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Why 2020 Is Likely to Be a Year of Big Growth for Square

By Daniel Sparks – Dec 3, 2019 at 10:11AM

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Could growth for this fintech company accelerate next year?

Shares of merchant solutions company Square (SQ 3.01%) have had a tough year. The stock is down 4% over the past 12 months. While Square has lifted its outlook for full-year revenue several times, its guidance for adjusted earnings before interest taxes, depreciation, and amortization (EBITDA) has remained the same. This unchanged outlook for EBITDA despite a more bullish view for revenue represents the company's stance on investing aggressively in growth opportunities -- a move that has some investors uneasy.

But a closer look at Square's business and its opportunities shows why it makes sense for management to be stepping up its investments. The company has some powerful tailwinds at its back. In addition, Square's opportunities for further growth are compelling.

A customer uses a chip reader built into Square Register

Square Register. Image source: Square.

Two important catalysts

A glance at Square's recent financials doesn't fully appreciate the company's momentum. Sure, 40% year-over-year growth in adjusted revenue in Q3 and an 185% increase in adjusted EBITDA over the same time frame is impressive. But there's more to like beneath the surface -- namely, Square's growing traction with larger sellers and its rapidly growing subscription and services segment capture two key catalysts that are seeing outsize growth and are becoming a larger portion of Square's business.

For instance, consider that while Square's gross payment volume (GPV) increased 25% year over year in Q3, its GPV from mid-market sellers, or sellers with $500,000 or more in annualized GPV, jumped 44% year over year and represented 27% of GPV.

Meanwhile, Square's subscription and services-based revenue was $280 million in Q3, up 68% year over year. Further highlighting the growing importance of this segment, subscription and services-based gross profit was $216 million, up 82% year over year.

These catalysts are likely to have a larger impact on Square's total results in 2020 as their contribution to the fintech company's overall results continues to increase.

Square's investment opportunities

Square's strategic investments could help drive more strong growth for the company. In Square's third-quarter earnings call, CFO Amrita Ahuja detailed three ways Square plans to invest in "tremendous, attractive opportunities."

First, Square wants to use marketing to "improve our awareness of the broader product set beyond just payments." She noted that even though 80% of its addressable merchants who are not already Square sellers are aware of Square, only 9% of them know about the products Square offers.

To further expand awareness and increase the size of the company's funnel of new merchants, the company plans to invest in sales, where it sees the same impressive three- to four-quarter payback period it is seeing with marketing.

Finally, Ahuja said there's an opportunity to drive meaningful growth in weekly unit sales of some of its point-of-sale hardware by lowering prices. "[W]e see that when we flex pricing on compelling products like terminal and register, we're able to attract more sellers," Ahuja said.

Management summed up the company's reasoning for making opportunistic investments in its third-quarter shareholder letter:

Our Seller ecosystem has achieved strong profitability with an expected Adjusted EBITDA margin of nearly 30% for full year 2019. Given this profitability and our 3- to 4- quarter payback period, we are increasing our investment in go-to-market initiatives to drive continued growth.

Combining the company's strong growth from mid-market sellers and its subscription and services-based segment with these strategic investments could lead to not just robust growth in 2020 -- but maybe even accelerated growth.

This growth stock's underwhelming past 12 months may be a good buying opportunity for investors willing to hold for the long haul.

Daniel Sparks has no position in any of the stocks mentioned. The Motley Fool owns shares of and recommends Square and recommends the following options: short January 2020 $70 puts on Square. The Motley Fool has a disclosure policy.

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