Square was founded in 2009, when glass-blower Jim McKelvey found he was unable to complete a sale because he couldn’t accept credit cards. He discussed the problem with his friend Jack Dorsey, and they co-founded Square, initially selling a cost-effective mobile phone accessory that allowed small businesses to accept credit card payments. This has since expanded to over 30 products and services for both sellers and consumers.
Square is one of our model portfolio stocks, and in this week’s pod we deep dive into the company and discuss recent developments for this fast-growing player in the e-payments space.
- What started with a dongle for a mobile device to allow sellers to accept credit cards has since expanded to a range of point-of-sale (POS) systems and seller services. Square have also launched tailored products and services for specific businesses, for example, the Square Kitchen Display System (KDS) recently launched as a standalone product worldwide to help restaurants manage and fulfil orders more efficiently
- The use of electronic payments has been increasing for many years and was accelerated by the pandemic. Digital wallets are now the most popular form of payment globally. The Square Cash App introduced in 2013 is one of the most popular digital wallets in the US, with 36M monthly active users at the end of last year, a jump from 24M at the end of 2019
- Square started offering Bitcoin trading in its Cash App in 2018 and the company has increased its stake in crypto by buying $170M of Bitcoin, representing 5% of its cash reserves. They saw over 1M users buy Bitcoin for the first time in January of this year, and their revenue from Bitcoin trading surged to $3.5B in Q1. This may be a cause for concern if crypto sees increasing regulation, restrictions, or volatility
- Square acquired the music streaming service, Tidal, earlier this year. Tidal’s once distinguishing feature of high-quality lossless audio are now available on other music streaming services, but the relationships with the artists may be the key differentiator. Could Square and Tidal become the “Shopify for music artists”?
- Another recent acquisition was Credit Karma Tax, a free tax filing tool that Square plans to integrate into its Cash App, further enhancing the Square payment ecosystem. Square payment processing is currently integrated with TurboTax from Intuit to simplify the tax filing for sellers. The acquisition of Credit Karma Tax may suggest a bigger move into the tax filing business, perhaps competing with Intuit instead?
- Square officially became a bank earlier this year. Previously, Square offered financial products such as small business loans via a partnership with Celtic Bank. They are now able to offer these products directly, and have recently announced they will launch checking and savings accounts, competing with incumbents such as JP Morgan and Wells Fargo
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Transcript
Albert: Hi, this is Albert.
Luke: And this is Luke.
Albert: Today is Monday the 24th of May.
Luke: Welcome to the Telescope Investing podcast.
Intro
Luke: This week we’re going to take another look at one of our model portfolio stocks, Square.
Albert: Yeah, we selected Square for our model portfolio that we announced back in January, but it’s not doing very well. It’s only down around 6% since then.
Luke: Actually, how deep in the hole is the model portfolio? Let’s take a quick look.
Albert: Go on, tell me then.
Luke: As of Friday’s close, the model portfolio is minus 8.14%, underperforming the market by 18%. So Square is bang on the money, actually, right now at minus 8%. So it’s the perfect centre of the model portfolio.
Albert: Uh, actually, I didn’t know that. I think I mentioned last week that I kind of stopped looking at my portfolio because it wasn’t very constructive.
Luke: I agree, emotionally draining. We did a whole episode on that last week, but this week let’s be positive and let’s look to the future and focus on the possibilities that Square creates in society.
Albert: Well, actually, let me look into the past. I first invested in Square in early 2018 and it’s up around 300% since then, and that makes me feel a lot better than looking at the year-to-date performance.
Luke: That’s great. You are definitely much earlier to this trend than I was, and I know you’ve been a real fan of electronic money, possibly because of your position in Asia and just being much more exposed to e-payments than we are in the Western world.
Albert: Yeah, I think we first talked about the trend of electronic payments back in episode three of the podcast, I believe, one of our earliest podcasts. It’s a bit rough, but I think we described quite well why we think electronic payments is a growing megatrend globally.
Luke: I agree, and my view hasn’t changed. Looking forward to getting into Square today and then we’ll re-examine some of those thoughts, perhaps in much more detail.
Albert: Yeah, we’ve done quite a lot of the model portfolio stocks now. How many have we done now, Luke?
Luke: I think this is our sixth model portfolio stock deep dive, and actually, we’ve done 12 deep dives overall.
