As Square (NYSE:SQ) celebrates its 10th birthday this year, one thing is certain: It's a long, long way from being the company that introduced a simple dongle to allow merchants to accept credit cards without expensive hardware or a landline. Never was that clearer than when the company released its 2018 fourth-quarter and full-year results late last month.
In Q4, Square's top- and bottom-line growth continued to explode upward. The company's adjusted revenue, which subtracts the fees collected by banks and credit card networks, rose to $464 million, a 64% increase year over year, and adjusted EBITDA grew to $81 million, a 97% increase. Gross payment volume, the total dollar amount of purchases facilitated by Square sellers, increased 28% to $23 billion.
|Square Metrics||2018 Q4||2017 Q4||Change|
|Adjusted revenue||$464 million||$283 million||64%|
|Adjusted EBITDA||$81 million||$41 million||97%|
|Gross payment volume||$23 billion||$17.9 billion||28%|
|Subscription and services-based revenue||$194 million||$79 million||144%|
And reading through the company's quarterly shareholder letter and conference call transcript revealed another important fact: Square is not done launching innovative products and services to ease the pain points of small businesses.
This quarter, Square introduced three new products for its sellers. The first, the Square Card, is a business debit card that gives merchants instant access to the money they have earned through their sales. It also helps sellers separate their business and personal expenses. When used at another Square point of sale, the cardholder receives 2.75% cash back and the seller is not charged the typical 2.75% debit card fee. Approximately 40% of Square Card holders did not previously have a business debit card.
The second product Square released is the In-App Payments SDK (or software development kit), which allows sellers to use Square to facilitate payments on mobile apps. While Square trailed other payment processing companies in releasing this type of feature, it now gives Square the ability to process payments in-person at the point of sale, online, or in-app.
And the third product launched recently is a mobile app for Square Payroll, its full-service payroll solution. With the mobile app, employers can handle overtime payments and payroll taxes. According to the shareholder letter, employees can use the app to "view their pay stubs, clock in and out of shifts, and manage their preferences, such as whether they'd like to be paid via Cash App." This feature has proven to be an especially valuable customer acquisition tool, as one-third of new Square Payroll businesses were new to Square in 2018.
A robust ecosystem
These types of services are accounted for in Square's subscription and services-based revenue segment. In Q4, this segment's revenue rose to $194 million, a 144% increase year over year! Even backing out the acquisitions of Weebly and Zesty, the segment's growth reached triple digits, rising 112% over last year. These services are high-margin growth drivers for Square's business, and perhaps even more important, they are helping Square develop a robust ecosystem.
In the conference call, founder and CEO Jack Dorsey explained why some sellers had briefly left Square's platform to explore payment processing services that were more aggressively priced, but quickly came back:
I believe the ecosystem is extremely sticky because it builds durable relationships. If we're just offering and we're just focused on providing payments in the Register, certainly there are so many other competitors out there. But when people come in for payments in the Register and then they use Payroll or they're a restaurant and they use Caviar or these are marketing and really getting offers from Square Capital, it's really hard to find that mix anywhere else, and that builds durability. ...[With] a lot of our single-focus competitors, a customer can fire them and it fires the entire company, whereas they may fire one part of our ecosystem but still use three other things [of ours]. So we think that adds a ton of resiliency, a ton of durability of the relationship. [emphasis added]
Square's core differentiator
Dorsey went on to call Square's growing ecosystem the company's "core differentiator," and he's right. As young entrepreneurs and new businesses start with Square, they will grow and add employees using Square for business loans, payroll needs, industry-specific point-of-sale solutions, scheduling solutions, and the like. These merchants' DNA will be imprinted across Square's ecosystem, making it almost impossible for them to leave.
This is why one of the most recognized economic moats is high switching cost. Even if a merchant or seller sees a better or cheaper payment processing provider than Square, they will be unlikely to switch, simply because doing so would be too onerous and disruptive to their day-to-day business operations.
The best part is that as these small businesses grow, Square will grow with them. The next large restaurant chain or beauty salon franchise could be a Square seller starting out right now. Square's valuation is still incredibly steep, with a forward price-to-sales ratio of 14.2. But I'm not selling my shares and am even considering adding more. Square is growing rapidly -- and, as evidenced by its sticky ecosystem, its existing customers are not going to be easily displaced.