Block (SQ 0.22%) was a market darling for many years. The financial technology (fintech) upstart benefited greatly during the COVID-19 pandemic as consumers and businesses switched from physical to digital payments. Investors loved the stock so much that -- even when the company announced a risky $29 billion acquisition for buy now, pay later (BNPL) provider Afterpay -- the stock shot up 10% to all-time highs. Shares of acquirers almost always fall they announce a huge acquisition, because they can dilute existing shareholder, burden the buyer with debt, and the deals don't often work out as planned.
That acquisition was in the summer of 2021. Today, the bull market mania has deflated, and so has Block's share price. With no signs of profitability, uncertain cryptocurrency and lending initiatives, and a damning investment report exposing some potential holes in the business, investors have gotten increasingly bearish on Block. The shares are down about 85% from all-time highs to about $44, which is where the stock traded during the March 2020 lows. The last two years have been brutal for any investor in this fintech disruptor.
Is there any hope left for Block shareholders? Or should investors cut their losses and try their luck elsewhere? Let's take a closer look and find out.
Bad acquisitions and no profit
The problems with Block mainly stem from undisciplined acquisitions. In 2021 it made the $29 billion all-stock purchase of Afterpay, a BNPL provider that was supposedly going to be integrated into Block's Square and Cash App payments ecosystems. So far, Afterpay hasn't done much to warrant its purchase price and has added a lot of credit risk to Block's balance sheet. It was supposed to be a huge benefit for the consumer-facing Cash App, which has tens of millions of customers who could use a BNPL service. Well, last quarter BNPL only yielded $118 million in revenue for Cash App.
Uncollectible consumer loans are also an increasing concern. In the first half of 2023, Block posted $308 million in consumer receivable losses, up from just $69 million two years ago. A lot of these loan losses are coming from its Afterpay subsidiary. Loan losses amounted to close to 10% of Block's consolidated gross profit in the period and will be a headwind to profitability.
There have been other problematic acquisitions as well. For example, Block acquired music streaming service TIDAL for $300 million back in March 2021 for reasons that were never made clear. It is hard to see what a fintech company could do with a music streaming service, and so far the subsidiary has been a drag on its financial performance. It only generated an estimated $10 million in gross profit last quarter and is likely losing a lot of money given its high overhead costs.
Speaking of which, Block has struggled to generate a profit in recent quarters as its post-pandemic growth slows. Since the start of 2022, Block's quarterly net losses have generally deepened, which is tough news for a company that has already gotten so big. During the past 12 months, the company has generated just under $7 billion in gross profit. Can it really not generate any net profit for shareholders?
Data source: YCharts
Cryptocurrency preaching was a warning sign
Some investors may ask if there were any signs that Block was taking too many risks. Could we have predicted these dire results? I think the answer is clearly yes. There were signs, if only investors looked.
The starkest example is the company's foray into cryptocurrencies. Founder and Chief Executive Officer Jack Dorsey loves cryptocurrencies and has started multiple crypto initiatives under Block. It is one of the reasons the company changed its name from Square to Block (Block referring to the blockchain). He even had the company buy a bunch of Bitcoin and put it on the company's balance sheet. Regardless of your views on crypto, these are objectively risky moves that should have made investors nervous.
We can also see now that Block traded at an absurd valuation back in 2021, even in the most generous terms. Even before the Afterpay acquisition closed (which increased the number of shares outstanding), Block had a market cap of $120 billion during the summer of 2021. At the time, it generated gross profit of around $3 billion, meaning the stock traded at around 40 times its gross profit then and 17.6 times its trailing-12-month gross profit today. Typically, stocks trade at well under 10 times trailing gross profit, and those are companies that actually generate positive net income.
Price matters. Block's huge decline should be a painful lesson for any investors who still need to learn this.
NYSE: SQ
Key Data Points
Can you trust this management team?
Although the valuation was absurd in 2021, today you could argue Block shares may be cheap from a gross profit perspective. With a current market cap of $27 billion, the stock trades at just 3.9 times trailing gross profit. Gross profit is also growing quickly, up 27% year over year last quarter. If the company ever generates positive earnings, the stock could be cheap at these levels.
But I still don't think you can have faith in this management team. Earlier this year, short seller Hindenburg Research released a damning report alleging that fraud, crime, and drug deals we being facilitated through Cash App with little oversight from Block. It also alleges that management artificially inflated the number of active users on Cash App, which is an important metric that investors follow.
If this short report is even remotely right, Block may be in big trouble. With ill-conceived acquisitions in BNPL, music streaming, and cryptocurrencies to add on top of this short report, there's no reason you should trust this management team. It is probably best to sell your shares and go for some safer, more profitable financial stocks for your portfolio.