Albert: It feels a lot more than that, maybe it’s because each of these takes a bit of work.
Luke: They do and we do generally produce a one-pager insights for the model portfolio stocks when we analyze them. This is number six and we’ve got nine more to go. Maybe we should do a bit of a Twitter poll with subscribers and let the audience choose which one we do next.
Albert: Oh, that’s a great idea, Luke, because I think we’ve covered most of the model portfolio stocks in one form or another in all our episodes, either individually or as part of a group, so maybe the next one we do, we should just open up to our listeners.
Luke: Great, let’s do that.
Albert: So before we get into Square, what did you do this weekend, Luke? You sent me quite an interesting message on WhatsApp. Something about Glastonbury?
Luke: Yeah, a friend was hosting a pool party and my brother set up a pretty amazing sound system and lighting, and we were all going to watch Glastonbury 2021 as it was being live-streamed from Worthy Farm. Well, it was a bit of a technical disaster, quite amusing. I think they had some sort of authentication problem and nobody could log in. So those first few bands that were playing Glasto, there was no one watching them.
Albert: Actually, Luke, you sound a bit croaky. Was there alcohol involved yesterday?
Luke: There was a lot of alcohol. This was actually Saturday night so you can tell how bad the hangover was. I’m still feeling the effects 36 hours later. So we had to make do with the Eurovision song contest instead of Glastonbury, at least for the first hour or two, until they sorted out their problems. So I would like to say congratulations to Italy and interestingly, though, England zero points, null points. I’ve got to be honest, the England contestant was not very good but some commentators think that this zero points effect is really a consequence of Brexit. No one wants to give England a point in Eurovision because of Brexit.
Albert: Well, I’m surprised they were allowed to enter given their stance on Europe.
Luke: Well, you’ve Australia entering Eurovision these days so I think the Euro in the title is brand only. Anyway, let’s get stuck into Square rather than laying into the British Entrant.
Square
Luke: So Square was founded back in 2000 by Jack Dorsey and Jim McKelvey. Actually, it’s quite an interesting origin story that you picked out. Do you want to tell us about that?
Albert: I’m not sure if this origin story is actually true, but legend has it that, Jim McKelvey, he was an amateur glassblower, or maybe he’s a professional, but he was not able to make a sale because the buyer wanted to use a credit card. So he had a chat with his friend, Jack Dorsey, and then they started Square.
Luke: It’s pretty cool if you’re hanging out with guys like Dorsey. I guess Dorsey was already running Twitter so a massive name in the tech sphere.
Albert: Actually, when Jim McKelvey talked to Jack Dorsey, he was actually in between being CEO of Twitter. He was having a Twitter break.
Luke: Ah, very good. We could all we do with one of those from time to time, I’m sure.
Albert: Yeah, I take one daily. They started with these points of sale card readers, a small dongle that you could plug into a mobile device called a Square Reader. The objective was to allow businesses to accept any form of payment that a customer wanted to use.
Luke: Yeah, I guess they’ve scaled beyond that piece of hardware a few years later, really building a whole ecosystem around electronic payments and digital wallets. And then more recently they’ve started to integrate capabilities like stock trading and cryptocurrency trading.
Albert: Yeah, I think you’re talking about the Square Cash App, which they launched back in 2013. I think Square is as famous for this Cash App as is for its point-of-sale readers now. You mentioned Bitcoin trading, Luke. It’s interesting to read that Square saw 1 million users buy Bitcoin for the first time in January this year. It really explains the rise of Bitcoin if not many people are starting to buy it for the first time.
Luke: And it’d be interesting to get into that in today’s episode because Bitcoin and all cryptocurrencies have taken a real pummeling just over the last few weeks. It’ll be interesting to see how that gets accounted for in Square’s numbers.
Albert: Yeah, I think that’s actually a cause for concern. Whether you like it or not, the fortunes of Square is now tied to the fortunes of Bitcoin, which is kind of unfortunate if you’re an investor who has no interest in crypto.
Luke: Yeah, I agree it’s interesting. Keeping a very high level though, Square really have two kinds of customer. They serve sellers, so these are retailers, food outlets, small businesses, and large. And they also serve consumers with the Cash App, and that enables things like peer-to-peer money transfer, saving, investing, and actually more recently, tax preparation.
