to the Technology-stack as more and more companies find a niche, but not all niches will lead to substantial mid- and/or long-term performance, critical to appreciate investor returns.
As has been the precedent for SQ, I believe that the company will continue to be driven by its Square and non-Bitcoin Cash App segment services. A company like SQ doesn't have the Cash Flow Margin to out-compete a company like COIN, that is more focused and does have a much stronger Cash Flow position.
The competitive landscape continues to get more competitive and SHOP is a major threat to SQ in my opinion as it leverages its GMV merchant relationships and translates them into GPV ShopPay services. SHOP's recent bolt-on acquisition of Deliverr is another great move to increase merchant services, while staying in the wheelhouse.
SQ's recent acquisition of AfterPay and moves into Crypto are red flags in my eyes, as they create more risk and have no gaurantee to add the ROI to further catalyze SQ's investment potential - on the contrary, both can become deadweights. Based on SQ's current risk/reward profile, I don't see a lot of upside for valuation multiple expansion from today's level, while companies like AFRM and COIN have seen a much further compression of their valuations offering greater investor upside potential.