Given the wailing and gnashing of teeth this time last year [1] when Square raised $150M on a $6B valuation, it is entirely possible this is their last change to raise capital. If it doesn't work, and they can't cross the line into operationally cash flow positive they will become one of the larger unicorns to die this season. I really hope it isn't the case because I love their product and their service, but the S-1 doesn't paint a picture of hope. Doing some back of the envelope calculations I can't see any scale where they are profitable given their current fee structure.
[1] http://www.theverge.com/2014/10/6/6918211/square-funding-sin...
> The new rule excludes from these calculations people who obtained equity under the company's equity compensation plans and investors who purchased securities pursuant to the crowdfunding exemption discussed in this alert.
“We lose money on every sale, but make it up on volume”
What are your calculations? Square, Stripe et al are making massive margins on debit card transactions right now. Thanks to recent regulations (the Durbin amendment), the average debit interchange fee is 0.89% all included.[1] Square charges 2.75%. That means they're netting around 1.5-2% on debit transactions. That's huge for a payment processor.
Sure, they have higher costs for credit cards, and their easier sign-up probably means more losses from seller-side fraud. But if they can control fraud then 2.75% is still a healthy gross margin even on credit transactions. And it's crazy big margin for debit.
[1] http://www.federalreserve.gov/paymentsystems/regii-average-i...
http://www.nilsonreport.com/upload/Nilson_Purch_Vol_2013.May...
Here is a more optimistic analysis from Re/Code: http://recode.net/2015/10/14/squares-ipo-filing-its-complica... that looks at the numbers minus the Starbucks deal and concludes that their core business is healthy and has a path to profitability.
"While Square will be a much smaller business from a revenue standpoint after the Starbucks deal lapses, it will be a faster-growing one with a much better shot at profitability."
So what is their target valuation when they go public? If they were going for $1 - $2B valuation? I think the world might buy that, but since their last round was at $6B, their investors would probably be pushing for $10B (because if you recall the Box IPO you remember that none of the late stage investors want to take a down round into the public markets) and that is like "Square 10 years from now" valuations.
So lets watch this one closely and see if they can get commitments for all their shares on the road show. And if not, we'll probably see a giant recapitalization or maybe a firesale to PayPal or something.
OTOH Square is on pace to hit $1B revenue / year and growing quickly vs. anybody else in the processing space, but it will all come down to how the market thinks about their business and their ability to cross the chasm from very small merchants (which makes up the majority of their business and they have locked up because other processors / ISOs cannot compete with their customer acquisition costs) into the next tier of small businesses...
Along those lines, great article from Bill Gurley about revenue multiples: http://abovethecrowd.com/2011/05/24/all-revenue-is-not-creat...
Could you explain? I'm sure you have much more experience reading such numbers[1] than I do, but at a glance they look viable if they can grow to something around double their size.
Ignoring Starbucks and doubling the amounts for 1H 2015 to make it annual, they'll have about $1000M of revenue from transactions, and will pay about $600M of transaction costs. They'll have about $500M of operating costs for 2015 and $100M of various other costs.
If in 201X they were to be double this size, they'd have $2000M of revenue, and $1200M of transaction costs. If they can keep their operating and other costs below $800M, they'll be profitable. Of their expenses, "Transaction and advance losses" will probably scale linearly, but all the rest plausible to be significantly sublinear.
Is this simplistic scenario clearly impossible for some reason?
[1] https://www.sec.gov/Archives/edgar/data/1512673/000119312515...
- the termination of the Starbucks agreement in 2016 (this already saves $27 million/year based on the 2014 numbers)
- raising flat-rate processing fees for businesses in the future
- reduce the cost of transactions by adding more fraud-prevention measures that make credit card processors happy (e.g. Chip and PIN)
- create a new business that allows Square to cut out the credit card networks by owning both sides of the transaction
- create a new business using the information from being in the credit card processing flow that is profitable enough to subsidize the credit card processing
Right now, I suspect they're trying to "pull an Amazon" -- they're operating at a loss, but they hope investors will like the brand and the vision enough that they'll put money in anyway.