Albert: Yeah, they’ve grown very quickly. They actually IPO’d back in November of 2015 with an initial market valuation of $2.9 billion. And as of last week, their market cap is $86 billion, around 30 times since IPO. And their main market is the US but they also operate in Canada, Australia, the UK, and Japan.
Luke: But they’re still a small player if we compare them to someone like PayPal who are available in 200 countries and I’m sure have far more users.
Albert: But you wouldn’t know that if you looked at their market capitalization. I think Square is around a third of PayPal’s.
Tailwinds
Luke: So let’s explore tailwinds. That’s always the linchpin of our Telescope Investing approach. What’s happening in the world that’s going to drive and be an enabler for Square to continue to grow and roll out at a rapid rate. And it’s really centred around e-commerce and e-payments.
Albert: As we mentioned back in episode three of the podcast, e-payments is a growing megatrend across the world, and Square’s a big player in that. The pandemic, actually, has accelerated the adoption of e-payments in many countries, the US included.
Luke: Yeah, the pandemic is interesting, isn’t it? It’s such a driver for so many of our megatrends. I know I said that before, but here actually, it’s really tangible. Like money, physical money, is grubby, right? It’s dirty. It’s a transmission vector for the virus. If I pay you physical cash, if you’re my taxi driver, if I’ve got COVID, I’m potentially giving it to you by giving you that money. That’s not going to happen if I wire you cash through the app.
Albert: What was that stat I read a few years ago? Every dollar bill has traces of cocaine on it.
Luke: I guess we’ve now adopted the innovation of that plasticized money, so I guess that’s much cleaner and can be washed. A new angle to money laundering.
Albert: I very rarely use cash in my life in Hong Kong. Usually, cash just sits in my wallet for weeks unused. But we did use cash last night to pay the handyman, but apart from that, I can’t remember the last time I used cash.
Luke: Yeah, kind of same here I guess. I paid for a sushi delivery on Friday in cash. That was probably the first time in a couple of weeks I’ve used cash. There’s a whole ton of other benefits though around having e-payments over physical payments. Crime, what’s the benefit in mugging someone or trying to steal from them as they’re leaving the cash point. People aren’t really carrying cash if they just don’t need it.
Albert: For me, the main benefit of e-payments is just convenience. I always have my phone with me and even if I leave my wallet at home, I can pay for something on my phone.
Luke: I think it’s also interesting around having traceability and good records and receipts. I’ve got to say, I’m super organized and if I buy any major purchase or gadget or something for the home, I actually take a photo of the receipt and keep it filed because I might want to make a warranty claim or maybe I have to make an insurance claim one day, so it’s good to have that record. It makes it easier if you need it in the future.
Albert: I think we’re in the minority here, Luke. I don’t think many people keep track of their spending and the way that we do. I’m with you, I keep track of all my spending down to the receipt and it’s quite interesting when you look back over what you spend your money on. You realize you actually buy a lot of crap.
Luke: Yeah, yeah, you do.
Albert: I want to add that I don’t think Square is a work-from-home stock, and when the pandemic ends and life goes back to normal, I don’t think Square’s usage will drop. You could view it as a reopening play because Square benefits when people stay at home and use digital payments and also when they go out and use the point-of-sale devices and pay for stuff they buy in physical stores.
Luke: And when we cover network effects, I think it’s particularly powerful for a company like Square.
Albert: And Luke, I think a more controversial tailwind is the rise of crypto and crypto-assets. You mentioned Bitcoin before, and I think Square’s decision to allow Bitcoin trading back in 2018 was ahead of its time, and it was the first digital wallet to allow Bitcoin trading. And PayPal has only just recently added it to Venmo just late last year.
Luke: Oh, do PayPal own Venmo? I didn’t know that.
Albert: Yeah, they bought it a few years ago.
Luke: Cool. Okay right, so there’s real consolidation happening in this sector I guess then.
Albert: It’s interesting because it might be a disadvantage because there’s increasing government regulation around Bitcoin as seen last week when China said it would crack down on cryptocurrencies, and the prices of a lot of cryptocurrencies just tanked 30 or 40%.
Luke: Yeah, I’ve got like 1% of my portfolio in crypto, mostly Ethereum. I’ve now got a personal lens into seeing that crash happening. Overall, I think it’s an advantage to Square to have a crypto holding because it’s going to enable them to transact in the biggest cryptocurrencies much more efficiently and cheaply, [and] service their customers better. But you’re right, the way they account for this could be quite difficult for them.
