Now That Square Is Buying Afterpay, Is It Becoming a Super App?

Square (SQ -1.57%) buys Afterpay (APT), the Australian payments company, for $29 billion in stock. Foot Locker (FL 2.83%) buys two smaller athletic apparel retailers (WSS and Atmos) for a combined $1.1 billion. In this episode of MarketFoolery, Jason Moser analyzes both acquisitions, as well as Square's second quarter results.

To catch full episodes of all The Motley Fool's free podcasts, check out our podcast center. To get started investing, check out our quick-start guide to investing in stocks. A full transcript follows the video.

This video was recorded on August 2, 2021.

Chris Hill: It's Monday, August 2nd. Welcome to MarketFoolery. I'm Chris Hill and with me today, Mr. Jason Moser. Good to see you.

Jason Moser: Good to see you. How's everything? 

Hill: Things are hopping. It's Merger Monday, really, it's Acquisition Monday. We have one in the retail industry, but we're going to start with the story of the day, and that is Square buying Afterpay, the Australian payments company, for $29 billion. This is an all stock deal that Wall Street appears to love because shares of Square are up 11%. Is that at all surprising to you, that it's up 11%?

Moser: A little bit, but I think it's also worth remembering too that with this release, they also released their quarterly results. I think maybe that is part of where the enthusiasm is coming from, because it was a very good quarter and we'll talk about that in a few minutes. But let's talk about the Square deal here with Afterpay because that, I think, is the bigger headline. I think the skeptic can look at this deal and say, well, Square is overpaying for something that's basically a feature. The glass half full investor might look at this and say, well, sometimes it's easier to buy it than to build it. We see that happen all the time and in this case, they are buying a leader in the space that's lobbying up some very impressive growth numbers and they are keying in on something that people clearly want. I fall in the middle there. I think this deal actually makes sense. I think they're paying through the nose for it, but I think there's a reason why they're paying through the nose for it. It's because they don't have time to sit back and try to develop something on their own at this point, I would imagine, because "buy now, pay later" has turned into such a popular space. There's all sorts of demand there from all sorts of different merchant partners. We saw PayPal recently build up this buy now pay later feature in their app. That's 400 million some-odd users. That's far bigger than where Cash App stands right now. 

For me, part of this was Times Square feels like they cannot let any more time go by without having a major presence in the space. This purchase gets them that presence immediately with a well-established business that knows what they're doing. $29 billion, is that they're paying basically around 60 times gross profit for Afterpay. The flip-side, it's a great time for them to use their stock as a currency given where the share price is. I think that's worth keeping in mind, but it is going to be something that dilutes that share count close to 25%. This is a big acquisition that they're going to need to make work.

Hill: Is the "buy now, pay later" space now at the level where every big financial company needs to be able to tell their Board of Directors, tell their shareholder base, tell themselves, what their plan is? Because I can see some businesses saying, no, we're not going into this.

Moser: I think that if you're a fintech, if you're already in financial services, I think you need to be looking at what kind of options you might provide here because I think the numbers show clearly there is demand for this. Now, there's a right way to do it and a wrong way to do it. It is a risky proposition if you get in there and you don't know what you're doing because it's like, you're having to underwrite lending just through a little bit of a different lens. There's going to be people on the hook for paying you back, and if you're not charging interest, if you're not charging late fees, if you're taking people at their word. 

There are some consequences that come with that, but I think that's why we're seeing everyone from PayPal to MasterCard and Visa, we're seeing Apple doing it with Goldman Sachs. It only makes sense to see Square do this. The interesting part of that is that because Square is so heavily tilted toward physical retail stores actually using that hardware and software, I think this is going to be a real opportunity to get out there for the smallest of small businesses to be able to offer this key feature. It is absolutely a way to stoke engagement, i.e. purchases. But there is a right way and a wrong way to do it, and I think with Square, again, sometimes buying it is the better way to go and at least they know in buying Afterpay, they're getting a reputable player in the space. They know what they're doing, and I think that can't be discounted.

Hill: Long time listeners will know that every once in a great while, we'll have Scott Philips, our colleague from Motley Fool Australia, the host of the Australian version of Motley Fool Money on this podcast. Go back to mid November 2019, he was visiting us in Alexandria. He was on MarketFoolery, I asked him for a couple of stocks in Australia that Americans should know about and he talked about Afterpay. I'll just point out that in mid-November of 2019, shares of Afterpay were in the low $30s. Today, it's somewhere in the neighborhood of $115 a share. Let's get to the quarter, because Square was going to report on Wednesday and they moved that up because of this deal. Gross profits in the second quarter, 91% higher than a year ago. Yeah, I could see some enthusiasm for the stock.

Moser: It's worth remembering, of course, this is a bit of a rebound quarter because at this time last year, clearly the retail environment, particularly the physical retail environment, was a much different one. That explains some of these numbers. But to your point, total net revenue, $4.68 billion, was up 143% from a year ago. You exclude Bitcoin from that, it's still up 87% from a year ago. Cash App, again, just really delivering tremendous numbers. Cash App generated better than $3.3 billion in revenue, better than $540 million of gross profit. That was up 177% and 94% respectively. Oftentimes we've seen that growth in that 25%, 30% range maybe. Gross payment volume, $42.8 billion. That was up 88% from a year ago. Again, rebound quarter, that number is to be expected, but those are still really impressive numbers. Frankly, I think you have a very well-established company here with an app in Cash App. They are building out the functionality, and I'd tell you what this really feels like it's shaping up to be is the battle of the super apps because we've heard with PayPal. 