Their flat rate of 2.75% is substantially more than what Visa charges for "card present" transactions. The highest cost cards are 2.4% but they're going to be a small portion of most stores' card mix. I'd think most shops cost Square 1.1-1.5% across all their transactions. Debit volume exceeds credit volume in the US -- most people are swiping their bank check cards, not commercial purchasing cards and the highest end reward cards that require pristine credit -- and the Durbin amendment capped the interchange fee on debit cards (when swiped a-la-Square Reader) at 0.05%+$0.21 per transaction. That means 2.75% is 98% profit for Square on a big debit card swipe.
https://usa.visa.com/dam/VCOM/download/merchants/Visa-USA-In...
The only place Square's subsidizing the transaction fees is on very small purchases where the flat ~$0.15 of the interchange fee amounts to more than 1-2% of the total transaction, and with AmEx where, if Square hasn't negotiated better than sticker rate, they could be paying 2.85-3.5% depending on business type.
If they're losing money on the one thing they charge money for, what's the business? And how are their competitors doing it? PayPal's historically offered merchants with volume as low as 1.9%. They offer 2.7% flat rate (no per-transaction flat fee either) for their swiper.
Square can only hope to make a decent margin on its 2.75% pricing by 1. seeing a preferred distribution mix on card types (such as, high debit card usage; less Amex; less expensive rewards cards; high cards qualifying at card present rates & no downgrades) and/or 2. special interchange discounts with the networks based on growth initiatives and/or fraud tools.
If they can't generate enough $$ from processing revenue, they'll need to use card processing as a loss leader for other services (loans, analytics, marketing)...
They marketed their service for years as 'free from chargebacks' and then (without notice!) silently deleted transactions which had, in fact, been charged back: http://venturebeat.com/2012/03/07/tradehill-sues-suing-dwoll...
Harassed as many people as I could for information on FiSync so I could try to offer integration to local credit unions and banks and couldn't get any real information out of them on it; it was a phantom program back when I was looking.
How would Dwolla help Square cut out the CC companies?
Credit cards won't be immediately replaced as they are accepted virtually everywhere. I think Square could be positioned well to replace credit cards though using the old Microsoft model of embrace, extend, extinguish.
Embrace credit cards in the short game. Extend with direct payments (bank to bank and alternative line of revolving credit). Extinguish; pull the plug on the credit card companies once they achieve high enough rate of adoption.
[1] https://en.wikipedia.org/wiki/Salesforce.com [2] http://www.npr.org/sections/money/2015/10/09/447249562/episo...
Looking at their financial statements, net loss for last FY was 250MM but depreciation and amortization was over 700MM.
In other words, the loss they show is just a paper loss. They make money. Unlike Enron which was making paper profit but they were actually losing money.
If they consistently do this then they're not making money. Depreciation/Ammortization is just an accounting method to distribute investments over time. If you're consistently returning a net loss it's not just a timing issue. In this case maybe Salesforce is like Amazon and continuously reinvests free cash flow so they don't return a profit to shareholders and instead reinvest it into new business. Is that what you mean?
Wall street rewards growth over profits so incentives for Salesforce are to keep purchasing businesses which at least break-even (e.g. Heroku) which in turn show growth in revenue but don't necessarily translate into growth in profits.
As long as Salesforce keeps buying these businesses, they can keep showing paper loss forever without actually being in any danger of running out of cash. And while they are doing this, their shareprice might double or triple.
It sounds crazy that it actually works but I'm not the one who is going to argue with markets.
That's not true, or at least it's only partially true. In the end, Wall street values discounted cash flow. As Bill Gurley has said:
> So growth is good, correct? There is a reason to save growth for last. While growth is quite important, and even thought we are in a market where growth is in particularly high demand, growth all by itself can be misleading. Here is the problem. Growth that can never translate into long-term positive cash flow will have a negative impact on a DCF model, not a positive one. This is known as “profitless prosperity.”
In other words, as long as you can show sustainable double digit growth, you can afford to value based on growth. If you don't and all of the sudden you can't maintain a positive DCF, the Street will hit you hard. SFDC, Amazon, etc are all teetering on the brink of collapse and equally becoming the next Walmart/Exxon.
[0] - http://abovethecrowd.com/2011/05/24/all-revenue-is-not-creat...
It can be a great tactic if the businesses you build/buy are the same your shareholders would buy with the dividends you'd pay out since you'll save them some taxes. Since the mother company can also hope to add some value to the businesses it buys the end result can be quite interesting. Buffet's Berkshire is based on this kind of setup.