Albert: And related to crypto is the emergence of NFTs or non-fungible tokens. I think you asked me, how is this relevant to Square? Well, Square bought Tidal earlier this year for around $300 million, and Dorsey said the reason for buying that was to find new ways for artists to make money. And he hasn’t given any details yet, but this may include the sale of NFTs.
Luke: Yeah, let’s get into it a little later in the episode, I’ll be quite interested to explore that Tidal acquisition because it potentially does open up a massive new market for them.
Leadership
Albert: Well first, let’s look at the leadership. We mentioned Jack Dorsey, one of the founders, and he serves as the CEO of Square, and he is also the CEO of Twitter. And Jack, he owns 15% of the shares of Square but he has 45% of the voting power. So he is more or less in control of the company.
Luke: Yeah, it’s quite interesting. He’s also the chair and CEO of Square, and I understand that there’s a shareholder vote at the board meeting this June on potentially him having to relinquish his chair role. Some minority shareholders feel that his time is spread too thin between these two companies, Square and Twitter. And also that their governance is impacted by having him as both the chair and the CEO.
Albert: Is he chair and CEO of Twitter and Square?
Luke: I think so. I’m not certain about Twitter. I think he may be.
Albert: How does he find the time to do all these roles? That’s why I want to ask.
Luke: Yeah, he’s clearly a busy guy. Well, apparently he only eats one meal a day, so maybe that’s where he gets all that time back.
Albert: Yeah, he saves quite a lot of time from that by not eating or sleeping or being human. Actually, if he was made to choose, which one do you think he would pick?
Luke: What between Twitter and Square?
Albert: As far as I know, he doesn’t have a third company, right?
Luke: Uh, yeah, interesting question. I don’t know. Yeah, maybe Square. I guess Twitter’s going to be a bit of a tough space now with all this regulation and scrutiny on social networks. I think Twitter have got away with not being the bad guy in the way that Facebook have. Any regulation that comes in, it’s going to affect them all equally.
Albert: Actually, the fact that Jack Dorsey is CEO of Square and Twitter could be a competitive advantage for Square. They could have collaborations between Square and Twitter that wouldn’t be available to other digital wallets.
Luke: Well, that’s an interesting comment in itself because that’s exactly the reason social networks potentially going to get regulated, because of founders and leadership misusing them to promote their own products. That’s exactly what governments are trying to stop.
Albert: Well, it hasn’t stopped them so far so until that government regulation comes this could be a good thing for Square.
Luke: Well, maybe. That’s not the way I’d like to see them prevail if I’m honest.
Albert: I think that’s fair enough, Luke. I wouldn’t want them to abuse market power either to get ahead.
Luke: So you mentioned really high levels of insider ownership and that’s great. The other thing that’s pretty good is their Glassdoor rating. So the company has 4.3 stars out of five, which is decent, not great. And Jack has a 93% CEO approval rating so also pretty solid.
Albert: That’s pretty good because they have over 5,000 employees so it’s not one or two people, giving those ratings.
Total addressable market
Total addressable market
Luke: So let’s take a look at their total addressable market, and I think this is quite interesting set of numbers. I’ve got to say, actually, we had a lot of help in preparing today’s episode from a chap that we’re collaborating with, Azirat, and he had some quite interesting insights on their total addressable market.
So at the top of the episode, we mentioned that they primarily service sellers and then end consumers through the Cash App. So breaking the TAM down through those two lenses, the seller ecosystem today is an $85 billion opportunity for Square, and that’s based on 20 million businesses doing $2 trillion a year in gross receipts.
Albert: And that’s just in the US right, Luke?
Luke: That’s right. Yeah, $85 billion that they could potentially make from that market today. And then the Cash App is another $60 billion and that’s based on $9 trillion of payment volume, again, in the US alone. And I think it’s quite interesting looking at how Square have broken down this $60 billion revenue from the Cash App.
So on $4 trillion of sending money, they make $20 billion profit; on $2 trillion of people’s spending, they make $41 billion of profit. So that’s significantly higher profit margin on money being spent the money being sent. And then on the newer market of investing that they’ve more recently accessed, on $3 trillion people investing, they make $2 billion. So actually a tiny proportion of profit on that total in invested assets.
