Block - More Than Just Payments?
Payment processing is one of those fields that used to be viewed as a "holy grail" for Silicon Valley. The stodgy old card readers that charged mega fees just didn't cut it anymore, so a few companies set out to change the game in the point-of-sale world. Now, the industry is flooded. We have the smaller players, like SumUp and Vend, as well as the big boys like PayPal, Stripe, Shopify and, of course, Square. But given the recent name change from Square to Block, it's worth digging into the payment processor-cum-all around tech giant to figure out why. Today, I'll dive into what Block actually does, why they're successful, and if the name change has anything to do with the direction they're headed in the next few years. This is a deep dive into Block.
Top-Line Numbers
FY 2020 Revenue: $9.5 billion (+101% YoY)
FY 2020 Net Income: $213.11 million (-43.24% YoY)
Q3 2021 Revenue: $3.84 billion (+26.73% YoY)
Q3 2021 Net Income: $84,000 (-99.77% YoY)
Market Capitalization: $77.45 billion
What Is The Business?
As I mentioned in the open, Block is a payments and point-of-sale provider, and they're kind of the new age OG at it. For a time, you could barely visit any small business without seeing the familiar white payments terminal or even the small block that plugged into the 3.5mm headphone port on smartphones. Block really changed the game in the payment provider space, but since then, they've expanded to quite a bit more than that.
Square Seller
The oldest revenue stream for the company is their payments platform, consisting of both the digital platform processor and the physical POS systems, which they call their "Seller" segment. The POS systems are pretty straightforward, consisting of the little block reader for smartphones and tablets, as well as newer technology like the Square Stand that is a much fancier, albeit less portable, version.
The digital Seller platform is much different. It's essentially an all-in-one merchant solution platform that can be standalone, or integrate into a variety of products to make the merchant's financial life easier.
The integration ecosystem makes the Seller platform extremely easy to use, therefore ubiquitous. That's how Block was able to grab such a strong foothold in they payments space: they flooded the zone. This strategy is now being adopted by Shopify for their own payments suite, which you can read more about in my piece on that company here.
The Seller segment may be the oldest part of the business, but it's still got plenty of life. This segment accounted for 55% of Block's full year 2020 gross profit, and approximately 37% of their revenue. So where does the rest of their piles of cash come from?
Cash App
That's right, the Cash App. Block debuted this one way back in 2013 when it was named "Square Cash," and I think we all agree they did the right thing changing the name pretty quickly. Cash App is a peer-to-peer payment system designed essentially to compete with Venmo, though it did gain some competitors in Apple and Google along the way.
Cash App has also been adding new features as it evolves. It's no longer just a place to pay your drug dealer under the table. Now it has stocks, ETF's and cryptocurrency trading where you can buy assets like Bitcoin and Ethereum.
Though Cash App's core peer-to-peer functionality is free to use, they do charge a fee if you want to expedite transferring funds in your Cash App to your bank account (standard transfers are also free), or if you pay for personal items with their Cash Card. Block has also come under a bit of fire for how they process their cryptocurrency transactions, with their exchange frequently coming in as the most expensive place to purchase Bitcoin due to the spread that they take on the asset. For example, if User A sells their Bitcoin on the Cash App for $4,900, then Block turns around and sells it to someone else at a markup and takes a fee on each part of transaction, thereby driving two types of revenue in the exchange. That might explain why Cash App made up 63% of Block's revenue for full year 2020, as well as a little less than half of their gross profit.
Tidal
This one goes down as the most blisteringly bewildering acquisition I can think of for some time. In March of 2021, Jack Dorsey announced on Twitter (more on him later) that Block was buying Jay-Z's music platform, Tidal, for $297 million, as well as giving Jay-Z a seat on the Board of Directors.
Tidal is a pretty unique business in that it gives artists new ways to create revenue with their work, and it likely gave eagle-eyed analysts a view of things to come from the company, namely in the crypto and NFT space. This brings us to...
