Despite warning investors on the bitcoin hype fueled results of Square (SQ), the market continues to pay up for the stock. Another big quarterly beat always helps fuel momentum, but the numbers were again boosted by bitcoin. My investment thesis is very bearish on the stock around $200 similar to my call when Square originally reached $100 back in September 2018 and fell over 65% in the next 18 months.
Image Source: Square website
One Table Matters
The Q3 news headlines tell all the story an investor needs to see. A company just doesn’t randomly beat revenue estimates by 50% unless the revenues are low calorie.
In this case, bitcoin falls into the extreme low calorie category. My warning last quarter occurred when bitcoin revenues were only $875 million. This quarter, related revenues nearly doubled sequentially to $1.6 billion, up ~$1.5 billion from last Q2.
Source: Square Q3’20 presentation
So, anybody paying attention should realize that bitcoin revenue accounted for over 50% of Q3 revenues when the related revenues were less than 10% last Q3. Why this matters is that bitcoin costs were a very similar $1.6 billion. The bitcoin business only generated ~$32 million in gross profit. Anybody looking at gross margins would shun a stock where total gross margins fell to only 26% from 39% last Q2.
Even the core seller GPV business only produced 9% growth. Transaction-based revenues were up approximately the same as payment volumes. Sure, the real excitement was around the Cash App revenues. But here again, these numbers were boosted by bitcoin trading revenues.
When stripping out bitcoin, Q3 revenues were $1.4 billion versus $1.12 billion last year. These net revenues only grew 25%. Even worse, bitcoin trades at multi-year highs. Square could see reported revenues collapse next year with any dip in the cryptocurrency.
Source: Coindesk
Extreme Valuation
Square has 515 million shares outstanding, placing the market valuation at an insane $103 billion. When stripping out the bitcoin trading revenues, the mobile payments company only generated $1.4 billion in quarterly sales and just $910 million in the adjusted revenue metric used prior to the SEC guidance requirement.
Outside of these revenue numbers not jiving due to bitcoin, the bottom line financial metrics tell a much different story than the inflated revenue metrics. For Q3, Square only generated a meager $37 million net income.
Source: Square Q3’20 presentation
The market will likely start focusing on the adjusted EBITDA metric to value Square. For Q3, the metric jumped to $181 million, up 38% from the $131 million level last Q2.
Yes, the number was impressive considering some of the pressure on the Seller ecosystem. At the same time, the Cash App appeared to benefit from the economic shutdowns as consumers moved more to online money transfers. The big question exists on where product demand will exist in a more normal economy and the market is already paying up for the stock.
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