Square's Potential Remains, I'm Not Accumulating Yet

James Chapter 1 verse 19 states, "My dear brothers and sisters, take note of this: Everyone should be quick to listen, slow to speak and slow to become angry."

I'll be straight forward here, I struggle with patience and often find myself becoming angry much quicker than I would like to admit. The good thing is, I am able to catch myself nearly every time, a and for the most part, fairly quickly. God's word is powerful, especially when it comes to reading it, and considering my actions. I quickly become aware of my faults and shortcomings, and therefore, need for God's wisdom and will in my life.

For investing, there is nothing like assessing my portfolio and reviewing the day's news/updates to get the blood pumping. I've made some mistakes this year with the portfolio, but I've also made many important decisions that offer strong mid- and long-term opportunity for robust performance and investment returns. Markets are riddled with angles being played for short/long positions and it's often hard to make black and white decisions in the short-term as opposite effects tend to occur. Over the long-term is where things will inevitably pay off.

With Square, Inc. (SQ), I've held since building the position last year. A couple recent pieces of information this week for Square to digest. A couple days ago, Bloomberg reported that Square code is pointing towards plans for checking and savings accounts, a direct pivot to competing against banks. This is important and a very correct move in my opinion as it is far more lucrative versus building a Cryptocurrency platform a la Bitcoin.

I continue to believe that fringe players like Square looking to compete against Coinbase Global (COIN) will more than likely end up partnering/appending with Cryptocurrency products and services from larger platforms over time. It's great for Coinbase to be at the forefront for something that everyone thinks they can replicate, especially as a key barrier to entry is scale and serious negative impacts to margins for a duration of years. Square may be willing to commit the resources to grow this further, or maybe not, but many other peers like PayPal Holdings (PYPL), Visa, Inc. (V), Mastercard Incorporated (MA), and the plethora of banks and credit card companies will be challenged to scale as legacy peers will not easily identify, provide autonomy, and/or sufficient capital support for the workforce resources required to successfully create such Cryptocurrency platform. It always sounds nice, but rarely do legacy players evolve or pivot quickly enough for the simple reason that they do not live and breath one business segment and focus.

The other piece of news is from Baird, which is neutral on Square's Stock Price, SP valuation form today's level. The key focal point is Square's comps getting tougher moving forward, and Bitcoin accounting. Some investors may recall that Square was notified by the SEC to no longer utilize its Adjusted Revenue metric from a few years back. The irony now is that with Bitcoin Gross Volume increasing as the single largest Revenue stream, there is a real need to revisit the Adjusted Revenue metric to properly account for Net Revenue Transaction Revenue as Coinbase does.

I've already taken the liberty to develop my own Adjusted Revenue metric and on a Last Twelve-Month, LTM basis, Square generated $5.6 billion after Q1 2021 versus $5 billion for all of 2020, while Gross Margin, GM, improved to 57% from 54.5% as of 2020, and Operating/Free Cash Flow, OCF/FCF, margins declined to 3%/9% respectively from 6%/11% in 2020.

For FCF Margin, investors need to recognize that Square now accounts for PPP Liquidity Facilities as working capital in the financing section, as well as the normal activities of proceeds from stock options and concurrent payments for tax withholdings to vesting restricted stock units. The PPP is not a long-term expectation, and as such, it's prudent to not include it for a further Adjusted FCF Excluding PPP Margin. Especially as there are provisions for these loans to be forgiven if requirements are met. Taking all of this into account, Square's peak OCF Margin at 10% in 2019 has declined to 3% on a LTM basis from Q1 2021 results, while Adjusted FCF Excluding PPP Margin peaked at 10% in 2017 and has declined to (4%) for the same LTM period. All of these downward trends are a direct result of Bitcoin impacts on margin compression.

Back to the initial point on Bloomberg's identification of banking services, and this makes much more sense. We've seen Square enter the food delivery service via Caviar which was then sold to DoorDash, Inc. (DASH), we've also seen Square purchase a streaming service in Tidal. Square is still an interesting company for mid- and long-term potential, but I have not been aggressively adding to my position, as I've questioned some of their decisions that have tended to get off track, and/or put capital and growth resources at risk. Sarah Friar's departure to Next Door has obviously been a big blow to the company. There's enough still in place for Cash App and Seller to not sell the position, it helps that my average unit cost is $111, but I'll continue to scrutinize the company's progress and decisions.

For the time being, I have been adding to Coinbase, SoFi, via common shares with the original warrants purchased at $1.97, and Affirm Holdings (AFRM), as they all are either first-movers and/or likely to see strong growth runways targeting banking and credit card companies. I also will be considering initiating with Marqeta, Inc. (MQ) who is competing against Fiserv, Inc. (FISV), Fidelity National Information Services (FIS), among other legacy payment providers, and also boasting a 20% OCF Margin to boot.

I hold Pershing Square Tontine Holdings (PSTH) warrants and am patiently waiting to see if indeed Mr. Ackman can land Stripe or not. Other than that, there are a few unicorns like Chime, Ripple, and Robinhood still on the IPO deck. For me, Fintech is all about companies that can find the right niche to target legacy financial companies, notably banks and credit card companies that will not, no matter what they say, be able to shift gears to impede losing market share.

14 views0 comments