Cowen's Damning Analysis of Square's IPO

George Mihalos from Cowen published a damning note examining Square's recently filed S1 and comparing the company to industry metrics. It was written with his universe in mind (GPN, VNTV, HPY) but it paints a negative picture of the outlook for this company with incredibly well received products.

In 2014 Square processed 446M transactions, with the average ticket size of ~$53 based on its $23.78B of GPV. On average, Square generates a take-rate of over 100 bps on every dollar of payment volume based on the company’s definition of adjusted revenue. There is little industry concentration with 5 industries accounting for 68% of sales. Health and Beauty, Contractor/Repair/Leisure, Food, Services and Retail.

Square does not generate profit on many small ticket transactions, as its transaction costs are higher than revenue generated. On a regulated visa debit card, costs on a small ticket debit transaction is 0.05% + $0.21. Therefore Square pays out more in interchange fees than it receives in transaction revenue for ticket items of $7.75 and under. On a Visa credit card, this threshold is $4.

Despite its rapid growth and expansion into larger vendors, roughly 65% of Square’s GPV stems from merchants with less than $125,000 of annual processing volume, with a substantial percentage likely well below the top-end of the range. The closest competitors: HPY, VNTV and GPN’s integrated-payments and ISO channels is well above the $125,000 threshold.

Software & Data, a key part of the Square value proposition to merchants accounts for just 10% of 1H15 adjusted revenue. This includes revenue from Square Capital – where Square extends cash advances to customers

Square may be marketed as more than a payment processor but the financials tell a different story. Software & Data, a key part of the Square value proposition to merchants accounts for just 10% of 1H15 adjusted revenue. This includes revenue from Square Capital – where Square extends cash advances to customers – and has little to do with leveraging analytics. While acquirers remain focused on differentiation through value-added services, revenue contribution from loyalty and analytics products remains sparse.

The Starbucks processing agreement – which the company expects will migrate to another processor – lost roughly $15M over 1H15. However, excluding SBUX losses, 1H15 adj. EBITDA was still ($19M) which includes a generous add-back of $29M in stock-based comp (+100% y-o-y). Square signed an agreement in 3Q12 to process credit and debit card transactions for Starbucks. The company expects SBUX to transition to another payment processor and will stop utilizing Square’s payment processing services prior to the agreement expiration of 3Q16.

Despite all the negative points in the summary, Cowen included a chart that shows he GPV by seller size. This chart shows a distinct trend to larger vendors. In 2011, the 92% came from vendors with less than 125k of payment volume. However by 2Q15, only 63% was from these small vendors. That said, with Starbucks disappearing over the next year, we don’t know how these metrics will change.

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