We heard it last week in their earnings call, this concept of a super app where you can go get everything in your financial life done within that one PayPal universe. Square is coming up with that same capability. They're a little bit behind, but they're still investing at a very rapid clip and they're pulling it off. They're getting more users in. It was interesting to note that in regard to Cash App, and this really is just such an important part of the business for a lot of reasons, inflows per monthly transacting active customer nearly doubled compared to two years ago. We would expect that number to be significant based on just a year-ago, but nearly doubled from two years ago. Ultimately, the reason why that matters is the growth in those inflows, that's the primary driver of the Cash App gross profit growth. They want to see more and more of those deposits coming in. Is it fair to assume that maybe we see a low in those inflows as stimulus starts to wear off? Yeah, perhaps. But still once you get them in there, if you can hit them with all different capabilities and services and features, that's really the idea at the end of the day, is to get them in and keep them in. If you can look at that inflows metric, it's a bit more of a long-term concept. There's something you want to just focus on over the longer haul. I think that's going to ebb and flow, but really it's about getting those users in there and keeping them. It seems like Square is doing a good job of that.

Hill: Before we move on, can I tell you what I hate about all of this?

Moser: Yes.

Hill: By all of this, I mean, Square buying Afterpay and Square moving up their earnings announcement.

Moser: That's sad.

Hill: I was going to buy Square this morning. I bought a bunch of stocks today, Square was on the list, and last night the news broke. I apologize to the Square shareholders including you, but I thought to myself, well, hopefully the stock drops 10% on thisprice deck and I can buy it later at a cheaper price. But I was going to buy it this morning.

Moser: It's funny that happens to us sometimes. I think it's always worth remembering for listeners who aren't familiar, we have internal trading guidelines that basically dictate when we can buy and sell. We have to shut up about them. We have to maintain a silent period and then when things are locked down in our universe for potential services, we're not able to transact. We do jump through some hoops. Listen, I expect nothing less than that from you, Chris. You're one of the most stand-up guys I know. To see that you're looking out for the dozens, first and foremost, that really tells us all we need to know, but it's something I already knew, buddy. It's something I already knew.

Hill: I appreciate that. I just hope I get an 11% bump when I finally do buy it. Let's move on to retail. Foot Locker is spending $1.1 billion to buy two smaller athletic apparel retailers. Yes, I did already make the joke in my mind when I saw the story. Foot Locker has $1 billion to spend? But they do. They're buying WSS, which is based in California, they're buying Atmos, which is based in Japan. All kidding aside, these are retailers with locations that are mainly in urban neighborhoods. Foot Locker is trying really hard to get out of malls. I get that the stock is down a little bit, maybe that's due to the price deck, but just from a strategy standpoint, this seems like a smart move.

Moser: I don't disagree with you. I do think this is a smart move. I think Foot Locker is a very interesting business from the perspective of, we talk often about time in the market is far more important than timing the market, Foot Locker is one of those cases where maybe that's not necessarily the case because you look at their financials, then, you don't even know what business you are looking at. I think you'd walk away looking at an income statement from Foot Locker and be, well, it just seems like the business is spending its wheels. It's not really able to grow. It's not making any progress over the last several years, but it does look like recently they've been able to start to pick things up a little bit. That makes sense, of course, with reopening and whatnot. 

But if you look at the last five years for Foot Locker, it's not been a good idea. It's been a bad investment. You've actually lost money in the market and returned better than 100% over that same period of time. If you look at three years, Foot Locker, you've made 18%, the market still beating you up with 57% returns. But then you start looking at the one-year chart, you start looking at the year-to-date chart and you start to see a business. This has been one where maybe it's been a good value investment. Maybe if someone identified that there was a point here where the stock was mispriced based on its potential because over the last year, the stock has almost doubled. It's having a very good year-to-date as well. Maybe this is a deal that helps them continue that. 

To your point, this gives them some additional geographical coverage that they didn't have before. The other thing I look at with any of these businesses in retail, even the legacy brands, is you want to see if they have any digital presence. They have to be able to move beyond that physical mall-based store. Interestingly enough, if you look at the last quarter results for Foot Locker, their digital business is pretty strong. It was up 43% from the previous year and represented about 25% of total sales for the quarter. That was actually higher than those that beat management's expectations. They have a strong app. They have a loyalty program there, the FLX or the FLX app loyalty program they have there. The 20 million members now enrolled where that program is active. They've clearly made some investments in that digital presence. I think bringing some more brands under their umbrella, that certainly gives them a chance to expand their customer base, which is ultimately what they need to focus on doing. Maybe there are some better days ahead for Foot Locker.

Hill: It's great context because this has been a challenging business over the past five, 10 years. Those digital numbers you cited, including the loyalty program, that's higher than I would've guessed. Maybe they can keep this going, but historically, this is one of those stocks when it had a good run over a shorter period of time, that was the time to sell.

Moser: Yeah. It is not the same as something like a Crocs, which is very specific. They've got something unique. Foot Locker isn't really unique from that perspective. If you're a Nike guy or a Nike girl, then maybe you're thinking, I'm going to just buy directly from Nike and they've got that sneakers app, or if you're an Under Armour fan, then maybe you're just buying those shoes directly from Under Armour. I know that a lot of my shopping behavior is direct-to-consumer now in a lot of cases. That's going to be a challenge, I think that Foot Locker is going to have to continue to battle. Everybody needs shoes, so that is a big market opportunity out there. If you could bring more choice under that umbrella, and you have a way to reach out to your customer in that mobile paradigm today, that's going to at least give you a fighting shot.

Hill: Jason Moser, great talking to you. Thanks for being here.

Moser: You've got it. Thank you.

Hill: As always, people on the program may have interest in the stocks they talk about and The Motley Fool and may have formal recommendations for or against, so don't buy or sell stocks based solely on what you hear. That's going to do it for this edition of MarketFoolery. The show was mixed by Dan Boyd. I'm Chris Hill. Thanks for listening. We'll see you tomorrow.