Albert: Those two markets you just mentioned, Luke, there just in the US and those numbers are big, but to be honest, they’re smaller than I expected. I would have thought these markets would be a bit bigger than that. But if you look at the global markets, they are huge. Just to give you an illustration of that, the global point-of-sale market is estimated to be $8.2 billion in 2019 and is expected to grow to $18.1 billion by 2027. And looking at the online payment market, in 2019, it was $3.3 trillion, and by 2027, this could be 17.6 trillion.
Luke: That’s really the key number because if Square are making $40 billion of profit today based on $2 trillion of spend, well, in six years’ time, if the world’s going to be doing nearly $18 trillion worth of spend as online payments, that revenue potentially rises to over $350 billion. That’s a lot of revenue that they’ll have access to, particularly if they can retain their place as the market leader.
Brand
Albert: Now moving on to their brand and reputation, I think most people have heard of Square in the US. It’s one of the most popular digital wallets in the country, and they have a net promoter score [of] 65, which is two times more than the traditional banking providers.
Luke: Yeah, that net promoter score is a really great metric. It shows how much their customers love the company and would recommend it to a friend, and a net promoter score of 65 is very, very good.
Albert: I’m not sure if you had a look at the ARK Invest Big Ideas Report for 2021. The digital wallet is one of their trends for this year and they state that one of the key benefits of digital wallets is the cost of acquiring customers. And they’re saying that for credit cards, on average, it takes about $250 to $1,500 to acquire each customer, but for digital wallets, it’s $20.
Luke: Wow, that’s a huge advantage, I agree. So have you used any of Square’s products? Have you tried the Cash App?
Albert: I haven’t, Luke, because it’s not available in Hong Kong.
Luke: It’s launched in the UK and I installed it the other day and had a play. It’s pretty average, actually. I’m not that impressed. I do hope that the version of the app available in the UK is maybe much thinner than the capabilities they offer in their core market of the US. The interface is okay but it only does domestic payments. There’s a £500 weekly limit. Although, I think you can upgrade that if you provide like a whole bunch of additional ID. Honestly, though, I prefer PayPal. I get much more utility out of that today.
Albert: Yeah, it’s possible that they’re just early in the development lifecycle for the Square Cash App in the UK, and all these features that you see in the US version are coming later.
Luke: Yeah, perhaps, and I know that they are ploughing a ton of cash into R&D, so hopefully, that’s where it’s going.
Albert: But the fact that they’re only operating in five or six countries could indicate that they have a massive runway to go in their international expansion.
Luke: Oh, that’s for sure. All countries must be moving in this direction. Like look at India even, they’re a long way ahead in terms of adopting e-payments.
Albert: I think the classic case is Sweden. I think they more or less have eliminated paper money.
Luke: I wonder if these markets have their own solutions already.
Albert: Well, just speaking from someone who lives in Hong Kong, there are multiple cash apps available here, and maybe there’s space for more than one winner. There is scope for a global digital wallet. I believe HSBC launched one last week which is an international digital wallet that is capable of holding multiple currencies.
Luke: Definitely, the traditional banks need to work hard to hang on to their market. They are getting disintermediated on every front by some of these fintechs.
Customers
Albert: Sellers represent a large range of industries, primarily in the services, food-related, and retail sectors.
Luke: Yeah, you mentioned their point-of-sale terminal Square Reader, and they’ve got a whole bunch of other capabilities to help sellers. I think in total, they’ve got something like 30 different products that are segmented into these two markets of sellers and end consumers.
Albert: Yeah, they have products and services tailored for specific businesses. For example, they recently launched something called Square Kitchen Display Systems, or KDS, which is a subscription-based business allowing restaurants to manage and fulfil orders more efficiently. It’s their software and hardware for doing that, and [the] interesting thing is, is that this is a standalone product. It’s not tied to their point-of-sale devices. This might be useful for restaurants but don’t have point of sales or seating areas, for example, ghost kitchens.
Luke: Yeah, absolutely, and Square do offer a bunch of products to try and help retailers and restaurants manage their whole end-to-end financial offering. With things like automated risk assessments using machine learning and solutions to help sellers engage with their buyers through different channels.
Albert: And as far as we know, they don’t have any customer concentration issues. They have a large number of small and medium-sized businesses as clients.
Luke: And on the Cash App side, so today they state they have 36 million monthly transacting customers, and the Cash App is the number one finance app in both the Google Play and Apple App Stores.
