Image source: Square.
After much speculation, payments start-up Square seems finally ready to go public. The company, led by Twitter's (TWTR +0.00%) Jack Dorsey, has now filed its S-1 Registration Statement with the SEC, baring its books to the public for the first time. This S-1 will inevitably be amended multiple times on the way to the IPO, and Square can also withdraw it altogether if it chooses. Square is looking to raise upwards of $275 million through the offering.
Over the past few years, Square has helped revolutionize and shape mobile payments, leading public investors to look on anxiously as they waited for their chance to buy a piece of the company. Has this hype been warranted by Square's financial results?
Back to basics
For starters, Square has generated a hair over $1 billion in total revenue over the past four quarters. The vast majority of this has been through its core transaction segment. That all translated into $294 million in gross profit, for a 28% gross margin. Like most start-ups, Square is incurring a large amount of operating expenses, mostly related to product development that should ideally support future growth. Operating losses over the past four quarters has been about $145 million, and net losses have been $152 million.
As far as key operating metrics are concerned, gross payments volume (GPV) is likely the most important. The good news is that GPV has put up healthy growth over the years, jumping from $6.5 billion in 2012 to $23.8 billion in 2014. Square's largest categories of sellers are retail and services, which comprise a combined 38% of GPV. Square attributes its GPV growth to new sellers coming to the platform, and there are currently about 2 million active sellers that contribute 97% of GPV. More granular details about the seller base over time would be useful.
Square may also need to invest more heavily in loss prevention. In the first quarter, Square lost $5.7 million to a single seller engaging in fraudulent activities.
In terms of valuation, no pricing information has been released, but Square did raise $150 million in new funding a year ago at a $6 billion valuation. Using those figures (which have likely changed by now) implies a price-to-sales ratio of six. Even if you add $1 billion to $2 billion to the valuation, Square doesn't look particularly expensive, especially compared to Twitter's P/S of 11.2
Jack is the boss
Following the IPO, Jack Dorsey should still retain the overwhelming power at Square. He owns 71.1 million shares, or 24% of outstanding shares, right now. The next largest shareholder is early backer Khosla Ventures, with 17% ownership. Thanks to his reputation following Twitter's success, Dorsey was able to negotiate very favorable ownership terms with his early venture capitalist backers, allowing him to retain a greater amount of ownership compared to a less established entrepreneur.
Furthermore, Square will be utilizing a dual-class structure, which isn't exactly uncommon these days where company founders wish to retain control. All current shares are Class B shares held by insiders, while public investors will be purchasing the Class A variety. Class B is very much a super-voting class, getting 10 votes per share while Class A shares receive 1 vote per share.
Since Square is still in the preliminary stages, it's not clear yet how much specific voting power Dorsey and insiders will retain -- but rest assured it will be a lot.
Starbucks hurt
Back in 2012, Square partnered with Starbucks (SBUX 4.83%) where the coffee chain would accept mobile payments via Square and Square would be Starbucks' primary payment processor. At the time, Starbucks invested $25 million in Square and Starbucks founder and CEO Howard Schultz joined Square's board of directors (he stepped down from Square's board in 2013). It sounded like an innovative solution initially: Customers would walk in to a Starbucks and be able to pay by simply giving their name. This was done by using a phone's GPS data combined with the Square Wallet app (which was pulled last year).
The partnership proved disastrous for Square, leading to a string of losses related to the deal. Over the past seven quarters, Square has suffered over $48 million in losses from the Starbucks partnership. This relationship has been falling apart for quite some time now, and will officially end in the third quarter of 2016 as Starbucks transitions to a new payment processor.
Starbucks has been so painful that Square is backing out all related results when calculating its adjusted EBITDA (non-GAAP).
Square is moving upmarket with sellers
Square has long appealed to small and local businesses, thanks to how incredibly easy it is to set up a payment service for a small business. All you really need is a smartphone or tablet. If you've ever been to a festival or bazaar with small merchants, you've undoubtedly encountered Square. But Square's mix of sellers is quickly changing, and the company is now processing payments for larger sellers.
For instance, four years ago, sellers that processed less than $125,000 annually in GPV comprised an overwhelming 92% of Square's GPV mix, with just 7% of sellers processing $125,000 to $500,000. Nowadays, the less than $125,000 sellers are "just" 63% of the GPV mix, while $125,000 to $500,000 sellers are 26% of GPV, and those that process over $500,000 per year are 11%.
Larger sellers are more likely to have sustainable businesses, so this is an overall positive for Square. Perhaps more importantly, larger sellers are also more likely to purchase other software and data products from Square, which is a very high margin business. Software and data product gross margin has been 67% over the past year, compared to 36% for the transactions business.
