One of investors' biggest fears is putting their hard-earned money into a corporation, only to discover that said company was, in fact, a giant scam. And if we are to believe a recent short-seller report, that is more or less the situation Block's (SQ 0.13%) shareholders find themselves in.
The report, published by the investment firm Hindenburg Research, made a series of damning allegations about Block's peer-to-peer (P2P) payment app, Cash App, which is an integral part of the fintech's business.
Block's shares dropped about 20% after the report's release. So obviously, many investors were spooked. Could this represent a good opportunity to scoop up Block's shares on the dip?
NYSE: SQ
Key Data Points
Looking closer at Hindenburg Research's allegations
Hindenburg Research's report is long, detailed, and comprehensive. The investigation that led to it lasted for two years and allegedly involved a number of people who have firsthand knowledge of the matter, such as former employees.
Of course, none of that means Hindenburg Research is correct, but these details are important to consider. What exactly is the investment investigative company claiming?
First, it asserts that Block is inflating Cash App's transacting actives, essentially a number that tells us how many active users are on the platform. Hindenburg Research argues that many accounts on the P2P payment app are duplicates or belong to criminals. That brings us to another important claim: According to Hindenburg Research, Cash App has become one of the payment methods most favored by criminals, helping facilitate murder, sex trafficking, and other crimes.
One former employee reportedly stated that "every criminal has a Square Cash App account" (Block was formerly known as Square). Further, Block has allegedly sought to avoid the typical regulatory oversight in the financial services industry, or so the claim goes.
The report makes a series of other accusations, including that Cash App is engaged in gouging users through excessive fees.
Clearly, if all (or even some) of this is true, Cash App should be immediately and thoroughly scrutinized by regulators and lawmakers. But not so fast.
There are a hundred sides to each story
Short-sellers profit when the shares of the companies they target decline. The financial incentive here doesn't mean their claims shouldn't be taken seriously, but even beyond the basic principle of "innocent until proven guilty," it's essential to take Hindenburg Research's report with a degree of skepticism precisely because of the incentives involved.
Block has responded to these allegations, but much to the dismay of Wall Street, the company was not very forthcoming with details. Block called the report inaccurate and an attempt to confuse investors, while also mentioning the regulatory and internal controls that ensure its disclosures' accuracy. The company also said it plans to pursue legal options against Hindenburg Research.
The fintech didn't say a lot more than that, perhaps in an attempt to avoid giving more attention to this issue than it deserves.
Don't be too quick to make a move
Putting aside Hindenburg Research's allegations and looking strictly at the financial results (assuming we can trust the company's quarterly reports), the argument in favor of investing in Block seems fairly straightforward. Last year, Block's gross profit was $5.99 billion, an increase of 36% from a year earlier.
Cash App's gross profit of $2.95 billion rose by 43% year over year; it increased faster than Block's Square ecosystem's gross profit of $3 billion, which jumped by 30% from 2021. Cash App is a central part of Block's business, and it will remain so. It ended 2022 with 51 million transacting actives, 16% higher than the year-earlier period. This number has grown at a good pace over the years.
The more it increases, the more money will flow to Block's Cash App ecosystem. The fintech giant has added new features over time to make it more attractive. The introduction of buy-now-pay-later (BNPL) capabilities broadens the app's appeal. Block's Square ecosystem looks promising too, with a combined $190 billion in gross profit opportunity between the two.
However, not everything about Block looks good. For instance, the company isn't consistently profitable, and its Bitcoin business has weighed on its revenue and gross profit. Despite that, many investors, myself included, believe the upside outweighs the risk over a sufficiently long period. So if Hindenburg Research's report is a nothingburger, now is as good a time as any to initiate a position while Block's shares are down.
That's especially the case since some of Hindenburg Research's claims seem unpersuasive. For instance, I don't doubt that there is some fraud on Cash App or that criminals sometimes use it in the course of their illicit activities. But that is hardly unique to this fintech. And Hindenburg Research provided very little proof that Block has somehow managed to escape lawmakers' scrutiny for years in an industry known to be highly regulated.
It's not impossible, but at the very least, it seems unlikely on the surface. Still, given the nature of these allegations, I am in no hurry to increase my position, even on the off chance that these allegations have some merit. But I am also in no hurry to sell my shares just based on this report alone. In my view, investors should stay put and watch this story unfold.