Albert: Yeah, this 36 billion is an increase from 24 million at the end of 2019, so they’re growing quite quickly.
Luke: Read an interesting tweet a couple of weeks ago that said that the top 10 apps in the US Apple App Store are all either social or financial. Guess it’s a real focus for people.
Albert: Yeah, that doesn’t really surprise me at all. I would guess the top app is Tik Tok. Is that right?
Luke: Oh, I don’t know. I imagine Facebook’s up there and Instagram. Probably Instagram, top of the pole. Maybe Twitter. I wonder if Jack’s got two of his apps and the top 10.
Albert: And we are seeing a merging [of] e-commerce and social media. A lot of social media apps now offer opportunities to buy and sell merchandise, and this is one of the key bull cases for Pinterest.
Optionality
Luke: Let’s talk about some of that optionality. So I’d like to dive into the Tidal acquisition a little bit. It is quite interesting, the new markets that opens up.
Albert: Yeah, Tidal’s a music streaming service that was famous for its lossless audio. I believe Apple, Spotify, and Amazon now offer lossless audio at no extra cost so I’m wondering whether or not this Tidal acquisition was a good thing.
Luke: Jack’s rationale for acquiring Tidal, he said on his own Twitter, “Tidal started with the idea of honouring artists by being artist-owned and led, focusing on an uncompromised experience of the art. Given what Square have been able to do for sellers of all sizes, we believe we can now work for artists to see the same success for them.”
This is quite interesting. It kind of reminds me of another company in our model portfolio, Shopify. You’re always hearing about how the music industry gobbles up performers and takes the lion’s share of revenues. Like Taylor Swift being in the news recently with all the legal blows between her and her record company.
Well, I wonder if Square plus Tidal could almost become the Shopify for musicians. You could look at say Spotify and Apple as just being an extension of the traditional music industry. And I guess they’re thinking of their customers as being like the end-user, the listener. Well, if Tidal are more focused on their customers being the artist, that’s pretty akin to the Shopify model.
Albert: As a Square shareholder, I really do hope that they have a roadmap to monetizing the Tidal acquisition because a less charitable reason why Square bought Tidal is because Jack Dorsey is friends with Jay-Z.
Luke: Yeah, perhaps! It is a big market though, and we were talking about total addressable market just now. Like I think the music industry is worth like another $100 billion, so that’s potentially another $100 billion revenue stream for Square right there.
Albert: What do you think of my idea that a large part of this is the development of NFTs and Square will allow music artists to sell NFTs on their platform?
Luke: Yeah, that makes sense, actually. I buy that. I suppose NFTs are much bigger than just music. Like they’re really any physical asset or piece of intellectual property, but I could see music being a key part. Would it be cool to own the NFT from your favourite dearly departed artist, perhaps David Bowie or Michael Jackson?
Albert: Has David Bowie died?
Luke: Has David Bowie died? Really, Albert? My God, are you that culturally divorced from the UK!
Albert: Well, I know Michael Jackson has died. Anyway, that reminds me. I just saw on YouTube just yesterday that Beeple sold a JPEG paid for $69 million. That’s huge.
Luke: It wasn’t a JPEG. I think it was like a thousand pieces of art that he’d stitched together he’s been producing for years, but yeah, that’s clearly massive.
Albert: Yeah. But it’s still a JPEG that you or I can just download and look at.
Luke: Let’s not go too deep into what NFTs are. I think it’s more than that, but you’re right, maybe I can just take a quick screenshot of you on zoom now and sell that as an NFT.
Albert: Go ahead. I don’t think you’ll get very much.
Luke: Before we get off of optionality. Let’s just pick up on another company they acquired in Q4 last year. They bought a company called Credit Karma Tax, which is adding a tax filing capability to the Cash App ecosystem. I don’t know much about Credit Karma, but I love the idea that Square are integrating this capability into their product set. Have you heard of a company called Intuit?
Albert: Yes, Luke, I think you and I have both used their product, Quicken, in the past. I’m not sure Quicken is one of their products now, but it definitely was about 10 or 20 years ago.
Luke: As I read more about this company in more recent years, it seems like Intuit are pretty unethical. They’ve been doing some pretty nasty things, actually, to make the tax system in the US more expensive and more complicated to navigate on the pretence of simplifying things and making it easier for consumers.