Bitcoin Balance Sheet Antics
Block has joined an increasingly growing line of companies that now include Bitcoin as part of their corporate balance sheet. In October of 2020, they purchased $50 million worth of Bitcoin, then loaded up with a further $170 million in February of 2021, with an average purchase price of right around $51,000 per token. This means that, at time of writing in December 2021, they're about breakeven. However, this does indicate their long-term commitment to Bitcoin, and was a precursor to the name change from Square to Block that insinuates a greater leap into the world of cryptocurrency. So who spearheaded this abrupt change in direction?
How Did They Get Started?
That would be one Jack Dorsey, the cofounder of Block. He, along with Jim McKelvey, a friend of Dorsey's, wanted to create a better mobile payments solution after McKelvey could not accept a small business sale because he was unable to accept a credit card on the spot. This pushed Dorsey and McKelvey to create a better solution, which was the genesis of Block back in 2009.
Fundraising began over the next five years from some of the biggest venture capital firms in the Valley, but the transition to the public markets didn't go totally according to plan. The company had reached a private market valuation of a little over $8 billion. However, upon their IPO in 2015, that number had been cut in half due to little institutional interest when shares began trading. Who is laughing now, though, as the stock has been a monster over the past 6 years, providing shareholder returns of 1,198% since the IPO.
The company's history is genuinely pretty boring, so I wanted to take this opportunity to talk about Dorsey. Dorsey is one of the most interesting Silicon Valley founders there is. Until recently, he was the only person who was the active CEO of two publicly traded companies, Block and Twitter, until November 29, 2021, when he stepped down from Twitter. It was shortly after that announcement that Square announced their name change. Coincidence? Yeah no.
Dorsey is FASCINATING. When you think about the Valley tech bro who wears the Patagonia and Allbirds while they e-cycle their way to a kale smoothie shop, that's pretty much Dorsey, except with a lot more trancendental meditation. Dorsey is also a big proponent of fasting, reportedly only eating seven meals per week (dinners only) in order to feel more focused throughout the day. He became a billionaire in 2013 after the public debut of Twitter, and was later worth about $2.2 billion in 2014. Thanks to both Twitter and Block, he's worth now about $12 billion, though the exact number is hard to pin down thanks to his newfound obsession with Bitcoin, whose holdings do not need to be reported. Additionally, he gave back 10% of his stock in Square in order to provide more equity for employees, as well as fund the acquisition of eventual failure Caviar, which was later spun out to Doordash.
Finally, there's the Azalea Banks story. In 2016, singer Azalea Banks tweeted an image of an envelope full of beard hair. She claimed that this was sent to her by Dorsey, with explicit instructions to weave it into a protective amulet and wear it around. Dorsey denies the story, but it definitely feels in his wheelhouse.
The Bull Case
Block is Actually an Inflation Hedge
I chatted above about the Seller segment of the business. Well that segment includes Square Invoices, which is the digital invoicing service for businesses that is rolling out more broadly over the coming months, and it generates revenue via a fee-based structure of anywhere from 1.6% to 3% on each invoice. You also can't escape the topic of inflation in the American economy at the moment, which increased at a 30 year record 6.2% in 2021. Assuming inflation carries over into 2022 and is not "transitory" as Jerome Powell likes to drunkenly yell from rooftops, then this percentage fee model that Block employs on their invoicing service could see revenue for the segment skyrocket. Higher inflation means higher prices which means higher invoices which means higher fees. Easy enough, right?
Aggressive Move Into Cryptocurrency
Cryptocurrency has been the talk of 2021, and it's only getting louder. In an interview with CNBC, financial advisor Douglas Boneparth stated that he used to see about 10% of his clients ask about Bitcoin exposure. That number now stands at closer to 50%, and it's still growing. Banks like JPMorgan are adopting the currency for their wealth clients, millennials and Gen-Z are adopting crypto en masse and even sovereign nations like El Salvador are using Bitcoin as a new official payment method.