This is generally a win, if you're expanding, because it means you pay no tax on your free cash.
Note that this isn't necessarily true. You can have negative Net Income, positive EBITDA but negative FCF (what really matters).
Look at a company like Amazon, their net income was stunningly negative for a very long time [1] -- it's barely positive today -- yet their market cap is north of $250B. There is plenty of room for companies making losses to go public if they have a realistic plan to make profits in the future.
In 2012, they lost $85m. In 2014, they lost $154m. How much bigger are were they in 2014 relative to 2012? If it's more than 2x (and I have no doubt it is), they're on the right track. If they're 5x bigger, they're doing fantastic - revenue growth is outpacing red ink growth by a healthy margin. That means sooner or later, they'll not only be profitable, but tremendously so.
Square is a category-killer, in a key category.
Says who? Growth is great, but it doesn't necessarily mean that profits are in the pipeline (e.g. Groupon).
And on top of that, what exactly is it that Square does that it's going to be profitable on? Is it the Point of Sale devices? Is it their Square Readers? Is it their small-business loans? They're not a terribly focused company, and maybe that's a reflection of their CEO doing double-time (completely speculation on my part).
Personally I see this as their last-ditch effort to grab some cash, to exit before the market gets worse. Their investors don't want to be left holding the bag when the IPO market gets cold, so it's better to cash out now while the name Square is worth something than to bet that they'll get bigger/better in the future.
We read about them because... I'm not too sure actually, I guess it's because they are burning VC money and have a splendid website.
As someone who uses other people's payment systems, Square makes me happy. It's a product that respects the users.
But too bad we don't actually make them money.
Really complex retailers with broad product lines, like supermarkets and big box retailers, will continue with highly customized in-house solutions. But for retailers with only dozens or hundreds rather than thousands of products, and limited budget to buy fancy solutions, it's a godsend.
And, because the customers are making a major, high-risk, customer-facing commitment, they're going to be very sticky, very unlikely to switch. Basically, Square is entering a market where the established players are too slow and coarse-grained to reach a lot of potential customers, and then they'll have a terrific barrier to entry. That sounds like a good deal to me, from an investment point of view.
Some citations would be nice
It's betting on a future, and the future is unpredictable.
"Too Big To Fail" is not the terminology I would ever want towards something I develop - I think Titanic.
I understand that businesses do not start out profitable from the get go, but $700 million in debt?
Edit: Here's First Data's S-1:
http://www.sec.gov/Archives/edgar/data/883980/00011931251533...
1. Shove it through while public market sentiments are still positive and accepting or riskier bets.
2. The numbers can only look worse in the future.
The fact that the company is in the red, in itself, is not a reason to stop going public. Companies like FireEye are in the red but have multiplied in market cap since going public.
FireEye debuted at $20. It hit a peak of ~$85 shortly after the IPO. Its closing price today is $28.76.
As of September, 40% of the companies that went public in the past year with market caps above $1 billion were below their offering prices[1]. The market for IPOs has become even tougher since September. Just look at Pure Storage[2] and CytomX[3].
In my opinion Square is getting out to market while they can.
[1] http://www.bloomberg.com/news/articles/2015-09-14/many-of-th...
[2] http://www.wsj.com/articles/pure-storage-trades-below-ipo-pr...
[3] http://www.bizjournals.com/sanfrancisco/blog/biotech/2015/10...
The motive is to raise capital. The same as the motive to go public any other time.
> Isn't the public market more averse to companies operating in the negative.
In very broad terms, on average, sure, probably. But there's lots of factors in how the public markets react to a firm's offerings, and profitability is far from the only consideration.
How do you sleep at night being the founder of a company with half a billion dollars in deficit? How do you go to work everyday? Is this "normal"? Is this expected?
I really don't understand how that situation can happen.
Edit: I just looked up their numbers. They have large revenues, but still. Such deficits would scare me.
This is not a comment on Square's prospects, but their business model is clearly one that is betting on getting to very big scale before turning a profit.
On a more serious note:
Twitter has a large following of powerful/smart people who don't leave over night. Sure, over time these people could leave, but why would they? What would a twitter competitor offer that twitter can't offer?
Also wouldn't the timing act more as a distraction for Jack?