Albert: Yeah, that’s how they make their money, is for consumers to buy the software because they feel that the tax system is too complicated to do by themselves. You know what, we’re spoiled in Hong Kong. I think my tax return takes me five or 10 minutes to fill in.
Luke: In the UK, it’s not so bad, but if you have to do a self-assessment, it’s a good one day of effort to pull all the information together.
Albert: I believe in the US, it could be several weeks of work if you do it by yourself.
Luke: And I think everybody needs to do it and it’s pretty painful. This company, Intuit, they’ve been actively lobbying to keep the tax codes complex and keep the processes hard because, as you say, that’s their market, that’s where they get their business. So I love the idea that Square are coming in with Credit Karma Tax and may be simplifying all of that.
Albert: How are they simplifying it? Maybe they have the same incentives as Intuit to keep the tax system complicated so they will sell more of Credit Karma Tax’s services.
Luke: Honestly, I don’t know. I haven’t looked into this acquisition, but I would be fairly confident that that wouldn’t be the case. I think one of the hardest parts of being a US taxpayer is collecting all your receipts so you can submit your tax return. So you can imagine if you’re transacting through the Cash App to buy most things and to do money transfers to friends and to businesses, well, actually it should be much more straightforward to produce your tax return.
Network effects
Albert: Luke, we skipped over one of the main benefits of Square, which is network effects. The more users you have on the Cash App, the more utility that app has. And as you say, they have around 36 million users now.
Luke: Yeah, I guess whenever you buy something from a Square point-of-sale terminal in a store, you’re seeing Square’s branding. That’s going to remind you of this company. It’s a really good brand exposure.
Albert: Yeah, if you’re a shop owner and you don’t accept credit cards, but your next-door neighbour does and you sell the same product, I think a lot of consumers would just go past your shop and go next door.
Competitors
Luke: Should we explore competitors to Square a little bit?
Albert: I think we mentioned the main one, which is PayPal, which is one of the earliest players in electronic payments. We mentioned before they now own the Venmo digital wallet.
Luke: There’s also like the traditional banking infrastructure though: banks, Visa, MasterCard. These are really Square’s competitors.
Albert: Yes, they are competitors in one sense, but they’re also collaborators. I believe in this Square Cash App, you can link your credit cards and use it to pay for things via the credit card.
Luke: I think Square are now a bank. As of sometime last year, they acquired a bank in the US and now they’re able to offer traditional banking services, which is how, I guess, they now got into this sort of investing and saving arm.
Albert: I believe that they did so beforehand but because they weren’t a regulated bank, they had to go through a third party. Basically, they were the front end to another player, another bank, in the background, but now they can do this without any third party.
Luke: And we shouldn’t forget the other interesting competitor to Square, which is actually all those e-commerce companies that we also have in the model portfolio. Shopify have got Shop Pay, MercadoLibre have MercadoPago, and Sea Limited have Shopee. They’ve all got their own payment apps.
Albert: Also Apple Pay, Google Pay, Samsung Pay. There seems to be hundreds of ways now that you can pay for your products and services. Everyone wants their piece of the pie.
Luke: And then more recently, maybe you’re paying for stuff without actually paying for it. Platforms like Klarna, offering deferred payment plans.
Albert: Well, you pay for it later in one way or another.
Luke: Yeah, you sure do. As you know, from a previous episode discussion, I’m not a huge fan of anything that’s encouraging reckless spending.
Albert: Well, unfortunately, Luke, it’s a growing trend and a lot of companies in the space are doing very well.
Financials
Luke: Well, should we see if Square are being reckless with their own money and take a look at their financials?
Albert: As of the end of last year, cash or cash equivalents of around $3 billion, which is triple the amount from the year before.
Luke: It’s interesting though is that they tripled it because they just issued a convertible senior note, basically a debt, so they’ve raised $2 billion. That’s interesting because they’re suddenly got a lot of cash on their books and I wonder what Jack’s got planned for that. Maybe there’s some other key acquisitions coming up.
Albert: I’m looking at the Cash App. Their sales have increased 666%.
Luke: The number of the beast, dah, dah, dah, dah.
Albert: I hope that’s a coincidence and not a sign of things to come. They say that sales of the Cash App increased 666% in the first quarter this year, which is huge, but a lot of that is due to Bitcoin trading. But without Bitcoin, Cash App revenues still increased by about 139% year-over-year.