As the appetite for Bitcoin grows, Cash App will be there to meet it. I already chatted about the spread that Block takes for each transaction, and that volume only serves to increase in the coming years as cryptocurrency adoption skyrockets.
The newest and most wholly confusing part of the Square-to-Block rebrand is the business segment "TBD54566975." No, I did not have stroke and pass out on my keyboard. That's the official business segment name as stated in Block's name change press release from December 1, and seems to be what Dorsey was hinting at in a tweet from July of 2021.
Can they achieve some sort of decentralized, permissionless payments ecosystem? Yeah, probably, but it probably won't be anytime soon.
The Buy Now Pay Later Revolution
Hot on the heels of a gigantic $29 billion acquisition of Afterpay, Block looks set to take on the emerging market of "Buy Now Pay Later" (BNPL). If you're unfamiliar with the space, I dive in in my dig into Affirm Holdings, a key competitor of Afterpay. What you need to know is this is essentially digital layaway: you can pay for your item in interest-free installments, or pay for larger items over time at a lower fixed-interest rate than credit cards can provide. This new industry is EXPLODING, so Block is a player now to watch in the space.
The Bear Case
Pandemic Concerns Lower Analyst Price Targets
On December 20, an analyst from Wedbush cut his price target of Block by 24%, below the $200 mark, citing concerns around the Omicron variant of COVID-19. The analyst argues that if people are again forced back indoors, then consumer spending will slow, which will slow the transaction volume in the Seller segment and the peer-to-peer volume in the Cash App segment. That could, in turn, provide higher revenue to Block's competitors that are better placed in the online e-commerce community, like PayPal, Stripe and Shopify.
Block No Longer Controls Its Own Destiny
With an outsized reliance on cryptocurrency and wading into the pool of BNPL, Block has found themselves in the two spaces most set for intense regulation discussions at the federal level. Both of these spaces have found themselves in the U.S federal government crosshairs, now facing pretty remarkable scrutiny. Cryptocurrency is an asset the government has found can evade tax and payment rules, creating a whole new set of loopholes they're looking to now close.
BNPL creates an entirely new set of problems. What looks like an excellent idea in theory is, in practice, turning out to be a new way for young people to fall into financial delinquency. As consumer spending has been HOT in recent months following many states reopening "after" the pandemic, BNPL has seen a dramatic uptick in use, as well as missed payments. According to a recent study, repayment rates for BNPL purchases after 30 days sits at a measly 30%. That number only increases to 60% after 90 days, meaning that 40% of people are not paying back their BNPL amount due even after three months. Even Afterpay themselves have reported that their receivables impairment (amount due to the company that has not been repaid on time) has jumped from $94 million in 2020 to $194 million in 2021. If you don't think the federal government is going to jump in to regulate the industry in 2022, you're kidding yourself.
The Bottom Line
I went into this analysis with the preconceived notion that I'd love this company. Now that I've done the work I'm...mixed. Do I think that cryptocurrency is going to be a huge part of the future? Yes. Do I think that the BNPL space could be as well? Also yes, but with the huge, hanging caveat that the federal government will look to curtail whatever the space ends up being.
When this was solely a payments company, I was 100% on board. Now that they have waded into the murky waters of pending regulation, I'm more like 85%. Do I think Dorsey and co can navigate this future? Sure I do. I also think that out of their competitors of PayPal, Shopify and Stripe, they are either the best or second best (behind PayPal) equipped outfit to do it. I believe in the long term future of Block, but I won't quite be jumping in with both feet anytime soon. I'll be hanging on the sidelines for a couple of quarters to see how they can circumnavigate this name change and Afterpay integration, as well as the TBD...thing....to see how Block fares. Long term, however, I quite like the company.
Short-term: Neutral
Long-term: Buy
This article is for information purposes only and should not be considered financial advice. For individual situations, please contact an investment/tax professional. The author does not have a financial stake in Block (SQ) and does not intend to open a position in the next 72 hours.
