Square complements Wi-Fi offerings

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Over the weekend, digital payment company Square Inc. (SQ, Financial) announced a $ 29 billion deal to acquire Australian company Afterpay Ltd (ASX: APT, Financial), an installment loan company, as the “buy now, pay later” trend really begins to take off.

This trend doesn’t seem likely to be going anywhere anytime soon. A “buy now, pay later” plan allows customers to purchase items they cannot afford up front, but unlike high interest credit cards, these installment loans allow customers to pay off. their purchases in a set number of interest-free payments. .

Traditionally, installment loans were only used for big ticket items, but now they are becoming available for items that cost $ 100 or even less as more and more customers look for alternatives to the credit system. Afterpay loans make money through a combination of trading fees (to help increase sales) and late fees (for customers who miss their loan payments), and although many other services from Installment loan charge interest, which is usually lower than the rates charged by credit cards. load.

Given that the “buy now, pay later” trend is likely to persist over the long term, it appears Square is making a cautious acquisition by buying Afterpay. However, many other financial companies are now rushing into this market, including PayPal (PYPL, Financial), Mastercard (MY, Financial), JPMorgan (JPM, financial) and even Apple (AAPL, Financial). Is this acquisition a growth opportunity for Square, or is it simply a necessary step in order not to be overwhelmed by competing services?

The terms of the agreement

Square plans to buy Afterpay in an all-stock transaction that values ​​the company at $ 29 billion, which is a 30% premium over its closing price on Friday. Since the announcement, Afterpay stock has gained over 18% to trade around AU $ 114.80 ($ 84.55).

“Square and Afterpay have a common goal,” Square CEO Jack Dorsey said in a statement regarding the deal. “We have built our business to make the financial system more fair, accessible and inclusive, and Afterpay has built a brand of trust aligned with these principles.”

The transaction is expected to close in the first quarter of calendar year 2022, subject to shareholder approval. Square also warned that the deal could potentially raise regulatory concerns, which could delay the process.

A necessary move

Amidst all the other companies trying to get into the installment loan market, it may seem like Square is just catching up with its competition. After all, if Square’s installment loan offerings weren’t as appealing as others, the company could see merchants and customers shifting to other platforms.

However, given that there is a high demand among Square’s own customers for installment loan offers, on both the buyer’s and the seller’s side, I don’t think this can be considered a catch-up. This is because if a business fails to develop its offerings in the way that customers want, it can often lead to lost opportunities.

Square also already has an installment loan program, although it is not as appealing to customers as Afterpay’s. Square’s own offering allows customers to pay eligible invoices from Square sellers in fixed monthly payments over three, six, or 12 months at an APR of 9.99%. Meanwhile, Afterpay allows customers to pay in four interest-free installments, although they have to pay a fee if they miss a payment.

According to Square’s press release about the deal:

“The acquisition aims to enable businesses to better offer attractive financial products and services that expand access to more consumers and generate additional income for merchants of all sizes. “

In other words, the Afterpay model can generate profits for merchants while reducing costs for buyers, which should lead to an overall increase in transaction volume. This is very much in line with Square’s motto of accessibility.

Additionally, unlike banks and credit cards that offer similar installment loan services, Square offers both its popular merchant / seller services and its Cash App ecosystem, with which it plans to fully integrate Afterpay. This gives Square the opportunity to strengthen merchant-customer relationships by acting as an intermediary for both parties.

Square CFO Amrita Ahuja, who sees the acquisition as an opportunity to create a “more powerful e-commerce platform,” said the following:

“We see a real opportunity to empower the next-generation consumer who is looking for different ways and, in this experience, an uninspiring way to expand purchasing potential. What it ends up doing is that merchants pay for the Afterpay experience, but they get higher average order volumes, they get higher conversion, they get higher frequency and lower returns, and they get higher average order volumes. get an Afterpay marketing channel … which ultimately helps these marketers grow there is business and that’s what Square is all about.

While the acquisition of Afterpay has great potential to spur Square’s growth, it is far from an attempt to catch up. These two companies have similar growth strategies, so they will likely be more profitable together.

Evaluation

Investors who wish to profit from the growth of the digital payment processing industry through Square are currently being asked to pay a premium price based on the stock’s current price-to-earnings ratio of 389. As of August 8, Square’s shares were trading around AU $ 273.36. for a market capitalization of 124.52 billion Australian dollars.

Despite the high earnings multiple, the GuruFocus Value chart rates Square as being fair valued based on its historical returns, historical earnings ratios, and analysts’ estimates of future earnings:

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The gurus also seem interested in the stock. According to data from GuruFocus, the gurus buying volume has exceeded the gurus selling volume for Square in the last few quarters:

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The most notable shareholder guru is

Catherine Wood (Trades, Portfolio) with 2.41% of shares outstanding, followed by

Frank sands (Trades, Portfolio) with 1.74% and

Philippe Laffont (Shops, Portfolio) with 0.85%.

Square certainly falls more in the category of growth stocks than value stocks, but when we factor in the growth estimates for the digital payments industry, especially for small merchants who typically use Square, the stock could. still be undervalued in relation to its growth. potential.

Indeed, in its recent fiscal second quarter 2021 earnings report, Square reported a 91% increase in gross profits, a 94% increase in Cash App profits, and an 85% increase in seller profits. Net revenue increased 87% year-on-year to $ 1.96 billion.

As for bitcoin, as the company’s second quarter bitcoin revenue increased 200%, it also suffered a $ 45 million loss in value. In all likelihood, bitcoin will be a source of continued volatility in the future, which investors should be wary of.

On the flip side, the company’s growth story is solid and its acquisition of Afterpay also promises to deliver growth as it fits well with Square’s business strategy and existing offerings. While Afterpay is not currently profitable, it could become so if it becomes more mainstream, and its acquisition by Square will help. Overall, this promises to be a high risk, high reward opportunity.


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