Should you buy, hold or sell Block shares?
Block Inc (ASX:SQ2) is a financial technology company that has created two large, independently successful businesses - Square and Cash App.
The company commenced its life as Square Seller (Square) in 2009 following co-founder Jim McKelvey's experience losing a product sale because his previous small business was not able to accept credit card payments.
Attempting to resolve his card acceptance problem, he uncovered an indecipherable US payments ecosystem that was generally too expensive for small businesses.
Square is founded
Together with McKelvey's business partner, Jack Dorsey, they set about building a solution.
They devised the now famous small, white square-shaped card reader that plugged into the audio jack of smartphones to allow small merchants to take card payments without a traditional expensive point of sales card reader.
Scaling Square from inception to a US$150 billion volume payments business was only part of Block's success story.
The success of Cash App
The company then followed up this success by launching consumer fintech Cash App - developed in 2013 at an internal company hackathon as a way for consumers to make electronic peer-to-peer payments.
Today, Cash App has over 50 million monthly users in the US. It is dual-listed in the US and in Australia, the local listing following Square's acquisition of Afterpay.
Block has multiple growth drivers which we believe will support mid-teens gross profit growth mid-term.
The Square division is expanding up-market in the US with 4% mid-market penetration today and is progressively rolling out its payment solutions globally - now in five international markets.
Meanwhile, Cash App is monetising its 50-plus million US consumer base by rolling out additional financial services - such as lending, savings and expanding payments functionality - that increasingly positions it as a primary bank account and builds consumer share-of-wallet.
The rise of Cash App Commerce
Finally, a unique opportunity exists to unlock customer value (and new revenue streams for Block) by connecting Block's merchants (Square and Afterpay) to Cash App consumers directly, via an initiative called Cash App Commerce.
The Commerce interface has the potential to move Cash App toward becoming a marketplace - one where its consumers would start their shopping journey within the app, transacting with merchants exclusive to Block's ecosystem, earning it attractive channel fees for payment facilitation.
The key to execution, however, will be the success of the strategy Block uses to drive consumer demand via its new interface. While we believe Block has tools to compel consumer demand - Boost Rewards and financial tools such as credit and BNPL - the hook will need to be compelling to attract consumer spend.
If successful, Commerce could create a new flywheel for both Square and Cash App ecosystems, whereby increasing consumer spend increases incentives for merchants to participate in the network, which in turn leads to more merchant offerings and greater personalisation for consumers.
Our investment thesis continues to look-through the shorter-term gyrations attributable to changing US consumer spend which has recently been a drag on Square's US payment volume growth causing investor sentiment volatility - resulting in share price variance from a high of $120 earlier this year to a recent $60 low in October.
We believe the current valuation at around 4x gross profit is compelling, pending its ability to execute on the strategic drivers outlined above.
We spend a lot of time researching exceptional businesses, looking for rare combinations of competitive advantages that create conditions where strong profitability can be protected and compounded over time.
Block is a high quality business trading at an undemanding valuation, that despite exceptional historical growth to date, has the opportunity to converge its networks to create a multi-layered financial hub connecting commerce (merchants) and money (consumers). Our recommendation is to buy.
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