Luke: But if you look at that revenue graph, they started reporting their Bitcoin profits and losses pretty much since 2019. In the first quarter of this year, their most recent report, that Bitcoin revenue number is through the roof. It’s like two or three times all the other revenue streams put together. That’s quite a concern if they’re tying their fortunes to the rise and fall of cryptocurrency.
Albert: But there is a bit of controversy in that Square reports its Bitcoin trading volume as revenue. Basically, the value of all the Bitcoin trading on their platform is treated as revenue. That doesn’t make sense to me. Surely the revenue should be the charges they charge for doing Bitcoin trading, not the value of the Bitcoin itself.
Luke: Yeah, I agree. They might come to regret this because they’ve reported this quote-unquote revenue, but I think that next quarter earnings can be pretty horrific if they have to report the losses associated with recent crashes in crypto.
Albert: Yeah, so their Bitcoin revenue for the first quarter was $3.5 billion, but the gross profit from that is just 75 million, a small fraction of that revenue.
Luke: It’s not going to damage their fortunes, and look let’s face it, they were holding a couple of hundred million dollars in Bitcoin. Even if that went to zero, that’s not really going to materially affect the company. I think this will create a lot of noise and confusion around the company’s future and potentially a lot more volatility in their stock price.
Albert: Yeah, they bought $50 million of Bitcoin last October and another 170 million in February this year, but combined, it’s just 5% of their cash position. It’s not a huge holding.
Luke: Let’s take a look at some of their other financial metrics. Probably the most interesting one is their price-to-sales ratio. I’m kind of used to seeing these eye-watering price-to-sales numbers well in the double digits, but actually Square’s is pretty sensible, a fairly low 6.5.
Albert: Well, as we said, that sales number includes Bitcoin trading volumes, so it’s a little bit misleading, but you’re right, a price-to-sales ratio of 6.5 does look quite small compared to the 20 or 30 or even 50 that we’ve seen.
Luke: And one thing that Azirat picked out of their annual report was that in 2020, Square obtained a half-billion-dollar COVID relief loan from the Fed. Quite interesting that they felt they needed that.
Albert: Or maybe they didn’t need it and they just got it because they could. I think a lot of businesses did that.
Luke: Yeah, I guess. In my books, perhaps slightly unethical, but I guess if it’s there, why not take it?
Albert: If someone offered you an interest-free loan, wouldn’t you take it?
Luke: I guess unless I knew that that loan was being provisioned for people with greater need.
Albert: You’re so ethical, Luke.
Luke: I do my best.
Key takeaways
Luke: So we’re bringing our episode to a close, Albert, and we’ve run through all the big Telescope lenses around this one. I’ve got to say, I’m really happy that this is a model portfolio pick, and I’m happy that you encouraged [me] to pick up at Square in my own portfolio. You know, it’s one of those stocks that I added to a couple of months ago, and my position might be down at a little bit year-to-date just because of the fluctuations in crypto and how that’s affected their fortunes. As a long-term hold, I’m very confident about this company.
Albert: I’ve held Square since 2018 when I bought Square and PayPal, and they’ve done really well for me. And I thought at the time that I got in late because these stocks were growing very quickly back then, but what’s happened is that they’ve grown even more quickly since then. So I’m really happy that it’s part of my portfolio.
Luke: That was a good deep dive. Albert and I would like to say a quick thank you to Azirat, who’s been really helpful in doing the research for today’s episode. I think as we said at the top, we’ve got nine more stocks in the model portfolio to do, so I think I’m going to throw four of those on a Twitter poll and let’s have our listeners vote on which one they’d like us to do next.
Wrap
Albert: Great, I’m looking forward to those results, but for now, thanks for listening.
Luke: Yeah, if there’s a future topic you’d like us to cover, you can message us on Twitter. I’m @LukeTelescope.
Albert: And I’m @AlbertTelescope, or you can email us at feedback@telescopeinvesting.com.
Luke: And if you enjoyed today’s episode, you can find more content at our website, telescopeinvesting.com, where you can leave us a comment or a review.
Albert: And if this is your first time tuning in, perhaps consider subscribing to the website so that you’re the first to hear about new articles and episodes as they drop.
Luke: Thanks, Albert.
Albert: Thanks, Luke.
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